2
INVENTORY
Learning Outcomes
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Introduction
Inventory, or previously known as ‘stock’, relates to the
finished products sold by a retailer.
The term inventory is broad and not only covers finished
products, it covers raw materials, work-in-progress and
finished products.
Due to overwhelming and huge size of inventory, the proper
accounting system to determine the cost of inventory
incurred and how much profits are derived is needed.
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Definition
Inventories are assets:
– held for sale in the ordinary course of business;
– in the process of production for such sale; or
– in the form of materials or supplies to be consumed in the
production process or in the rendering of services.
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Classification of Inventory
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Measurement
Inventories shall be measured at the lower of cost and nett
realizable value (NRV).
Cost of inventories consists of costs of purchase, costs of
conversion and other costs which are included in the cost of
inventories only to the extent that they are incurred in
bringing the inventories to their present location and
condition.
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Measurement (cont.)
Other costs that cannot be included in the cost of inventories
are:
– abnormal amounts of wasted materials, labour or other
production costs
– storage costs unless those costs are necessary in the
production process before a further production stage
– administrative overheads that do not contribute to bringing
inventories to their present location and condition
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Measurement (cont.)
Other costs that cannot be included in the cost of inventories
are:
– selling and marketing costs
– agents’ commissions
– tax cost (other than non-refundable tax), settlement
discounts, and rebates
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Cost Formulas
Three cost formulas allow for the measuring of the cost of
inventory: specific identification; first-in, first-out (FIFO); or
weighted average cost.
• Specific identification applies where each item of the inventory
can be identified separately and individually, provided the cost
of inventories are not ordinarily interchangeable and goods or
services are produced and segregated for specific projects.
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Cost Formulas (cont.)
First-in, first-out (FIFO)—The cost of inventory is calculated on
the assumption that the inventory on hand at the beginning of
the period will be sold first, and the latest inventory received will
be the inventory on hand at the end of the period.
Weighted average cost—The cost of all inventories available for
sale is divided by the number of units of all inventories available
for sale for the period.
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Nett Realizable Value
Inventories shall be measured at the lower of cost and nett
realizable value.
The practice of writing inventories down below cost to nett
realizable value is consistent with the view that assets should
not be carried in excess of amounts expected to be realized
from their sale or use.
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Nett Realizable Value (cont.)
Inventories are usually written down to nett realizable value
item by item. It is still appropriate to group similar or related
items.
Estimates of nett realizable value are based on the most
reliable evidence available at the time the estimates are
made.
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Disclosure Requirement
In the Statement of Comprehensive Income, the disclosure
requirement of inventory will include:
expenses (cost of sales) that are not carried forward as inventories at
the reporting date.
cost of sales comprises cost of goods sold for the year, cost of
inventory that was lost or damaged during the year, the cost of writing
inventory down to nett realizable value, unallocated overheads and
excessive wastage, or any other manufacturing costs that cannot be
included in the cost of inventory.
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Disclosure Requirement (cont.)
On the face of the Statement of Financial Position, the disclosure
requirement is:
the accounting policy selected to treat the inventories should
be disclosed, including the method to determine the inventory
cost and the total carrying amount of inventories.
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