IAS 2 INVENTORIES
Overview
This Accounting Standard is aimed tostreamline the accounting methods forinventories.
The foremost concern in Inventoryaccounting is that the cost would beconsidered as asset which gets carriedfurther until the other relevant revenuesare recorded.
Overview
This provides guidance for determiningthe cost and its consecutive records asexpense. It includes all written down tothe net value which is realizable.
Added to this it provides guidelines oncost formulas employed to assign costsfor inventories.
Objectives
The objective of IAS 2 is to set outthe accounting treatment forinventories. It provides guidance ondetermining cost and its subsequentrecognition as an expense includingany write down to net realizablevalue. [IAS 2 para 1].
Objectives
A primary issue in accounting forinventories is the amount of cost to berecognized as an asset and carriedforward until the related revenues arerecognised
Objectives
It also provides guidance on the cost formulas that are used to assign costs to inventories.“Inventories shall be measured at the lower of cost and net realizable value”
Scope
Applicable to all the inventories, except• work in progress on construction
contracts and service contracts.• financial instruments (IAS 32 &
IFRS 9).• biological assets arising from
agricultural activity at the point ofharvest (IAS 41).
Scope
The Standard is also not applicable totheproducers of agricultural and forest
products after harvest,mineral and mineral products andcommodity broker-traders who
measure their inventories at fairvalue less costs to sell
Scope
The improvements to IFRSs amendedIAS 41, ‘Agriculture’, which resulted inan amendment to IAS 2. Agricultureinventories comprising agriculturalproduce that an entity has harvestedfrom its biological assets are nowmeasured on initial recognition at theirfair value less costs to sell at the pointof harvest.
Definitions
Inventories are assets:• held for sale in the ordinary course of
business;• in the process of production for sale,
or• in the form of materials or supplies to
be consumed in production or inrendering services. [IAS 2 para 6].
Definitions
Definitions
Net Realizable Value: is the estimatedselling price in the ordinary course ofbusiness less the estimated cost ofcompletion and the estimated costsnecessary to make the sale.
Definitions
Fair Value: is the amount for which anasset could be exchanged, or a liabilitysettled, between knowledgeable, willingparties in an arm’s length transaction.
Recognition
An entity should initially recogniseinventory when it has control of theinventory, expects it to provide futureeconomic benefits and the cost of theinventory can be measured reliably.[Framework paras 49(a), 89].
Recognition
Assets held in an entity’s premises maynot qualify as inventories if they areheld on consignment (that is, on behalfof another entity and where no liabilityto pay for the goods exists unless theyare sold).
Measurement
Initial measurement of inventories is atcost. The cost of inventories includes allcosts of purchase, costs of conversionand all other costs incurred in bringingthe inventories to their present locationand condition.
Measurement
The costs of purchase include thepurchase price, import duties andother taxes (not recoverable from thetaxing authorities), transport andhandling costs and other costsdirectly attributable to the acquisitionof the inventory. Reductions aremade for trade discounts, rebatesand other similar items. [IAS 2 para 9
Measurement
Agricultural produce, such as wool, logsand grapes is the harvested product ofbiological assets and is recognised asinventory. [IAS 2 para 20]. The cost ofagricultural produce at initialrecognition is its fair value less costs tosell at the point of harvest. [IAS 41 para13].
Measurement
Costs of acquisition, manufacture,exchange and other expenses areincluded in the inventories that havemade it be in the current position.• Purchase costs include;• purchase price,• Transport costs,• import duties,
Measurement
• handling taxes and• other expenses that have direct
impact on the procurement ofproducts.
Measurement
Costs not included in the valuation ofinventories but treated as expenseswhen they occur include;• Abnormal wastage of materials, labor
and other production costs• Storage costs not essential for the
production process• Selling and distribution costs• Administrative costs
Measurement
Measurement
Measurement
Example 1Tuntufye Trading Company purchasesmotorbikes from several countries andsells them to Northern regions. Duringthe current year, the company hasincurred following expenses:1. Trade discounts on purchase2. Handling costs relating to imports.Cont ….
Measurement
3. Salaries of accounting department4. Sales commission paid to sales agents5. Import duties6. After sales warrant costs7. Costs of purchases (supplier’s invoices)8. Freight expensecont ….
Measurement
9. Insurance of purchases10. Brokerage commission paid toindenting agentsTuntufye Trading Company seeks youradvice on which costs are allowed byIAS 2 for inclusion in the cost ofinventory. Advice
Measurement
Solution:Items 1, 2, 5, 7, 8, 9, 10 are allowed by IAS
2 for the calculation of cost ofinventories.Salaries of accounts department, sales
commission, and after sales warrantycosts are not considered to be the cost ofinventory therefore they are not allowedby IAS 2 for inclusion in cost of inventory
Measurement
Subsequent to initial recognition,entities should measure inventories atthe lower of cost or net realisablevalue (defined as the estimatedselling price in the ordinary course ofbusiness less the estimated costs ofcompletion and the estimated sellingcosts). [IAS 2 paras 9, 6].
Measurement
Cost should be determined based onspecific identification for goods notordinarily interchangeable or thosesegregated for specific projects. Specificidentification costing is not appropriate forinventories of homogeneous products,such as raw materials to be used inproduction. FIFO or weighted averagemethods may be used to determine the
Measurement
Example 2 Hapa kazi Plc manufactures mechanicalparts, which trade under the name ‘Faru’.In the year ended 31 December 2015,10,000 Faru were manufactured and therelated costs were:• Materials
3,000,000• Labour
4 000 000
Measurement
• Sundry factory expenses 2,000,000
• Production storage costs 1,000,000
• Selling expenses 2,000,000
• Expenses at head office 4,000,000
At 31 December 2015, there were 1,000Faru in inventory Assuming that these
Measurement
Solution•Materials
3,000,000•Labour 4,000,000•Depreciation of machinery
2,000,000•Factory rates
1,000,000•Sundry factory expenses
2 000 000 cont
Measurement
•Production storage costs 1,000,000
•Total cost 13,000,000
•Units manufactured 10,000
•Unit cost 1,300Number of units at year end 1,000Value of closing inventory
MeasurementIAS 2 does not permit exchangedifferences arising directly on therecent acquisition of inventoriesinvoiced in a foreign currency to beincluded in the costs of purchase ofinventories.
MeasurementIAS 2 does not permit exchangedifferences arising directly on therecent acquisition of inventoriesinvoiced in a foreign currency to beincluded in the costs of purchase ofinventories.
Measurement
Net realizable valueThe estimated selling price in theordinary course of business less theestimated costs of completion and lessthe estimated costs necessary to makethe sale
Provision for inventory impairment
The cost of inventories may not berecoverable if those inventories aredamaged, if they have become whollyor partially obsolete, or if their sellingprices have declined.
The cost of inventories may also not berecoverable if the estimated costs ofcompletion or the estimated costs to beincurred to make the sale have increased.The practice of writing inventories downbelow cost to net realisable value isconsistent with the view that assets shouldnot be carried in excess of amountsexpected to be realized from their sale oruse.
DerecognitionInventory is derecognised when it is sold.It is recognised as an expense in thesame period as the revenue from its saleis recognised. An entity should alsoderecognise inventory when it has nofuture economic value, for example,obsolete inventory.The point at which to derecogniseinventory is not always straightforward,example where an entity supplies goodsunder sale and repurchase agreements,the entity may retain the risks andrewards of ownership and should
Derecognition
Disclosure• Accounting policy adopted in measuring
inventories, including cost formulas• Carrying amount of inventories under major
headings (e.g. raw materials, WIP and finished goods)
• Carrying amount of inventories at fair value less costs to sell
• Amount expended in the period• Amount of any write downs of inventories• Amount of any reversal of write downs• Cause of write downs• Carrying amount of inventories pledged as
it
End
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