ACC101 FINANCIAL ACCOUNTING

Week 3, Lecture

 Can

be very significant for some businesses.

E.g. Manufacturing entities.

Impacts

financial statements in two ways:

Statement of financial position (previously known as Balance Sheet)

Potentially large balance within current assets

Income statement

Opening and closing inventories have a direct impact on cost of sales and therefore profits.

 Value

changes over time, how should this be

accounted for? Should it be valued at cost?

Market value? Or some other price?
Treatment

of inventory is described in IAS 2 :

Inventories.
Inventories

should be measured at the lower

of cost and net realisable value.

 Cost

comprises of 3 elements. They are:

Cost of purchase
Purchases price Import duties BUT NOT sales tax and trade discounts

Cost of conversion

Relating to productions: direct labour direct/variable overheads an allocation of fixed overheads (based on normal level of activity)

Other costs incurred in bringing the inventories to their present location and condition.

Carriage inwards

 According

to IAS 2: Inventories, which of the following should NOT be included in valuing the inventories of an entity?
(1) Labour costs (2) Transport costs to deliver goods to customers (3) Administrative overheads (4) Depreciation on factory machine (A) All four items (B) 1 only (C) 2 and 3 only (D) 2, 3, and 4 only

 According

to IAS 2: Inventories, which of the following should NOT be included in valuing the inventories of an entity?
(1) Labour costs (2) Transport costs to deliver goods to customers (3) Administrative overheads (4) Depreciation on factory machine (A) All four items (B) 1 only (C) 2 and 3 only (D) 2, 3, and 4 only

The net realisable value of an item is essentially its net selling proceeds after all costs have been deducted. It is calculated as: Estimated selling price X Less: estimated costs of completion (X) Less: estimated selling and distribution costs (X) X No netting off

The IAS 2 rule 'lower of cost and net realisable value should be applied as far as possible on an item by item (or line by line) basis.

 Suppose

an entity has four items of inventories on hand at the year end. Their costs and NRVs in $ are as follows:
Inventory item 1 2 3 Cos t 27 14 43 NRV 32 8 55 Lower of cost and NRV 27 8 43

29
113

40
135

29
107

It would be incorrect to compare the total cost of $113 to the total NRV of $135 and state inventories as $113. The comparison should be for each item, thus $107 would be attributed. Dr Inventories $107 Cr Cost of goods sold $107

 Jessie

is trying to value her inventory. She has the following information available:
Selling price Cost incurred to date Cost of work to complete it Selling costs per item 35 20 12 1

Required: What is the net realisable value of Jessie's inventory?

Estimated selling Price

Less: estimated cost of completion Less: Selling costs per item

35
( 12) ( 1)

NRV

22

Cost was given as 20 NRV calculated is 22 Therefore, inventory must be valued at 20 (lower of the cost and net realisable value.

 The

basic rule per IAS 2: Inventories is: 'Inventories should be measured at the lower of cost and net realisable value.' This is an example of prudence in presenting financial information. (a) If inventory is expected to be sold at a profit:

(i) value at cost (ii) do not anticipate profit.

(b)

If inventory is expected to be sold at a loss:

(i) value at net realisable value

FIFO (First In First Out)

(i) first goods purchased/produced will be the first to be sold

(ii) remaining inventories are the most recent

purchases/production.

LIFO (Last In First Out) AVCO (Average Cost). Two averages available:

Simple average cost Weighted average cost

 Simple

average cost

The cost of all purchases/production during the year

is divided by the total number of units purchased
Weighted

average cost

The weighted average of the cost of similar items is recalculated each time a new item is

purchased/produced during the period (IAS 2

requires the weighted average to be used)

On 1 January 20X2 a company held 200 units of finished goods valued at $10 each. During January the following transactions took place.
Date 10 Jan 20 Jan 25 Jan Units purchased 300 350 250 Cost / unit $10.85 $11.50 $13.00 Date 14 Jan 21 Jan 28 Jan Units sold 280 400 80 Sales price / unit $18.00 $18.00 $18.00

Required Determine the valuation of closing inventories and cost of sales using: (a) FIFO (b) Weighted average cost

Inventories should be valued at the lower of cost and net realisable value.

The cost of inventory includes the cost of purchase, costs of conversion and any other costs necessary to bring the inventory to its present location and condition.

Methods available to estimate the cost of inventories are first in, first out (FIFO) and average cost.

In times of rising prices, using FIFO will mean the financial statements show higher inventory values and higher profits.

Net realisable value is the estimated selling price less the costs to completion and any selling and distribution costs.