Initial recognition
An entity should initially recognise inventory
when it has control of the inventory, expects it
to provide future economic benefits [F.49(a)] and
the cost of the inventory can be measured reliably
[F.89]. Initial recognition
of inventory is straightforward. Entities recognise
inventories when they expect to generate benefits
from their use, or eventual sale to customers.
The primary issue in accounting for inventories
is the amount of cost to be recognised as an asset
and carried forward until revenue is recognised.
Initial measurement
Initial measurement of inventories is at cost [F.100(a)].
The cost of inventories includes: the cost of all
materials that enter directly into production and
the costs of converting those materials into finished
goods. The direct materials costs include, in addition
to the purchase price, all other costs necessary
to bring them to their existing condition and location
[IAS2.10(R.05)].
The cost of raw materials, consumables and land
and buildings purchased for resale is the purchase
price including transportation charges, import duties,
insurance, warehousing and handling costs, reductions
made for trade discounts, rebates and other similar
items [IAS2.11(R.05)]
.
Agricultural produce, such as wool, logs and grapes
are the harvested product of biological assets and
are recognised as inventory [IAS2.20(R.05)]. The cost
of agricultural produce at initial recognition is
its fair value less estimated point-of-sale costs
at the point of harvest [IAS41.13].
Investment property is reclassified as inventory
when an entity proposes to develop the property
for sale [IAS40.57(b)(R.05)].
The property's cost at initial recognition would
be its cost less accumulated depreciation [IAS40.59(R.05)]
or fair value at the date of transfer [IAS40.60(R.05)],
depending on the measurement alternative the entity
previously adopted in accounting for the investment property.
Measurement subsequent to initial recognition
Subsequent to initial recognition, entities should
measure inventories at the lower of cost or net
realisable value [IAS2.9(R.05)] .
Cost should be determined based on specific identification
for goods not ordinarily interchangeable or those
segregated for specific projects [IAS2.23(R.05)]. Specific
identification costing is not appropriate for inventories
of homogeneous products, such as raw materials to
be used in production and spare parts that have
often been purchased at different prices [IAS2.24(R.05)].
Weighted average or FIFO (the benchmark treatment)
[IAS2.25(R.05)] may be used to determine the cost of
such inventory.
There are a number of methodologies for inventory
costing, which fall within the categories of weighted
average and FIFO. Many methods are specific to an
entity or industry and some are complex .
IFRS describe methods of application only
very generally, and any method that produces a result
consistent with the principles in the standard is
acceptable. Whatever application method an entity
uses, it should apply that method consistently [IAS2.25,26(R.05)]
.
Conversion costs
Entities engaged in manufacturing goods must assign
costs to inventory. The costs of inventories should
include all costs of purchase, costs of conversion
and other costs incurred in bringing the inventories
to their present location and condition [IAS2.10(R.05)]
. IFRS do not permit
direct costing methods, where all overheads are
expensed. Such costs are allocated to inventory,
regardless of their classification by the entity
[IAS2.13(R.05)].
Fixed production overheads are recognised as part
of the cost of inventories based on normal capacity
. Normal capacity is the level of
production that an entity expects to achieve on
average over several periods [IAS2.13(R.05)]. Variable
production overhead costs are recognised for each
unit produced, on the basis of actual production
[IAS2.13(R.05)]. An entity must charge unallocated overheads,
such as idle capacity variances to the cost of sales
in the current period
[IAS2.13(R.05)] .
Capitalisation of storage costs is appropriate
only if the storage is necessary in the production
process prior to a further production stage or to make the product saleable [IAS2.16(b)(R.05)]
.
Joint products and by products
Products that are produced together are known as
joint products or common products. The costs of
these products incurred after the point at which
the individual products become identifiable (often
called separable or added costs) can easily be identified
with the product. The entity, however, must allocate
costs before that point to individual products by
applying a reasonable method [IAS2.14(R.05)].
The allocation of costs based on the relative sales
value of the joint products is one method of allocating
joint costs. Joint costs are allocated based on
the relative sales value of the products at the
point of separation [IAS2.14(R.05)]. This method is practical
when joint products are equally profitable, but
inappropriate where products have significantly
different profit margins.
By-products are joint products of relatively insignificant
value. Accounting for them as joint products is
not appropriate. An appropriate alternative is to
assign costs to by-products equal to their net sales
value by deducting their net sales value from the
main product [IAS2.14(R.05)].
Inventories of a service provider
Inventories of service providers are costs incurred
in providing the services, for which the entity
has not recognised revenues. These costs consist
of labour and related employment costs of employees
directly engaged in providing the service, including
supervisory personnel [IAS2.19(R.05)]. All indirect costs
(overheads) associated with providing the service,
such as the cost of facilities, transportation,
training, supplies etc., should also be recognised
as part of the cost of service inventories. Labour
and associated costs relating to sales and general
administrative personnel should not be included
in inventory, but recognised as expense in the period
incurred [IAS2.19(R.05)].
Revenues from the rendering of services should
be recognised under the percentage-of-completion
method [IAS18.20(R.05)]. Revenues are recognised in the
period to the extent that services are rendered
[IAS18.21(R.05)]. Accordingly, the costs of those services
are also charged to expense in that period. The
balance sheets of service providers reflect relatively
minor amounts of inventories.
Derecognition
Inventory is derecognised when it is sold. An entity
should also derecognise inventory when it has no
future economic value, for example obsolete inventory
[F.83(a)].
The point at which to derecognise inventory is
not always straightforward. Inventory de-recognition usually occurs
when revenue for the sale of goods is recognised. For example, where an
entity supplies goods to a dealer on consignment
[IAS18.Appendix.2(c)] or under sale and repurchase agreements
[IAS18.Appendix.5], the entity may retain the risks and
rewards of ownership and should continue to recognise
the asset [IAS18.13(R.05)] .
Impairment
The requirements to measure inventory at the lower
of cost and net reliasable value (NRV) [IAS2.9(R.05)] forces the recognition
of impairment losses as they occur. Write-downs
to NRV may be triggered where selling prices have
declined or costs of completion or direct selling
costs have increased. Some products may have become
damaged or some may be held in quantities that will
not be sold in a reasonable period [IAS2.28(R.05)]. In
these circumstances the inventories should be written
down below cost to expected recoverable amounts.
The amount of the impairment should be determined
on an item-by-item basis. Such an assessment may
not be practical, in which case impairment is measured
for a group of similar or related items. Items are
similar or related if they are from the same product
line, have similar purposes or end uses and are
produced and marketed in the same geographical segment.
The write-down should take into account the estimated
completion and disposal costs but should not include
a profit margin arising in the future production
stages [IAS2.28-33(R.05)] .
The market prices of materials and supplies held
for use in manufacturing may decline below cost.
The entity should however continue to recognise
the materials at cost if it expects to sell the
finished products at prices above cost [IAS2.32(R.05)]
.
NRV should be determined based on the conditions
that existed at the balance sheet date. Events after
the end of the period should be considered to the
extent that they confirm conditions existing at
or before the balance sheet date [IAS2.30(R.05)]. This
evaluation calls for the exercise of judgement.
All available data should be considered including
subsequent changes in selling prices or costs [IAS2.30(R.05)]
.
IFRS require that a write-down to NRV taken in
a prior period be reinstated when the conditions
causing the write-down cease to exist [IAS2.33(R.05)].
Use of financial instruments in the measurement of inventories
Purchase of inventories
Commodity price and foreign exchange price movements
between the date of order and settlement may expose
an entity to risks when purchasing inventories.
Commodity price risk arises where an entity purchases
a commodity that is subject to price fluctuation,
and a foreign exchange risk arises where the entity
pays for the inventory in a foreign currency.
a) Managing commodity price risk
To mitigate or hedge the price risk, the entity
may enter into a fixed price forward contract to
buy the commodity at a fixed price at a future date. Some
forward contracts may fall within the scope of IAS 39 if they can be settled net.
Net settlement can be quite broad.
The entity does not recognise the forward
contract as a derivative where it takes physical
delivery of the inventory and for which it has
no practice of settling net [IAS39.5-7(R.05)]
[IAS39IG.A1(R.05)].
Alternatively, the entity may settle the contract
prior to taking delivery of the commodity. The forward
contract is recognised as a derivative in this case
. The derivative may qualify as
a hedging instrument. Any changes in fair value
would be initially deferred in equity if it is designated
as a cash flow hedge of a highly probable forecasted
future transaction. The amount deferred in equity
is included as part of the cost of inventory on
initial recognition [IAS39.95,97,98(R.05)].
b) Managing foreign exchange risk
An entity may enter into a contract to purchase
inventory in a currency other than that of the entity's
reporting currency. Such a contract is comprised of a
host contract to purchase inventory and a swap or
forward contract to exchange one currency for another
(an embedded derivative).
The entity should not separately recognise a
derivative if the currency for the forward purchase
is the supplier's measurement currency [IAS39.AG33(R.05)].
A forward purchase contract denominated in a third
currency, that is, not the measurement currency
of the supplier or the purchaser, would be regarded
as a host contract with an embedded foreign currency
derivative unless the third currency is one in which
the contract prices are routinely quoted in international
commerce [IAS39.AG33(R.05)]. The embedded derivative
should be recognised separately from the host contract
in accordance with the requirements of accounting
for derivatives [IAS39.11(R.05)]. The remaining host
contract will be a forward purchase contract in
the entity's own currency .
Presentation and disclosure
Inventories should be presented as a line item
on the face of the balance sheet [IAS1.68(g)(R.05)].
Classification of inventory (in the balance sheet
or notes) should be in a manner appropriate to the
entity and applied consistently [IAS1.74(R.05)] [IAS1.27(R.05). The most common
classifications are supplies, raw materials, work-in-progress
and finished goods ( [IAS2.36(b)(R.05)][IAS2.37(R.05)].
The following disclosures are required [IAS2.36(a)-(h)(R.05)]:
| a) |
accounting policies
adopted including cost formula used; |
|
| b) |
carrying amount of inventories and carrying
amount in classifications appropriate to the
entity; |
|
| c) |
carrying amount of inventories
carried at fair value less costs to sell ; |
|
| d) |
the amount of inventories recognised
as an expense during the period; |
|
| e) |
the amount of any write-down
of inventories; |
|
| f) |
the amount reversed of a previous
write-down recognised as income in the period;
|
|
| g) |
the circumstances that led
to the reversal of a previous write-down; and |
|
| h) |
the carrying amount of inventories
pledged as security for liabilities. |
|
