Inventories the highlights

Inventories the highlights as it says provides a high level summary of the accounting and financial reporting in respect of inventory.

See Inventories for IFRS for Small and Medium-sized entities, the complete IAS 2 Inventories standards is also available.

Inventory is also called stock in trade, or just stock. Inventories the highlights

Scope

Applies to all inventories except:

  • work in progress on construction and service contracts (IAS 11);
  • financial instruments (IAS 32 and IFRS 9); and
  • biological assets arising from agricultural activity (IAS 41).

Does not apply to the measurement of inventories held by:

  • producers of agricultural and forest products, and minerals and mineral products, that are measured at net realisable value in accordance with well-established practices in those industries; and
  • commodity broker-traders who measure their inventories at fair value less costs to sell.

Changes in the above inventory values are recognised in profit or loss in the period of the change.

The IFRS definition of inventory is brief, let’s add some juice (if that is possible in accounting, and off course it is possible!!) or look at it as being in business.

Inventories consist of the value of materials and goods held by an entity:

  1. to support production (raw materials, subassemblies, work in process), Inventories the highlights
  2. for support activities (repair, maintenance, consumables), or Inventories the highlights
  3. for sale or customer service (merchandise, finished goods, spare parts). Inventories the highlights

Inventory is often one of the largest items in the current assets category, and must be accurately counted and valued at the end of each accounting period to determine a company’s profit or loss. However, using the current days Enterprise Resource Planning (ERP) automation software systems means counting it not that necessary anymore. Inventories the highlights

Inventory keeping Inventories – the highlights

Organizations whose inventory items have a large unit cost generally keep a day to day record of changes in inventory (called perpetual inventory method) to ensure accurate and on-going control. Organizations with inventory items of small unit cost generally update their inventory records at the end of an accounting period or when financial statements are prepared (called periodic inventory method). Inventories the highlights

ERP provides an integrated and continuously updated view of core business processes using common databases maintained by a database management system. ERP systems track business resources—cash, raw materials, production capacity—and the status of business commitments: orders, purchase orders, and payroll. The applications that make up the system share data across various departments (manufacturing, purchasing, sales, accounting, etc.) that provide the data. ERP facilitates information flow between all business functions and manages connections to outside stakeholders.

Sales matching costs of sales Inventories – the highlights

In general inventory is recognised as an asset of the entity until the related revenues are recognised (ie the item is sold and this sales transaction is recognised as revenue and trade receivable) and the inventory is recognised as an expense (ie recorded as cost of sales and derecognised from inventory). In other words, the matching principle as one of the fundamental accounting assumptions requires costs (not being period cost!) to be matched with associated revenues. In order to achieve this, costs incurred for goods which remain unsold at the year end must be carried forward in the statement of financial position and matched against future revenues.

Impairment of obsolete inventory Inventories – the highlights

Net realisable value (NRV) – the estimated selling price less the estimated costs of completion and the estimated costs necessary to make the sale.

Cost of inventories – all costs incurred in bringing the inventories to their present location and condition, including the costs of purchase and conversion.

  • Costs of purchase of inventories comprise the purchase price (less trade discounts, rebates and similar items), irrecoverable taxes, and transport, handling and other costs directly attributable to their acquisition. Inventories the highlights
  • Costs of conversion include costs directly related to the units of production, such as direct labour and systematically allocated fixed and variable production overheads incurred in producing finished goods. Inventories the highlights

Part or all of the cost of inventories may also be impaired if a write-down to net realisable value is necessary (the measurement of inventories is ‘Inventories should be measured at the lower of cost and net realisable value.’). Inventories the highlights

Inventories the highlights

Obsolescence is the state of being which occurs when an object, service, or practice is no longer wanted even though it may still be in good working order. Potential reasons for obsolescence are:

  • The most simple reason for obsolescence is the ‘use by’ or ‘best before’ date on food and drinks. Inventories the highlights
  • A second good reason is Spring/Summer and Fall/Winter seasons in fashion stocks. Now-a-days the fashion industry is even designed to make consumers feel ‘out of trend’ after one week! But the idea is if fashion merchandise is not sold quickly enough it gets obsolete. Spanish retailer Zara pioneered the fast-fashion concept with new deliveries to its stores coming in twice per week. H&M and Forever21 both get daily shipments of new styles, while Topshop introduces 400 styles a week on its website. Inventories the highlights
  • Most Slow-moving and Obsolete stock comes from new-product launches that don’t quite meet expectations.
  • Other reasons might be technological development – in some industries new products get created to replace competing or older products at a higher speed than in others.

Cost formula Inventories – the highlights

The IAS also provides guidance on the cost formulas that are used to assign costs to inventories. The cost of inventories should be assigned by using the first-in, first-out (FIFO) or weighted average cost formulas. The LIFO formula (last in, first out) is not permitted by IAS 2. Inventories the highlights

IAS 2 provides that an entity should use the same cost formula for all inventories having similar nature and use to the entity.

To the extent that service providers have inventories, they measure them at the costs of their production. Inventories the highlights

These costs are primarily the costs of labour directly engaged in providing the service, including supervisory personnel, and attributable overheads.

The cost of inventories of items that are ordinarily interchangeable and have not been produced and segregated for specific projects is determined by using the first-in, first-out (FIFO) or weighted average cost formula. The same cost formula shall be adopted for all inventories having a similar nature and use to the entity.

Inventories are usually written down to NRV on an item by item basis, unless it is more appropriate to group similar or related items.

Examples of costs excluded from the cost of inventories and recognized as an expense when they are incurred: Inventories the highlights

  • Abnormal amounts of wasted materials, labour or other production costs; Inventories the highlights
  • Storage costs, unless those costs are necessary in the production process before a further production stage; Inventories the highlights
  • Administrative overheads that do not contribute to bringing inventories to their present location and condition; and
  • Selling costs. Inventories the highlights Inventories the highlights

Disclosure Disclosure impairment

The following shall be disclosed in the financial statements

  • the accounting policies for inventories Inventories the highlights
  • the total carrying amount of inventories and the carrying amount in classifications appropriate to the entity
  • the carrying amount of inventories carried at fair value less costs to sell Inventories the highlights
  • the amount of inventories recognised as an expense during the period Inventories the highlights
  • the amount of any write-down of inventories recognised as an expense Inventories the highlights
  • the amount of any reversal of any write-down that is recognised as a reduction in the amount of inventories recognised as an expense
  • the circumstances or events that led to the reversal of a write-down of inventories Inventories the highlights
  • the carrying amount of inventories pledged as security for liabilities. Inventories the highlights

General background

Inventory is defined as a stock or store of goods. These goods are maintained on hand at or near a business’s location so that the firm may meet demand and fulfill its reason for existence. If the firm is a retail establishment, a customer may look elsewhere to have his or her needs satisfied if the firm does not have the required item in stock when the customer arrives. If the firm is a manufacturer, it must maintain some inventory of raw materials and work-in-process in order to keep the factory running. In addition, it must maintain some supply of finished goods in order to meet demand. Inventories the highlights

Sometimes, a firm may keep larger inventory than is necessary to meet demand and keep the factory running under current conditions of demand. If the firm exists in a volatile environment where demand is dynamic (i.e., rises and falls quickly), an on-hand inventory could be maintained as a buffer against unexpected changes in demand.

This buffer inventory also can serve to protect the firm if a supplier fails to deliver at the required time, or if the supplier’s quality is found to be substandard upon inspection, either of which would otherwise leave the firm without the necessary raw materials. Other reasons for maintaining an unnecessarily large inventory include buying to take advantage of quantity discounts (i.e., the firm saves by buying in bulk), or ordering more in advance of an impending price increase.

Generally, inventory types can be grouped into four classifications: raw material, work-in-process, finished goods, and maintenance, repair and operating (MRO) goods.

See Reference for business for a very complete discussion on inventory from a business perspective. Inventories the highlights

See also: The IFRS Foundation

Inventories the highlights

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