Accounting for Assets

Facilitator: Mr Fredrick Otieno

Class etiquette
Definitions
The following terms are used in this Standard with the meanings specified: Inventories are
assets:
(a)held for sale in the ordinary course of business;
(b)in the process of production for such sale; or
(c)in the form of materials or supplies to be consumed in the production process or in the
rendering of services.
Net realisable value
•is the estimated selling price in the ordinary course of business less the estimated costs of
completion and the estimated costs necessary to make the sale.
Fair value
•is the price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date.
• Inventories encompass goods purchased and held for resale including, for example,
merchandise purchased by a retailer and held for resale, or land and other property held for
resale.
• Inventories also encompass finished goods produced, or work in progress being
produced, by the entity and include materials and supplies awaiting use in the production
process.
• Costs incurred to fulfil a contract with a customer that do not give rise to inventories (or
assets within the scope of another Standard) are accounted for in accordance with IFRS 15
Revenue from Contracts with Customers.
Measurement of inventories
Inventories shall be measured at the lower of cost and net realisable value.
Cost of inventories
•The cost of inventories shall comprise all costs of purchase, costs of conversion and other
costs incurred in bringing the inventories to their present location and condition.
Costs of purchase
•The costs of purchase of inventories comprise the purchase price, import duties and other
taxes (other than those subsequently recoverable by the entity from the taxing authorities),
and transport, handling and other costs directly attributable to the acquisition of finished
goods, materials and services. Trade discounts, rebates and other similar items are deducted in
determining the costs of purchase.
Costs of conversion
• The costs of conversion of inventories include costs directly related to the units of
production, such as direct labour. They also include a systematic allocation of fixed and
variable production overheads that are incurred in converting materials into finished
goods.
• ‘Fixed production overheads are those indirect costs of production that remain relatively
constant regardless of the volume of production, such as depreciation and maintenance of
factory buildings, equipment and right-of-use assets used in the production process, and
the cost of factory management and administration.
• Variable production overheads are those indirect costs of production that vary directly,
or nearly directly, with the volume of production, such as indirect materials and indirect
labour.
• The allocation of fixed production overheads to the costs of conversion is based on the
normal capacity of the production facilities. Normal capacity is the production expected to
be achieved on average over a number of periods or seasons under normal circumstances,
taking into account the loss of capacity resulting from planned maintenance.
• The actual level of production may be used if it approximates normal capacity. The amount
of fixed overhead allocated to each unit of production is not increased as a consequence of
low production or idle plant.
• Unallocated overheads are recognised as an expense in the period in which they are
incurred. In periods of abnormally high production, the amount of fixed overhead allocated
to each unit of production is decreased so that inventories are not measured above cost.
• Variable production overheads are allocated to each unit of production on the basis of the
actual use of the production facilities.
• A production process may result in more than one product being produced simultaneously.
This is the case, for example, when joint products are produced or when there is a main
product and a by-product.
• When the costs of conversion of each product are not separately identifiable, they are
allocated between the products on a rational and consistent basis. The allocation may be
based, for example, on the relative sales value of each product either at the stage in the
production process when the products become separately identifiable, or at the completion
of production.
• Most by-products, by their nature, are immaterial. When this is the case, they are often
measured at net realisable value and this value is deducted from the cost of the main
product. As a result, the carrying amount of the main product is not materially different
from its cost.
Other costs
Other costs 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. For example, it may be
appropriate to include non-production overheads or the costs of designing products for
specific customers in the cost of inventories.
Examples of costs excluded from the cost of inventories and recognised as expenses in the
period in which they are incurred are:
(a)abnormal amounts of wasted materials, labour or other production costs;
(b)storage costs, unless those costs are necessary in the production process before a further
production stage;
(c)administrative overheads that do not contribute to bringing inventories to their present
location and condition; and
(d)selling costs.
Techniques for the measurement of cost
Techniques for the measurement of the cost of inventories, such as the standard cost method
or the retail method, may be used for convenience if the results approximate cost.
•Standard costs take into account normal levels of materials and supplies, labour, efficiency
and capacity utilisation. They are regularly reviewed and, if necessary, revised in the light of
current conditions.
•The retail method is often used in the retail industry for measuring inventories of large
numbers of rapidly changing items with similar margins for which it is impracticable to use
other costing methods. The cost of the inventory is determined by reducing the sales value of
the inventory by the appropriate percentage gross margin. The percentage used takes into
consideration inventory that has been marked down to below its original selling price. An
average percentage for each retail department is often used.
Cost formulas
• The cost of inventories of items that are not ordinarily interchangeable and goods or
services produced and segregated for specific projects shall be assigned by using specific
identification of their individual costs.
• The cost of inventories, other than those dealt with in paragraph above, shall be assigned by
using the first-in, first-out (FIFO) or weighted average cost formula. An entity shall use
the same cost formula for all inventories having a similar nature and use to the entity. For
inventories with a different nature or use, different cost formulas may be justified
Net realisable value
• The cost of inventories may not be recoverable if those inventories are damaged, if they
have become wholly or partially obsolete, or if their selling prices have declined.
• The cost of inventories may also not be recoverable if the estimated costs of completion or
the estimated costs to be incurred to make the sale have increased.
• The practice of writing inventories down below cost to net realisable value is consistent
with the view that assets should not be carried in excess of amounts expected to be realised
from their sale or use.
Recognition as an expense
• When inventories are sold, the carrying amount of those inventories shall be recognised as
an expense in the period in which the related revenue is recognised. The amount of any
write-down of inventories to net realisable value and all losses of inventories shall be
recognised as an expense in the period the write-down or loss occurs.
• The amount of any reversal of any write-down of inventories, arising from an increase in
net realisable value, shall be recognised as a reduction in the amount of inventories
recognised as an expense in the period in which the reversal occurs
Control of Inventory
Two primary objectives of control over inventory are as follows:
▪ Safeguarding the inventory from damage or theft.
▪ Reporting inventory in the financial statements.
Safeguarding Inventory:
The following documents are often used for inventory control:
▪ Purchase order - authorizes the purchase of the inventory from an approved vendor. As soon
as the inventory is received, a receiving report is completed.
▪ Receiving report - establishes an initial record of the receipt of the inventory
▪ Vendor’s invoice -
Source: Cengage Learning
To illustrate, assume that three identical units of merchandise are purchased during May, as
follows:

Date Units Cost Ksh

May 10 1 900
18 1 1,300
24 1 1,400
3 3,600

Assume that one unit is sold on May 30 for Ksh 2,000

Inventory systems
• In business, the inventory system is how you keep track of your goods and materials. This
is an essential part of your business, as good inventory management can make or break a
business!  
• If you’re not properly keeping track of your inventory, you’re not maximizing your profit.  
• You also run the risk of running out of cash since you are paying suppliers before you get
paid by customers – in most cases the cash conversion cycle is not in your favor.
• There are two main types of inventory systems, the perpetual inventory system and
the periodic inventory system.  
• The main difference between the two systems is how often inventory data is updated. 
The periodic inventory method
• The periodic inventory method – is one in which inventory data is updated after a
specific interval of time, usually once a year.
• This is where the term periodic comes from. Data is entered into the inventory systems
after a specific period of time, unlike with perpetual inventory, where the data is updated
constantly as sales occur.
• In the  periodic inventory method, information is not kept consistently up to date.
Inventory information is noted, but total store of the inventory is only taken once a year.
• This inventory management system appeals to many people because you don’t have to
spend as much money up front to set up the technology and inventory software needed to
keep track of data in a perpetual inventory system.
• Excel may well suffice for this type of inventory control.  And when you are starting a
business, upfront cost minimization is critical. 
The perpetual inventory method 
• The perpetual inventory method is one in which inventory data is updated continuously.
When an order is placed or received, that data immediately is entered into the system to
update the quantity and inventory availability right away.
• This is where the term perpetual comes from. Data is entered perpetually, or continuously,
as opposed to the periodic system, where data is updated according to a set interval of time.
• The perpetual inventory method has gained in popularity with the rise of computers and
technology.
• In a perpetual inventory system, quantity information is often updated automatically
thanks to bar code scans and radio frequency identification. Technology makes keeping this
type of inventory control system even easier to use.
 Measure @ lower of

Cost NRV
Costs incurred in bringing inventory to its Selling price X
present condition and location Less:
Materials Costs to complete (X)
Labour Costs of selling (X)
Manufacturing overheads (based on NRV X
normal output)
Example 2 – Inventory (valuation)
Neil paid $3 per unit for the raw materials of its products. To complete each unit incurred $2 per unit in direct
labour.
Production overheads for the year based on normal output of 12,000 units was $72,000.
Due to industrial action only 10,000 units were produced and 1,000 units were in inventory at the end of the
year.
As a result of the industrial action some units were badly stored and became damaged. It’s is estimated that
200 of the units will now only be sold for $12 each after minor repairs of $2 each
What figure for closing inventory would be shown in the Statement of Financial Position?
Example 3
A manufacturer is valuing its inventory at the reporting date and has identified the
following items to be valued:
Inventory A – work in progress consists of 10 items that have cost $2,500 to produce in
total. It is expected that each item will sell for $280, where direct selling costs are
expected to be 5% of the selling price, and it is estimated that costs to complete would
be $10 per unit.
Inventory B – the company has 1,000 units costing $10 each, where the packaging has
been damaged. It will cost $2,000 to repackage all of the units allowing them to be sold
at $11 each.
Inventory C – the company has produced inventory costing $7,000 that it is expecting to
sell at $10,000 to one of its customers. Changes in production methods mean that the
goods are cheaper to produce and will only cost $6,000 in the future.
At what amounts should the inventory be valued in the financial statements.
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