Acca f3 Financial Accounting (int) Study Text

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8: Inventory   Part D  Recording transactions and events 

5.4.3 Other costs 

Any other costs should only be recognised if they are incurred in bringing the inventories to their 

present

location and condition.

The standard lists types of cost which 

would not be included in cost of inventories. Instead, they should 

be recognised as an 

expense in the period they are incurred. 

Abnormal amounts of wasted materials, labour or other production costs 

Storage costs (except costs which are necessary in the production process before a further 

production stage) 

Administrative overheads not incurred to bring inventories to their present location and conditions 

Selling costs

5.4.4 Techniques for the measurement of cost 

Two techniques are mentioned by the standard, both of which produce results which 

approximate to cost,

and so both of which may be used for convenience. 

(a)

Standard costs are set up to take account of normal production values: amount of raw materials 

used, labour time etc. They are reviewed and revised on a regular basis. 

(b)

Retail method: this is often used in the retail industry where there is a large turnover of inventory 

items, which nevertheless have similar profit margins. The only practical method of inventory 

valuation may be to take the total selling price of inventories and deduct an overall average profit 

margin, thus reducing the value to an approximation of cost. The percentage will take account of 

reduced price lines. Sometimes different percentages are applied on a department basis. 

5.5 Cost formulas 

Cost of inventories should be assigned by 

specific identification of their individual costs.

(a) 

Items that are 

not ordinarily interchangeable

(b) 

Goods or services produced and segregated for 

specific projects.

Specific costs should be attributed to individual items of inventory when they are segregated for a specific 

project, but not where inventories consist of a large number of interchangeable (ie identical or very 

similar) items. In the latter circumstances, one of 

two approaches may be taken. 

The cost formula is that the cost of inventories should be assigned by using the 

first-in, first-out (FIFO) or

weighted average cost formulas. 

Under the weighted average cost method, a recalculation can be made after each purchase (as we 

calculated),

or alternatively only at the period end.

LIFO is no longer permitted under IAS 2. 

Question

Inventory valuation 

You are the accountant at Water Pumps Co, and you have been asked to calculate the valuation of the 

company's inventory at cost at its year end of 30 April 20X5. 

Water Pumps manufactures a range of pumps. The pumps are assembled from components bought by 

Water Pumps (the company does not manufacture any parts). 

The company does not use a standard costing system, and work in progress and finished goods are 

valued as follows. 

(a) 

Material costs are determined from the product specification, which lists the components required 

to make a pump. 

(b) 

The company produces a range of pumps. Employees record the hours spent on assembling each 

type of pump, this information is input into the payroll system which prints the total hours spent 

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Part D  Recording transactions and events

  8:  Inventory

145

each week assembling each type of pump. All employees assembling pumps are paid at the same 

rate and there is no overtime. 

(c) 

Overheads are added to the inventory value in accordance with IAS 2 Inventories. The financial 

accounting records are used to determine the overhead cost, and this is applied as a percentage 

based on the direct labour cost. 

For direct labour costs, you have agreed that the labour expended for a unit in work in progress is half that 

of a completed unit. 

The draft accounts show the following materials and direct labour costs in inventory. 

Raw materials 

Work in progress 

Finished goods 

Materials ($) 

74,786

85,692

152,693

Direct labour ($) 

13,072

46,584

The costs incurred in April, as recorded in the financial accounting records, were as follows. 

$

Direct labour 

61,320

Selling costs 

43,550

Depreciation and finance costs of production machines 

4,490

Distribution costs 

6,570

Factory manager's wage 

2,560

Other production overheads 

24,820

Purchasing and accounting costs relating to production 

5,450

Other accounting costs 

7,130

Other administration overheads 

24,770

For your calculations assume that all work in progress and finished goods were produced in April 20X5 

and that the company was operating at a normal level of activity. 

Required

Calculate the value of overheads which should be added to work in progress and finished goods in 

accordance with IAS 2 Inventories.

Note. You should include details and a description of your workings and all figures should be calculated to 

the nearest $. 

Answer

Calculation of overheads for inventory 

Production overheads are as follows. 

$

Depreciation/finance costs

4,490

Factory manager's wage

2,560

Other production overheads

24,820

Accounting/purchase costs

  5,450

37,320

Direct labour = $61,320 

 Production overhead rate =  

61,320

37,320

  =   60.86% 

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