Acca f3 Financial Accounting (int) Study Text

146

8: Inventory   Part D  Recording transactions and events 

Inventory valuation

Raw

Finished

materials

WIP

goods

Total

  $

  $

  $

  $

Materials

74,786

85,692

152,693

313,171

Direct labour

–

13,072

46,584

59,656

Production overhead

 

 

 

 

   (at 60.86% of labour)

          –

    7,956

  28,351

  36,307

74,786

106,720

227,628

409,134

Variable overheads will be included in the cost of inventory. 

5.6 Net realisable value (NRV) 

As a general rule assets should not be carried at amounts greater than those expected to be realised from 

their sale or use. In the case of inventories this amount could fall below cost when items are 

damaged or 

become obsolete, or where the costs to completion have increased in order to make the sale. 

In fact we can identify the principal situations in which 

NRV is likely to be less than cost.

(a) An 

increase in costs or a fall in selling price

(b) A 

physical deterioration in the condition of inventory 

(c)

Obsolescence of products 

(d) 

A decision as part of the company's marketing strategy to manufacture and sell products at a 

loss

(e)

Errors in production or purchasing

A write down of inventories would normally take place on an item by item basis, but similar or related 

items may be 

grouped together. This grouping together is acceptable for, say, items in the same product 

line, but it is not acceptable to write down inventories based on a whole classification (eg finished goods) 

or a whole business. 

The assessment of NRV should take place 

at the same time as estimates are made of selling price, using the 

most reliable information available. Fluctuations of price or cost should be taken into account if they relate 

directly to 

events after the reporting period, which confirm conditions existing at the end of the period. 

The reasons why inventory is held must also be taken into account. Some inventory, for example, may be 

held to satisfy a firm contract and its NRV will therefore be the 

contract price. Any additional inventory of 

the same type held at the period end will, in contrast, be assessed according to general sales prices when 

NRV is estimated.

Net realisable value must be reassessed at the end of each period and compared again with cost. If the 

NRV has risen for inventories held over the end of more than one period, then the previous write down 

must be 

reversed to the extent that the inventory is then valued at the lower of cost and the new NRV. 

This may be possible when selling prices have fallen in the past and then risen again. 

On occasion a write down to NRV may be of such size, incidence or nature that it must be 

disclosed separately.

5.7 Recognition as an expense 

The following treatment is required 

when inventories are sold.

(a) The

 carrying amount is recognised as an expense in the period in which the related revenue is 

recognised

(b) 

The amount of any 

write-down of inventories to NRV and all losses of inventories are recognised 

as an expense in the period the write-down or loss occurs 

(c) 

The amount of any 

reversal of any write-down of inventories, arising from an increase in NRV, is 

recognised as a reduction in the amount of inventories recognised as an expense in the period in 

which the reversal occurs 

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Part D  Recording transactions and events

  8:  Inventory

147

Chapter Roundup 

 The 

cost of goods sold is calculated as: 

 

Opening inventory + purchases – closing inventory. 

Opening inventories brought forward in the inventory account are transferred to the trading account, and 

so at the end of the accounting year, the balance on the inventory account ceases to be the opening 

inventory value b/f, and becomes instead the closing inventory value c/f. 

 

The value of 

closing inventories is accounted for in the nominal ledger by debiting an inventory account 

and crediting the trading account at the end of an accounting period. The inventory will therefore always 

have a debit balance at the end of a period, and this balance will be shown in the statement of financial 

position as a current asset for inventories. 

 The 

quantity of inventories held at the year end is established by means of a physical count of inventory in 

an annual counting exercise, or by a 'continuous' inventory count. 

 The 

value of these inventories is then calculated, taking the lower of cost and net realisable value for 

each separate item or group of inventory items. 

 

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

Quick Quiz 

1 

When is an inventory account used?  

2 

How is closing inventory incorporated in the financial statements?  

A 

Debit: income statement 

Credit: statement of financial position 

B 

Debit: statement of financial position 

Credit: income statement 

3 

What is 'continuous' inventory counting?  

4 

An item of inventory was purchased for $10. However, due to a fall in demand, its selling price will be only 

$8. In addition further costs will be incurred prior to sale of $1. What is the net realisable value? 

 A $7 

 B $8 

 C $10 

 D 

$11 

5 

Why is inventory not valued at expected selling price?  

6 

When valuing inventory at historical cost, the following methods are available. 

(1) FIFO 

(2) AVCO 

(3) LIFO 

(4) Standard 

cost 

Which methods are allowable under IAS 2 Inventories?

A 

(1), (2), (3) 

B 

(1), (2), (3), (4) 

C (1) 

only 

D (1), 

(2) 

7 

What is included in the cost of purchase of inventories according to IAS 2?  

A 

Purchase price less trade discount 

B 

Purchase price plus transport costs less trade discount 

C 

Purchase price less import duties less trade discount 

D 

Purchase price plus import duties plus transport costs less trade discount 

8 

What type of costs should be recognised as an expense, not as part of the cost of inventory?

9 

What are the most likely situations when the NRV of inventories falls below cost?  

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