Lecture Note on Inventories (IAS 2)

Definition of inventory
The nature of inventories varies depending on the type of business. Generally, inventories are stocks of
finished goods, raw materials, work in progress or materials or supplies to be consumed in the production
process or in the rendering of services.

There are two main methods of recording inventory so as to allow the calculation of cost of sales. There
are:
Periodic inventory system (period end system)
Perpetual inventory system

A perpetual inventory system is constantly updated as each sale/order happens. A periodic inventory
system is updated manually after each accounting period.

Inventory cards
This is a ledger card (bin card).that is used to record the receipts and issues of inventory on a daily weekly
or monthly basis. In modern systems the card might be a computer record.

Example: Inventory ledger card

On1January a company had an opening inventory of 100 units.
During the month it made the following purchases:
5 April: 300 units
14 July: 500 units
22 October: 200 units
During the period it sold 800 units as follows:
9 May: 200 units
25 July: 200 units
23 November: 200 units
12 December: 200 units
Show each of these on an inventory ledger card

Inventory counts (Stock takes)

A stock take is a physical verification of the amount of inventory that a business has. Each item of inventory
is counted and entered onto inventory sheets. The inventory counted can then be valued. After the stock
taking, the actual physical quantity of inventory has to be compared with the records. Any difference
should be investigated. Possible causes of difference between the balance on the inventory account and
the physical inventory counted include the following.
– Theft of inventory.
– Damage to inventory with failure to record that damage.
– Mis-posting of inventory receipts or issues (for example posting component A as component B).
– Failure to record a receipt.
– Failure to record an issue.

Stock takings falls into two systems:

Periodic inventory systems
Inventory counts are done at the end of each period being recognized in the system of accounts.

Perpetual inventory systems

Inventory counts are done after every issue or receipt.

Disclosure requirements for inventory

IAS 2 requires the following disclosures in notes to the financial statements.
▪ The accounting policy adopted for measuring inventories, including the cost measurement method used.
▪ The total carrying amount of inventories, classified appropriately. (For a manufacturer, appropriate
classifications will be raw materials, work-in - progress and finished goods.)
▪ The amount of inventories carried at net realizable value or NRV.
▪ The amount of inventories written down in value, and so recognized as an expense during the period.
▪ Details of any circumstances that have led to the write-down of inventories to NRV.
▪ The amount of any reversal of any write-down that is recognized as a reduction in the amount of
inventories recognized as expense in the period.
▪ The circumstances or events that led to the reversal of a write-down of inventories.

MEASUREMENT OF INVENTORY
IAS 2 requires that inventory must be measured in the financial statements at the lower of:
– cost, or
– net realisable value (NRV).

The standard gives guidance on the meaning of each of these terms as follows:

(a) Cost of inventories

IAS2 states that ‘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.
Purchase cost
The purchase cost of inventory will consist of the following:
– The purchase price
– Plus import duties and other non-recoverable taxes (but excluding recoverable sales tax)
– Plus transport, handling and other costs directly attributable to the purchase (carriage inwards), if these
costs are additional to the purchase price.
The purchase price excludes any settlement discounts and is the cost after deduction of trade discount.

Illustration on Purchase cost of Inventory

ABC Plc buys goods from an overseas supplier. It has recently taken delivery of 1,000 units of component
X. the quoted price of component X was N1200 per unit, but ABC Plc has negotiated a trade discount of
5% due to the size of the order.
The supplier offers an early settlement discount of 2% for payment within 30 days and KCE intends to
achieve this. Import duties of N60 per unit must be paid before the goods are released through custom.
Once the goods are released through customs ABC Plc must pay a delivery cost of N5,000 to have the
component taken to its warehouse.
Show the cost of the inventory.

Conversion costs
When materials purchased from suppliers are converted into another product in a manufacturing or
assembly operation, there are also conversion costs to add to the purchase costs of the materials.
Conversion costs must be included in the cost of finished goods and unfinished work in progress.
Conversion costs consist of:
– costs directly related to units of production, such as costs of direct labour (i.e. the cost of the labour
employed to perform the conversion work)
– fixed and variable production overheads, which must be allocated to costs of items produced and closing
inventories.
– other costs incurred in bringing the inventories to their present location and condition.
– costs of indirect labour, including the salaries of the factory manager and factory supervisors
– depreciation costs of non-current assets used in production
– costs of carriage inwards, if these are not included in the purchase costs of the materials

Note: Only production overheads are included in costs of finished goods inventories and work-in-progress.
Administrative costs and selling and distribution costs must not be included in the cost of inventory.

(b) Net realisable value

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
Net realisable value is the amount that can be obtained from selling the inventory in the normal course
of business, less any further costs that will be incurred in getting it ready for sale or disposal.

Illustration on the measurement of Inventory

A business has four items of inventory. Account of the inventory has established that the amounts of
inventory currently held, at cost, are as follows:

Cost Sales price Selling costs

Inventory item A 8,000 7,800 500
Inventory item B 14,000 18,000 200
Inventory item C 16,000 17,000 200
Inventory item D 6,000 7,500 150
Show how each component of the inventory should be valued in the statement of financial position

INVENTORY VALUATION
With some inventory items, particularly large and expensive items, it might be possible to recognise the
actual cost of each item. In practice, however, this is unusual because the task of identifying the actual
cost for all inventory items is impossible because of the large numbers of such items.
A system is therefore needed for measuring the cost of inventory. The historical cost of inventory is usually
measured by one of the following methods:
First in, first out (FIFO)
Weighted average cost (AVCO)
Last in, first out (LIFO)
It is important to note that IAS 2 does not support the Last in, first out (LIFO) method of inventory
valuation.
(1) FIFO:
This method operates with the assumption that inventory received first are the first to be issued. This
implies that issues (sales) are valued at the price of the oldest batch, until all units of that batch have been
exhorted then the price of the next oldest batch is used and so on.
2. LIFO:
This method operates with the assumption that inventory received last are the first to be issued. This implies
that issues are valued at the price of the latest batch, until all units in that batch have been exhausted, then
the price of the next latest batch is used and so on.

3. Weighted Average Price Method (WAP)

This method operates with the assumption that issues are valued at a weighted average price, obtained by
dividing the value f inventory at hand by the units of inventory at hand at hand. Issues price will only change
when a new batch is received, and a new weighted average recalculated. This implies that a new weighted
Average Price is calculating each time a new batch is received.

Illustration I:
Below are the details of purchases and sales material for ABC Ltd for the month of January, 2016.
January 2 purchased 40,000 kilos at N300 per kilo
5 purchased 10,000 kilos at N400 per kilo
12 purchased 24,000 kilos at N500 per kilo
16 sold 48,000 kilos at N600 per kilo
19 purchased 34,000 at N450 per kilo
26 sold 40,000 kilos at N580 per kilo
Required
Using the above data, ascertain the units and values of closing inventory at 31st January 2016 and prepare
the statement of profit or loss for the month using

a. First-in-first-out (FIFO) method.

b. Last-in-first-out (LIFO) method.
c. Weighted average cost method.

Assignment 1
On 1st January, 20x4, CHI Plc had opening inventories of 34,000 units at a weighted average cost of ₦11
per unit, and made the following purchases during 20x4
Date of purchase Number of units cost per unit (₦) Total cost (₦)
1 January 18,000 10 180,000
1 March 17,000 12 204,000
1 May 10,000 16 160,000
1 June 19,000 14 266,000
1 September 13,000 15 195,000
1 November 9,000 20 180,000
1 December 10,000 15 150,000
Total 96,000 1,335,000
The units of unsold goods (i.e. closing inventory) as at 31 December, 20x4 were 30,000 units.
Required
Determine the unit and value of closing inventory as at 31 December, 20x4, and prepare the statement of
profit or loss for the month:

a. Using weighted average cost method.

b. Using first-in-first-out (FIFO) method.
c. Using first-in-first-out (LIFO) method.

Assignment 2
On 1 January, 2025 a company had an opening inventory of 100 units which cost N50 each. During the
month it made the following purchases:
5 April: 300 units at N60 each
14 July: 500 units at N70 each
22 October: 200 units at N80 each.
During the period it sold 800 units as
follows: 9 May: 200 units
25 July: 200 units
23 November: 200 units
12 December:200 units

Determine the unit and value of closing inventory as at 30 January, 20x5, and prepare the statement of
profit or loss for the month:

1. Using weighted average cost method.

2. Using first-in-first-out (FIFO) method.
3. Using first-in-first-out (LIFO) method.