IAS 2: Inventory IAS 2: Inventory (Students names removed) IAS 2: - - PDF document

IAS 2: Inventory IAS 2: Inventory

(Students’ names removed)

IAS 2: Inventory

Agenda Agenda

I t b i

• Inventory basics
• Major requirements of IAS 2
• Similarities and Differences to US

GAAP

• Measurement example
• Comparison to US GAAP
• Comparison to US GAAP
• Ratio Analysis
• Conclusion

IAS 2: Inventory

Cl ifi t i ti f i f I t Cl Class assifi ifica cati tion

• n of

f an an I Inven nventory

• ry

IAS 2 6 IAS 2.6 Inventories are assets: ) h ld f l i th di f a.) held for sale in the ordinary course of business; b ) i th f d ti f l b.) in the process of production for sale; or c.) in the form of materials or supplies to be consumed in the production process or in consumed in the production process or in the rendering of services”

IAS 2: Inventory

N t N t R R li bl V l l V l Net R t Rea eali liza zabl ble V Value ue

IAS 2 7 IAS 2.7

• “Net realisable value refers to the net

amount that an entity expects to realise amount that an entity expects to realise from the sale of inventory in the ordinary course of business. Fair Value reflects the t f hi h th i t amount for which the same inventory could be exchange between knowledgeable and willing buyers and g g y sellers in the marketplace. The former is an entity-specific value; the latter is not. Net realisable value for inventories may not realisable value for inventories may not equal fair value less costs to sell”

IAS 2: Inventory

Terms erms

• Net realizable value

Net realizable value

– Estimated Selling Price less estimated costs of completion and necessary to make the sale.

• Historical cost
• Historical cost

– The cash equivalent price of goods or services at the date of acquisition

• Market value

– “Replacement cost”

• The cost that would be required to replace an existing asset
• Fair Value

– Is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction.

IAS 2: Inventory

M j R R i t f IAS 2 f IAS 2 Major

• r R

Requ equiremen rements of IAS 2 f IAS 2

M t f I t

• Measurement of Inventory
• Limited Costing Methods
• Writing-down Inventory
• Reversal of Write-downs

Reversal of Write downs

• Product and Period Costs

Additi l Di l

• Additional Disclosure

IAS 2: Inventory

M t M t f f I t Measuremen easurement t of I f Inven nventory

• ry

IAS 2 9 IAS 2.9

• “Inventories shall be measured at the

lower of Cost and Net Realizable Value”

IAS 2: Inventory

M t M t f f I t Measuremen easurement t of I f Inven nventory

• ry

In entor Cost Details Inventory Cost Details Historical cost M k t t $5,000 2 000 Market cost 2,000 Estimated selling price Estimated costs to complete sale 4,000 1,000 Net realizable value Normal profit margin – 45% 3,000 1,350 Net realizable value less PM $1,650

IAS 2: Inventory

I t I t C C ti M M th d Inven nventory

• ry C

Cos

• sti

ting ng M Meth thods

IAS 2 25 IAS 2.25

• “The cost of inventories…shall be

assigned by using the first-in, first-

• ut (FIFO) or weighted average cost

formula.”

IAS 2: Inventory

I t I t C C ti M M th d Inven nventory

• ry C

Cos

• sti

ting ng M Meth thods US GAAP IAS 2 US GAAP

• Average Cost

IAS 2

• Average Cost

Method Method

• First-In, First-Out

Method

• First-In, First-Out

Method

• Last-In, First-Out

M th d Method

IAS 2: Inventory

I t I t C C ti M M th d Inven nventory

• ry C

Cos

• sti

ting ng M Meth thods

IAS 2 27 IAS 2.27

• “The FIFO formula assumes that the items of

inventory that were purchased or produced first ld fi t d tl th it are sold first, and consequently the items remaining in inventory at the end of the period are those most recently purchased or produced.”

• “Under the weighted average cost formula, the

cost of each item is determined from the weighted cost of each item is determined from the weighted average of the cost of similar items at the beginning of a period and the cost of similar items purchased or produced during the period.” purchased or produced during the period.

IAS 2: Inventory

W i W iti d I d I t Writi iting- ng-dow n

• w n I

Inven nventory

• ry

IAS 2 28 IAS 2.28

• “The cost of inventories may not be recoverable if

those inventories are damaged, if they have b h ll ti ll b l t if th i become wholly or partially obsolete, or if their selling prices have declined. The cost of inventories may also not be recoverable if the ti t d t f l ti th ti t d estimated costs of completion or the estimated costs to be incurred to make the sale have

• increased. The practice of writing inventories

d b l t t t li bl l i down below cost to net realizable value is consistent with the view that assets should not be carried in excess of amounts expected to be li d f th i l ” realized from their sale or use.”

IAS 2: Inventory

W i W iti d I d I t Writi iting- ng-dow n

• w n I

Inven nventory

• ry

I t V l ti d IAS 2 Inventory Valuation under IAS 2

• Inventory cost is valued at lower of:

Historical Cost $5 000 Historical Cost $5,000 Net Realizable Value $3,000

IAS 2: Inventory

W i W iti d I d I t Writi iting- ng-dow n

• w n I

Inven nventory

• ry

I t V l ti d US GAAP Inventory Valuation under US GAAP

• Inventory cost is valued at lower of

Historical cost $5 000 Historical cost $5,000 Market cost $2,000

IAS 2: Inventory

R l R l f f W it d Reversa eversal l of W f Writ ite- e-dow ns

• w ns

IAS 2 33 IAS 2.33

• “A new assessment is made of net realizable

value in each subsequent period. When the i t th t i l d i t i circumstances that previously caused inventories to be written down below cost no longer exist or when there is clear evidence of an increase in net li bl l b f h d i realizable value because of changed economic circumstances, the amount of the write-down is reversed (i.e. the reversal is limited to the amount f th i i l it d ) th t th

• f the original write-down) so that the new

carrying amount is the lower of the cost and the revised net realizable value”

IAS 2: Inventory

R l R l f f W it d Reversa eversal l of W f Writ ite- e-dow ns

• w ns

Changes in Values Changes in Values

• NRV increases from $3,000 to $4,000

Under IAS 2, $1,000 of original write-down may be recovered to bring NRV up from $3 000 t $4 000 $3,000 to $4,000

• Reversals are limited to the amount of the
• Reversals are limited to the amount of the
• riginal write-down (IAS 2.33)

– Original write down $2,000 R l $1 000 – Reversal $1,000

IAS 2: Inventory

R l R l f f W it d Reversa eversal l of W f Writ ite- e-dow ns

• w ns

Inventory Valuation Differences Inventory Valuation Differences

• Market Value increases from $2,000

to $3 000 to $3,000 U d US GAAP th l f

• Under US GAAP, the value of

Inventory is $2,000 even though the new market value is $3 000 new market value is $3,000

– No adjustment is made Reversal is prohibited – Reversal is prohibited

IAS 2: Inventory

P d P d t d d P i P i d C t Pro roduc uct t an and P d Per eriod C d Cos

• sts

P d t C t US GAAP Product Costs US GAAP

• US GAAP only allows the following

three cost elements to be assigned to products for external financial reporting:

– Direct materials – Direct labor – Manufacturing overhead

IAS 2: Inventory

P d P d t d d P i P i d C t Pro roduc uct t an and P d Per eriod C d Cos

• sts

Prod ct costs in International Standards Product costs in International Standards IAS 2.15 “Oth t i l d d i th t f

• “Other costs are included in the cost of

inventories only to the extent that they are incurred in bringing inventories to their incurred in bringing inventories to their present location and condition. For example, it may be appropriate to include p , y pp p non-production overheads or the costs of designing products for specific customers in the cost of inventories.”

IAS 2: Inventory

P d P d t d d P i P i d C t Pro roduc uct t an and P d Per eriod C d Cos

• sts

Product Costs in International Standards Product Costs in International Standards

• Cost elements of Inventory

– Direct materials Direct materials – Direct labor – Manufacturing Overhead – Research and Development – Designing a product

• Under US GAAP developmental costs are

recorded in separate asset account: Research and Development

IAS 2: Inventory

P d P d t d d P i P i d C t Pro roduc uct t an and P d Per eriod C d Cos

• sts

Period Costs Period Costs IAS 2.16

• “Examples of costs excluded from the cost of

inventories and recognized as expenses in the period in which they are incurred are: (a) Abnormal amounts of wasted materials, labor or

• ther production costs; (b) Storage costs, unless

those costs are necessary in the production process before a further production stage; (c) p p g ( ) Administrative overheads that do not contribute to bringing inventories to their present location and condition; and (d) Selling costs.” ( ) g

IAS 2: Inventory

P d P d t d d P i P i d C t Pro roduc uct t an and P d Per eriod C d Cos

• sts

Period Costs Period Costs

• Under US GAAP the following are included

in product costs

– Abnormal amounts of wasted materials, labor,

• r other production costs

– Storage costs, unless those costs are g necessary in the production process before a further production stage

• Under IAS 2, these costs are excluded

from inventory and recognized as period expenses expenses

IAS 2: Inventory

Additi Additi l Di l Di l Additi Additiona

• nal Di

l Disc sclosure

• sure

IAS 2.36 IAS 2.36 The financial statements shall disclose:

(a) The accounting policies adopted in measuring inventories, including the cost formula used; (b) The total carrying amount of inventories and the carrying amount in ( ) y g y g classifications appropriate to the entity; (c) The carrying amount of inventories carried at fair value less costs to sell; (d) The amount of inventories recognized as an expense during the period; period; (e) The amount of any write-down that is recognized as a reduction in the amount of inventories recognized as expense in the period in the period; (f) The amount of any reversal of any write-down that is recognized as a ( ) y y g reduction in the amount of inventories recognized as expense in the period; (g) The circumstances or events that led to the reversal of a write-down

• f inventories; and

(h) The carrying amount of inventories pledged as security for liabilities (h) The carrying amount of inventories pledged as security for liabilities

IAS 2: Inventory

Additi Additi l Di l Di l Additi Additiona

• nal Di

l Disc sclosure

• sure

US GAAP Similarities US GAAP Similarities The financial statements shall disclose:

(a) The accounting policies adopted in measuring inventories, including the cost formula used; (b) The total carrying amount of inventories and the carrying amount in ( ) y g y g classifications appropriate to the entity; (c) The carrying amount of inventories carried at fair value less costs to sell; (d) The amount of inventories recognized as an expense during the period; period; (e) The amount of any write-down that is recognized as a reduction in the amount of inventories recognized as expense in the period in the period; (f) The amount of any reversal of any write-down that is recognized as a ( ) y y g reduction in the amount of inventories recognized as expense in the period; (g) The circumstances or events that led to the reversal of a write-down

• f inventories; and

(h) The carrying amount of inventories pledged as security for liabilities (h) The carrying amount of inventories pledged as security for liabilities

Designer Jeans Company

Historical cost 100,000 $ M k t t 80 000 $ 20 000 Diff

Designer Jeans Company

Market cost 80,000 $ 20,000 Difference Estimated selling price 88,000 $ Estimated costs to complete sale 5,000 $ Net realizable value 83,000 $ 17,000 Difference Normal profit margin - 15% 12 450 $ Normal profit margin - 15% 12,450 $ Net realizable value less PM 70,550 $ I AS I nventory 8 3 ,0 0 0 $ US GAAP I nventory 8 0 ,0 0 0 $ y , $ US GAAP Price Ceiling 83,000 $ US GAAP Price Floor 70,550 $

IAS 2: Inventory

Adj Adj t d C d C t Adj Adjus usted C d Cos

• sts
• US Inventory cost is valued at lower of:
• US Inventory cost is valued at lower of:

Historical cost $100,000 or M k t t $80 000 Market cost $80,000 IAS Inventory cost is valued at lower of:

• IAS Inventory cost is valued at lower of:

Historical cost $100,000 or $ Net realizable value $83,000 Eff t fi i l t t t

• Effects financial statements

IAS 2: Inventory

R l R l Reversa eversal

Change in Market Cost

• Change in Market Cost

Old Market cost $80,000 New Market cost $90,000

• Change in Net Realizable Value

Old Net realizable value $83 000 Old Net realizable value $83,000 New Net realizable value $93,000

*Within the same period of write-down

IAS 2: Inventory

M t M t Measuremen easurement

U d IAS 2 th hi t i l t f

• Under IAS 2, the historical cost of

inventory is used in applying the l f t NRV th ti lower of cost or NRV over the entire period the inventory is held.

• Under US GAAP, the inventory write-

y down at the end of the period is the new cost used in applying the lower pp y g

• f cost or market rule.

IAS 2: Inventory

R l R l Reversa eversal

US i t i d t l f

• US inventory is measured at lower of:

– Historical Cost $80,000 or – Market Cost $90,000

• IAS inventory is measured at lower
• f:

– Historical Cost $100,000 or – Net Realizable Value $93,000 Net Realizable Value $93,000

IAS 2: Inventory

IAS 2: Inventory

C l C l i Conc

• nclus

usion

• n

M j i t f IAS 2 Major requirements of IAS 2:

• Measurement of Inventory
• Limited Costing Methods
• Writing-down Inventory

Writing down Inventory

• Reversal of Write-downs

P d t d P i d C t

• Product and Period Costs
• Additional Disclosure

Question and Answ er Session