#1CAT CHARREDACCOUNTS OF AL CA THE INSTITUTE OF A CHARTERED ACCOUNTANTS OF SRI LANKA LKAS 2 Inventories STA Presented by: Priyoshini Fernando PricewaterhouseCoopers 10/31/2016 1#2CAT THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI LANKA Overview 1. Introduction - Scope & definitions 2. Recognition as an expense 3. Measurement 4. Disclosures Objective: Prescribe the accounting treatment for inventories CAT THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI LANKA Introduction - Scope & definitions . LKAS 2 applies to all inventories, except: (a) Work in progress under construction contracts (b) Financial instruments (c) Biological assets related to agricultural activity (d) Agricultural produce at point of harvest LKAS 2 applies to measurement of all inventories within scope, except : • • Agricultural and forest products, agricultural produce after harvest and minerals & mineral products to extent measured at net realizable value Inventories of commodity brokers measured at fair value less costs to sell. 10/31/2016 2#3CA T THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI LANKA Introduction - Scope & definitions Inventories are assets: (3) Held for sale in the ordinary course of business; (1) In the form of materials or supplies to be consumed in production process or in the rendering of services (2) In the process of production for such sale CAT THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI LANKA Recognition as an expense • Recognition When inventories are sold, the carrying amount of those inventories shall be recognized as an expense in the period in which the related revenue is recognized. The amount of any write-down of inventories to net realizable value (NRV) and all losses of inventories shall be recognized as an expense in the period the write-down or loss occurs. Reversal of any write-down of inventories, arising from an increase in NRV shall be recognized as a reduction in the amount of inventories recognized as an expense in the period in which the reversal occurs. 10/31/2016 3#4CAT THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI LANKA Measurement Inventories shall be measured at lower of cost and NRV Cost of inventories : (i) Purchase costs Purchase price Import duties and other taxes (other than those subsequently recoverable from taxing authorities) Transport, handling & other directly attributable costs Deductions: Trade discounts, rebates & other similar items (ii) Costs of conversion ➤ Costs directly related to units of production. E.g. Direct labor, production overheads (iii) Other costs Other costs directly attributable to bringing inventories to present location & condition CAT THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI LANKA Measurement Costs of conversion Variable production overheads Fixed production overheads Basis Actual use of production facilities Normal capacity of production facilities Costs excluded from the cost of inventories : (i) abnormal amounts of wasted materials, labor or other production costs; (ii) storage costs, unless those costs are necessary in the production process before a further production stage; (iii) administrative overheads that do not contribute to bringing inventories to their present location and condition (iv) selling costs 10/31/2016 4#5CAT THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI LANKA Measurement Which of the above cost categories do the following costs belong to : Cost Selling costs Direct labour Design of finished goods Storage costs not necessary in production process Import duties on raw materials Fixed production overheads Purchase of raw materials Abnormal wastage of material, labor & other production costs Administrative overheads not contributive to bringing inventories to present location & condition Cost Category CAT THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI LANKA Measurement Which of the above cost categories do the following costs belong to : Cost Selling costs Direct labour Design of finished goods Storage costs not necessary in production process Import duties on raw materials Fixed production overheads Purchase of raw materials Cost Category Excluded Costs of conversion Other costs Excluded Costs of purchase Costs of conversion Costs of purchase Excluded Abnormal wastage of material, labor & other production costs Administrative overheads not contributive to bringing inventories to present location & condition Excluded 10/31/2016 5#6CAT THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI LANKA Measurement Example - Allocation of Overheads The following example illustrates how to allocate overhead cost to inventory at normal capacity. The following is relevant information of entity A. Full capacity Normal capacity Actual labor hours for current period Total fixed production overhead Total variable production overhead 10,000 hours in a year 7,500 hours in a year 6,500 hours 1,500 CU Total opening inventory Total units produced in a year Total units sold in a year Total ending inventory 2,600 CU 2,500 units 6,500 units 6,700 units 2,300 units The total cost of inventories is assigned by using FIFO cost formula. Compute overhead amounts absorbed to ending inventory and recognized as an expense during the year. CAT THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI LANKA Measurement Fixed POAR: Total Fixed POH Normal capacity 1,500 CU 7,500 hours in a year 0.20 CU per hour Number of hours taken to produce each unit Actual hours for current period Total units produced in a year 6,500 hours in a year 6,500 units 1.00 hours per unit Total POH recognized absorbed per unit of inventory: - Variable POAR: Total Variable POH Actual hours 2,600 CU 6,500 hours in a year 0.40 CU per hour [0.20 CU per hour x 1 hour p.u.] + [0.40 CU per hour x 1 hour p.u.] 0.60 CU p.u. 10/31/2016 6#7CAT THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI LANKA Measurement Total ending inventory Total POH recognized as part of ending inventory Total fixed POH Total variable POH Total POH Absorbed to ending inventory Total POH recognized as an expense Reconciliation: Total fixed POH Absorbed fixed POH Fixed production OAR 2,300 Units 1,380 CU 1,500 CU 2,600 CU 4,100 CU (1,380) CU 2,720 CU 1,500 CU Actual hours for year Unabsorbed fixed POH ---- (1) Absorbed total POH Total POAR Units sold from during year production CAT THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI LANKA Measurement Cost formulas: 0.20 CU/hour 6,500 hours 1,300 CU 200 CU 0.60 CU/unit 4,200 units 2,520 CU 2,720 CU (i) Specific identification Specific costs are attributed to identified items of inventory (ii) First In First Out (FIFO) Assumes oldest inventories are used up first, so that the cost attached to those items still held at the balance sheet date is at the most recent cost incurred. (iii) Weighted Average Cost Cost is based on an average price computed by dividing the total cost of units by the total number of such units. 10/31/2016 7#8CAT THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI LANKA Measurement 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 above, shall be assigned by using the 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 CAT THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI LANKA Measurement Scenario 1: Pencil Company Ltd manufactures pencils and produced the following brushes in the period: three units at a cost of Rs 20/- each, then five units at Rs 30/- and a final batch of four at Rs 40/- p.u. There are six units left at balance sheet date. Calculate the cost of inventory using the following cost formula: (i) FIFO (ii) Weighted Average (iii) LIFO 10/31/2016 8#9CAT THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI LANKA Measurement Solution: (i) FIFO (2 units at Rs 30 p.u.) + (4 units at Rs 40 p.u.) = Rs 220/- (ii) Weighted Average Cost: (3 units at Rs 20 p.u.) + (5 units at Rs 30 p.u.) + (4 units at Rs 40 p.u.) = Rs 30.83 p.u. 12 units Six pencils remain: 6 units at Rs 30.83 p.u. = Rs 185/- (iii) LIFO : (3 units at Rs 20 p.u.) + (3 units at Rs 30 p.u.) = Rs 150 / - CAT THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI LANKA Measurement Net Realizable Value Net realizable value is the estimated selling price in the ordinary course of business less estimated costs of completion and the estimated costs necessary to make the sale Evaluation of net realizable vale is critical if inventories - (1) are damaged, (2) have become wholly or partially obsolete, (3) selling prices have declined, or (4) if the estimated costs of completion or the estimated costs to be incurred to make the sale have increased. 10/31/2016 9#10CAT THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI LANKA Measurement Does NRV and fair value have the same meaning? No; 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. (See IFRS 13 Fair Value Measurement.) NRV refers to the net amount that an entity expects to realize from the sale of inventory in the ordinary course of business. Therefore, NRV is an entity-specific value. NRV for inventories may not equal fair value less costs to sell. CAT THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI LANKA Measurement Scenario 2: Per unit details relating to item A is as follows. What would be the valuation of inventory of item A? Cost Selling price Rs 900/ - Rs 1,200/- Estimated modification cost to enable sale Rs 300/- Estimated marketing costs Rs 200/- Units held 150 10/31/2016 10#11CA THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI LANKA Measurement Solution: Cost Rs 900/ - p.u. Selling price Less: Estimated modification costs to enable sale Less: Estimated marketing costs NRV Lower of cost and NRV = NRV = Rs 700 /- p.u. Number of units = 150 units at Rs 700/- p.u. = Rs 105,000/- CAT THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI LANKA Measurement Rs p.u. 1,200 (300) (200) 700/- Disclosures include the following: ➤ Accounting policy Statement of Financial Position (SoFP) (i) Carrying amount of inventories (on face of SoFP) (ii) Analysis of inventories by classification Statement of Comprehensive Income (i) Cost of inventories expensed in period ➤ Other 10/31/2016 11#12CAT THE CHARTERED OF L THANK YOU 10/31/2016 12