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 • Inventory basics I t b i • 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 Class Cl assifi ifi ifica i cati t ti tion i on of f f f an an I I Inven nventory t ory IAS 2 6 IAS 2.6 Inventories are assets: a.) held for sale in the ordinary course of ) h ld f l i th di f business; b.) in the process of production for sale; or b ) i th f d ti f l 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 Net R N t R N t t Rea R eali li liza zabl bl V l ble V l V l 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 amount for which the same inventory t f hi h th i t 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 Major M j or R R R Requ equiremen i rements of IAS 2 t f IAS 2 f IAS 2 f IAS 2 • Measurement of Inventory M t f I t • Limited Costing Methods • Writing-down Inventory • Reversal of Write-downs Reversal of Write downs • Product and Period Costs • Additional Disclosure Additi l Di l

IAS 2: Inventory Measuremen M M easurement t of I t f t f I f Inven nventory t ory IAS 2 9 IAS 2.9 • “Inventories shall be measured at the lower of Cost and Net Realizable Value”

IAS 2: Inventory Measuremen M M easurement t of I t f t f I f Inven nventory t ory In entor Inventory Cost Details Cost Details Historical cost $5,000 Market cost M k t t 2 000 2,000 Estimated selling price 4,000 Estimated costs to complete sale 1,000 Net realizable value 3,000 Normal profit margin – 45% 1,350 Net realizable value less PM $1,650

IAS 2: Inventory Inven I I nventory t t ory C C C Cos osti ti ting ng M Meth M M th d thods IAS 2 25 IAS 2.25 • “The cost of inventories…shall be assigned by using the first-in, first- out (FIFO) or weighted average cost formula.”

IAS 2: Inventory I I Inven nventory t t ory C C C Cos osti ting ti ng M Meth M th d M thods US GAAP US GAAP IAS 2 IAS 2 • Average Cost • Average Cost Method Method • First-In, First-Out • First-In, First-Out Method Method • Last-In, First-Out M th d Method

IAS 2: Inventory I I Inven nventory t t ory C C C Cos osti ti ting ng M Meth M th d M thods IAS 2 27 IAS 2.27 • “The FIFO formula assumes that the items of inventory that were purchased or produced first are sold first, and consequently the items ld fi t d tl th it 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 Writi W i W iti iting- ng-dow n d d ow n I I I Inven nventory t ory IAS 2 28 IAS 2.28 • “The cost of inventories may not be recoverable if those inventories are damaged, if they have b become wholly or partially obsolete, or if their h ll ti ll b l t if th i selling prices have declined. The cost of inventories may also not be recoverable if the estimated costs of completion or the estimated ti t d t f l ti th ti t d costs to be incurred to make the sale have increased. The practice of writing inventories down below cost to net realizable value is d b l t t t li bl l i consistent with the view that assets should not be carried in excess of amounts expected to be realized from their sale or use.” li d f th i l ”

IAS 2: Inventory W i W iti Writi iting- ng-dow n d d ow n I I I Inven nventory t ory Inventory Valuation under IAS 2 I t V l ti d IAS 2 • Inventory cost is valued at lower of: Historical Cost Historical Cost $5 000 $5,000 Net Realizable Value $3,000

IAS 2: Inventory W i W iti Writi iting- ng-dow n d d ow n I I I Inven nventory t ory Inventory Valuation under US GAAP I t V l ti d US GAAP • Inventory cost is valued at lower of Historical cost Historical cost $5 000 $5,000 Market cost $2,000

IAS 2: Inventory Reversa R R eversal l f l l of W f W it f Writ ite- e-dow ns d ow ns IAS 2.33 IAS 2 33 • “A new assessment is made of net realizable value in each subsequent period. When the circumstances that previously caused inventories i t th t i l d i t i to be written down below cost no longer exist or when there is clear evidence of an increase in net realizable value because of changed economic li bl l b f h d i circumstances, the amount of the write-down is reversed (i.e. the reversal is limited to the amount of the original write-down) so that the new f th i i l it d ) th t th carrying amount is the lower of the cost and the revised net realizable value”

IAS 2: Inventory R R Reversa eversal l l f l of W f W it f Writ ite- e-dow ns d ow 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 $3,000 to $4,000 $4 000 • Reversals are limited to the amount of the • Reversals are limited to the amount of the original write-down (IAS 2.33) – Original write down $2,000 – Reversal R l $1 000 $1,000

IAS 2: Inventory R R Reversa eversal l l f l of W f W it f Writ ite- e-dow ns d ow ns Inventory Valuation Differences Inventory Valuation Differences • Market Value increases from $2,000 to $3 000 to $3,000 • Under US GAAP, the value of U d US GAAP th l f 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 Pro P P roduc d d uct t t an and P d P d d Per P eriod C i i d C d Cos osts t Product Costs US GAAP P d t C t 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 P Pro roduc d d uct t an t and P d Per d d P P eriod C i d C i d Cos osts t Product costs in International Standards Prod ct costs in International Standards IAS 2.15 • “Other costs are included in the cost of “Oth t i l d d i th t f 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 Pro P P roduc d d uct t t an and P d P d d Per P eriod C i d C i d Cos osts t 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 P Pro roduc d d uct t t an and P d Per d P d P eriod C i d C i d Cos osts t 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 other 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