Exercise for accounting inventories free download pdf

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Banking Order Processing Multiple Price Level This represents the payments an entity makes on account of inventories and not the payments it receives from customers. For a service provider, inventories may simply be classified as work in progress. The classifications chosen should be applied consistently. Some companies will adopt a classification of expenses according to the nature of the expense and others will choose to present expenses based on their function.

Either method of presentation is permitted by IAS 1. For example, an entity that adopts the 'nature of expense' approach would disclose wages of factory employees as staff costs, but one that adopts the 'function of expense' approach would disclose such wages as part of cost of sales. The amount recognised as an expense in respect of inventories should also include unallocated production overheads and abnormal amounts of production costs of inventories.

The standard also notes that in some specific circumstances of an entity other costs, such as distribution costs, may also be included. Thus they would disclose the cost of raw materials and consumables, labour costs and other operating costs, together with the amount of the net change in inventories for the period.

IAS 1 revised is dealt with in chapter 4. Practical application Publication date: 07 Oct Practical application - Sale and repurchase of inventories Copyright protected - see copyright notice s within the document. It gives an example of a sale of goods where the seller, at the same time, enters into a separate contract to repurchase the goods at a later date.

It states that this negates the substantive effect of the transaction and, in such a case, the two transactions are dealt with together. In a more complicated situation, inventory may be sold with an option rather than an unconditional contract to buy it back. The detailed terms of such options vary and, indeed, the options may sometimes be expressed at market value such that it is by no means certain that the options will be exercised.

Perhaps more commonly, however, the option is constructed so that it is reasonably certain that it will be exercised. The arrangement may run for months, or even years, during which time the company that sold the inventory will use the sale proceeds as a form of finance.

In such a situation, there is an overriding requirement in IAS 8 to develop policies that ensure that the financial statements " However, a transaction structured so that in practice the purchaser secures a lender's return on the purchase price without genuine exposure to, or benefit from, changes in value of the underlying assets for example, if the repurchase price is predetermined as original sale price plus an increment based on interest rates applied to the finance provided , should be treated as a financing arrangement.

When the seller has retained the risks and rewards, even if legal title has been transferred, the transaction is a financing arrangement and does not give rise to revenue. Example — Accounting for an inventory financing arrangement A company sells inventory in year one for C, and at the same time enters into an agreement to repurchase it a year later for C, The C10, should not be treated as part of the cost of the inventory, but represents interest and should be charged to the profit and loss account.

The company should initially show in its balance sheet inventory of C, and a financing liability of C, Interest should be calculated using the effective interest method as set out in paragraph 9 of IAS This means that the interest is charged at a constant rate on the carrying value of the liability.

If, for example, the buyer receives more than merely a lender's return, as significant other benefits and risks associated with the asset have been transferred to the buyer, the seller will not have retained the original asset. In this situation, and if the likelihood of the repurchase commitment being called upon is not probable, the asset should be derecognised. Such situations are particularly common in the automotive industry where the seller is a manufacturer or dealer and like many others in that industry it sells vehicles with a buy back commitment of short duration.

In such a situation the treatment adopted is to retain the vehicle in its entirety in the balance sheet and treat the transaction as a short term operating lease during the buyback commitment period. The objective of both parties to a consignment arrangement is to enable the dealer to sell as many units of the product as possible. The dealer is often given some incentive by the manufacturer through various bonus schemes to ensure that the volume of items sold is as high as possible.

The consignment arrangement serves to achieve this objective and benefit both parties. This may be when the dealer sells the goods or has held them for a set period, or some other event triggers the dealer's adoption of the goods that is, when he pays for them and acquires title.

But the date that title transfers tends to be some time after the date that the inventory item is physically transferred to the dealer. Title will generally pass on receipt of cleared funds but not to the dealer if he has already sold the vehicle on. It states that where the recipient of the goods buyer undertakes to sell goods on behalf of the shipper seller , revenue is recognised by the shipper when the goods are sold by the recipient to a third party.

The Copyright protected - see copyright notice s within the document. Paragraph 10 of IAS 8 requires that in the absence of a standard or an interpretation that specifically applies to a transaction, other event or condition, management should use its judgement in applying accounting policies that result in information that satisfies the qualitative characteristics of the IASB's Framework.

These characteristics include reflecting the economic substance of transactions and not merely the legal form. IAS 8, sets out a hierarchy of guidance to which management refers and whose applicability it considers when selecting accounting policies. IAS 8, specifically requires that in making the judgement in selecting accounting policies, management should consider the applicability of the requirements in IFRS dealing with similar and related issues. For example, the following questions have to be answered to determine whether an asset can be derecognised: 1.

Have the rights to the cash flows from the asset expired? Has the entity transferred its contractual rights to receive the cash flows from the asset?

Has the entity assumed an obligation to pay the cash flows from the assets to another party? Has the entity transferred substantially all the risks and rewards? Has the entity relinquished control of the asset?

If the manufacturer no longer has rights to the cash flows from the asset question 1 then it could derecognise the asset. Similarly, it could derecognise the asset if it can answer yes to questions 2 and 4 or to questions 3 and 4. If the manufacturer retains some of the risks and rewards, it can only derecognise the asset if it no longer controls the asset. Example — Manufacturer supplies goods to a distributor on a consignment basis A distributor purchases clothes from a manufacturer on extended credit and stores the goods in its own warehouse until they are sold to a third party.

Legal title to the goods passes to the distributor when the distributor receives them. The distributor does not have to pay for the goods until it receives payment from the third party customer. If the clothes are not sold within three months, the distributor can either return them to the manufacturer or pay for them and keep them. Until it is known that the goods have been sold whether to a third party or to the distributor after three months , the goods should be treated as the manufacturer's inventory, that is, consignment inventory, and excluded from the distributor's balance sheet.

Arrangements where a manufacturer supplies goods to a distributor on consignment are common in certain industries. These arrangements enable the dealer to maximise sales. The manufacturer usually retains title to the product and thereby substantial risks and rewards until triggered by some event when title is transferred. IFRS Manual of Accounting » 20 - Inventories IAS 2 Global the most recent pronouncements of other standard-setting bodies that use a similar conceptual framework to develop accounting standards.

Practical application - Financial instruments Publication date: 07 Oct Commodity price risk arises where an entity enters into a contract to purchases a commodity whose price varies.

Foreign exchange risk arises where the entity pays for the inventory in a foreign currency. If the contract is entered into and continues to be held for the purpose of the delivery of the commodity in accordance with the entity's expected purchase or usage requirements, the entity does not recognise the forward contract as a derivative.

If the entity has a practice of settling net either with the counterparty or by entering into offsetting contracts or by taking delivery of the commodity and selling it within a short period after delivery for the purpose of generating a profit from short term fluctuations in price or dealer's margin , then the forward contract will have to be recognised as a derivative.

This is because such a contract to buy or sell non-financial items for example, inventory would be within the scope of IAS In practice many contracts to buy or sell a commodity fall within IAS 39's scope. See further chapter 6. Example 1 — Own use exemption for a contract to buy a commodity An entity enters into a fixed-price forward contract to purchase one million kilograms of iron ore in accordance with its expected usage requirements. The contract permits the entity to take physical delivery of the iron ore at the end of 12 months or to pay or receive a net settlement in cash, based on the change in iron ore's fair value.

If the entity intends to settle the contract by taking delivery and has no history for similar contracts of settling net in cash or of taking delivery of the iron ore and selling it within a short period after delivery for the purpose of generating a profit from short-term fluctuations in price or dealer's margin the contract is not recognised as a derivative under IAS 39, even though it meets the definition of a derivative.

Instead, it is considered an executory contract. The definition of and accounting for derivatives is dealt with in chapter 6. Example 2 — Practice of net settlement for forward contracts to purchase oil held as inventory An entity enters into a forward contract to purchase oil.

The entity has an established pattern of settling such contracts net before delivery by contracting with a third party. The entity settles any market value difference for the contract price directly with the third party. IAS 39 applies to a contract to purchase a non-financial asset if the contract meets the definition of a derivative and the contract does not qualify for the exemption for delivery in accordance with the entity's expected purchase or usage requirements.

The entity does not expect to take delivery. A pattern of entering into offsetting contracts that effectively accomplishes settlement on a net basis means that the transaction does not qualify for the exemption for delivery in accordance with the entity's expected purchase or usage requirements.

In effect, the contract is a host contract to purchase inventory and a swap or forward contract to exchange one currency for another an embedded derivative. Embedded derivatives are considered in chapter 6. Where the criteria in paragraph 88 of IAS 39 are met, an entity is permitted to account for the hedging instrument using hedge accounting. The criteria are dealt with in chapter 6.

This is because the purchase of inventory can either be a highly probable forecast transaction or an unrecognised firm commitment. A hedge of the foreign currency risk of a highly probable forecast transaction would be designated as a cash flow hedge.

A hedge of the foreign currency risk of a firm commitment may be accounted for as a fair value hedge or as cash flow hedge. The ineffective portion of the gain or loss on the hedging instrument is recognised in profit or loss.

Any losses that are deemed irrecoverable should be recognised in profit or loss immediately. However, it is not possible to hedge a particular ingredient or component of an item of inventory, because changes in price of the ingredient generally do not have a predictable, separately measurable effect on the price of the inventory.

For this reason, an inventory can only be designated as a hedged item in its entirety for all risk or for foreign currency risk. For example, inventories of manufactured tyres cannot be hedged for changes in the price of rubber, because the tyre includes other components and the change in fair value of rubber is not necessarily representative of the change in fair value of the tyre.

For further guidance on measurement of fair value, see chapter 5. Practical application - Reservation of title Publication date: 07 Oct This enables the selling company to retain legal ownership of those goods until the purchaser has paid for them. The main effect of trading with reservation of title is that the position of the unpaid seller may be improved if the purchaser becomes insolvent. However, whether an effective reservation of title exists depends upon the construction of the particular contract.

The liability to the supplier is also recognised. However, the Framework emphasises that to represent faithfully transactions and events it is necessary that they are accounted for in accordance with their substance and economic reality and not merely their legal form.

However, in practice, this note is often not given where the purchasing company is a going concern such that the likelihood of the reservation of title clause Copyright protected - see copyright notice s within the document. Whether or not disclosure is necessary in order to give a fair presentation will be a matter for judgement. A fair presentation requires an entity to provide additional disclosures when compliance with the specific requirements in IFRSs is insufficient to enable users to understand the impact of particular transactions, other events and conditions on the entity's financial position and financial performance.

An example might be where the company did not have legal title to assets and disclosure of this fact was necessary for a fair presentation to be given. Practical application - Inventory or investment property Publication date: 07 Oct Example 1 — Renting before completion of entire property Entity A, a property developer with a history of developing properties for sale immediately after completion, constructs a residential property for sale.

To increase the possibility of selling the entire property after completion, the entity decides to lease out individual apartments when completed. The tenants move in before the property is completed in its entirety and before it is sold. How should entity A account for the property? The leases are intended to increase the possibility of selling the property rather than to earn rental income on a continuing basis, and the property is not held for capital appreciation.

Example 2 — Renting until market activity improves Entity B, a property developer with a history of developing properties for sale immediately after completion, constructs a residential property for sale. Entity B believes it will be better able to find a buyer for the property at that time. How should entity B account for the property? Entity B needs to carefully assess whether the property should continue to be classified as inventory or be transferred to investment properties in accordance with paragraph 57 d of IAS Determining the correct classification of such a property requires judgement.

The inception Copyright protected - see copyright notice s within the document. The property may, therefore, continue to be classified as inventory to the extent it is available for immediate sale in its present condition, at a current market price, in the ordinary course of business. Factors to consider include: Is the property actively marketed for sale?

Is the property available for sale at a price that is reasonable relative to its current market value? Does a market exist for properties with sitting tenants, with longer lease terms, such that the property is in a condition to be sold immediately? Where there is no market for properties with sitting tenants, are the terms of any leases less than the length of the period that other similar properties take to be sold in the ordinary course of business under current market conditions?

Factors to consider are: Has the board decided to postpone the sale of the property until the market price recovers? Is there a change in the business plan that takes into account the rental income earned and the necessary future maintenance expenses? Is the property no longer actively marketed for sale? Is there still an active market for similar properties?

Is the property available for sale only at a price that is not reasonable relative to its current market value? Example 3 — Change in intended use Entity C, a property developer with a history of developing properties for sale immediately after completion, constructs a residential property for sale.

However, as property prices are at a multi-year low, entity C decides to no longer pursue the plan to sell the property after completion and to reconsider the decision to sell at a later stage when the market improves. Entity C intends to rent the property out to third parties on longer lease terms. However, at the year end, no lease contract has been signed.

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