UNIVERSITY OF LIMPOPO

SCHOOL OF ACCOUNTANCY

CACN040/CACB080
2022

Module 5

IAS 2

Inventories
A. GENERAL

1. Purpose of the topic

Inventories normally constitute one of the largest assets of a manufacturing or trading

enterprise.

Inventories represent the portion of past costs that has not yet been used or otherwise
sold and which may therefore be carried forward as an asset that will have future
economic benefits for the enterprise (Everingham & Watson, 1998: 76).

2. Prescribed literature

• IAS 2 – Inventories. (PART A2; A guide through IFRS)

3. Examination possibilities

The examination of IAS 2 can be combined with Financial Management (determination

of contribution/costs/profit for individual products or for a period of time), Taxation
(determination of the tax implications of S 22 of the Income Tax Act) or Auditing (an
evaluation of the valuation and disclosure of inventories as part of a substantive test
programme of the production cycle).

4. Foreknowledge

You should be able to:

• discuss the objectives and scope of IAS 2;

• identify, recognise, measure, present and disclose inventories in accordance with the
stipulations of IAS 2; and

• intergrate inventories with other IFRS Standards.

5. Study outcomes

After studying this document, you should be able to:

• discuss and explain the contents of IAS 2

• explain the stipulations of IAS 2 in terms of the Conceptual Framework for Financial
Reporting; and

• apply the stipulations of IAS 2 to practical case studies.

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B. GENERAL OVERVIEW

1. Definition

Inventory are ASSETS (both tangible and intangible), that:

• Are held for sale in the ordinary course of business; or

• Are in the process of production for such sale; or

• Are consumed during the production of saleable goods or services.

Whether a certain item is classified as inventory depends solely on its purpose to the
entity.

2. Recording of inventory

The acquisition of inventory can be recorded by using one of the following to methods:

• The periodic recording method – a system that records inventory on hand at the
end of each period.

• The perpetual recording method – a system that records inventory in real time.
This means that the inventory on hand is always up to date.

The recording system chosen by the entity may depend on the following factors:

• The size of the business

• The sophistication of the entity’s computerized accounting system

• The importance of having information on inventory levels that is always up to

date.

3. Measurement

Initial measurement:

Inventory is measured at cost, which include:

• Purchasing cost.

• Conversion cost.

• Other costs incurred in bringing inventories to their present location and

condition.

Subsequent measurement:

Inventory is measured at the lower of cost and net realisable value.

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4. Disclosure
UL LTD
[EXTRACT FROM THE] STATEMENT OF FINANCIAL POSITION AS AT
31 DECEMBER 2019
ALL MONETARY MOUNTS EXPRESSED IN
THOUSANDS OF RANDS Note(s) 2019 2018
ASSETS
Current assets
Inventories 2 XXX XXX
Trade and other receivables XXX XXX
Contract asset
Contract costs XXX XXX
Cash and cash equivalents XXX XXX
Non-current assets classified as held for sale
Total current assets XXX XXX

UL LIMITED
[EXTRACT FROM THE] STATEMENT OF PROFIT OR LOSS AND OTHER
COMPREHENSIVE INCOME (BY FUNCTION) FOR THE YEAR ENDED 31 DECEMBER
2019
ALL MONETARY MOUNTS EXPRESSED IN
THOUSANDS OF RANDS Note(s) 2019 2018
Revenue XXX XXX
Cost of sales (XXX) (XXX)
Gross profit XXX XXX

UL LIMITED

[EXTRACT FROM THE] NOTES TO THE FINANCIAL STATEMETNS FOR THE YEAR
ENDED 31 DECEMBER 2019

1. SIGNIFICANT ACCOUNTING POLICIES

The principal accounting policies applied in the preparation of these financial statements have
been consistently applied to all years presented, unless otherwise stated.

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1.1 INVENTORY

Inventories are valued at the lower of cost and net realisable value, where the cost is
calculated using the actual cost/standard cost/retail method. Inventory movements are
recorded using the weighted average formula/first-in-first-out method/Specific identification
method.

1.2 COST OF SALES

When inventories are sold, the carrying amount of those inventories is recognised as an
expense in the period in which the related revenue is recognised. The amount of any write-
down of inventories to net realisable value and all losses of inventories are recognised as an
expense in the period the write-down or loss occurs. The amount of any reversal of any write-
down of inventories, arising from an increase in net realisable value, is recognised as a
reduction in the amount of inventories recognised as an expense in the period in which the
reversal occurs.

The related cost of providing services recognised as revenue in the current period is included
in cost of sales.
2. PROFIT BEFORE TAX

ALL MONETARY AMOUNTS ARE EXPRESSED IN 2019 2018

THOUSANDS OF RANDS
Profit / loss before interest and taxation for the year is arrived at XXX XXX
after taking into account:
Inventory write-downs XXX XXX
Reversal of write-down of inventory XXX XXX

3. INVENTORIES

ALL MONETARY AMOUNTS ARE EXPRESSED IN 2019 2018

THOUSANDS OF RANDS
Finished goods XXX XXX
Work in progress XXX XXX
Raw materials XXX XXX
XXX XXX
The entire finished goods have been pledged as security for a loan (see note X for further
details).

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C. EXAMPLES

EXAMPLE 1: Costs of Purchase

ABC Limited has purchased inventory from an enterprise in the Eastern Cape. The following
costs were incurred in the purchase of the 100 inventory items:

- Purchase price of 100 units is R300 per unit (VAT excl.)

- Transportation costs (from Eastern Cape to Gauteng): R5 000 (VAT excl)

- Insurance costs on transportation: R4 000 (VAT excluded)

- Received 10% trade discount from the supplier

- Paid VAT of R4 000 on the above transactions (ABC Ltd is registered for VAT purposes)

- Received 5% settlement discount from the supplier in respect of payment.

YOU ARE REQUIRED TO:

Calculate total cost of purchase of the 100 inventory items.

SOLUTION: EXAMPLE 1

Purchase price (100 x R300) 30 000

Transportation costs 5 000

Insurance costs 4 000

Trade discount (10% x 30 000) (3 000)

VAT (recoverable from SARS) -

Settlement discount -

36 000

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EXAMPLE 2: Conversion costs

You are provided with the following information of a company for the financial period-ended
31 March:

Normal production capacity per period 200 000 units

Actual production capacity – current period 160 000 units

Production costs incurred during the period: R

Variable costs incurred 800 000

Fixed costs incurred 1 600 000

At period-end there are 10 000 finished products on hand. These products can be sold at a
selling price of R16 each. Sales commission of R2 per unit is payable per unit.

YOU ARE REQUIRED TO:

Calculate at which value the 10 000 finished products will be included on the balance sheet of
the company on 31 March.

SOLUTION – EXAMPLE 2

Costs per unit:

Variable costs per unit (R800 000/160 000 units) 5

Fixed costs (R1 600 000/200 000 units) 8

Costs per unit 13

The costs per unit is R13.

The inventory has to be valued at the lowest of cost or net realisable value. The net
realisable value is R14 per unit.

Value at period end: 10 000 units x R13 R130 000

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EXAMPLE 3: Conversion Costs

You are provided with the following information for the financial period ended 31 March:

Normal production capacity per period 200 000 units

Actual production capacity – current period 300 000 units

Production costs incurred during the period: R

Variable costs incurred 900 000

Fixed costs incurred 1 500 000

At period-end there are 10 000 finished products on hand. These products can be sold at a
selling price of R16 each. Sales commission of R2 per unit is payable per unit.

Assume that the production of 300 000 units was an abnormal high number of units that were
produced.

YOU ARE REQUIRED TO:

Calculate at which value the 10 000 finished products will be included on the statement of
financial position of the company on 31 March.

SOLUTION – EXAMPLE 3

Variable costs per unit (R900 000/300 000 units) 3

Fixed costs (R1 500 000/300 000 units) 5

Costs per unit 8

The costs per unit is R8.

Value at period end: 10 000 units x R8 = R80 000

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EXAMPLE 4: By- products

During the production of product AB, a by-product ABC is also produced.

The total cost to produce one unit of AB is R80.

The selling prices of the product AB and ABC are as follows:

AB 150

ABC 15

At period-end there are 500 units AB on hand and 30 units of ABC on hand.

YOU ARE REQUIRED TO:

Calculate the carrying value of inventory to be disclosed on the statement of financial position
at period-end

SOLUTION – EXAMPLE 4

AB (500 x 80) 40 000

ABC (30 x 15) (450)

Carrying value at period-end 39 550

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EXAMPLE 5: NRV and Disclosure

At period end a company has 200 units on hand at a cost price of R200 each.

The normal selling price of each item is R210. Sales commission of 10% is payable on these
items.

The company has a contract to sell 50 of the items at a fixed price of R300 each.

YOU ARE REQUIRED TO:

Calculate at what value the 200 items will be disclosed on the financial statements of the
company at periodend.

SOLUTION – EXAMPLE 5

Inventory must be valued at the lowest of cost and NRV.

150 items

Cost: R200 each

NRV: R189 each (R210 x 90%)

50 items

Cost: R200 each

NRV: R270 each (R300 x 90%)

Value

150 items x R189 28 350

50 items x R200 10 000

38 350

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EXAMPLE 6: Disclosure

XYZ limited produces cd’s. Normal production amounts to 100 000 units per period.

The following information is provided to you:

Opening inventory (1 January 2015):

Raw material 50 000

Finished products (20 000 units) 160 000

During the period ended 31 December 2015 the company produced 90 000 units and sold
95 000 units at R14 each.

Costs incurred during the period ended 31 December 2015:

Raw materials purchased 260 000

Abnormal production costs 35 000

Labour costs of production 233 000

Fixed production costs 400 000

Closing inventory (31 December 2015):

Raw materials 30 000

The company uses the First-in-First-out method to value inventory.

YOU ARE REQUIRED TO:

Calculate and disclose all the relevant information in the financial statements of XYZ limited
for the period ended 31 December 2015.

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SOLUTION – EXAMPLE 6

STATEMENT OF FINANCIAL POSITION OF XYZ LIMITED AT 31 DEC 2015

Note R

ASSETS

Current assets

Inventory 9 175 500

STATEMENT OF PROFIT OR LOSS OF XYZ LIMITED FOR THE PERIOD ENDED 31 DEC
2015

Revenue (95 000 x R14) 1 330 000

Cost of inventory (962 500)

Gross profit 367 500

NOTES TO THE FINANCIAL STATEMENTS OF XYZ LIMITED

1. Accounting policy

1.4 Inventory

Inventory is valued at the lowest of cost and net realisable value according to the First-In-
First-Out valuation method.

9. Inventory

Raw material 30 000

Finished products 145 500

175 500

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Calculations (not part of the disclosure!)

Raw material used in the production of 90 000 units:

Opening inventory 50 000

Purchases 260 000

Closing inventory (30 000)

Cost of production 280 000

Production costs of 90 000 units

Raw materials used 280 000

Labour costs 233 000

Fixed production costs (400 000 x 90 000/100 000) 360 000

Cost of producing 90 000 units 873 000

Cost per unit (873 000/90 000) 9,70

Finished products on hand – 31 Dec 2015 (units)

Opening inventory 20 000

Units produced 90 000

Sold (95 000)

Closing inventory 15 000

Closing inventory of finished products: 15 000 units x R9,70 = R145 500

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Cost of sales for the period

Cost of finished goods sold 887 500

Under-recovery of fixed production costs 40 000

Abnormal production costs 35 000

962 500

Cost of finished goods = (20 000 units x R8) + (75 000 units x R9.70)

= 160 000 + 727 500

= 887 500

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