[et_pb_section admin_label=”Header – All Pages” global_module=”1221″ transparent_background=”off” background_color=”#1e73be” allow_player_pause=”off” inner_shadow=”off” parallax=”off” parallax_method=”off” padding_mobile=”off” make_fullwidth=”off” use_custom_width=”off” width_unit=”on” make_equal=”off” use_custom_gutter=”off” gutter_width=”3″ custom_padding=”||0px|”][et_pb_row global_parent=”1221″ admin_label=”row”][et_pb_column type=”4_4″][et_pb_post_title global_parent=”1221″ admin_label=”Post Title” title=”on” meta=”off” author=”on” date=”on” categories=”on” comments=”on” featured_image=”off” featured_placement=”below” parallax_effect=”on” parallax_method=”on” text_orientation=”left” text_color=”light” text_background=”off” text_bg_color=”rgba(255,255,255,0.9)” module_bg_color=”rgba(255,255,255,0)” title_all_caps=”off” use_border_color=”off” border_color=”#ffffff” border_style=”solid” title_font=”|on|||” title_font_size=”35″ custom_padding=”10px|||”] [/et_pb_post_title][/et_pb_column][/et_pb_row][/et_pb_section][et_pb_section admin_label=”Section” global_module=”1228″ fullwidth=”off” specialty=”off” transparent_background=”off” allow_player_pause=”off” inner_shadow=”off” parallax=”off” parallax_method=”off” custom_padding=”0px||0px|” padding_mobile=”on” make_fullwidth=”off” use_custom_width=”off” width_unit=”on” make_equal=”off” use_custom_gutter=”off” gutter_width=”3″][et_pb_row global_parent=”1228″ admin_label=”Row” make_fullwidth=”off” use_custom_width=”off” width_unit=”on” use_custom_gutter=”off” gutter_width=”3″ custom_padding=”0px||0px|” padding_mobile=”off” allow_player_pause=”off” parallax=”off” parallax_method=”off” make_equal=”off” parallax_1=”off” parallax_method_1=”off” column_padding_mobile=”on”][et_pb_column type=”4_4″][et_pb_text global_parent=”1228″ admin_label=”Text” background_layout=”light” text_orientation=”left” text_font_size=”14″ use_border_color=”off” border_color=”#ffffff” border_style=”solid”]
[/et_pb_text][/et_pb_column][/et_pb_row][/et_pb_section][et_pb_section admin_label=”Section” fullwidth=”off” specialty=”off”][et_pb_row admin_label=”Row”][et_pb_column type=”1_2″][et_pb_text admin_label=”Text” background_layout=”light” text_orientation=”center” text_font_size=”14″ use_border_color=”off” border_color=”#ffffff” border_style=”solid”] [button link=”http://www.frs102.com/members/premium-toolkit/” type=”big” color=”red”] Return to Main Index[/button] [/et_pb_text][/et_pb_column][et_pb_column type=”1_2″][et_pb_text admin_label=”Text” background_layout=”light” text_orientation=”center” text_font_size=”14″ use_border_color=”off” border_color=”#ffffff” border_style=”solid”] [button link=”http://frs102.com/members/premium-toolkit/section-13/” type=”big” color=”red”] Return to Section 13 Home[/button] [/et_pb_text][/et_pb_column][/et_pb_row][/et_pb_section][et_pb_section admin_label=”Section” fullwidth=”off” specialty=”off” transparent_background=”off” allow_player_pause=”off” inner_shadow=”off” parallax=”off” parallax_method=”off” padding_mobile=”off” make_fullwidth=”off” use_custom_width=”off” width_unit=”on” make_equal=”off” use_custom_gutter=”off” gutter_width=”3″][et_pb_row admin_label=”Row”][et_pb_column type=”4_4″][et_pb_text admin_label=”Main Body Text” background_layout=”light” text_orientation=”justified” use_border_color=”off” border_color=”#ffffff” border_style=”solid”]Extract from FRS 102 – Section 13.2-13.3
13.2 This section applies to all inventories, except:
(a) work in progress arising under construction contracts, including directly related service contracts (see Section 23 Revenue);
(b) financial instruments (see Section 11 Basic Financial Instruments and Section 12 Other Financial Instruments Issues); and
(c) biological assets related to agricultural activity and agricultural produce at the point of harvest (see Section 34 Specialised Activities).
13.3 Other than the disclosure requirements in paragraph 13.22, this section does not apply to the measurement of inventories at fair value less costs to sell through profit or loss at each reporting date. Inventories shall not be measured at fair value less costs to sell unless it is a more relevant measure of the entity’s performance because the entity operates in an active market where sale can be achieved at published prices, and inventory is a store of readily realisable value.
OmniPro comment
Unlike old GAAP the rules for accounting for construction contracts are not within the inventory standard instead this is dealt with in Section 23 of this guide.
Measurement of inventory
Extract from FRS 102 – Section 13.4-13.4A
13.4 An entity shall measure inventories at the lower of cost and estimated selling price less costs to complete and sell.
13.4A Inventories held for distribution at no or nominal consideration shall be measured at the lower of cost adjusted, when applicable, for any loss of service potential and replacement cost.
OmniPro comment
The inventories are measured at lower of cost or estimated selling price less costs to complete and sell. The cost of purchase, cost of conversion and any other costs incurred in getting the inventory to its current location and condition.
Examples of inventories held at no or nominal consideration would be promotional material which the company holds. No or nominal consideration means goods which are not invoiced to customers but instead given free of charge. Another example would stationary stock.
Example 2: inventories held for distribution
Company A holds stock of promotional material for entities main product; widgets. The cost of these materials was CU5,000 and none have been used since purchase. At year end the company would be required to recognise this as stock in the balance sheet.
Cost of purchase
Extract from FRS 102 – Section 13.5-13.7
13.5 An entity shall include in the cost of inventories all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition.
13.5A Where inventories are acquired through a non-exchange transaction, their cost shall be measured at their fair value as at the date of acquisition. For public benefit entities and entities within a public benefit entity group, this requirement only applies to inventories that are recognised as a result of the requirements for incoming resources from non-exchange transactions as prescribed in Section 34 Specialised Activities.
13.6 The costs of purchase of inventories comprise the purchase price, import duties and other taxes (other than those subsequently recoverable by the entity from the taxing authorities), and transport, handling and other costs directly attributable to the acquisition of finished goods, materials and services. Trade discounts, rebates and other similar items are deducted in determining the costs of purchase.
13.7 An entity may purchase inventories on deferred settlement terms. In some cases, the arrangement effectively contains an unstated financing element, for example, a difference between the purchase price for normal credit terms and the deferred settlement amount. In these cases, the difference is recognised as interest expense over the period of the financing and is not added to the cost of the inventories unless the inventory is a qualifying asset (see Section 25 Borrowing Costs) and the entity adopts a policy of capitalisation of borrowing costs.
OmniPro comment
The purchase prices of inventories include:
- Purchase price;
- Import duties and other taxes other than recoverable tax
- Transportation and handling costs
- And other costs directly attributable to the acquisition of the materials
- Less rebates or discounts received.
In relation to the inclusion of irrecoverable taxes in inventory, consideration should be given as to when they should be included in the cost where they are held in warehouses and the tax is not payable until they are taken out of this warehouse. In such situations, the tax should not be absorbed in the cost of stock until the goods are taken from the warehouse as it is at this point that the tax becomes payable. An example of such a situation would be stock of wine held in a customs free zone.
In relation to the absorption of rebates, the amount of rebates is allocated on a per unit basis to determine the value to be absorbed into stock. Note rebates or any other types of discount are not absorbed in stock until the likelihood of receipt of the rebate is certain i.e. it meets the definition of an asset under Section 21-Provisions.
Example 3: Cost of inventory – rebates
Company A received CU200,000 in rebates for purchases of particular products from a supplier. The company purchased 300,000 of the products from the supplier over the year and 20,000 of these products remain in stock. The total purchase cost of the stock before rebates is CU20 per unit. The level of rebates received to be absorbed in inventory is as follows:
| CU200,000 / 300,000 units = CU1.50 |
Therefore for every unit purchased, CU1.50 of a rebate was received. The value to be absorbed in stock at the year-end is CU30,000 (20,000 * CU1.50). Stock should be valued at CU370,000 ((CU20-CU1.50)*20,000).
Stock purchased on beyond normal credit terms
Where stock is purchased on deferred payment terms which are beyond normal credit terms, there is deemed to be a financing element included in the purchase cost. In this case the finance cost element of the item purchased is determined by taken the purchase price less the price that would have been paid if this was paid for straight away. Where this cannot be determined then a market rate of interest would be charged i.e. a rate a third party i.e. a bank would charge for the extended credit.
Example 3A: Purchase with unusual credit terms
Company A purchased goods worth CU50,000 with unusual credit terms on 01/12/13. The credit provided is for a period up to 31/12/15. The normal cash price for these goods would be CU35,000. The difference of CU15,000 is determined to be a financing transaction and should be accounted for under Section 11. The effective interest rate is calculated at 18.62% as per below. The effective interest rate is determined so as to write the deemed interest into the P&L over the life of the transaction. The effective interest rate is determined through trial and error or through the use of an excel calculation.
For the purchasing company the journals to post are:
| CU | CU | |
| Dr Inventory | 50,000 | |
| Cr Trade Creditors | 50,000 |
Being journal to reflect purchase of stock
| CU | CU | |
| Dr Trade Creditors | 15,000 | |
| Cr Inventory | 15,000 |
Being journal to reflect the deemed financing element of the sale so as to show the correct amortised cost
| CU | CU | |
| Dr Finance Expense in P&L (so that the carrying amount is now CU35,536) | 536 | |
| Cr Trade Creditors | 536 |
Being journal reflect the deemed interest expense in the profit and loss for the year for one month. The same type of journal is posted for the other two years.
Borrowing costs
Borrowing costs can be absorbed into stock but in limited circumstances. Where the borrowing costs are incurred on qualifying assets as defined in Section 25.2, (an asset that takes a substantial time to get ready for use of sale) the costs can be absorbed. An example of where this could occur is in the production of whiskey which takes a significant time to mature. Another example would be industries where a small volume of products are produced but take considerable time to produce.
Cost of conversion – production overheads
Extract from FRS 102 – Section 13.8-13.11 and 13.14-13.15
13.8 The costs of conversion of inventories include costs directly related to the units of production, such as direct labour. They also include a systematic allocation of fixed and variable production overheads that are incurred in converting materials into finished goods. Fixed production overheads are those indirect costs of production that remain relatively constant regardless of the volume of production, such as depreciation and maintenance of factory buildings and equipment, and the cost of factory management and administration. Variable production overheads are those indirect costs of production that vary directly, or nearly directly, with the volume of production, such as indirect materials and indirect labour.
13.8A Production overheads include the costs for obligations (recognised and measured in accordance with Section 21 Provisions and Contingencies) for dismantling, removing and restoring a site on which an item of property, plant and equipment is located that are incurred during the reporting period as a consequence of having used that item of property, plant and equipment to produce inventory during that period.
13.9 An entity shall allocate fixed production overheads to the costs of conversion on the basis of the normal capacity of the production facilities. Normal capacity is the production expected to be achieved on average over a number of periods or seasons under normal circumstances, taking into account the loss of capacity resulting from planned maintenance. The actual level of production may be used if it approximates normal capacity. The amount of fixed overhead allocated to each unit of production is not increased as a consequence of low production or idle plant. Unallocated overheads are recognised as an expense in the period in which they are incurred. In periods of abnormally high production, the amount of fixed overhead allocated to each unit of production is decreased so that inventories are not measured above cost. Variable production overheads are allocated to each unit of production on the basis of the actual use of the production facilities.
13.10 A production process may result in more than one product being produced simultaneously. This is the case, for example, when joint products are produced or when there is a main product and a by-product. When the costs of raw materials or conversion of each product are not separately identifiable, an entity shall allocate them between the products on a rational and consistent basis. The allocation may be based, for example, on the relative sales value of each product either at the stage in the production process when the products become separately identifiable, or at the completion of production. Most by-products, by their nature, are immaterial. When this is the case, the entity shall measure them at selling price less costs to complete and sell and deduct this amount from the cost of the main product. As a result, the carrying amount of the main product is not materially different from its cost.
13.11 An entity shall include other costs in the cost of inventories only to the extent that they are incurred in bringing the inventories to their present location and condition.
Cost of inventories as a service provider
13.14 To the extent that service providers have inventories, they measure them at the costs of their production. These costs consist primarily of the labour and other costs of personnel directly engaged in providing the service, including supervisory personnel, and attributable overheads. Labour and other costs relating to sales and general administrative personnel are not included but are recognised as expenses in the period in which they are incurred. The cost of inventories of a service provider does not include profit margins or non-attributable overheads that are often factored into prices charged by service providers.
13.15 Section 34 requires that inventories comprising agricultural produce that an entity has harvested from its biological assets should be measured on initial recognition, at the point of harvest, at either their fair value less estimated costs to sell or the lower of cost and estimated selling price less costs to complete and sell. This becomes the cost of the inventories at that date for application of this section.
OmniPro comment
Section 13 is very specific in what should be included in the cost of conversion. It includes all costs directly related to the cost of producing the inventory including direct labour, variable and fixed production overheads that are incurred in converting the material to finished goods.
Normal capacity should be reviewed on a regular basis. Normal capacity would be considered to be:
- The budgeted level of activity for the current year or for the following year
- The volume of production that the production facilities are intended to produce under the working conditions act
- The average level of activity achieved for the current and in the previous year
See below for how the above guidance is applied in practice.
Example 4: Allocation of overheads to production with overheads higher than normal:
Company A operate a construction timber company constructing wooden material for site boundaries. Details are as follows:
Normal level of activity is 100,000 machine hours per annum
Full capacity of the plant is 120,000 machine hours per annum
Actual machine hours incurred for the year was 110,000 hours
Total fixed overheads were CU2,000,000
Opening stock was 100,000 units and closing stock is 125,000 units.
Total produced in the year was 290,000 units and total sales in the year was CU7,500,000.
Using the above example the production overhead to be allocated to inventory is:
Production overheads/machine hours for normal capacity = CU2,000,000 / 100,000 = CU20
As stated in 13.9, overhead should be allocated on normal levels of activity which would be CU20 per hour in this example. Therefore, the total costs if this were allocated to all units produced would be CU5,800,000. As this is well in excess of the actual fixed overhead costs incurred, the entity would need to absorb the cost on the actual level of activity to ensure that stock is not overstated. i.e. 2,000,000 / 110,000 = CU18.18. The amount to be allocated to inventory at year end is therefore 125,000 units * CU18.18 = CU2,272,500.
Joint products and by-products
Where as part of the production process a by-product emerges, the proceeds receivable from the sale of this by product should be absorbed into stock so as to reduce to cost of stock for the main product particularly where the proceeds obtained from by-product is small in proportion to the main product. An example of a by-product which would be absorbed into stock would be whey which is a by-product on the production of cheese.
Where two products are produced at the same time during the production process e.g. a factory which distributes milk and manufactures cheese has two products. In these circumstances cost is allocated to each product on a reasonable basis as possible based on the proportion of sales.
Cost excluded from inventories
Extract from FRS 102 – Section 13.13
13.13 Examples of costs excluded from the cost of inventories and recognised as expenses in the period in which they are incurred are:
(a) abnormal amounts of wasted materials, labour or other production costs;
(b) storage costs, unless those costs are necessary during the production process before a further production stage;
(c) administrative overheads that do not contribute to bringing inventories to their present location and condition; and
(d) selling costs.
OmniPro comment
Section 13 makes it clear that any selling costs, abnormal wasted material, labour and administration overheads not contributing to bringing the inventory to its saleable condition should not be absorbed.
Abnormal costs
An entity will need to ensure a detailed review is carried out on the costs included in fixed and variable production overhead to ensure no abnormal costs are included. Examples of abnormal costs would be;
- once off write off of inventory,
- over usage of material due to testing being carried out by a new machine,
- downtime in production due to unscheduled maintenance,
- labour costs incurred when employees were on strike etc.
Selling costs
No selling costs should be absorbed in stock which includes distribution costs to the customer. However, where an entity incurs costs in transporting stock from its factory to its sales depot, whether that be in the same country or another country, then such costs can be absorbed in the cost of inventory as it meets the definition of it being a cost of bringing the inventory to its present location. If this were transport to the customer site, it could not be absorbed. For large retailers where they move goods from a central distribution warehouse to points of sale this would usually be allowed to be absorbed in inventory.
Storage costs
In the majority of circumstances storage should not be absorbed within inventory as it does not contribute to bringing the inventory to its present condition and location. Hence warehousing of inventory or overheads of retail supermarkets could not be absorbed in inventory. However for some entities where storage is necessary to produce the final product, storage costs can be absorbed. Examples of this would include; whiskey which must be stored for long periods for it to mature, grain purchased directly from the field (undried grain) which has to be dried out for a number of months before it is ready for onward sale. In the case of grain, after a set period of months when the grain is dried, absorption must cease.
General and administrative overheads
When assessing whether any administrative overheads should be absorbed in inventory, care should be taken. The administrative overheads should be split into functions and an analysis provided of how the departments support the production process and an allocation made based on the contribution they make. An accounting department for example will normally support the following functions:
- Marketing and distribution costs – costs for analysing sales and controlling the sales ledger
- Production – paying invoices, ordering, invoice matching, providing management accounts
- General administration – preparation of management accounts for production, budgets, costing and managing cash resources.
Generally, management costs cannot be allocated however in smaller entities where a lot of work is done by the same person then a reasonable allocation can be made.
Cost measurement techniques
Extract from FRS 102 – Section 13.16-13.18
13.16 An entity may use techniques such as the standard cost method, the retail method or most recent purchase price for measuring the cost of inventories if the result approximates cost. Standard costs take into account normal levels of materials and supplies, labour, efficiency and capacity utilisation. They are regularly reviewed and, if necessary, revised in the light of current conditions. The retail method measures cost by reducing the sales value of the inventory by the appropriate percentage gross margin.
13.17 An entity shall measure the cost of inventories of items that are not ordinarily interchangeable and goods or services produced and segregated for specific projects by using specific identification of their individual costs.
13.18 An entity shall measure the cost of inventories, other than those dealt with in paragraph 13.17, by using the first-in, first-out (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. The last-in, first-out method (LIFO) is not permitted by this FRS.
OmniPro comment
Retail method
The retail method takes the selling price of the stock and reduces this by the gross margin for the product which then equates to cost. It is used by retail units and similar industries where there is a high volume of line items where similar margins are made on the products e.g. a clothing retailer where similar margin is made on the clothes. This is a quick and easy way to measure inventory. It is determined by taking all stock on hand and allocating the sales value to this inventory and then applying a set margin based on product categories.
Standard costs
Standard costing is usually used by large manufacturing organisations. It is based on budgeted costs for the coming years. All raw material inventory is measured at the standard cost. Then fixed and variable production overheads are absorbed based on budgeted figures. Difference between the actual purchase cost and the standard cost are posted as variances in cost of sales. Where applied it must be reviewed regularly to ensure the standard cost equates to actual. Usually at year end to ensure the carrying value of stocks equates to the actual cost, entities will absorb purchase price and material usage variances into the inventory number at each month/year end.
The absorption of these variances would usually be based on the average stock turn. As with any costing techniques, care must to be taken to ensure there were no abnormal costs posted to the purchase price and the material usage variances as abnormal costs are not permitted to be absorbed.
Most recent purchase price
Section 13 allows the most recent purchase price which was not allowed under old GAAP. By its name it values stock based on the last purchase invoice. Where this costing method is used care needs to be exercised to ensure that the last purchase invoice was not unusually high and therefore does not represent the cost for the rest of the items in stock therefore overstating inventory at year end.
Cost formulas
For non-interchangeable goods i.e. specific goods, and goods and services used for specific projects, these should be stated at the purchase cost. This type of formula is usually used for entities who prepare bespoke goods or services e.g. bespoke furniture, specific to customer circumstances. This method cannot be used where there is a large number of interchangeable items e.g. widgets and bolts.
Where goods and services are interchangeable then they should use the first-in first-out basis (FIFO) or the weighted average basis. The FIFO basis uses the logic that the first stock item purchased and put into stock/used in production is the first one that is sold. The weighted average method on the other hand uses the average cost of the period for the same types of goods. This is the simplest formula to use.
Last-in last-out is not permitted under Section 13.
An entity should use the same cost formula for the same types of inventory. It must have applied this consistently.
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