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Contents
13.1.1 Extract from FRS 102 – Section 13.1 – 13.3.
13.2 Measurement of inventory.
13.2.1 Extract from FRS 102 – Section 13.4-13.4A.
13.2.2.1 Inventory other than inventory held at or nominal consideration.
13.2.2.2 Inventory held at no or nominal consideration.
13.2.2.3 Definition of no or nominal consideration.
13.3.1 Extract from FRS 102 – Section 13.5-13.7.
13.3.2.1.1. Irrevocable taxes and taxes incurred only an extraction from warehouses.
13.3.2.2 Stock purchased on beyond normal credit terms.
13.3.2.4 Non-exchange transaction.
13.4 Cost of conversion – production overheads.
13.4.1 Extract from FRS 102 – Section 13.8-13.11 and 13.14-13.15.
13.4.2.1 Cost to be recognised in inventory – production overheads.
13.4.2.1.2 Illustration of allocation of overheads to production – normal capacity.
13.4.2.2 Joint products and by-products.
13.5 Cost excluded from inventories.
13.5.1 Extract from FRS 102 – Section 13.13.
13.5.2.5 General and administrative overheads.
13.6 Cost measurement techniques.
13.6.1 Extract from FRS 102 – Section 13.16-13.18.
13.6.2.4 Most recent purchase price.
13.6.2.5.1 Non-interchangeable goods.
13.6.2.5.2 Interchangeable goods.
13.6.2.5.4 Requirements for consistency.
13.7 Impairment of inventories.
13.7.1 Extract from FRS 102 – Section 13.19.
13.7.2.2 Assessing the selling price less cost to sell
13.7.2.3 Post period end events and impairments.
13.7.2.4 Reversal of impairments.
13.8 Derecognition as an asset
13.8.1 Extract from FRS 102 – Section 13.20-13.21.
13.9.1 Extract from FRS 102 – Section 13.22.
13.9.2.3 Notes to the financial statement.
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13.4 Cost of conversion – production overheads
13.4.1 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.
13.4.2 OmniPro comment
13.4.2.1 Cost to be recognised in inventory – production overheads
Section 13.8 and 13.9 of FRS 102 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.
13.4.2.1.1. Normal capacity
Section 13.9 of FRS 102 requires fixed overheads and cost of conversion to be allocated on the basis of normal capacity of production facility.
Section 13.9 of FRS 102 requires variable production overheads to be allocated to each unit of production on the basis of the actual use of the production facility.
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 in section 13.8 to 13.11 of FRS 102 is applied in practice.
13.4.2.1.2 Illustration of allocation of overheads to production – normal capacity
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.
13.4.2.2 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 the by-product is small in proportion to the main product. This is made clear in section 13.10 of FRS 102. 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.
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Examples
Example 2: Inventories held for distribution.
Example 3: Cost of inventory – rebates.
Example 3A: Purchase with unusual credit terms.
Example 3B: Non-exchange transaction.
Example 4: Allocation of overheads to production with overheads higher than normal:
Example 6: Raw material less than cost but finished good not
Example 7: Post balance sheet events and requirement for impairment
Example 8: Post balance sheet events and requirement for impairment
Example 9: Derecognition of inventory.
Example 10: Extract from an accounting policy note and required inventory disclosures.
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