Chapter 11 - Inventory Valuation


A primary issue in accounting for inventories is the amount to be recognised in the statement of financial position. The objective of IAS 2 is to prescribe the accounting treatment for inventories.  Inventories are assets:

  • held for sale in the ordinary course of business
  • in the process of production for such sale
  • in the form of materials to be consumed in the production process

Inventories are valued at the lower of cost and net realizable value so as not to overstate inventories and eventually profit. This is in line with the prudence concept which states that the accounts of a business should anticipate losses and not profits.


Effects on


Gross Profit

Profit for the year

Current assets

Opening inventory understated

Overstated

Overstated

No effect





Opening inventory overstated

Understated

Understated

No effect





Closing inventory understated

Understated

Understated

Understated





Closing inventory overstated

Overstated

Overstated

Overstated


According to IAS 2, the cost of inventories shall comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition.  The net realizable value of inventories is the estimated selling price in the ordinary course of business less the estimated costs necessary to make the sale.

Example 1

A company has two items in inventory which require to be repaired before sale


Cost($)

Selling Price ($)

Repair costs (S)





Item 1

5 200

7 500

800

Item 2

2 300

2 400

200

What is the total inventory value of these items?

Item 1 =  $ 5 200

Item 2 = $ 2 200

Value of inventory = $ 7 4 00

Example 2

Inventory has been damaged. The inventory cost S 1200. It would have been sold for $ 1 800 when perfect. It can be sold for $ 1 700 if repairs are undertaken at $ 600. To replace the inventory would cost $ 1 000. At what value should the damaged inventory be shown in the final accounts?

Value of inventory = $ 1 700 - $ 600 = $ 1 100

If various batches of inventories have been purchased at different times during the year and at different prices, it may be impossible to determine precisely which items are still held at the year end. In such circumstances, IAS 2 allowed the following methods to be used

  • FIFO (First In First Out) – Items of inventory that were purchased first are sold first. Inventories are valued at the latest price.
  • AVCO (Average Cost) – The cost of inventories are determined by calculating an average price each time items are purchased.
  • IAS 2 does not allow the use of LIFO (Last In First Out) since it overstate inventory and profit.


The following information is available from a business.

Jan 1

Balance

20 units at $ 35

Jan

Purchases

100 units at $ 40

Feb

Sales

85 units

Mar

Purchases

90 units at $ 45

Apr

Sales

110 units


Prepare an inventory valuation statement.

Inventory Valuation Statement

Opening Inventory

20

Add Purchases (100+90)

190

Less Sales (85+110)

(195)

Closing inventory (Units)

15

Unit Price (Last price)

45

Closing inventory (Value)

675