ACCA Paper F 7 Financial Reoirting F7FR Session14 d08

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  OVERVIEW Objective ¾ To prescribe the accounting treatment for inventories under historical cost. ¾
  To provide practical guidance on: ‰ determination of cost; ‰ expense recognition (including any write-down to net realisable value); ‰ cost formulas.
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  Objective BASICS
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  Scope
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  Definitions
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  Measurement NET REALISABLE COST
  VALUE
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  Need for Meaning of cost
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  Considerations Components of cost
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  Materials Techniques
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  Timing Cost formulas
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  As an expense
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  RECOGNITION As an asset
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  In financial statements
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  DISCLOSURE Expense recognition 1 BASICS
  1.1 Objective ¾ To prescribe the accounting treatment for inventories. ¾
  Primary issue – the amount of cost to be recognised as an asset and carried forward until related revenue is recognised.
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  IAS 2 provides guidance on: ‰ cost determination; ‰ subsequent recognition as expense (including any write-down to net realisable value);
  ‰ cost formulas used to assign costs to inventories.
  1.2 Scope ¾
  All inventories except: ‰ contract work in progress (IAS 11); ‰ financial instruments (IASs 32 and 39); ‰ biological assets related to agricultural activity and agricultural produce at the point of harvest (IAS 41).
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  These inventories are entirely outside the scope of IAS 2. Some inventories that are within the scope of the Standard with regard to disclosure, but not measurement.
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  The measurement provisions of IAS 2 do not apply to inventories held by: ‰ producers of agricultural and forest products, agricultural produce after harvest, and minerals and mineral products, to the extent that they are measured at net realisable value in accordance with well-established industry practices;
  ‰ commodity broker-traders who measure their inventories at fair value less costs to sell.
  Commentary When such inventories are measured at net realisable value, changes in that value are recognised in profit or loss in the period of the change.
  1.3 Definitions ¾
  Inventories are assets:
  ‰ held for resale in the ordinary course of business (e.g. merchandise purchased by retailer); or
  ‰ in the process of production for resale (e.g. finished goods, work in progress, raw materials); or
  ‰ in the form of materials or supplies to be consumed in the production process or rendering of services.
  ¾ Net realisable value is the estimated selling price in ordinary course of
  business less the estimated cost of completion, and estimated costs necessary to make the sale.
  1.4 Measurement ¾ Inventories are measured at the lower of cost and net realisable value.2 COST
  2.1 Meaning of cost ¾
  Cost includes all costs involved in bringing the inventories to their present location and condition.
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  Components of cost: ‰ purchase costs ‰ costs of conversion ‰ other costs.
  2.2 Components of cost Purchase costs Conversion costs Other costs ¾ ¾ ¾
  Purchase price Direct production costs Only if incurred in
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  Import duties/non- Production Overheads bringing inventories to present location and refundable taxes Based On normal
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  capacity – i.e. expected condition e.g. non- Transport/handling
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Deduct trade on average under production overheads
  (e.g. storage in whiskey discounts/rebates. normal circumstances
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  distillers) and specific Joint product costs (deduct net realisable design costs
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  value of by-products). Borrowing costs in limited circumstances (in accordance with IAS 23).
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  Commentary This is not practicable in many businesses.
  Specific identification of individual costs is required for: ‰ items not ordinarily interchangeable; and ‰ goods/services produced and segregated for specific projects.
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  2.4 Cost formulas
  An average percentage for each retail department is often used.
  This is a management tool which may need to be adapted to conform to IAS 2.
  This is a practical means of measurement for financial reporting purposes.
  
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  Reduces sales value by appropriate percentage gross margin.
  For inventories of large numbers of rapidly changing items with similar margins.
  The following expenditures are excluded: ‰ abnormal amounts of wasted materials, labour and other production costs; ‰ storage costs unless necessary to the production process; ‰ administrative overheads; and ‰ selling costs.
  
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  Standards must be regularly reviewed and revised as necessary.
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  Takes into account normal levels of materials, labour, efficiency and capacity utilisation.
  Standard cost Retail method ¾
  2.3 Techniques for measurement of cost ¾ Two costing methods can be used for convenience if results approximate actual cost.
  Commentary But not profit margins or non-production costs that are often factored into prices charged by service providers.
  For service providers the cost of inventories consists primarily of labour including supervisory personnel and attributable overheads.
  ¾2.4.1 Specific identification
  2.4.2 Formulae ¾
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  January 10 @ $20 each 200 April 10 @ $24 each 240 May 8 @ $45 each 360 October 20 @ $30 each 600 November 20 @ $60 each 1,200 ___ _______ _______ 40 1,040 1,560 ___ _______ ________
  $ $
  Bought Sold
  XYZ sells telephones and is valuing its inventory at FIFO cost price at 31 December. A record of the transactions is shown below.
  Example 1
  Commentary In practice these formulas are likely to produce similar results when price changes are small and infrequent and there is a fairly rapid turnover of inventories.
  Used for like items used in production/sold without regard to when received.
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  Used, for example, for: ‰ cars on a production line; ‰ retail produce with a “sell by” (or “best before”) date.
  May be calculated on a periodic basis or on each additional shipment.
  Formulae are permitted where specific identification of individual costs to individual items is not practicable.
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  Determined from weighted average cost of: ‰ i

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