IFRS PRACTICAL IMPLEMENTATION GUIDE AND WORKBOOK

Wiley IFRS: Practical Implementation Guide and Workbook

4. MEASUREMENT OF INVENTORIES

In general, inventories are valued at the

"lower of cost and net realizable value." There are, how–

ever, two exceptions

to this principle of measuring inventories; they are clearly explained in the

Standard (these are covered in Section 2.2 of this chapter).

5. COST OF INVENTORIES

5.1 The cost of inventories comprises all

(a) Costs of purchase

(b) Costs of conversion

5.2 Costs of Purchase

The costs of purchase constitute all of

• The purchase price

• Import duties

• Transportation costs

• Handling costs directly pertaining to the acquisition of the goods

Trade discounts and rebates are deducted when arriving at the cost ofpurchase of inventory.

5.3 Costs of Conversion of Inventory

Cost of conversion of inventory includes costs directly attributable to the units of production, for

example, direct labor. The conversion costs could also include variable and fixed manufacturing

overhead incurred in converting raw material into finished goods .

Fixed overhead costs

are those

costs that remain constant irrespective of the units of production. The best example would be the

depreciation of factory building and equipment.

Variable costs

are those costs that vary directly

with the volume of production, such as indirect material and labor costs. The allocation of overhead

to the cost of conversion is based on the "normal capacity" of the facility .

Normal capacity

is the

production that is normally achieved on average over a number of periods, taking into account the

loss of capacity that may result. Costs that could not be reasonably allocated to the cost of inven–

tory should be expensed as they are incurred. When production process leads to "joint products" or

"by-products," then the cost of conversion of each product should be ascertained based on some

rational and consistent basis, such as the "relative sales value" method .

5.4 Other Costs in Valuing Inventories

Other costs in valuing inventories include those costs that are incurred in bringing the inventories

to their present location and condition. An example of such "other costs" is costs of designing

products for specific customer needs.

5.5 Excluded Costs from Inventory Valuation

5.5.1 Certain costs are not included in valuing inventory . They are recognized as expenses dur–

ing the period they are incurred.

5.5.2 Examples of such costs are

(a) Abnormal amounts of wasted materials , labor, or other production costs

(b) Storage costs unless they are essential to the production process

location and condition

(d) Selling costs

5.6 Inventory Purchased on Deferred Settlement Terms

When inventories are purchased on deferred settlement terms, such arrangements in reality contain

a financing element. That portion of the price that can be attributable to extended settlement terms,

the difference between the purchase price for normal credit terms and the amount paid, is recog–

nized as interest expense over the period of the financing arrangement.