Accounting for inventories- FRS 102

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Whilst we hope that the below questions are beneficial to you, they are not a substitute for reading the relevant accounting standards in full and are not intended to replace the accounting standards. Users of these pages should be aware that different facts and circumstances may exist in relation to similar accounting matters which may significantly change the financial reporting implications, and as a result, these Q&As do not represent a "one size fits all" solution to financial reporting issues.

In these Q&As, we look at Inventories under FRS 102 and some of the commonly asked questions.

1. What is meant by inventory under FRS 102?
2. Are there any assets that are excluded from the application of Section 13- Inventories?
3. How should inventory be measured?
4. What is an entity required to assess in relation to inventory when considering if it is impaired?
5. What are “Inventories held for distribution at no or nominal consideration”?
6. How should inventories held for distribution at no or nominal consideration be measured?
7. How is the cost of inventory measured?
8. What should “costs of purchase” include?
9. What should “costs of conversion” include?
10. What are “fixed production overheads”?
11. What are “variable production overheads”?
12. What costs are specifically excluded from being included in inventory?
13. In relation to service providers with inventory at the year end, how should inventory be measured?
14. What methods can be used to establish inventory cost?
15. What is required to be disclosed in relation to inventories under FRS 102?

1. What is meant by inventory under FRS 102?

   FRS 102 defines inventory as follows:

   “Assets which are:

   1. held for sale in the ordinary course of business;
   2. in the process of production for such sale; or
   3. in the form of materials or supplies to be consumed in the production process or in the rendering of services.”
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2. Are there any assets that are excluded from the application of Section 13 - Inventories?

   ''Section 13 - Inventories'' applies to all inventories except for:

   • Work in progress arising under construction contracts, including directly related service contracts (dealt with under section 23 of FRS 102).
   • Financial instruments (sections 11 & 12 of FRS 102).
   • Biological assets related to agricultural activity and agricultural produce at the point of harvest (section 34).

    

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3. How should inventory be measured?

   Inventory should be measured at the lower of cost and estimated selling price less costs to complete and sell.

   This means that if an item of inventory is held at cost, then it should be written down to its selling price less costs to complete and sell if cost exceeds selling price less costs to complete and sell.

   Example - stock write off

   NL Gaming Limited is a company specialising in the sale of video games. At 31 December 20X1 it held stock of the popular videogame "Zombie Golf 8". There were 200 units of this in stock at a cost of €40 per unit. The recommended retail price of the units on 1st December 20X1 was €50 per unit. On 28th December 20X1, a newer version of this popular game was released called “Zombie Golf 9”. As a result, the selling price less cost to complete Zombie Golf 8 reduced to €30 per unit at the year end. At the year ended 31 December 20X1, NL gaming should reduce the carrying value of the inventory by €10 per unit to reflect the fact that the selling price less cost to complete and sell of Zombie Golf 8 (€30) is now lower than cost (€40).

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4. What is an entity required to assess in relation to inventory when considering if it is impaired?

   Entities should refer to section 27 of FRS 102.

   At the end of each reporting date, an entity should assess whether inventories are impaired. This should be done by comparing the carrying amount of each item of inventory (or group of similar items) with its selling price less costs to complete and sell.

   If an item (or group of items) is impaired then the carrying amount of the inventory should be reduced to its selling price less costs to complete, with the reduction recognised immediately in profit or loss.

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5. What are “Inventories held for distribution at no or nominal consideration”?

   FRS 102 defines inventories held for distribution at no or nominal consideration as

   “Assets that are:

   (a) held for distribution at no or nominal consideration in the ordinary course of operations;

   (b) in the process of production for distribution at no or nominal consideration in the ordinary course of operations; or

   (c) in the form of material or supplies to be consumed in the production process or in the rendering of services at no or nominal consideration.”

   The standard does not provide a list of these assets but could likely include assets for distribution, such as samples.

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6. How should inventories held for distribution at no or nominal consideration be measured?

   FRS 102 requires that 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.

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7. How is the cost of inventory measured?

   “Cost” should include:

   • All costs of purchase;
   • Costs of conversion; and
   • Other costs incurred in bringing the inventories to their present location and condition.

    

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8. What should “costs of purchase” include?

   Costs of purchase include:

   • Purchase price;
   • Non-recoverable import duties and other taxes;
   • Transport costs;
   • Handling costs; 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 costs of purchase.

   If inventories are purchased on deferred terms and the transaction contains a financing element then the related interest should be recognised as an interest expense over the period of financing and is not added to the cost of the inventories unless the inventory is a qualifying asset under section 25 and the entity adopts a policy of capitalisation of borrowing costs.

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9. What should “costs of conversion” include?

   Costs of conversion include:

   • Costs directly related to the units of production, such as direct labour; and
   • A systematic allocation of fixed and variable production overheads that are incurred in converting materials into finished goods.

   Production costs also include the costs for provisions of dismantling, removing and restoring a site on which an item of property, plant and equipment (PPE) is located that are incurred during the reporting period as a consequence of having used that item of PPE to produce inventory during that period.

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10. What are “fixed production overheads”?

    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.

    Section 13.9 of FRS 102 sets out the process for allocation of production overheads.

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11. What are “variable production overheads”?

    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.

    Section 13.9 of FRS 102 sets out the process for allocation of production overheads.

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12. What costs are specifically excluded from being included in inventory?

    The following costs should be excluded from cost of inventories and expensed in the period incurred:

    • Abnormal amounts of wasted materials, labour or production costs;
    • Storage costs unless those costs are necessary during the production process before a further production stage;
    • Administrative overheads that do not contribute to bringing inventories to their present location and condition; and
    • Selling costs.

    Example

    GR Limited produces men’s clothing. It incurred the following costs during the year and wants to know which items are excluded from classification as inventory under FRS 102;

    • GR Limited purchased €250,000 worth of denim material from a supplier. However, 40% of this had to be disposed of as it was irrecoverably damaged during the dyeing process due to human error. The cost of this was €100,000.

       

      This cannot be included in inventory as it amounts to abnormal waste.

       

    • Between the “denim dyeing” process and the “clothing manufacturing” process, GR must store the material in a special container that maintains a consistent humidity level. The container has inbuilt technology to ensure that the humidity levels are monitored and maintained. The running cost of this is €50,000 per annum.

       

      As this is a necessary storage between production stages it is not specifically disallowed and could be included as part of inventory.

       

    • GR Limited has a finance function who deal with debtors and creditors and general financial accounting matters relating to the sale of their denim products.

       

      As this cost does not involve bringing inventories to their present location and condition, it is excluded from classification as inventory.

     

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13. In relation to service providers with inventory at the year-end, how should inventory be measured?

    If a service provider has inventory at the year-end, then inventories should be measured at the costs of production. These costs will primarily be labour and other costs of personnel directly engaged in providing the service, including supervisory personnel and attributable overheads.

    Labour costs relating to sales and general administrative personnel are not included but are recognised as expenses as incurred.

    Costs of inventory should not include profit margins or non-attributable overheads that are often factored into prices charged by service providers.

    Example

    MB Limited is a professional services provider with its main inventory cost being costs of production relating to labour costs. It bills its clients the labour cost plus 60% for its services. At the year ended 31 December 20X1, it included an inventory amount of €16,000 for its labour costs (represented by €10,000 in salaries plus 60% profit margin to be billed to the client). The costs do not yet qualify for revenue recognition.

    In this instance, FRS 102 does not allow a profit margin to be recognised in inventory and as a result, only €10,000 (being the actual labour cost) should be recognised in inventory at 31 December 20X1.

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14. What methods can be used to establish inventory cost?

    If an entity’s inventory consists of items that are not ordinarily interchangeable or goods/services produced and segregated for specific projects then the cost should be measured by specifically identifying their individual costs.

    Any other inventories not covered above should be measured using the first-in, first-out formula or the weighted average cost formula for all inventories having a similar nature and use to the entity.

    FRS 102 does not permit the use of the last-in, first-out (LIFO) method.

    Example

    GS Limited is a coal wholesaler who apply FRS 102. Its finance director believes that applying a last-in, first-out (LIFO) method for valuing stock provides a more accurate method of valuing its stock as, upon receipt of a delivery, trucks will typically pile the most recently received stock on top of the older stock. The newer stock is then more likely to be used first.

    Unfortunately, under FRS 102, LIFO is not allowed and GS must use an alternative method of valuing its stock.

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15. What is required to be disclosed in relation to inventories under FRS 102?

     

    • The accounting policy used in measuring inventories, including the cost formula used;
    • The total carrying amount of inventories and the carrying amount in classifications appropriate to the entity;
    • Impairment losses recognised or reversed in the period; and
    • The total carrying amount of inventories pledged as security for liabilities.

     

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