IFRS PRACTICAL IMPLEMENTATION GUIDE AND WORKBOOK

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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 (c) "Other costs" incurred in bringing the inventories to their present location and condition 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 (c) Administrative overheads that do not contribute to bringing inventories to their present 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.