FAF3
Syllabus D. Recording Transactions And Events D3. Inventory

D3e. Costs included in valuing inventories 5 / 10

Syllabus D3e)

Recognise which costs should be included in valuing inventories.

Cost

The cost of inventories will consist of all the following costs

  1. Purchase

  2. Costs of conversion

  3. Other costs incurred in bringing the inventories to their present location and condition, e.g. carriage inwards

Costs of purchase

IAS 2 lists the following as comprising the costs of purchase of inventories

  • Purchase price; plus

  • Import duties and other taxes; plus

  • Transport, handling and any other cost directly attributable to the acquisition of finished goods, services and materials; less

  • Trade discounts, rebates and other similar amounts

Costs of conversion

Costs of conversion of inventories consist of two main parts

  1. Costs directly related to the units of production, e.g. direct materials, direct labour

  2. Fixed and variable production overheads that are incurred in converting materials into finished goods, allocated on a systematic basis.

Fixed production overheads are those indirect costs of production that remain relatively constant regardless of the volume of production, e.g. the cost of factory management and administration.

Variable production overheads are those indirect costs of production that vary directly, or nearly directly, with the volume of production, e.g. indirect materials and labour. (IAS 2)

Net Realisable Value

The net realisable value of an item is essentially its net selling proceeds after all costs have been deducted.

It is calculated as:

$
estimated selling price x
less: estimated costs of completion (x)
less: estimated selling and distribution costs (x)
----
x
===

As a general rule, assets should not be carried at amounts greater than those expected to be realised from their sale or use.

In the case of inventories this amount could fall below cost when items are damaged or become obsolete, or where the costs to completion have increased in order to make the sale.