Chapter 14: Inventories

Lecture 2
Chapter 14: Inventories
Lecture 1:
Definition
Initial measurement
Inventory systems
Lecture 2:
Cost formulas
Inventory shortages
Insurance claims
Subsequent measurement
Presentation and Disclosure
Categories of inventory

Specifically identifiable inventory items

Examples:
• Cars at motor dealership
• Paintings by an art dealer

Uniform interchangeable units per inventory item

Examples:
• Lays at Pick ‘n Pay
• Coca cola at Spar
Cost formulas
Methods used to determine the cost of trade inventory on hand at the reporting
date and the cost of sales

Specific identifiable inventory items

• Specific identification method – where all costs incurred on a specific item are
allocated to that specific item to make up its cost.

Uniform interchangeable units of inventory

• Elects either FIFO or weighted average cost
• Part of the entities accounting policy
FIFO method
= First in first out

The cost of sales and cost of inventory on hand at year end is calculated
based on the following assumption:

Units purchased FIRST are sold FIRST

FIFO method
Example: Perpetual inventory system

BOX A

BOX B

Required:

Calculate the cost of sales per sales transaction for 2 Feb, 15 June, 21 Dec
FIFO method
Solution

Units on hand: 1800

Cost of units on hand: (300 x R240) + (1500 x R300) = R522 000
FIFO method
Example: Periodic inventory system

Required:
1. Calculate the cost of the inventory on hand- Physical stock count = 1800 units.
2. Calculate the cost of sales for the period.
FIFO method
Solution
1. Cost of units on hand: (300 x R240) + (1500 x R300) = R522 000
2. Cost of sales for the period: R1 048 000
Weighted average cost method
• Weighted average cost per unit:

Rand value of Inventory (opening balance) + Rand value of purchases

Number of units
Weighted average cost method
Example: Perpetual inventory system

Required:
1. Calculate the cost of the inventory on hand
Weighted average cost method
Example: Perpetual inventory system

• The cost of sales amount is calculated at the weighted average cost per unit
at the time of sale
• The cost of inventory on hand at year end is calculated at the weighted
average cost per unit at the reporting date
Weighted average cost method
Solution
Weighted average cost method
Example: Periodic inventory system

Required:
1. Calculate the cost of the inventory on hand- Physical stock count = 1800 units.
2. Calculate the cost of sales for the period.
Periodic inventory system
1. Calculate the cost of the inventory on hand- Physical stock count = 1800 units

Calculated weighted average cost per unit:

(Opening stock + Purchases)/ Number of units
(400 000 + 720 000 + 450000)/ 6 500 = R241,54 per unit

Closing inventory balance:

(weighted average cost per unit x inventory on hand)
R241,54 x 1 800 = R434 772
Periodic inventory system
2. Calculate the cost of sales for the period
Retail Method
• Technique which is only suitable for use by entities that maintain a fairly
constant gross profit margin.

• Cost = Sales price – Gross profit

• Gross profit percentage expressed as a percentage of sales or cost of
sales
Retail method
Gross profit percentage calculated in 2 ways:
• as % of sales
GP% = Gross profit / Sales x 100

• as % of cost of sales
GP% = Gross profit / COS x 100
 Retail method
Mark up formula: CP + GP = SP
Assume GP of 20%

Where GP % on sales

Where GP % on COS
Retail method
Example

60% 40%
Retail method
Solution

60% 40%

R9 800 000 (Selling price) x WANT/HAVE

R9 800 000 x 60/100
= R5 880 000
Inventory shortages
Inventory shortages
Example: FIFO method using the perpetual inventory system
Date Detail Units R/p.unit (excl VAT)
1 Jan Opening Balance 2000 200
2 Feb Sales (1200)
5 Apr Purchases 3000 240
15 Jun Sales (2000)
20 Sept Purchases 1500 300
21 Dec Sales (1500)
Inventory shortages
Solution
Inventory shortages
Solution
Inventory Shortages
Periodic inventory system
• Cost of sales calculated at end of the year
• Physical stock count will reveal actual units on hand at
end of year
• Whether there was a loss due to shortage will be
unknown
• If there was a loss it would be automatically included in
cost of sales.
Losses due to an event
• Inventories can be destroyed or damaged in an event or stolen

• Perpetual inventory system

• Periodic inventory system

Losses due to an event
Under the perpetual and periodic inventory system,
losses due to events are closed off to cost of sales

Dr Cost of sales (P/L)

Cr Loss due to ‘event’ (P/L)
Insurance against events
• Hedge the risk of loss due to events such as fires, theft,
floods etc.
• The loss due to event and proceeds from insurance = 2
separate transactions – do not offset
• Proceeds paid out on claim = income
• Insurance compensation closed off against cost of sales
Insurance against events
Amount of insurance claim payout:

• Insurer determines the amount based on cost of

inventories destroyed and cost of inventories on hand
before event subject to the average clause
Insurance against events
Average clause

Insured amount (excl VAT) < cost of inventories on hand just before event
=Underinsured

Payout = Cost of inventories

destroyed
x
Insurance against events
Example

• AC Entity is a registered VAT vendor and uses the perpetual inventory system to
recognise transactions in respect of trade inventories.
• AC Entity's trade inventories are insured at R388 125 (including VAT)
• During the night of 12 January, trade inventories were destroyed in a fire
• On 11 January, AC Entity had trade inventory with a cost of R375 000 on hand.
R75 000 worth of inventory was undamaged.

Required:
A) Recognise the loss in respect of trade inventory destroyed in a fire
B) Calculate the amount of the claim that would probably be paid by the insurer .
Insurance against events
Solution
Insurance against events
Solution

338 125 X100/115

Insurance against events
Solution
2015 Dr Cr
12 Dec Insurance company (receivable) (SFP) 310 500
VAT output (SFP) (310 500 x 15/115) 40 500
Insurance compensation (P/L) (310 500 x 100/115) 270 000
Recognise insurance compensation

2015 Dr Cr
13 Dec Bank (SFP) 310 500
Insurance company (receivable) (SFP) 310 500
Derecognise receivable due to settlement
Insurance against events
Solution – alternative journal
• n Dr Cr
Bank (270 000x 115/100) (SFP) 310 500
VAT output (310 500 x 15/115) (SFP) 40 500
Insurance compensation (P/L) 270 000
Recognise insurance compensation
Subsequent measurement
At reporting date, trade inventories must be measured at the
lower of cost and net realisable value.

NRV = estimated selling price – estimated costs necessary to make the sale.

Why measure inventory at lower of cost and NRV?

• Ensure that the carrying amount of an asset is not overstated
• Reflects how much you can actually get from an asset
Subsequent measurement
Each reporting date, measured at:
Lower of cost and net realisable value
Therefore, if cost > NRV  Write down to NRV

Applies to perpetual AND periodic inventory system

Presentation and Disclosure
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 2019

STATEMENT OF PROFIT AND LOSS FOR THE YEAR ENDED 31 DECEMBER 2019

2019 2018
Note R’000 R’000
Revenue 5 xxx xxx
Cost of sales (xxx) (xxx)
Gross profit xxx xxx
Presentation and Disclosure
Profit before tax
Profit before tax is shown after inter alia the following items, which are items
additional to the items in notes (other notes), had been taken into account:

R
Income
Insurance compensation in respect of trade inventories xxx
destroyed in an incident
R
Expenses
Loss with write-down of inventories to net realisable value xxx
Loss due to inventories destroyed in an incident xxx