Q&A IAS 2: 10-2 — LEASE COSTS INCLUDED IN THE COST OF INVENTORIES[Added 4 April 2008] BackgroundAn entity enters into a 50-year lease of land with the intention of constructing a building. The building will be sold together with any remaining lease interest over the land and is, therefore, classified as inventories when construction commences. Because of various required legal permits, construction begins in Year 6 of the lease and is completed in Year 10.QuestionShould the operating lease payments for the land be included in the cost of inventories?
AnswerYes. IAS 2.10 states that the cost of inventories should include all costs of “bringing the inventories to their present location and condition”. The operating lease cost of the land is required to construct the building and is, therefore, a cost of bringing the building to a condition in which it can be sold. However, only the operating lease payments made during the period of construction (i.e. Years 6 to 10) shall be capitalised. All operating lease payments made outside of this period must be recognised in profit or loss in accordance with paragraph 33 of IAS 17 Leases.
Q&A IAS 2: 11-1 — DISCOUNTS AND REBATES[Added 27 October 2006] QuestionEntity A is granted a 10 per cent settlement discount by its main supplier on all purchases of inventories settled within 30 days of purchase. How should the prompt settlement discount be recognised by Entity A?
Answer
“Initial measurement of inventories is at cost. The cost of inventories includes all costs of purchase, costs of conversion and all other costs incurred in bringing the inventories to their present location and condition. The costs of purchase include the purchase price, import duties and other taxes (so far as not recoverable from the taxing authorities), transport and handling costs and other costs directly attributable to the acquisition of the inventory. Reductions are made for trade discounts, rebates and other similar items. [IAS 2 para 9 to 11].” NOT CASH DISCOUNT
In accordance with IAS 2.11, rebates and discounts that have been received as a reduction in the purchase price of inventories should be taken into consideration in the measurement of the cost of those inventories. Rebates that specifically and genuinely refund selling expenses should not be deducted from the cost of inventories.Entity A should deduct the prompt settlement discount from the cost of the inventories. When measuring the cost of the inventories, the purchaser should estimate the expected settlement discount to be received from the supplier.This is consistent with the accounting by the supplier required by paragraph 10 of IAS 18 Revenue, which states that a transaction should be measured “at the fair value of the consideration received or receivable taking into account the amount of any trade discounts and volume rebates allowed by the entity”.
Q&A IAS 2: 12-1 — IS IT ACCEPTABLE TO OMIT OVERHEADS FROM THE COST OF INVENTORIES ON THE BASIS OF PRUDENCE?
[Issued 14 May 2004]
Question
Is it acceptable to omit overheads from the cost of inventories on the basis of prudence?
Answer
No. Such an approach (sometimes called 'direct costing') is not acceptable under IAS 2, which requires a systematic allocation of production overheads.
Q&A IAS 2: 12-2 — 'MARGINAL COSTING' APPROACHES TO INVENTORY VALUATION
[Issued 14 May 2004]
Question
Is it acceptable to use a 'marginal costing' approach to inventory valuation, whereby only costs that vary directly with volume of output are included in the measurement of inventories, and costs that accrue on a time basis (such as some overheads) are excluded?
Answer
No. IAS 2.10 requires that “the cost of inventories shall comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition”. Furthermore, IAS 2.12 requires that the cost of conversion should include a systematic allocation of fixed and variable production overheads (fixed production overheads being the indirect costs of production that remain relatively constant regardless of the volume of production).Therefore, marginal costing approaches to inventory valuation are not acceptable because they fail to allocate fixed production overheads.
Q&A IAS 2: 22 -1 — RETAIL METHOD FOR THE MEASUREMENT OF THE COST OF INVENTORIES
[Added 9 July 2010]
Question
Under what circumstances is it acceptable to use the retail method for the measurement of the cost of inventories?
Answer
IAS 2.22 states that the retail method is often used by retailers who sell a large number of relatively homogeneous items with similar gross profit margins. The cost of inventories is determined by deducting the average margin from the selling price of the inventories. Such average margins take into account any reductions from the original selling price of items due to sales or other promotions. When the retail method is used, average margins are often determined on a departmental basis.
This method results in a valuation of inventories that approximates to average price and is, therefore, acceptable subject to certain constraints. The method only works satisfactorily for an entire department or shop if all of the lines held are expected to generate similar profit margins. For example, the inventories of a newsagent and confectioner normally include lines of widely differing profit margins; therefore, to arrive at an acceptable inventory valuation using the retail method, it is necessary to divide the inventories into categories according to the profit margin achieved. A further problem with the retail method arises if the selling price on slow-moving items has been marked down. If the normal gross profit percentage is then deducted from such items, this will result in their being valued below cost, giving a result that may well be excessively prudent and, therefore, unacceptable. It is, therefore, necessary to ensure that the volume of marked-down items is insignificant or, alternatively, they should be segregated and valued separately.
See more example of IAS 2 part 2
Tuyen Fibi
See more example of IAS 2 part 2
Tuyen Fibi
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