IAS 2 Case studies and examples (Part 2)

Background

A reporting entity decides to change from one cost formula to another (e.g. from the weighted average formula to FIFO) on the basis that the latter is more widely used in its particular industry and will therefore enhance comparability and provide more relevant information.

Question

Does this change constitute a change in accounting policy or a change in estimate?

Answer

It is sometimes argued that changing from one cost formula to another merely represents a change in estimate, in that it is a revision of the method of estimating cost. On balance, however, it seems appropriate to treat this as a change of accounting policy, for the following reasons.

•             For inventories that are ordinarily interchangeable, IAS 2.24 states that a specific identification approach is inappropriate. Accordingly, the use of cost formulas is not merely a method of estimating the aggregate actual cost of individual items, because otherwise a specific identification approach would not be inappropriate, but would instead give the best possible estimate. Rather, cost formulas are used to arrive at a different figure that avoids the unacceptable distortions that would occur if a specific identification approach were adopted.

•             IAS 2.36(a) requires disclosure of the accounting policies used for measuring inventories "including the cost formula used", which reinforces the view that the cost formula selected is a matter of accounting policy.

Requirements and disclosures relating to changes in accounting policy are set out in IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.

Other changes to the way in which inventories are measured (e.g. any changes in the basis for allocation of overheads or other costs of conversion to inventories) are likely to be changes of estimate rather than matters of accounting policy. Under IAS 8.39, the effect of a change in estimate should be separately disclosed, where material. 

Question

An item of inventory which cost CU100 is sold after the reporting period for CU80.

Should the sales price obtained from the sale of the goods after the end of the reporting period be taken into consideration when measuring the inventories in the statement of financial position at the end of the reporting period?

Answer

Generally, yes. A sale after the reporting period at a lower price generally provides evidence of the net realisable value of inventories at the end of the reporting period and the closing inventories should therefore be measured at CU80 less any costs to sell.

However, this will not always be the case. If, for example, further investigation shows that the decrease in sales price arose because of damage to the inventories that occurred after the reporting period, this would indicate that the CU80 sales price did not reflect conditions existing at the end of the reporting period and that the loss in value should not be recognised until the next period. In these circumstances, it would be necessary to assess whether the item could have been sold undamaged for an amount at or in excess of its cost (CU100) less any costs to sell. If so, no write-down of inventories would be required.

 Background

Entity P is a property developer. It is preparing its financial statements for the year ended 31 December 20X0, which will be authorised on 31 March 20X1.

At 31 December 20X0, Entity P holds a property as development work in progress. Costs incurred to date are CU20 million. Estimated costs to complete are CU10 million (therefore, total costs will be CU30 million). Completion and sale of the development are expected within 18–24 months.

Entity P estimates net realisable value (NRV) for developments work in progress based on the projected sales price for the property when it is complete, discounted back to current value. Based on market information on sales prices for similar, finished properties at 31 December 20X0, NRV is estimated at CU32 million (implying a net development profit of CU2 million).

However, property prices in the relevant market are falling. At 31 March 20X1 (date of authorisation of financial statements), the observed sales prices for similar, finished properties have declined to CU27 million (implying a net development loss of CU3 million). Estimated costs to complete (and other applicable factors) are unchanged since year end.

Question

Should Entity P recognise an inventory write-down in its 31 December 20X0 financial statements?

Answer

Yes. The development property is not available for sale at the year end. IAS 2.30 acknowledges that “fluctuations of price or cost directly relating to events occurring after the end of the period” are relevant to NRV estimates “to the extent that such events confirm conditions existing at the end of the period”. Because Entity P estimates NRV based on projected sales prices of completed property, discounted back to current value, information received after the end of the reporting period (including revised sales price estimates) provides further evidence as to conditions that existed at the end of the reporting period, unless the changes in sales prices clearly relate to a separate event subsequent to the period end.