Learning objectives
After studying the material in this chapter you
will be able to do the following:
LO1
Explain the nature, purpose and importance of inventory to an
entity.
LO2
Distinguish between the perpetual and periodic methods of
inventory control.
LO3
Distinguish among the different cost formulas used to account
for inventory and cost of sales, and understand the impact the
different cost formulas have on the amounts reported in the
financial statements.
LO4
Explain the lower of cost and NRV (net realizable value) rule.
LO 5
Explain the concept of conservatism.
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LO3
Inventory Valuation
IFRS Cost Formulas
• First in, first out (FIFO)
• Average cost
• Specific identification
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LO3
First-In, First-Out (FIFO)
• Balance sheet values are from most recent
purchases
• Cost of goods sold are from oldest purchases
• Flow of costs matches flow of goods
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LO3
FIFO Inventory System
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LO3
Average Cost
• All goods for the period have same cost
• No differentiation between products
• Particularly appropriate in process
environments
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LO3
Specific Identification
• Assigns the actual cost to the unit of
inventory
• Tracks each item separately
• Flow of costs exactly matches flow of goods
• Suitable for expensive/unique inventory
• Opportunity for manipulation by
management
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LO3
Choice of Formula
• Specific identification required where
inventory items are not interchangeable
• Choice exists between FIFO and average cost
where inventory is homogeneous and
interchangeable
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LO3
Impact of Choices
• Choice has no effect on underlying economic
activity - does not reflect or affect physical
flow of inventory
• Cost formulas move costs from balance sheet
to income statement
• Cost formulas allocate costs differently
between ending inventory and cost of sales
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LO3
Cash Flow and Other Impacts
• Cash flow is not directly affected by the cost
formula used
• Individual values for cost of sales and
inventory change with method
• Measures and ratios will change
• Economic consequences
• Managers have discretion
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LO3
Which Method is Best?
• Depends on the objectives of the users and
preparers
• Each has different impacts on the financial
statements - it is important to be aware of
consequences
• But remember, no effect on underlying
economic activity
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LO3
Cost Formulas and Objectives
When prices are rising,
• Average costs yields lower income figure
• FIFO yields higher income figure
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LO3,4
Disclosure Requirements
• Accounting policies adopted, including cost
formula used
• Carrying amount of inventories
• Carrying amount of inventories carried at
NRV
• Amount of inventory expensed during the
period
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LO3,4
Disclosure Requirements (Continued)
• Inventory writedowns and reversals of
writedowns
• Carrying amount of inventories pledged as
security for liabilities
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