- 20 Marks
Question
a. Explain the term “inventories” as defined by IAS 2 – Inventories.
(3 Marks)
b. Explain the costs that should be included when measuring the value of inventories.
(8 Marks)
c. Identify the costs that should be excluded from the measurement of inventories.
(4 Marks)
d. Ebuka and Sons Enterprise is a manufacturing entity which imports some of its raw materials from overseas. The entity recently took delivery of some materials as detailed below:
(i) 2,000kg of materials at ₦625 per kg subject to a trade discount of 5%.
(ii) Import duties and other non-recoverable taxes paid amounted to ₦266,000.
(iii) 3% early payment discount allowance enjoyed by the enterprise amounted to ₦37,500.
(iv) Delivery cost on materials imported from customs warehouse to production plant was ₦125,000.
(v) 3,500kg of local materials at ₦250 per kg subject to a trade discount of ₦50,000.
(vi) Carriage inwards on local materials purchased was ₦205,000.
(vii) Special toll fare paid to commodity board for local materials purchased was ₦25,000.
Required:
i. Calculate the total cost of inventory of raw materials. (3 Marks)
ii. It is estimated that these materials can produce 5,000 units of finished product. Calculate the material cost per unit of finished product. (2 Marks)
Answer
a. Definition of Inventories:
IAS 2 defines inventory as an asset: i. Held for sale in the ordinary course of business.
ii. In the process of production for sale.
iii. In the form of materials or supplies to be used in the production process.
b. Costs Included in Measuring Inventory:
Inventories should be measured at cost, which comprises the following: i. Costs of Purchase: This includes the purchase price, less trade discounts, and rebates. It also includes import duties, taxes, and transport costs directly attributable to bringing the inventories to their present location and condition.
ii. Costs of Conversion: Includes direct labour, direct materials, and an allocation of fixed and variable production overheads. Overheads should be allocated based on normal production capacity.
iii. Other Costs: Any costs incurred to bring inventories to their current location and condition, such as design costs for specific customers.
c. Costs to be Excluded from Inventory Measurement:
i. Costs of abnormal wastage.
ii. Storage costs unless necessary in the production process.
iii. Administrative overheads not related to production.
iv. Distribution overheads.
d. Calculation of Total Cost of Inventory:
| Item | ₦ |
|---|---|
| Purchase price (2,000kg × ₦625) | 1,250,000 |
| Less: Trade discount (5% of ₦1,250,000) | (62,500) |
| Net cost of imported materials | 1,187,500 |
| Import duties and taxes | 266,000 |
| Delivery cost | 125,000 |
| Local materials (3,500kg × ₦250) | 875,000 |
| Less: Trade discount on local materials | (50,000) |
| Net cost of local materials | 825,000 |
| Carriage inwards | 205,000 |
| Special toll fare | 25,000 |
| Total cost of inventory | 2,633,500 |
e. Material Cost Per Unit:
Material cost per unit = Total cost of inventory ÷ Number of units
Material cost per unit = ₦2,633,500 ÷ 5,000
Material cost per unit = ₦526.70
Explanation:
- a. Definition: Inventories are assets held for sale or to be used in production, as defined by IAS 2.
- b. Included Costs: The costs include purchase price, conversion costs, and any other costs incurred to bring the inventories to their location and condition.
- c. Excluded Costs: Certain costs, such as abnormal wastage and storage costs not necessary for production, are excluded.
- d. Inventory Calculation: The total cost of inventory includes direct material costs, less discounts, plus any additional costs like import duties, delivery charges, and carriage inwards.
- e. Per Unit Cost: The material cost per unit is calculated by dividing the total inventory cost by the number of finished units.
- Tags: Cost of Conversion, Exclusion of Costs, IAS 2, Inventories
- Level: Level 1
- Topic: Accounting for Inventories (IAS 2)
- Series: NOV 2022
- Uploader: Theophilus