PROCEDIMIENTO PARA REDUCIR LAS PERDIDAS POR REPOSICION EN EL·ALQU/L E R DE ENCOFRADOS

The cost of inventories will consist of all the following costs. (a) Purchase

(b) Costs of conversion

(c) Other costs incurred in bringing the inventories to their present location and condition

5.4.1 Costs of purchase

The standard lists the following as comprising the costs of purchase of inventories. (a) Purchase price;plus

(b) Import duties and other taxes; plus

(c) Transport, handling and any other cost directly attributable to the acquisition of finished goods, services and materials; less

(d) Trade discounts, rebates and other similar amounts.

5.4.2 Costs of conversion

Costs of conversion of inventories consist of two main parts.

(a) Costs directly related to the units of production, eg direct materials, direct labour

(b) Fixed and variable production overheads that are incurred in converting materials into finished goods, allocated on a systematic basis.

You may have come across the terms 'fixed production overheads' or 'variable production overheads' elsewhere in your studies. The standard defines them as follows.

x Fixed production overheads are those indirect costs of production that remain relatively constant regardless of the volume of production, eg the cost of factory management and administration. x Variable production overheads are those indirect costs of production that vary directly, or nearly

directly, with the volume of production, eg indirect materials and labour. (IAS 2)

The standard emphasises that fixed production overheads must be allocated to items of inventory on the basis of the normal capacity of the production facilities. This is an important point.

(a) Normal capacity is the expected achievable production based on the average over several periods/seasons, under normal circumstances.

(b) The above figure should take account of the capacity lost through planned maintenance. (c) If it approximates to the normal level of activity then the actual level of production can be used. (d) Low production oridle plant willnot result in a higher fixed overhead allocation to each unit. (e) Unallocated overheads must be recognised as an expense in the period in which they

were incurred.

(f) When production is abnormally high, the fixed production overhead allocated to each unit will be reduced, so avoiding inventories being stated at more than cost.

(g) The allocation of variable production overheads to each unit is based on the actual use of production facilities.

Exam focus

point

5.4.3 Other costs

Any other costs should only be recognised if they are incurred in bringing the inventories to their present location and condition.

The standard lists types of cost which would not be included in cost of inventories. Instead, they should be recognised as an expensein the period they are incurred.

x Abnormal amounts of wasted materials, labour or other production costs

x Storage costs (except costs which are necessary in the production process before a further production stage)

x Administrative overheads not incurred to bring inventories to their present location and conditions x Selling costs

5.4.4 Techniques for the measurement of cost

Two techniques are mentioned by the standard, both of which produce results which approximate to cost, and so both of which may be used for convenience.

(a) Standard costs are set up to take account of normal production values: amount of raw materials used, labour time etc. They are reviewed and revised on a regular basis.

(b) Retail method: this is often used in the retail industry where there is a large turnover of inventory items, which nevertheless have similar profit margins. The only practical method of inventory valuation may be to take the total selling price of inventories and deduct an overall average profit margin, thus reducing the value to an approximation of cost. The percentage will take account of reduced price lines. Sometimes different percentages are applied on a department basis.

5.5 Cost formulas

Cost of inventories should be assigned by specific identification of their individual costs. (a) Items that are not ordinarily interchangeable

(b) Goods or services produced and segregated for specific projects.

Specific costs should be attributed to individual items of inventory when they are segregated for a specific project, but not where inventories consist of a large number of interchangeable (ie identical or very similar) items. In the latter circumstances, one of two approaches may be taken.

The cost formula is that the cost of inventories should be assigned by using the first-in, first-out (FIFO) or weighted average cost formulas.

Under the weighted average cost method, a recalculation can be made after each purchase (as we calculated),or alternatively only at the period end.

LIFO is no longer permitted under IAS 2.

Question

You are the accountant at Water Pumps Co, and you have been asked to calculate the valuation of the company's inventory at cost at its year end of 30 April 20X5.

Water Pumps manufactures a range of pumps. The pumps are assembled from components bought by Water Pumps (the company does not manufacture any parts).

The company does not use a standard costing system, and work in progress and finished goods are valued as follows.

(a) Material costs are determined from the product specification, which lists the components required to make a pump.

each week assembling each type of pump. All employees assembling pumps are paid at the same rate and there is no overtime.

(c) Overheads are added to the inventory value in accordance with IAS 2 Inventories.The financial accounting records are used to determine the overhead cost, and this is applied as a percentage based on the direct labour cost.

For direct labour costs, you have agreed that the labour expended for a unit in work in progress is half that of a completed unit.

The draft accounts show the following materials and direct labour costs in inventory.

Raw materials Work in progress Finished goods

Materials ($) 74,786 85,692 152,693

Direct labour ($) 13,072 46,584

The costs incurred in April, as recorded in the financial accounting records, were as follows. $

Direct labour 61,320

Selling costs 43,550

Depreciation and finance costs of production machines 4,490

Distribution costs 6,570

Factory manager's wage 2,560

Other production overheads 24,820

Purchasing and accounting costs relating to production 5,450

Other accounting costs 7,130

Other administration overheads 24,770

For your calculations assume that all work in progress and finished goods were produced in April 20X5 and that the company was operating at a normal level of activity.

Required

Calculate the value of overheads which should be added to work in progress and finished goods in accordance with IAS 2 Inventories.

Note.You should include details and a description of your workings and all figures should be calculated to the nearest $.

Answer

Calculation of overheads for inventory

Production overheads are as follows.

$

Depreciation/finance costs 4,490

Factory manager's wage 2,560

Other production overheads 24,820

Accounting/purchase costs 5,450

37,320 Direct labour = $61,320

? Production overhead rate = 61,320 37,320

Inventory valuation

Raw Finished

materials WIP goods Total

$ $ $ $ Materials 74,786 85,692 152,693 313,171 Direct labour _– 13,072 46,584 59,656 Production overhead (at 60.86% of labour) – 7,956 28,351 36,307 74,786 106,720 227,628 409,134 Variable overheads will be included in the cost of inventory.