International Reporting Standards and Inventory Valuation

The assignment emphasizes that companies should value inventories at lower cost and net realizable value, rather than higher cost or gross profit method. This is essential to produce quality information about a firm's financial performance, allowing external users to take informed decisions. The importance of IFRS in inventory valuation is highlighted through various sources, including books, journals, and online resources.

International
Financial Reporting

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
Question 1........................................................................................................................................1
Preparation of income statement for Able Plc........................................................................1
Question 2........................................................................................................................................4
Critical evaluation of the statement of financial reporting ....................................................4
Question 3........................................................................................................................................7
Critical evaluation of the statement based on IAS 2..............................................................7
CONCLUSION..............................................................................................................................10
REFERENCES..............................................................................................................................11

INTRODUCTION
International financial reporting standards are required to be followed in order to produce
fair financial statements. Present report deals with the preparation of income statement of Able
Plc. for the particular year. Moreover, IAS standards such as IAS 2 related to inventories is
explained by carrying out analysis of the cost of same. Furthermore, IAS 38 related to intangible
assets are also accounted for in effective way. Thus, these standards are required for preparing
correct financials of organisation.
QUESTION 1
Preparation of income statement for Able Plc.
Income statement for the year
ended 31 December 2017
Particulars Amount
Revenue 195000
Less: COGS 122000
Gross profit 73000
Operating expenses
Rent and Rates 2000
Salaries Outstanding 1000
Bad Debts 1000
Motor expenses 6000
Warehouse Salaries 25000
Hire of vehicles 2000
Finance costs 3000
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Loss on closed branch 20000
Depreciation on Non-current assets
Fixtures @ 10% 2000
Motor Vans @ 10% 1000
Directors Salary 10000
Insurance 1000
Total operating expenses 74000
Operating income
EBT (Loss) -1000
Add: Depreciation 3000
Tax paid 3000
Net Loss -1000
Workings
1.
Workings for COGS (Cost of Goods
Sold)
Beginning inventory 20000
Purchases 130000
Ending inventory 26000
124000
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Less: Return outwards 1000
123000
Less: Carriage Inwards 1000
COGS 122000
2.
Workings for revenue
Sales 205000
Less: Return Inwards 10000
Revenue for period 195000
Income statement is prepared for the year ended 31st December 2017 for the organisation.
It is being prepared with the help of financial reporting standards provided by IFRS
(International Financial Reporting Standards) which provides an effective way to prepare
financials in the best possible manner. The income statement is prepared for Able Plc and
transactions are extracted from the trial balance from the books of accounts. Trial balance is a
useful statement which is prepared from transactions imparted by journal entries and then ledger
accounts are formulated quite effectually. It is effectively prepared by using information from
trial balance with much ease. In relation to this, statement of Profit and Loss is formulated in an
effectual way.
Moreover, expenditures incurred and incomes earned are taken into account and thus,
income statement is prepared showing the highlights of expenses and gains made during past
financial year in the best possible way. It can be said that such statement is required which
provides clarity to organisation whether it has incurred more of expenditures in relation to the
income garnered in past year (Stent, Bradbury and Hooks, 2017). Thus, income should be more
than expenses so that financial performance of organisation may be enhanced in a better way. It
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can be interpreted from the income statement of Able Plc which shows that firm is not able to
earn profits in the period. Loss has been incurred for the period amounting to -1000.
In relation to this, revenue attained in financial year was 195000 which can be further
bifurcated into sales accomplished amounting to 205000 and return inwards have been deducted
from the same to effectively get amount of revenue which is equal to 195000. On the other hand,
COGS amounts to 122000 which has been attained by applying formula of calculating COGS.
The formula is Beginning inventory + Purchases – Closing stock and thus, it can be referred to
working notes that figure arrived is 124000. From this, return outwards are deducted such as
1000 and further, carriage inwards are reduced amounting to 1000. Thus, net amount is of COGS
which comes to 122000.
On the other hand, by deducting sales revenue from cost of sales, gross profit of 73000 is
attained which is good for Able Plc and it shows that organisation is able to initiate control upon
expenses and as a result, gross income is positive implying earning capability of firm in an
effective way. Moreover, operating expenditures such as Rent and Rates, salaries outstanding
and bad debts are allowed. Moreover, motor expenses, warehouse salaries, hire of vehicles and
finance costs are applied. On the other side, loss incurred on closed branch of organisation is
applied amounting to 20000. Depreciation is provided on non-currents assets at the rate of 10 %
and so, total of 3000 is deducted. Directors Salary amounting to 10000 and insurance expense of
1000 is also accounted for. By applying such operational expenditures, total amount equals
74000. It clearly shows that expenses have exceeded income earned for the year and as a result,
loss is incurred. Thus, it is required that Able Plc should effectively initiate control upon
expenses so that necessary ones can be reduced up to a high extent and net income can be
garnered from the business operations in the best possible manner. Hence, profits will exceed
expenditures in the future course of action.
QUESTION 2
Critical evaluation of the statement of financial reporting
The financial reporting standards help accountants to effectively carry out proper
statements of organisation's position in an effectual manner (Maradona and Chand, 2017). These
standards are required to be followed so that accurate financial statements may be extracted
easily. It can be said that accounting standards when effectively complied with the provisions of
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professional body provides true and fair view of the financial health of firm quite effectually.
There are various financials such as cash flow statement, balance sheet, statement of changes of
equity and income statement are prepared with highlighting the performance of firm in a
particular year. This information is quite useful for the external stakeholders like suppliers,
investors, creditors and other users that rely on financials and thus, they are able to take decisions
in an effective manner.
In relation to this, statement provided is accounting for intangible assets in specific area
of capitalising research and development costs. While addressing this statement, IAS 38 can be
applied to classify intangible assets and accounting treatment can be easily made. The accounting
professional body IAS (International Accounting Standards) 38 is dedicated to the regulation of
treatment of intangible assets in the best possible manner. This is required so that accounting can
be applied effectually. The intangible assets are termed as those assets which cannot be
physically touched. IAS para 8 states that these are identified as non-monetary assets having no
physical substance. On the other hand, fixed assets such as machinery, furniture and fixtures as
well as related items can be touched physically. However, in the statement, research and
development costs are provided which are reported as intangible assets as they are incurred on
formulating any research and as a result, they are regarded as intangible ones (Graham and et.al,
2017).
In relation to this, goodwill has been excluded by IAS 38 because it is non-identifiable
and so, it is not included as per the standards. The main reason behind exclusion of goodwill is
that future economic benefits are realised from assets are not capable for being identified and
thus, exclusion is required for effective accounting treatment of intangible assets. On the other
hand, when intangible assets are identified, next step is to recognise and measure the same with
much ease. In relation to this, main objective of IAS 38 is that only those assets can be classified
as intangible assets which meet with the specific criteria imparted by the body. The standard also
provides the way to recognise and measure value of various intangible assets in the best possible
way. The intangible assets are identifiable when it is separable governed by IAS 38.12. It further
clarifies assets being capable of sold, transferred and rented as well as exchanged which are
useful in carrying out accounting treatment. Moreover, they are identifiable when any contractual
rights arise on the behalf of entity.
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Intangible assets can be effectively acquired by purchasing separately, part of
combination of business, government grant, internal generation and exchanging assets quite
effectually (Kettunen, 2017). In relation to this, recognition is required to meet the criteria
effectually. IAS 38.21 requires that organisation should recognise intangible assets be it is
purchased or internally generated at cost only and applies to if it is probable that economic
benefits will be realised in the future course of action. Moreover, these future benefits are
attributable to assets and would flow towards entity. Another is that asset cost can be measured
quite reliably. This requirement is applied whether intangible assets is acquired externally or
internally produced in the best possible manner. In relation to this, IAS 38 includes provision of
extra recognition for internally generated assets. Moreover, future economic benefits should be
based on reasonable ground that benefits will flow towards organisation and thus, firm will be
benefited. The probable condition based on such benefits is considered as satisfied for those
assets which are acquired internally or through business combination.
On the other hand, if the said recognition criteria of a particular intangible asset is not
met then IAS 38 has different opinions regarding the same (IAS 38 — Intangible Assets. 2018). It
states that when criteria has not been met, expenses on particular asset should be recognised as
expenditure only when it is actually incurred by organisation. Furthermore, business combination
has a pre-assumption regarding an intangible asset. It is that fair value of particular asset can be
acquired through business combination and as a result, it can be effectively measured on reliable
basis. As per IAS 38.35, if an asset whose expenditure incurred cannot be classified as per the
meaning of intangible assets and recognition criteria, then the same should be treated as a part of
goodwill amount that is attributed to it based on its date of acquisition in the best possible
manner. Reinstatement is also termed which means that IAS has prohibited organisation which
subsequently indulges in reinstating as intangible asset usually at the future date implying an
expenditure being charged to an expense on original basis.
Research and development costs are initially expenses which are incurred by company in
initiating research of new things and that can be included in its product portfolio quite
effectually. It can be said that these expenditures are accounted for so that organisation may be
able to provide goods and services to the customers to earn profits with much ease. This
enhances overall satisfaction of customers quite effectually and thus, income generated is helpful
for company to survive in the future course of action. Research is required so that new insights
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can be extracted and business may provide better quality of goods to consumers with beating
rivals in the same industry (Davidson and et.al, 2015). Thus, organisation produces profits that
help to attain future operational tasks and activities with much ease and as a result, recognition of
such costs are necessarily required by company to effectively comply with the standards of
professional body.
As per IAS 38.54, it is required that all costs incurred on research and development costs
should be charged to expenses. This clearly shows that organisation is required to charge cost to
expenses for initial recognition of the same quite easily. Furthermore, IAS 38.57 states that all
the costs related to development are required to be capitalised when technical feasibility and
commercial viability have been effectively established for the sale or use of an intangible asset.
In simple words, statement clarifies that business should state the use and provide clarity
regarding main intent to use such assets in an effective manner. Moreover, organisation should
also state that whether economic benefits will be realised in the future through usage of such
assets in the best possible way. Moreover, if business cannot differentiate research phase from
development one, then it should be treated as expense of research phase only.
In relation to this, research and development are recognised initially, then organisation
measures asset at cost less accumulated amortisation. There are mainly two types of models
which are applied to such asset after initially recognising the same quite effectually. They are
cost and revaluation model. The basic model usually applied by organisation is cost model which
means that intangible assets must be carried towards the cost less accumulated impairment losses
and amortisation if any (Graham and et.al, 2017). On the other side, revaluation model states that
assets should be carried at revalued figure less accumulated amortisation and impairment losses
only when fair value may be assessed from the active market. Thus, it can be said that firm is
able to carry out research and development costs which are effectively capitalised and forms the
part of intangible assets of organisation.
QUESTION 3
Critical evaluation of the statement based on IAS 2
Inventory is an integral part of the organisation as without the same, production cannot be
achieved by the company quite effectively. Manufacturing firm which has immense relying on
the inventory is the main part of firm as without having adequate amount of stock in hand,
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customers' demand cannot be fulfilled. On the other hand, if inventory is purchased in more
quantum, firm has to incur additional expenditures for handling of stock and it should be ordered
in an adequate quantity only. Moreover, if it is not ordered in an optimum manner and less is
purchased, then demand of production department cannot be accomplished in a better way. Thus,
it is required to purchase inventory in that way which will increase production and as a result,
customers may be provided with quality goods (Borio, James and Shin, 2014).
In relation to this, there is a standard provided by the IAS 2 which is purely dedicated to
the inventory only. The main objective is to effectively make accounting treatment for shares.
One of the problems in accounting for stocks is that amount of expense to be recognised as asset
and which are carried forward till revenues from the same have been recognised. The IAS 2
provides evaluation of cost and recognition to be as expense and including write-down to net
realisable amount quite easily. Moreover, cost formula is provided as well which is utilised for
assign inventory's cost. The standard is applicable to the company when assets are held for sale
in normal business operations entitled as finished items, assets held in production process for
selling purpose entitled as work-in-process and raw materials consumed in manufacturing.
On the other hand, IAS 2 prohibits certain types of inventories within above discussed
scope (IAS 2 — Inventories. 2018). These are work-in-process from contracts in the field of
construction which is governed by IAS 11. Financial instruments are not within the scope and is
referred to IAS 39 standard relating to recognition and measurement and so, it do not apply to
IAS 2. Moreover, biological assets which are related with accomplishment of agricultural
activities and harvesting point are governed by IAS 41 dedicated to agriculture. On the other
hand, measurement of inventory also do not apply when it is held by producers of items related
to agriculture and mineral products to the extent and are measured at net realisable amount which
is according to the practices adopted by company in industrial sector. Hence, when such changes
are made in realisable value of inventory, changes can be recognised in profit and loss of
particular period. On the other side, measurement of stock cannot be applied when the same is
held by brokers and dealers measuring stock at fair value deducted to sales cost. The profit and
loss is affected when inventories are measured in such way.
The main principle of IAS 2 is that inventories should be stated at lower of cost and net
realisable value. In relation to this, Net Realisable Value (NRV) is termed as net amount that
business expects to realise in normal operations by selling inventory. As per the stated standard
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of IAS 2, it is justified to state inventory at lower cost and NRV so that valuation can be made in
the best possible manner. The measurement of inventories are cost of purchase, cost of
conversion and other costs are accounted for. The cost of purchase includes purchase price,
import duties and taxes as well. Moreover, it also includes transport, handling and related
expenditures which are in direct relation and attributable to finished items, services and materials
which are acquired. Moreover, rebates and discounts are deducted and costs are determined.
Cost of conversion is directly related to units attained in the production process of
company and are direct labour. It includes properly allocating fixed and variable overheads
incurred in conversion of raw materials into finished items. Fixed overheads are those which are
required to be incurred irrespective of units being produced by company such as depreciation,
maintaining factory's equipment, etc. On the other side, variable overheads are directly related to
production and it varies directly with production volume. Allocating fixed overheads to
conversion cost is based on normal capacity. On the other hand, it is measured at net realisable
value and thus, cost of product is deducted in the best possible way. IAS 23 is related to
borrowings cost which means that these costs can be included in cost of inventories meeting
meaning of qualifying asset. Other than that, there are various costs which do not classify as
inventory cost and should not be included.
Other costs are taken to the cost of inventories to the extent incurred on bringing stocks to
adequate location. Example of not be included in cost of inventory are costs related to abnormal
amount of materials wasted and labour costs. Storage expenses are also not accounted for.
Administrative costs of overheads are also not included in the cost of inventories as these do not
make any contribution for bringing stocks to present location and further, selling costs are also
not taken into account (Vishny and Zingales, 2017). Another cost that should be excluded from
cost of inventory is differences in foreign exchange which arise from the acquisition of stocks
made in foreign currency quite effectually. Interest costs are also there when inventory is
purchased by having terms of deferred settlement.
The standard cost and methods should be applied and so measurement of inventory can
be made in an effective way. Moreover, stock items which cannot be changed, specific cost are
attributable to particular item of stock in effective way. On the other hand, when items are
classified as changeable, IAS 2 guides to use FIFO (First in First Out) method and related
weighted average formulas to carry out cost of inventories quite easily. In relation to this, LIFO
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(Last in Last Out) method is not allowed as per the revised standard of IAS 2. The same formula
should be applied by company and having same nature. Thus, cost of inventory can be calculated
with much ease (Avdjiev, McCauley and Shin, 2016).
If inventories are of varied nature, then different formulas should be used to compute
inventory's cost. On the other hand, expense recognition is also relevant to IAS 18 which states
that revenue produced from sale of stocks. This is the reason when stock is sold-off and from the
same, revenue is recognised. As a result, carrying amount realised from inventories is termed as
Cost of Goods Sold which is an expenditure. Thus, write-down to net realisable value and losses
to stocks are required to recognised as expenditure only when actually occur. Thus, it is justified
that company should value inventory cost which is lower cost and net realisable value only for
correct valuation.
CONCLUSION
Hereby, it can be concluded that organisation is required to follow international reporting
standards in that which produces true and fair financial statements of firm. This is essentially
required so that accounting rules and standards should be followed so that company may produce
effective information in the form of financials. These are required in order to impart sufficient
information to the external users by which they are able to take well-structured decisions. Hence,
such standards produce quality information regarding financial performance of the firm.
REFERENCES
Books and Journals
Avdjiev, S., McCauley, R. N. and Shin, H.S., 2016. Breaking free of the triple coincidence in
international finance. Economic Policy. 31(87). pp.409-451.
Borio, C. E., James, H. and Shin, H. S., 2014. The international monetary and financial system: a
capital account historical perspective.
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Davidson, G. and et.al., 2015. Supported decision making: a review of the international
literature. International journal of law and psychiatry. 38. pp.61-67.
Graham, A. and et.al, 2017. Macroeconomic Determinants of International Financial Reporting
Standards (IFRS) Adoption: Evidence from the Middle East North Africa (MENA)
Region.
Graham, J. R. and et.al., 2017. Tax rates and corporate decision-making. The Review of
Financial Studies. 30(9). pp.3128-3175.
Kettunen, J., 2017. Interlingual translation of the International Financial Reporting Standards as
institutional work. Accounting, Organizations and Society. 56. pp.38-54.
Maradona, A.F. and Chand, P., 2017. The Pathway of Transition to International Financial
Reporting Standards (IFRS) in Developing Countries: Evidence from Indonesia. Journal
of International Accounting, Auditing and Taxation.
Stent, W., Bradbury, M.E. and Hooks, J., 2017. Insights into accounting choice from the
adoption timing of International Financial Reporting Standards. Accounting & Finance.
57(S1), pp.255-276.
Vishny, R. and Zingales, L., 2017. Corporate Finance. Journal of Political Economy. 125(6).
pp.1805-1812.
Online
IAS 2 — Inventories. 2018 [Online] Available Through:
<https://www.iasplus.com/en/standards/ias/ias2>
IAS 38 — Intangible Assets. 2018 [Online] Available
Through:<https://www.iasplus.com/en/standards/ias/ias38>
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