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PART D: RECORDING TRANSACTIONS AND EVENTS 

 

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QUESTION 

FIFO

 

A firm has the following transactions with its product R. 

Year 1 

Opening inventory: nil 

Buys 10 units at $300 per unit 

Buys 12 units at $250 per unit 

Sells 8 units at $400 per unit 

Buys 6 units at $200 per unit 

Sells 12 units at $400 per unit 

Year 2 

Buys 10 units at $200 per unit 

Sells 5 units at $400 per unit 

Buys 12 units at $150 per unit 

Sells 25 units at $400 per unit 

Required 

Using FIFO, calculate the following on an item by item basis for both Year 1 and Year 2. 

(a) 

The closing inventory 

(b) The 

sales 

(c) 

The cost of sales 

(d) 

The gross profit 

ANSWER 

Year 1 

   

Inventory 

Unit 

Cost 

of 

 

Purchases  

Sales  

Balance  

value cost sales Sales 

Units Units Units  $ 

$ 

$ 

$ 

 10 

 

 10 

 3,000 

 300 

 

 

 12 

 

  

  3,000 

 250 

 

 

 

 

22 

 6,000 

 

 

 

 

 8 

 

 (2,400) 

 

 2,400 

 3,200 

 

 

 14 

 3,600 

 

 

 

 6 

 

  

  1,200 

 200 

 

 

 

 

20 

 4,800 

 

 

 

 

 12 

  

 (3,100)* 

 

 3,100 

 4,800 

  

8 

 

 

1,700 

 

 5,500 

 8,000 

* 2 @ $300 + 10 @ $250 = $3,100 

Year 2 

   

Inventory 

Unit 

Cost 

of 

 

Purchases  

Sales  

Balance  

value cost sales Sales 

Units Units Units  $ 

$ 

$ 

$ 

B/f 

 

 8 

 1,700 

 

 

 

 10 

 

 

  2,000 

 200 

 

 

 

 

 18 

 3,700 

 

 

 

 

 5 

 

 (1,100)* 

 

 1,100 

 2,000 

 

 

 13 

 2,600 

 

 

 

 12  

25 

 

 

1,800 

 150 

 

 

 

 

  

 4,400 

 

 

 

 25 

 

 

(4,400)**

 

 4,400 

 10,000 

  0 

 

 

       0 

 

 5,500 

 12,000 

* 2 @ $250 + 3 @ $200 = $1,100 

** 13 @ $200 + 12 @ $150 = $4,400 

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CHAPTER 7  

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  INVENTORY 

 

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PROFIT OR LOSS ACCOUNT 

FIFO 

 

$ 

$ 

Year 1 

 

 

Sales 

 

 8,000 

Opening inventory 

 

 

Purchases (3,000 + 3,000 + 1,200) 

 7,200 

 

 

 7,200 

 

Closing inventory 

 1,700 

 

Cost of sales 

 

 5,500 

Gross profit 

 

 2,500 

Year 2 

 

 

Sales 

 

 12,000 

Opening inventory 

 1,700 

 

Purchases (2,000 + 1,800) 

 3,800 

 

 

 5,500 

 

Closing inventory 

        0 

 

Cost of sales 

 

 5,500 

Gross profit 

 

 6,500 

 

 

5

   IAS 2 Inventories

 

 

IAS 2 Inventories lays out the required accounting treatment for inventories under International Financial 

Reporting Standards. 

5.1 Scope 

The following items are excluded from the scope of the standard. 

 

Work in progress under construction contracts (covered by IAS 11 Construction Contracts, which 

you will study in later financial accounting exams) 

 

Financial instruments (ie shares, bonds) 

 

Livestock, agricultural and forest products, and mineral ores 

(IAS 2, para. 2) 

5.2 Definitions 

The standard gives the following important definitions. 

 

'

Inventories

 are assets: 

 

– 

held for sale in the ordinary course of business 

 

– 

in the process of production for such sale; or 

 

– 

in the form of materials or supplies to be consumed in the production process or in the 

  rendering 

of 

services.' 

 

'

Net realisable value

 is the estimated selling price in the ordinary course of business less the 

estimated costs of completion and the estimated costs necessary to make the sale.' 

 

(IAS 2, para. 6) 

 

Inventories can include any of the following. 

 

Goods purchased and held for resale, eg goods held for sale by a retailer, or land and buildings 

held for resale 

 

Finished goods produced 

 

Work in progress (WIP) being produced 

 

Materials and supplies awaiting use in the production process (raw materials) 

(IAS 2, para. 8) 

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PART D: RECORDING TRANSACTIONS AND EVENTS 

 

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5.3 Measurement of inventories 

The standard states that 'Inventories shall be measured at the lower of cost and net realisable value' 

(IAS 2, para. 9). 

 

5.4 Cost of inventories 

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 

(IAS 2, para. 10) 

5.4.1 Costs of purchase  

The standard lists the following as comprising the costs of purchase of inventories. 

(a) 

Purchase price 

(b) 

Import duties and other taxes 

(c) 

Transport, handling and any other cost directly attributable to the acquisition of finished goods, 

services and materials 

(d) 

Less any trade discounts, rebates and other similar amounts 

(IAS 2, para. 11) 

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 (IAS 2, para. 12). You may have come across the terms 

'fixed production overheads' or 'variable production overheads' elsewhere in your studies. The 

standard refers to them as follows. 

 

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. 

 

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, para. 12) 

 

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 or idle plant will not 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. 

 EXAM FOCUS POINT 

This is a very important rule and you will be expected to apply it in the exam. 

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(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. 

(IAS 2, para. 13) 

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 (IAS 2, para. 15). 

The standard lists types of cost which would not be included in cost of inventories. Instead, they should 

be recognised as an expense in the period they are incurred. 

 

'abnormal amounts of wasted materials, labour or other production costs; 

 

storage costs, unless those costs are necessary in the production process before a further 

production stage; 

 

administrative overheads that do not contribute to bringing inventories to their present location 

and condition; and 

 

selling costs.' 

(IAS 2, para. 16) 

5.5 Determining cost  

Cost of inventories should be assigned by specific identification of their individual costs for items that 

are not ordinarily interchangeable (ie identical or very similar) and for goods or services produced and 

segregated for specific projects. Specific identification of cost means that specific costs are attributed to 

identified items of inventory. However, calculating costs on an individual item basis could be onerous. 

For convenience, IAS 2 allows the use of cost estimation techniques, such as the standard cost method 

or the retail method, provided that the results approximate cost 

(IAS 2, para. 21).  

(a) 

Standard costs take into account normal levels of materials and supplies, labour, efficiency and 

capacity utilisation. They are regularly reviewed and revised if necessary to ensure that they 

appropriately resemble actual costs. 

(IAS 2, para. 21) 

(b) The 

retail method is often used in the retail industry for measuring inventories of large numbers 

of rapidly changing items with similar margins for which it is impracticable to use other costing 

methods. The cost of the inventory is determined by reducing the sales value of the inventory by 

the percentage gross margin.  

(IAS 2, para. 22) 

5.5.1 Interchangeable items 

Where inventories consist of a large number of interchangeable (ie identical or very similar) items, it will 

be virtually impossible to determine costs on an individual item basis. Therefore IAS 2 allows the 

following cost estimation techniques.  

(a) 

FIFO. Using this technique, we assume that components are used in the order in which they are 

received from suppliers. The components issued are deemed to have formed part of the oldest 

consignment still unused and are costed accordingly. 

(b) 

Weighted average cost (AVCO). As purchase prices change with each new consignment, the 

average cost of components in inventory is constantly changed. Each component in inventory at 

any moment is assumed to have been purchased at the average price of all components in 

inventory at that moment. Under the AVCO method, a recalculation can be made after each 

purchase, or alternatively only at the period end.   

The same technique should be used by the entity for all inventories that have a similar nature and use. 

 

(IAS 2, paras. 25 and 27) 

Note that the LIFO formula is not permitted by IAS 2. 

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