Tutorial 8 (Week beginning 16th September 2019)

Topic 7: Inventory (Part 2): AASB102 – cost of inventory, cost-flow

assumptions, lower of cost and NRV, inventory writedowns

SOLUTION TO HOMEWORK QUESTIONS

1. Q5.7 (p. 322)

Lee Ltd is using the FIFO method of inventory costing and Lam Ltd is using the LIFO
method. Under FIFO, the latest goods purchased remain in inventory. Thus, the
inventory on the statement of financial position should be close to current costs. The
reverse is true of the LIFO method. Lee Ltd will have the lower gross profit because
cost of goods will include a higher proportion of goods purchased at earlier (higher)
costs.

2.
a) Explain the components of the cost of inventory according to AASB102

Cost of inventories is defined at paragraph 10 of AASB 102 as the aggregate of:

• the cost of purchase;
• the cost of conversion; and
• other costs incurred in bringing the inventories to their present location and
condition.

b) Briefly distinguish between the following costing methods: Specific identification,

weighted average, FIFO, LIFO

Specific Identified Cost

AASB 102 requires that the cost of inventories of items that are not ordinarily
interchangeable, or are produced and segregated for specific projects, must be
assigned a cost by using specific identification. Specific costs are attributed to
specifically identified items of inventory. Such inventory is usually unique for a
specific purpose or contract.

Average
The average cost is calculated from the goods available for sale, on a periodic basis
(weighted average) or as each inventory is purchased (moving average).

FIFO
Assumes that inventory is sold in the order of the first in first out and that inventory
on hand is the most recently purchased.

LIFO
Assumes that inventory is sold in the order of the last in first out and that inventory
on hand is the oldest purchased.

c) Explain net realizable value according to the accounting standard

Net realizable value is defined in AASB 102 para 6 as “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”.
Examples of these costs include:
 Transport out
Carry bag for customer
Handling costs to repackage

d) Explain the lower of cost and net realizable value rule according to the accounting
standard

According to the accounting standard (AASB 102 par 9) inventory should be valued
at the lower of cost and NRV. This rule is based on the principle of conservatism.
This is done to avoid overstating the asset and profit.

e) Briefly explain what factors may lead to the Net Realizable value falling below the
cost of inventory

• Pressure of competitors that necessitates a reduction in selling price

• Obsolete inventory
– Perishable
– Technological (new/updated models)
• Customer changes in tastes etc

3. PSB5.3 (pp. 334-335) – ignore LIFO.

Rye Sails

(a) Cost of Goods available for Sale

Date Explanation Units Unit Cost Total Cost

March 1 Beginning inventory 150 $35 $5,250

5 Purchase 350 40 14,000
13 Purchase 550 45 24,750
21 Purchase 400 50 20,000
26 Purchase 150 55 8,250
Total 1,600 $72,250

(b) FIFO
(1) Ending Inventory

Date Units Unit Cost Total Cost

March 26 150 $55 $8,250

21 100 50 5,000
*250 $13,250

*1,600 – 1,350

(2) Cost of sales

 Cost of goods available for sale $72,250
Less: Ending inventory (13,250)
Cost of sales $59,000

Proof of Cost of sales

Date Units Unit Cost Total Cost

March 1 150 $35 $5,250

5 350 40 14,000
13 550 45 24,750
21 300 50 15,000
1350 $59,000

Average Cost

(1) Ending Inventory

$72,250 ÷ 1,600 = $45.16

Units Unit Cost Total Cost

250 $45.16 $11,290

(2) Cost of sales

Cost of goods available for sale $72,250

Less: Ending inventory (11,290)
Cost of sales $60,960

(c) (1) As shown in (b) above, FIFO produces the highest inventory amount,
$13,250.
4. Rihanna Ltd is a new business that sells perfume bottles. The business had started
operations with 100 bottles purchased for $40 each. During the first month of operation
the following purchases were made:

1 July 2019 Purchased 300 bottles (invoice price = $38.00). The freight and
insurance cost on the entire order was $1,800.

18 July 2019 Purchased 200 bottles from a different supplier whose normal retail
price was $40.00 per unit. However, the supplier granted Rihanna Ltd a trade
discount of 10% and offered free freight and insurance.

Sales of bottles for the month were as follows:

Units sold Selling price per unit
20 July 2019 100 $124
20 July 2019 100 $124
23 July 2019 100 $128
350
20 bottles from the purchase on the 18 July 2019 were found to have been left in the
sun and have become discoloured. These bottles can only be sold for $20 each. A
physical stocktake revealed 250 units on hand at the end of the period.
Rihanna Ltd uses the periodic inventory method and the first in first out (FIFO) cost-
flow method.
Required:
Calculate the cost of closing inventory, in accordance with the requirements of relevant
Australian accounting standards. Justify ALL elements of your calculations in
accordance with Australian accounting standards.

1. Identify costs which attach to inventory

July
1st Beginning inventory 100 bottles @ $40
1st Purchased 300 bottles @ $38 + (1800/300) = 38 + 6 = $44
18th Purchased 200 bottles @ $40-4 = $36

The accounting standard requires that the cost of inventory is purchase price plus
transport in if material. It also requires trade discounts to be deducted if material
Transport in is material if they affect decision making
Not sure – go to guideline
1,800/(11,400) = 15.8% therefore influences decision making and is material and
included in cost

2. Select a cost determination method

Question says FIFO
3. Determine cost of product on the basis chosen
Ending inventory 250 units
Ending inventory: First in first out (FIFO) Latest 200 x $36
Next latest 50 x $44

4. Determine NRV for each product

Value inventory at lower of cost and NRV
NRV = estimated selling price less costs to sell
180 bottles at $128 – 0 = $128
20 bottles at $20 – 0 = $20

5. Compare cost vs NRV and select the lower value

FIFO Cost NRV Lower
Latest 200 x $36 180 @ $128 180 @ $36 =
$6,480
20 @ $20 =
20 @ $20
$400

50 @ $44 =
Next latest 50 x $44 50 @ $128 $2,200

Total $9,080

5. Hardwick Artwork Pty Ltd is in business selling framed prints of classic paintings. The
prints are produced on high-quality paper and to the highest possible standards, so
they are expensive to purchase from the importer.

Pricing the prints is difficult because popularity of a print is difficult to predict.

Sometimes prints do not sell well at all and are then disposed of in bulk for use in hotels
and motels. The transaction data on two recent prints are as follows:

City scene print Rural scene print

Units Cost per Unit Units Cost per Unit
$ $
Inventory, 1 July 2013 4 340 11 500
Purchases during 2013 – 2014:
During July-December 2013 10 350 25 480
During January – June 2014 15 330 30 510
 Sales during 2013 – 2014 13 38

Purchase of the city scene print requires payment of an import duty of $50 per print.
The latest selling price of city scene prints was $650 per print.
The rural scene print has not sold any copies since March 2014. In late June 2014, a
country motel chain offered $300 each for all the rural scene prints that Hardwick
Artwork has left, if Hardwick Artwork will pay the $30 per print freight cost. Hardwick
Artwork management realises this is the highest offer they are likely to receive.
Required:
Calculate the following:
(i) Ending inventory value for the city scene print as at 30 June 2014, using a FIFO
cost flow assumption.
(ii) Cost of goods sold for the year ended 30 June 2014 and ending inventory as at
30 June 2014 for the rural scene print, using the weighted-average cost flow
assumption.
Justify your answers and show all workings.
(i)

1. Identify costs which attach to inventory

Inventory, 1 July 2013 4 $340

Purchases during 2013 – 2014:
During July-December 2013 10 350 + 50 = $400
During January – June 2014 15 330 + 50 = $380

The accounting standard requires that the cost of inventory is purchase price plus import
duties if material. Import duties are material if they influence economic decisions. Not sure –
go to guidelines

50/350 = 14.29% therefore influence economic decisions and is material and included in
cost

2. Select a cost determination method

Question says FIFO

3. Determine cost of product on the basis chosen

4 (open balance) + 10 + 15 – 13 = 16

Ending inventory: First in first out (FIFO) Latest 15 x $380 = $5,700

Next latest 1 x 400 = $400

4. Determine NRV for each product

NRV = estimated selling price less costs to sell
16 units at $650

5. Compare cost vs NRV and select the lower value

Inventory must be valued at the lower of cost and NRV on an item by item basis
 City Scene Prints Cost NRV Lower
Latest 15 x $380 16 units at $650 Latest 15 x $380 =
$5,700

Next latest 1 x $400 Next latest 1 x $400

= $400

= $6,100

(ii)

1. Identify costs which attach to inventory

Inventory, 1 July 2013 11 500

Purchases during 2013 – 2014:
During July-December 2013 25 480
During January – June 2014 30 510

The accounting standard requires that the cost of inventory is purchase price. Nothing else
relevant.

2. Select a cost determination method

Question says Weighted Average

3. Determine cost of product on the basis chosen

Weighted-average cost calculation:

Units Cost Total
$ $
11 500 5,500
25 480 12,000
30 510 15,300
Total 66 32,800

Average cost = $32,800/66 = $496.97 per unit

Cost of goods sold = $496.97 x 38 units = $18,884.86

Ending inventory = $496.97 x 28 units

4. Determine NRV for each product

NRV = estimated selling price less costs to sell

66 – 38 = 28 units left
28 units at ($300 - 30) = 7,560
5. Compare cost vs NRV and select the lower value
Inventory must be valued at the lower of cost and NRV on an item by item basis

Rural Scene Prints Cost NRV Lower

28 x $496.97 28 units at $270 28 units at $270 =
$7,560