Regulating Inventory – An Examination of AASB 102 “Inventories” Inventories are in essence what organisations hold with an intention to sell, however directly or indirectly. For most businesses, this is how their profits are made, and it is reasonable to assume that these items account for much of an organisation’s activities. Such a big influence on indicators of financial performance and position warrants an equally large need for regulation to ensure that users of the financial statements are given a clear picture of the state the organisation is in. The Australian Accounting Standards Board (AASB) is responsible for developing the standards that govern the way reporting entities disclose their accounting figures. Despite much international debate, the regulation of inventories has changed over the years, and problems that appear in even the current regulations make it likely that more changes are to come.
The standards governing inventories are contained in AASB 102 “Inventories.” Paragraph 6 of this standard defines inventories as assets held for sale in the ordinary course of business, in the process of production for such sales, or held in the form of materials or supplies to be consumed in the production process or rendering of services (2009). In order to give more conservative figures for the value of inventories held, they are to be valued at the “lower of cost and net realisable value” under paragraph 9, net realisable value being defined in paragraph 7 as the net amount expected to be realised from the sale of the inventory in the ordinary course of business.
The “cost” of inventories is defined as “all costs of purchase and conversion, and other costs incurred in bringing the inventories to their present location and condition,” in paragraph 10. Paragraphs 11-15 define the three elements of this cost. The “cost of purchase” includes in addition to the purchase price, any costs incurred in the acquisition of the finished goods less any discounts or rebates. “Conversion costs” includes costs incurred in the production of the finished goods, such as direct labour.
In compliance with paragraph 6 of AASB 102, paragraph 12 states that fixed production and manufacturing overheads, such as factory depreciation or rent, must also be allocated to the cost of inventories as they are incurred as conversion costs to the same extent as direct labour and other variable costs (Deegan, 2010, pp. 227).” This is done using the “absorption costing” method, the method required by AASB 102, although “standard costs,” that is predetermined product costs based on prior planning, can be used where they can be attained realistically and reviewed regularly. In order to provide consistent cost figures, paragraph 13 prescribes that costs be allocated based on “normal capacity,” the production expected to be achieved based on the average production of past periods, and taking into account diminished production levels resulting from planned maintenance. However actual production levels may be used if they approximate normal capacity. Additionally AASB 102 allows different methods of measuring cost for service providers, agricultural produce harvested from biological assets, and retailers. Paragraph 19 requires that service providers include labour, other costs of personnel directly engaged in providing the service, and attributable overheads. In administering the measurement of agricultural inventories, paragraph 20 makes reference to another standard AASB 141, which requires that the cost harvested inventories be measured at their fair value less the costs to sell at the point of harvest. The retail method is set out in paragraph 22, and requires the cost of inventory to be determined by reducing the sales value of the inventory by an average gross margin (i.e mark-up) percentage for each relevant department, taking into account any mark-ups or mark-downs applied.
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