3. Objectives
Meaning of accounting policies
Considerations in selection of Accounting Policies
Disclosure of Accounting Policies
Fundamental Accounting Assumptions
Deviations in Accounting Assumptions
4. To promote better understanding of Financial
Statement by establishing through an accounting
standard:
• The Disclosure of Significant Accounting Policies,
and
• The Manner of their disclosure
5. Meaning of Accounting Policies
Accounting policies refer to specific accounting
principles and the method of applying those principles
adopted by the enterprises in preparation and
presentation of the financial statement.
6. Primary consideration in selection of accounting policies
is that it should reflect a true and fair view
For this purpose, use the canons of :
• Prudence
• Substance over form
• Materiality
7. PRUDENCE
Where uncertainty attached to future events,
• Anticipate no profits
• Provide for all possible losses and liabilities even if
amount cannot be determined with certainty
8. SUBSTANCE OVER FORM
The accounting treatment and presentation in financial
statements of transactions and events should be
governed by their substance and not merely by the legal
form
9. MATERIALITY
• FS should disclose all 'material' items,
• Item is regarded material if knowledge of it might
influence the decisions of the user of the financial
statements.
10. For proper and better understanding of financial
statement, it is required that all significant accounting
policies followed in preparation of financial statement
should be disclosed. Because assets and liabilities in
balance sheet and profit and loss account are
significantly affected by accounting policies followed.
12. • Enterprise normally viewed as a going concern,
• It means continuing in operation for the
foreseeable future.
• Assumed that enterprise has no intention/
necessity of liquidation or of curtailing materially
the scale of the operations.
13. It is assumed that accounting policies are consistent from
one period to another.
14. • Revenues recognised as they are earned
• Costs are recognised when incurred
• Receipt or payment of money has no relevance
• Revenues and costs recorded in the period to which they
relate
15. If above assumptions followed - No specific disclosure
is required.
If above assumptions not followed, the fact should be
disclosed
16.
17. Objectives
Definition
Measure of inventories
Determination of Cost of Inventories
Determination of net realizable value of Inventories.
Comparison between the cost and net realizable value
Methods of computing Inventories
Disclosure in financial statements
18. Objective of Accounting
Standards
The basic objective of accounting standards is to
remove variations in the treatment of several
accounting aspects and to bring about standardization
in presentation
The ACCOUNTING STANDARDS BOARD (ASB)
which functions under ICAI issues accounting
standards
19. Objective
Valuation of Inventories
Formulate the method of computation of cost of
inventories/stock.
Determining the value of closing stock at which it is
to be shown in balance sheet till it is not sold and
recognized as revenue.
20. Definition
Inventories are assets:
Held for the sale in the ordinary course of
business (Finished Goods).
In the process of production of such sale
(Raw material and working progress).
In the form of materials and supplies to be
consumed in the production process or in
the rendering of services (Stores, Spares,
Raw material).
Inventories do not include machinery.
21. Measure Of Inventories
Inventories should be valued at the lower of cost
and net resale value
MAJOR POINTS FOR VALUATION OF INVENTORIES
Determination of cost of Inventories
Determination of net realizable value of
inventories
Comparison between the cost and net
realizable value
22. Determination of Cost of
Inventories
Cost of Inventories Includes:
Cost of Purchase
Cost of Conversion
Other Costs
23. Cost Of Purchase
Cost of Purchase Price includes :
• Duty and Purchase Price
• Taxes
• Freight Inward
• Other Expenditure directly attributable to
the acquisition.
Less :
• Duties and taxes recoverable by enterprises
from taxing authorities
• Trade discount
24. Example
Purchase Price 100 x 10 1000
Less : Trade Discount -100
Net Price 900
Add : Sales Tax +36
Less : Refundable Duties -100
Add : Transportation & Loading Chg +50
Total Cost of Purchases 886
25. Cost of Conversion
Includes cost directly related to units of
production
E g. Direct labour , Direct expenses ,
production overheads
Overheads are classified as fixed and
Variable overheads that are incurred in
converting material into finished goods.
26. Other Costs
Cost incurred in bringing the inventories to
their present location and condition
Excise duty contributes directly to bringing
the inventories to its present location and
condition
Excise duties is direct costs, which should be
included in the valuation of inventories
27. Exclusion From Cost of
Inventories
Abnormal amounts of wasted materials,
labour or other production cost
Storage cost unless they are necessary in
the production process
Administrative cost
Selling & distribution cost
28. Determination of net
realizable value of Inventories.
Net realizable value means
Estimated selling price - Estimated cost - Estimated costs
in ordinary course of of completion necessary to make
business sale
If the finished product is sold at cost or above cost, then the
estimated realizable value of raw material and supplies is
considered more than its cost.
If the finished product is sold below cost, then the estimated
realizable value of raw material or supplies is equal to
replacement price of raw material or supplies.
29. Comparison between the cost
and net realizable value
The comparison between the cost and net
realizable value should be made by
grouping the items.
30. Example of comparison
Item Historical NRV Valuation
X 20000 30000 20000
y 12000 10000 10000
Z 28000 26000 26000
A 12000 18000 12000
32. First-in, First-out (FIFO)
This method assumes that inventory purchased first is
sold first. Therefore, inventory cost under FIFO
method will be the cost of latest purchases. Consider
the following example:
33. Example
Bike LTD purchased 10 bikes during January and sold 6 bikes,
details of which are as follows:
January 1 Purchased 5 bikes @ $50 each
January 5 Sold 2 bikes
January 10 Sold 1 bike
January 15 Purchased 5 bikes @ $70 each
January 25 Sold 3 bikes
The value of 4 bikes held as inventory at the end of January
may be calculated as follows:
The sales made on January 5 and 10 were clearly made from
purchases on 1st January. Of the sales made on January 25, it
will be assumed that 2 bikes relate to purchases on January 1
whereas the remaining one bike has been issued from the
purchases on 15th January. Therefore, the value of inventory
under FIFO is as follows:
34. Solution
Date Purchase Issues Inventory
Units $/Units $ Total Units $/Units $ Total Units $/Units $ Total
Jan 1 5 50 250 - - - 5 50 250
Jan 5 -- - - 2 50 100 3 50 150
Jan 10 - - - 1 50 50 2 50 100
Jan 15 5 70 350 - - - 5 70 350
Jan 15 - - - - - - 7 - 450
Jan 25 - - - 2 50 100 - - -
1 70 70 4 70 280
As can be seen from above, the inventory cost under FIFO method relates to the cost
of the latest purchases, i.e. $70
35. Last-in, First-out(LIFO)
This method assumes that inventory purchased last is
sold first. Therefore, inventory cost under LIFO
method will be the cost of earliest purchases.
Consider the following example:-
36. Example
Bike LTD purchased 10 bikes during January and sold 6 bikes,
details of which are as follows:
January 1 Purchased 5 bikes @ $50 each
January 5 Sold 2 bikes
January 10 Sold 1 bike
January 15 Purchased 5 bikes @ 70 each
January 25 Sold 3 bikes
The value of 4 bikes held as inventory at the end of January
may be calculated as follows:
The sales made on January 5 and 10 were clearly made from
purchases on 1st January.
However, all sales made on January 25 will be assumed to have
been made from the purchases on January 15. Therefore, the
value of inventory under LIFO is as follows:
37. Solution
Date Purchase Issues Inventory
Units $/Units $ Total Units $/Units $ Total Units $/Units $ Total
Jan 1 5 50 250 - - - 5 50 250
Jan 5 - - - 2 50 100 3 50 150
Jan 10 - - - 1 50 50 2 50 100
Jan 15 5 70 350 - - - 5 70 350
Jan 15 - - - - - - 7 - 450
Jan 25 - - - 3 70 210 2 50 100
2 70 140
4 - 240
38. Weighted average Cost (WAC)
This method assumes that the goods available for the
sale are homogeneous
The average cost is computed by dividing the cost of
goods available for sale by the number of the units
available by sale. Consider the following example:-
39. Example
Bike LTD purchased 10 bikes during January and sold
6 bikes, details of which are as follows:
January 1 Purchased 5 bikes @ $50 each
January 5 Sold 2 bikes
January 10 Sold 1 bike
January 15 Purchased 5 bikes @ 70 each
January 25 Sold 3 bikes
The value of 4 bikes held as inventory at the end of
January may be calculated as follows:
All issues of inventory will be assumed to carry the
average cost of all purchases up to the date of the
issue. Average cost will be calculated by dividing total
units of inventory by the total cost.
40. Solution
Date Purchase Issues Inventory
Units $/Units $ Total Units $/Units $ Total Units $/Units $ Total
Jan 1 5 50 250 - - - 5 50 250
Jan 5 - - - 2 50 100 3 50 150
Jan 10 - - - 1 50 50 2 50 100
Jan 15 5 70 350 - - - 5 70 350
Average Cost of Inventory 7 64.28 450
Jan 25 - - - 3 64.28 192.85 4 64.28 257.14
Average cost of inventory changes every time a purchase is made at a different price.
Therefore the average cost of inventory changed from $50 to $64.286 after the
purchase on January 15
41. Example
Glucose Labs manufactures glucose for use in medicine. On 1 December 2012,
the company had 5 tons of sucrose (which is a raw material) costing $5,000,
during the month it purchased 200 tons for $220,000, 3 tons remained at the
year-end costing $3,000. Its labor cost amounted to $10,000 while its overheads
were $15,000. Work-in-process inventory on 1 December 2012 was worth $10,000
while the work-in-process inventory as at 31 December 2012 was $8,000. Finished
goods inventory as at 1 December 2012 was $25,000 while cost of goods sold for
December amounted to $240,000. Find the finished goods.
Solution:
Finished goods produced = opening raw materials inventory ($5,000) + raw
materials purchased ($220,000) − closing raw materials inventory ($3,000) +
labor ($10,000) + overheads ($15,000) + opening work in process inventory
($10,000) − closing work in process ($8,000) = $249,000
Finished goods at the end of a period = finished goods at the start of period
($25,000) + finished goods produced ($249,000) − finished goods sold
($240,000) = $34,000.
42. Disclosure in financial
statements
Accounting policy adopted in measuring inventories
Cost formula used
Classification of inventories like Finished Goods, WIP,
Raw Materials, Spare Parts.
