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Manchester International College

Course: Diploma in Business Management

Lecturer:Susantha Udagedara Date:03/03/2011

Valuation of Non-Current Assets and Inventories

Main purpose
The main purpose of this chapter is to explain the accounting principles involved in the valuation of Non current asset and inventory

Inventory defined
IAS 2 Inventories defines inventories as assets:
Held for sale in the ordinary course of business In the process of production for such sale In the form of materials or supplies to be consumed in the production process or in the rendering of services.

Inventory has great impact on profit

Figure 18.1

Coats Viyella plc

Inventory valuation
Important to get closing stock accurate Possibility for profit smoothing.

Figure 18.2

Inventory values manipulated to smooth income

Inventory valuation (Continued)

Figure 18.2

Inventory values manipulated to smooth income

Inventory valuation methods

Figure 18.3

First-in-first-out method (FIFO)

Inventory valuation methods (Continued)

Figure 18.4

Average cost method (AVCO)

Methods rejected by IAS 2


LIFO and (by implication) replacement cost are rejected by IAS 2. Last-in-first-out (LIFO)

The cost of the inventory most recently received is charged out first at the most recent cost, i.e. the inventory value is based upon an old cost, which may bear little relationship to the current cost.

Last-in-first-out

Figure 18.5

Last-in-first-out method (LIFO)

Net realisable value (NRV)


Prudence requires lower of cost and NRV
Permanent fall in market price
Excessively priced stock High stock levels and liquidity problems Deteriorating Obsolescence Marketing strategy to penetrate a market.

Net realisable value (NRV) (Continued)


Numerical example.

IAS 16 defines tangible assets


Held by an enterprise for use
In production

For rental
For administration

Expected to be used for more than one period


Consider materiality.

How is cost determined


Purchase price Import duties Directly attributable costs bringing to working condition
Site preparation Delivery costs Installation costs Professional fees Dismantling and restoring site

Capitalisation of borrowing costs for self-constructed assets


IAS 23 treatment
Qualifying asset time criterion Funds borrowed specifically use actual rate Funds borrowed generally use weighted average

Capitalisation ceases when asset substantially prepared for its intended use or sale.

Subsequent expenditure
Normally expensed
Capitalised if excess future economic benefits will flow
Extending useful life Upgrade to improve quality Adopting new production processes to significantly reduce costs.

Depreciation
Systematic allocation
funds already expended matching concept Going concern concept ignores net realisable value

Depreciable amount
Useful economic life.

Useful economic life IAS 16 definition


Period of time in use Number of production units expected from an asset Freehold land infinite life

Useful economic life how determined


Economic life differs from working life Consider factors such as:
Repair costs Availability of replacement parts

Comparative cash flows of alternative assets


Lower life to compensate for inflation to advance the depreciation charge.

Straight line method


Cost-Residual value =results/years of expected use 10000-1000=9000/4 $2250

Reducing balance method


Cost =10000*50/100 Year one charge=5000 Year two charge=5000*50/100 =2500

Year three charge=2500*50/100 =1250

Depreciation sum of the units method

Figure 15.2

Sum of the units method

IAS 36 impairment of assets


Impaired if Carrying > Recoverable amount.

Loss must be written off Ex Asset cost 2m After 3 years revalue 3 m( revaluation reserve 1 m) Current year impairment review and recoverable amount Found to be 1.2 m Impairment incurred is 1.8 m 1 m is charge to revaluation reserve .8 m to the income statement

Indications of impairment

IAS 40 investment property definition


Held as assets
Not employed in normal activities To earn rentals

For capital appreciation.

IAS 40 investment property does not include


Held for production or for sale in normal course of business

Being constructed for future use as investment property


Held under an operating lease Mineral rights.

IAS 40 accounting models


Fair value model
Recognise changes in FV in income statement

Cost model
Apply same principle as IAS 16

Disclose FV as a note to accounts.

Review questions
1. Define PPE and explain how materiality affects the concept of PPE. 2. Define depreciation. Explain what assets need not be depreciated and list the main methods of calculating depreciation. 3. What is meant by the phrases useful life and residual value?

Review questions (Continued)


4 Define cost in connection with PPE. 5. What effect does revaluing assets have on gearing (or leverage)? 6. How should grants received towards expenditure on PPE be treated? Define an investment property and explain its treatment in financial statements. Depreciation should mean that a company has sufficient resources to replace assets at the end of their economic lives. Discuss.

Review questions
Discuss why some form of theoretical pricing model is required for inventory valuation purposes.
Discuss the acceptability of the following methods of inventory valuation: LIFO; replacement cost. Discuss the application of individual judgement in inventory valuation, e.g. changing the basis of overhead absorption.

Review questions (Continued)


Explain the criteria to be applied when selecting the method to be used for allocating costs. Discuss the effect on work-in-progress and finished goods valuation if the net realisable value of the raw material is lower than cost at the statement of financial position date.
Discuss why the accurate valuation of inventory is so crucial if the financial statements are to show a true and fair view.