The guidance provided outlines how inventories should be measured and what constitutes the cost of inventories. Here’s a breakdown of the key points:
### Measurement of Inventories
- **Lower of Cost and Net Realisable Value**: Inventories should be valued at the lower of their cost or the amount they can be sold for, net of selling costs.
### Components of Inventory Cost
1. **Costs of Purchase**:
- **Purchase Price**: The amount paid to acquire the inventories.
- **Import Duties and Other Taxes**: Includes all non-recoverable taxes incurred to bring the inventories to their location.
- **Transport, Handling, and Other Direct Costs**: Any additional costs directly attributable to acquiring the goods.
- **Deductions**: Trade discounts, rebates, and similar reductions are subtracted to determine the actual cost.
2. **Costs of Conversion**:
- **Direct Labour**: Costs that are directly tied to the production of inventory items.
- **Fixed Production Overheads**: These are indirect costs such as depreciation, maintenance of factory buildings and equipment, and costs of factory management that remain relatively constant regardless of production levels.
- **Variable Production Overheads**: Indirect costs that fluctuate with the level of production, such as indirect materials and indirect labor.
### Allocation of Overheads
- **Normal Capacity**: The allocation of fixed overheads is based on the expected average production under normal circumstances, accounting for planned maintenance.
- **Low Production or Idle Plant**: Fixed overheads are not increased per unit in times of low production or idle capacity. Unallocated overheads during such times are expensed.
- **High Production**: During periods of unusually high production, fixed overheads allocated per unit are decreased to prevent overvaluation of inventories.
- **Variable Overheads**: These are allocated based on the actual usage of production facilities.
### Joint and By-Products
- **Joint Products**: When a production process yields multiple products simultaneously, and costs cannot be distinctly identified, they are allocated based on a rational and consistent method, such as relative sales values.
- **By-Products**: These are typically minor in value. Often measured at net realizable value, this amount is deducted from the cost of the main product, ensuring the main product’s cost is not materially misstated.
So the principle behind these guidelines is to ensure inventories are reported at a value that reflects their true economic benefit and costs. By valuing at a lower cost and net realizable value, potential losses are anticipated. Including all relevant costs ensures comprehensive valuation and proper allocation of overheads and maintains accuracy in production cost accounting. Handling joint and by-products in a rational manner ensures fair value distribution among products derived from the same process.
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