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ManchesterInternational College

Course: Diploma in BusinessManagement

Lecturer:Susantha Udagedara

Date:03/03/2011


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Valuation of Non-Current Assets and Inventories


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The main purpose of this chapter is to explain theaccounting principles involved in the valuation of Noncurrent asset and inventory

Main purpose


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Inventory defined

IAS 2Inventories

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.


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Inventory has great impact onprofit

Figure 18.1 Coats Viyella plc


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Figure 18.2 Inventory values manipulated to smooth income

Inventory valuation

Important to get closing stock accurate

Possibility for profit smoothing.


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Inventory valuation(Continued)

Figure 18.2 Inventory values manipulated to smooth income


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Inventory valuation methods

Figure 18.3 First-in-first-out method (FIFO)


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Inventory valuation methods(Continued)

Figure 18.4 Average cost method (AVCO)


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Methods rejected by IAS 2

LIFO and (by implication) replacement cost are rejectedby IAS 2.

Last-in-first-out (LIFO)

The cost of the inventory most recently received ischarged 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.


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Figure 18.5 Last-in-first-out method (LIFO)

Last-in-first-out


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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.


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Net realisable value (NRV)(Continued)

Numerical example.


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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.


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How is cost determined

Purchase priceImport duties

Directly attributable costs bringing to working condition Site preparation

Delivery costs Installation costs

Professional fees

Dismantling and restoring site


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Capitalisation of borrowing costsfor 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 forits intended use or sale.


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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 reducecosts.


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Depreciation

Systematic allocation funds already expended

matching concept

Going concern concept ignores net realisable value

Depreciable amount

Useful economic life.

U f l i lif IAS 16


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Useful economic life

IAS 16definition

Period of time in use

Number of production units expected from an asset

Freehold land infinite life


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Useful economic life howdetermined

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 thedepreciation charge.


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Straight line method

Cost-Residual value =results/years of expected use

10000-1000=9000/4

$2250


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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


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Depreciation sum of theunits method

Figure 15.2 Sum of the units method


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IAS 36 impairment of assetsImpaired 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


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Indications of impairment


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IAS 40 investment property definition

Held as assets

Not employed in normal activities

To earn rentals

For capital appreciation.


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IAS 40 investment property doesnot include

Held for production or for sale in normal course ofbusiness

Being constructed for future use as investment property

Held under an operating lease

Mineral rights.


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IAS 40 accounting modelsFair value model

Recognise changes in FV in income statement

Cost model

Apply same principle as IAS 16 Disclose FV as a note to accounts.


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Review questions1. Define PPE and explain how materiality affects the

concept of PPE.

2. Define depreciation. Explain what assets need not bedepreciated and list the main methods of calculating

depreciation.3. What is meant by the phrases useful life and residual

value?


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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 economiclives. Discuss.


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Review questions

Discuss why some form of theoretical pricing model isrequired for inventory valuation purposes.

Discuss the acceptability of the following methods ofinventory valuation: LIFO; replacement cost.

Discuss the application of individual judgement ininventory valuation, e.g. changing the basis ofoverhead absorption.


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Explain the criteria to be applied when selecting themethod to be used for allocating costs.

Discuss the effect on work-in-progress and finished goodsvaluation if the net realisable value of the raw material

is lower than cost at the statement of financial positiondate.

Discuss why the accurate valuation of inventory is socrucial if the financial statements are to show a true

and fair view.

Review questions (Continued)

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