International Financial Reporting Standards_guide.pdf

Chapter 16 Inventories (IAS 2) 191
EXAMPLE 16.6
Arco Inc. is a manufacturing company in the food industry. The following matters relate to
the company’s inventories:
A. In recent years the company utilized a standard costing system as an aid to management.
The standard cost variances had been insignificant to date and were written off
directly in the published annual financial statements. However, the following two
problems were experienced during the year ending March 31, 20X3:
■ Variances were far greater as a result of a sharp increase in material and labor costs
as well as a decrease in production.
■ A large number of the units produced were unsold at year-end. This was partially
attributable to the products of the company being considered overpriced.
The management of the company intends, as in the past, to write off these variances
directly as term costs, and to also write off a portion of the cost of surplus unsold
inventories.
B. Chocolate raw material inventories on hand at the end of the year represent eight
months of usage. Inventory levels normally represent only two months’ usage. The
current replacement value of the inventories is less than the initial cost.
EXPLANATION
A. Both writing off the variances in labor and material as term costs and writing off a
portion of the unsold inventories are unacceptable for the following reasons:
■ The write-offs of the large variances result in the standard values not approximating
cost according to IAS 2.
■ Standard costs should be reviewed regularly and revised in light of the current
conditions. The labor and material variances should be allocated to the standard
cost of inventories. The production overhead variance resulting from idle capacity
should be recognized as an expense in the current period.
■ The term “overpriced” is arbitrary, and any write-down of inventory should be done
only if the NRV of the inventory is lower than its cost.
B. The abnormal portion of raw material on hand (representing six months of production)
might need to be written down to NRV. The other raw materials (representing two
months of production) should be written down to NRV only if the estimated cost of the
finished products will be more than the NRV.