CA Final FR Ind AS 2 Inventories Important Solved Questions

Ind AS 2, Inventories, Important Questions with Solutions for CA Final Financial Reporting May & Nov 2021 Exams

Question 1

On 31 March 20X1, the inventory of ABC includes spare parts which it had been supplying to a number of different customers for some years.  The cost of the spare parts was Rs.10 million and based on retail prices at 31 March 20X1, the expected selling price of the spare parts is Rs.12 million.  On 15 April 20X1, due to market fluctuations, expected selling price of the spare parts in stock reduced to Rs.8 million.  The estimated selling expense required to make the sales would Rs.0.5 million.  Financial statements were authorised by Board of Directors on 20th April 20X1.

As at 31st March 20X2, Directors noted that such inventory is still unsold and lying in the warehouse of the company.  Directors believe that inventory is in a saleable condition and active marketing would result in an immediate sale.  Since the market conditions have improved, estimated selling price of inventory is Rs.11 million and estimated selling expenses are same Rs.0.5 million.

What will be the value inventory at the following dates:

(a) 31st March 20X1

(b) 31st March 20X2

Solution

As per Ind AS 2 ‘Inventories’, inventory is measured at lower of ‘cost’ or ‘net realisable value’. Further, as per Ind AS 10: ‘Events after Balance Sheet Date’, decline in net realisable value below cost provides additional evidence of events occurring at the balance sheet date and hence shall be considered as ‘adjusting events’.

(a) In the given case, for valuation of inventory as on 31 March 20X1, cost of inventory would be Rs. 10 million and net realisable value would be Rs. 7.5 million (i.e. Expected selling price Rs. 8 million- estimated selling expenses Rs. 0.5 million). Accordingly, inventory shall be measured at Rs. 7.5 million i.e. lower of cost and net realisable value. Therefore, inventory write down of Rs. 2.5 million would be recorded in income statement of that year.

(b) As per para 33 of Ind AS 2, a new assessment is made of net realizable value in each subsequent period. It Inter alia states that if there is increase in net realizable value because of changed economic circumstances, the amount of write down is reversed so that new carrying amount is the lower of the cost and the revised net realizable value. Accordingly, as at 31 March 20X2, again inventory would be valued at cost or net realisable value whichever is lower. In the present case, cost is Rs.10 million and net realisable value would be Rs. 10.5 million (i.e. expected selling price Rs. 11 million – estimated selling expense Rs.0.5 million). Accordingly, inventory would be recorded at Rs.10 million and inventory write down carried out in previous year for Rs.2.5 million shall be reversed.

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Question 2 –

Mars Fashions is a new luxury retail company located in Lajpat Nagar, New Delhi. Kindly advise the accountant of the company on the necessary accounting treatment for the following items:

(a) One of Company’s product lines is beauty products, particularly cosmetics such as lipsticks, moisturizers and compact make-up kits. The company sells hundreds of different brands of these products. Each product is quite similar, is purchased at similar prices and has a short lifecycle before a new similar product is introduced. The point of sale and inventory system is not yet fully functioning in this department. The sales manager of the cosmetic department is unsure of the cost of each product but is confident of the selling price and has reliably informed you that the Company, on average, make a gross margin of 65% on each line.

(b)  Mars Fashions also sells handbags. The Company manufactures their own handbags as they wish to be assured of the quality and craftsmanship which goes into each handbag. The handbags are manufactured in India in the head office factory which has made handbags for the last fifty years. Normally, Mars manufactures 100,000 handbags a year in their handbag division which uses 15% of the space and overheads of the head office factory. The division employs ten people and is seen as being an efficient division within the overall company.

In accordance with Ind AS 2, explain how the items referred to in a) and b) should be measured.

Solution –

(a) The retail method can be used for measuring inventories of the beauty products. The cost of the inventory is determined by taking the selling price of the cosmetics and reducing it by the gross margin of 65% to arrive at the cost.

(b) The handbags can be measured using standard cost especially if the results approximate cost. Given that The company has the information reliably on hand in relation to direct materials, direct labour, direct expenses and overheads, it would be the best method to use to arrive at the cost of inventories.

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Question 3 –

The following is relevant information for an entity :

• Full capacity is 10,000 labour hours in a year.
• Normal capacity is 7,500 labour hours in a year.
• Actual labour hours for current period are 6,500 hours.
• Total fixed production overhead is Rs. 1,500.
• Total variable production overhead is Rs. 2,600.
• Total opening inventory is 2,500 units.
• Total units produced in a year are 6,500 units.
• Total units sold in a year are 6,700 units.
• The cost of inventories is assigned by using FIFO cost formula.

How overhead costs are to be allocated to cost of goods sold and closing inventory?

Solution –

Hours taken to produce 1 unit = 6,500 hours / 6,500 units = 1 hour per unit.

Fixed production overhead absorption rate:

= Fixed production overhead / labour hours for normal capacity

= Rs. 1,500 / 7,500

= Rs. 0.2 per hour

Management should allocate fixed overhead costs to units produced at a rate of Rs. 0.2 per hour.

Therefore, fixed production overhead allocated to 6,500 units produced  during  the  year (one unit per hour) = 6,500 units x1 hour x Rs. 0.2 = Rs. 1,300.

The remaining fixed overhead incurred during the year of Rs. 200 (Rs. 1500 – Rs. 1300) that remains unallocated is recognised as an expense.

The amount of fixed overhead allocated to inventory is not increased as a result of low production by using normal capacity to allocate fixed overhead.

Variable production overhead absorption rate:

= Variable production overhead/actual hours for current period

= Rs. 2,600 / 6,500 hours = Rs. 0.4 per hour

Management should allocate variable overhead costs to units produced at a rate of Rs. 0.4 per hour.

The above rate results in the allocation of all variable overheads to units  produced during  the year.

Closing inventory = Opening inventory + Units produced during year – Units  sold  during year

= 2,500 + 6,500 – 6,700 = 2,300 units

As each unit has taken one hour to produce (6,500  hours  /  6,500 units produced), total  fixed and variable production overhead recognised as part of cost of inventory:

= Number of units of closing inventory x Number of hours to produce each unit x (Fixed production overhead absorption rate + Variable production overhead absorption rate)

= 2,300 units x 1-hour x (Rs. 0.2 + Rs. 0.4) = Rs. 1,380

The remaining Rs. 2,720 [(Rs. 1,500 + Rs. 2,600) – Rs. 1,380] is recognized as an expense in the income statement as follows:

	Rs.
Absorbed in cost of goods sold (FIFO basis) (6,500 – 2,300) = 4,200 x Rs. 0.6	2,520
Unabsorbed fixed overheads, not included in the cost of goods sold	200
Total	2720

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Question 4 –

Night Ltd. sells beer to customers; some of the customers consume the beer in the bars run by Night Limited. While leaving the bars, the consumers leave the empty bottles in the bars and the company takes possession of these empty bottles. The company has laid down a detailed internal record procedure for accounting for these empty bottles which are sold by the company by calling for tenders. Keeping this in view:

(i) Decide whether the stock of empty bottles is an asset of the company;

(ii) If so, whether the stock of empty bottles existing as on the date of Balance Sheet is to be considered as inventories of the company and valued as per IND AS 2 or to be treated as scrap and shown at realizable value with corresponding credit to ‘Other Income’?

Solution –

Tangible objects or intangible rights carrying probable future benefits, owned by an enterprise are called assets. Night Ltd. sells these empty bottles by calling tenders. It means further benefits are accrued on its sale. Therefore, empty bottles are assets for the company.

As per IND AS 2 “Valuation of Inventories”, inventories are assets held for sale in the ordinary course of business. Stock of empty bottles existing on the Balance Sheet date is the inventory and Night Ltd. has detailed controlled recording and accounting procedure which duly signify its materiality. Hence stock of empty bottles cannot be considered as scrap and should be valued as inventory in accordance with Ind AS 2.

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Question 5 –

XYZ Limited has a plant with the normal capacity to produce 10,00,000 units of a product per annum and the expected fixed overhead is Rs. 30,00,000, Fixed overhead, therefore based on normal capacity is Rs. 3 per unit.

Determine Fixed overhead as per Ind AS 2 ‘Inventories’ if

• Actual production is 7,50,000 units.
• Actual production is 15,00,000 units.

Solution –

Actual production is 7,50,000 units: Fixed overhead is not going to change with the change in output and will remain constant at Rs. 30,00,000, therefore, overheads on actual basis is Rs. 4 per unit (30,00,000 / 7,50,000).

Hence, by valuing inventory at Rs. 4 each for fixed overhead purpose, it will be overvalued and the losses of Rs. 7,50,000 will also be included in closing inventory leading to a higher gross profit then actually earned.

Therefore, it is advisable to include fixed overhead per unit on normal capacity to actual production (7,50,000 x 3) Rs. 22,50,000 and balance Rs. 7,50,000 shall be transferred to Profit & Loss Account.

Actual production is 15,00,000 units: Fixed overhead is not going to change with the change in output and will remain constant at Rs. 30,00,000, therefore, overheads on actual basis is Rs. 2 (30,00,000 / 15,00,000).

Hence by valuing inventory at Rs. 3 each for fixed overhead purpose, we will be adding the element of cost to inventory which actually has not been incurred. At Rs. 3 per unit, total fixed overhead comes to Rs. 45,00,000 whereas, actual fixed overhead expense is only Rs. 30,00,000. Therefore, it is advisable to include fixed overhead on actual basis (15,00,000 x 2) Rs. 30,00,000.

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Question 6 –

On 5th April, 20X2, fire damaged a consignment of inventory at one of the Jupiter’s Ltd.’s warehouse. This inventory had  been  manufactured  prior  to  31st  March  20X2  costing Rs. 8 lakhs. The net realisable value of the inventory prior to  the  damage was estimated at Rs. 9.60 lakhs. Because of the damage caused to the consignment of inventory, the company was required to spend an additional amount of Rs. 2 lakhs on repairing and re- packaging of the inventory. The inventory  was sold on  15th  May,  20X2 for  proceeds of Rs. 9 lakhs.

The accountant of Jupiter Ltd. treats this event as an adjusting event and  adjusted  this event of causing the damage to the inventory in its financial statement and accordingly re-measures  the inventories as follows:

	Rs. lakhs
Cost	8.00
Net realisable value (9.6 -2)	7.60
Inventories (lower of cost and net realisable value)	7.60

Analyse whether the above accounting treatment made by the accountant in regard to financial year ending on 31.0.20X2 is in compliance of the Ind  AS.  If  not,  advise  the correct treatment along with working  for the same.

Solution –

The above  treatment  needs  to  be  examined  in  the  light  of  the  provisions   given   in Ind AS 10 ‘Events after the Reporting Period’ and Ind AS 2 ‘Inventories’.

Para 3 of Ind AS 10 ‘Events  after  the  Reporting  Period’  defines  “Events  after  the reporting period are those events, favourable and unfavourable, that  occur between  the end of the reporting period and the date when the financial statements  are approved  by  the Board of Directors in case of a company, and, by the  corresponding  approving  authority in case of any other entity for issue. Two types of events can be identified:

(a) those that provide evidence of conditions that existed at the end of the reporting period (adjusting events after the reporting period); and

(b) those that are indicative of conditions that arose after the reporting period (non- adjusting events after the reporting period).

Further, paragraph 10 of Ind AS 10 states that:

“An entity shall not adjust the amounts recognised in its financial statements to reflect non-adjusting events after the reporting period”.

Further, paragraph 6 of Ind AS 2 defines:

“Net realisable value is the estimated selling  price in  the  ordinary  course  of  business less the estimated costs of completion and the estimated costs necessary to make the  sale”.

Further, paragraph 9 of Ind AS 2 states that:

“Inventories shall be measured at the lower of cost and net realisable value”.

Accountant of Jupiter Ltd.  has re-measured the inventories  after  adjusting  the  event  in its financial statement which  is  not  correct  and  nor  in  accordance  with  provision  of Ind AS 2 and Ind AS 10.

Accordingly, the event causing the damage to the inventory occurred after the  reporting date and as per the principles laid down under Ind AS  10  ‘Events  After  the  Reporting  Date’ is a non-adjusting event as it does not affect conditions at the reporting date. Non-adjusting events are not recognised in the financial statements, but are  disclosed where their effect is material.

Therefore, as per the provisions of Ind AS 2 and Ind AS  10,  the  consignment  of inventories shall be recorded in the Balance Sheet at a value of Rs. 8 lakhs calculated below:

	Rs. lakhs
Cost	8.00
Net realisable value	9.60

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Question 7 –

On 31 March 20X1, the inventory of ABC includes spare parts which it had been supplying to a number of different customers for some years. The cost of the spare parts was Rs. 10 million and based on retail prices at 31 March 20X1, the expected selling price of the spare parts is Rs. 12 million. On 15 April 20X1, due to market fluctuations, expected selling price of the spare parts in stock reduced to Rs. 8 million. The estimated selling expense required to make the sales would Rs. 0.5 million. Financial statements were authorised by Board of Directors on 20th April 20X1.

As at 31st March 20X2, Directors noted that such inventory is still unsold and lying in the warehouse of the company. Directors believe that inventory is in a saleable condition and active marketing would result in an immediate sale. Since the market conditions have improved, estimated selling price of inventory is Rs. 11 million and estimated selling expenses are same Rs. 0.5 million.

What will be the value inventory at the following dates:

(a) 31st March 20X1

(b) 31st March 20X2

Solution –

As per Ind AS 2 ‘Inventories’, inventory is measured at lower of ‘cost’ or ‘net realisable value’. Further, as per Ind AS 10: ‘Events after Balance Sheet Date’, decline in net realisable value below cost provides additional evidence of events occurring at the balance sheet date and hence shall be considered as ‘adjusting events’.

(a) In the given case, for valuation of inventory as on 31 March 20X1, cost of inventory would be Rs. 10 million and net realisable value would be Rs. 7.5 million (i.e. Expected selling price Rs. 8 million- estimated selling expenses Rs. 0.5 million). Accordingly, inventory shall be measured at Rs. 7.5 million i.e. lower of cost and net realisable value. Therefore, inventory write down of Rs. 2.5 million would be recorded in income statement of that year.

(b) As per para 33 of Ind AS 2, a new assessment is made of net realizable value in each subsequent period. It Inter alia states that if there is increase in net realizable value because of changed economic circumstances, the amount of write down is reversed so that new carrying amount is the lower of the cost and the revised net realizable value. Accordingly, as at 31 March 20X2, again inventory would be valued at cost or net realisable value whichever is lower. In the present case, cost is Rs. 1 million and net realisable value would be Rs. 10. 5 million (i.e. expected selling price Rs. 11 million – estimated selling expense Rs. 0.5 million). Accordingly, inventory would be recorded at Rs. 10 million and inventory write down carried out in previous year for Rs. 2.5 million shall be reversed.

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