Inventory and Cost of sales

Same facts except, XYZ accounts for individual sales separately. 1/1/Y1, it purchased 1,000 units of merchandise UPC 123456 for 10.50 per unit.

1/2/X1, it sold 2 units of #123 for 20. 1/7/X1, it sold one unit of #234 for 50 and three of #123 for 20.

During January, records showed that 800 units of #123, 300 of #234 and zero of #456 had been sold.

Same facts except, XYZ recognized purchases directly to cost of sales.

IAS 2.21: Techniques for the measurement of the cost of inventories, such as the standard cost method or the retail method, may be used for convenience if the results approximate cost. ...

ASC 330-10-30-13: In some situations, a reversed mark-up procedure of inventory pricing, such as the retail inventory method, may be both practical and appropriate. ...

For illustration purposes, only a single, annual adjustment is shown.

Fixed does not necessarily mean linear.

For example, depreciation calculated using a diminishing balance method is still considered fixed. The difference between fixed and variable is that the latter correlates with production levels while the former does not.

Some overhead costs are, by their nature, always variable. For example the coke used to smelt iron or electricity used to power production machines.

Other overhead costs, for example supervisor salaries or maintenance, can be either fixed or variable (or a combination) depending on how they are determined.

For example, some companies compensate supervisors with fixed salary, at others a wage, while still others pay out bonuses when extra work calls for extra hours. Similarly, production managers can also receive bonuses during times of extra high production.

Costs like waste removal are also generally fixed, but can be subject to surcharges when extra heavy production leads to extra waste.

Maintenance of production buildings tends to be fixed, while maintenance of production machinery variable.

The proper allocation of overheads thus requires both judgment and an accounting system sufficiently flexible to cope with the variations.

IAS 2.10: The cost of inventories shall comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition.

IAS 2.12: ... [costs of conversion] include a systematic allocation of fixed and variable production overheads that are incurred in converting materials into finished goods. Fixed production overheads are those indirect costs of production that remain relatively constant regardless of the volume of production, such as depreciation and maintenance of factory buildings, equipment and right-of-use assets used in the production process, and the cost of factory management and administration. Variable production overheads are those indirect costs of production that vary directly, or nearly directly, with the volume of production, such as indirect materials and indirect labour.

While its guidance is not nearly as detailed, US GAAP's requirements are the same.

ASC 330-10-30-1: The primary basis of accounting for inventories is cost, which has been defined generally as the price paid or consideration given to acquire an asset. As applied to inventories, cost means in principle the sum of the applicable expenditures and charges directly or indirectly incurred in bringing an article to its existing condition and location. It is understood to mean acquisition and production cost, and its determination involves many considerations.

While the general appraoch is simple to illustrate, applying it in practice requires an accounting system that can keep track of both accounts and account attributes.

In addition to the four delimitations used in the expanded COAs (see: Expanded Universal COA), this example uses a comma to designate the nature of the expense and a colon to designate a specific recognized item.

Matching expense to revenue is a key IFRS and US GAAP concept, which this example goes against.

While it is true that neither the IFRS nor US GAAP conceptual frameworks specifically define a "matching principle", the concept of matching expense to revenue is the basis for accrual accounting and reflected in numerous standards.

Recognizing expenses before the associated revenue, contradicts this guidance even when it is necessary.

Nevertheless, provided adequate adjustments are made, the accounting procedure illustrated in this example would not contradict the overall aim of either IFRS or US GAAP guidance.

It buys material for cash and on credit. It accrues wages at month end and pays them after month end. It recognizes depreciation each month. It also recognizes utilities (electricity and natural gas) each month.

Natural gas is pre-paid on a quarterly basis and actual usage is billed at the end of the period. At the end of each month, XYZ estimates its gas usage to determine the monthly expense.

Electricity is also paid on a quarterly basis but the supplier bills actual usage. At the end of each month, XYZ estimates its electricity usage to determine the monthly expense.

This example uses a rent expense account for the amortization of, or rent payments associated with, ROU assets.

A "right of use" asset may or may not be recognized depending on the characteristics of the ROU.

Please go to the Leasing page for illustrations of this issue.

This example only includes "short-term employee benefits" which IAS 19.9 defines to include: wages, salaries and social security contributions; paid annual leave and paid sick leave; profit-sharing and bonuses; and non-monetary benefits (such as medical care, housing, cars and free or subsidised goods or services) for current employees.

In some jurisdictions, in addition to social security contributions, healthcare and other similar contributions are also mandated by law.

Although US GAAP (ASC 710-10-30) does not include any guidance on "short-term employee benefits", the accounting would be the same.

However, "There are a number of significant differences between US GAAP and IFRS in the area of accounting for pension and other postretirement and postemployment benefits."

A discussion of these issues is provided here link: PwC.

In practice, separate accounts (i.e. Electricity 5.1.1.3.4.1.2.1, Natural Gas 5.1.1.3.4.1.2.2, Water And Sewage 5.1.1.3.4.2, Waste Removal 5.1.1.3.4.3, etc.) would be used for the various utilities.

Since the credits are illustrated in the previous example, they are not shown again.

The colon delimits the specific item. In this case, a product model.

The comma delimits the expense classified by its function.

For illustration, this entry is simplified. The information carried over to finished goods would include:

For illustration, this entry is simplified. The information carried over to the cost of sales schedule would include:

An IFRS nature of expense profit and loss statements includes an Increase (decrease) in inventories of finished goods and work in progress line item.

This item reflects the procedure used when preparing this P&L, which involves expensing costs prior to recognizing revenue as outlined above.

Note: the same general procedure is used for self-manufactured assets and presented in the Other work performed by entity and capitalized line item.

Since US GAAP does not allow nature of expense income statements to be presented, these would be adjustment made at the G/L level only, and would never be reported in a US GAAP financial statement.

As US GAAP does not allow entities to present nature of expense income statements, this item is never taken to a US GAAP income statement.

For illustration, this entry is simplified. The information carried over to inventory would include:

In the next period, its raw material and WIP accounts would have the above opening balances.

Although less precise, the same general result can be achieved using function of expense accounts only.

Unlike in the previous example, rather recognize production by nature, XYZ charges them directly to cost of sales.