Monday, May 30, 2016

IAS 2 –Pampering the Golden Goose

“What is sauce for the goose may be sauce for the gander but is not necessarily sauce for the duck or the turkey.”
                                                Alice B. Toklas


It’s another edition of IFRS is easy.

You might start wondering why the IASB decided to issue a whole standard on a seemingly harmless aspect of the financial statement.
I understand. Maybe this will throw a little light on the dark stage:

Imagine a company buys 500 bags of flour for ₦50 each. The company uses just 300 bags and sold the product for ₦18,000.
Here, the cost of sales is simply

  300 bags * ₦50 = ₦15,000 

Hence, profit is ₦3,000 i.e. Sales less Cost of sales (₦18,000 –₦15,000 = ₦3,000)
That’s simple right? Ok, what then happens when the company buys in batches? Say the company buys as follows:
250 bags of flour for ₦30 each
100 bags of flour for ₦45 each
150 bags of flour for ₦25 each
When the company issues just 300 bags for production, how then will the company value its cost of sales?
The 300 bags will be at what price? That’s where the challenge lies.

Don’t forget that this value will ultimately affect the profit disclosed which will in turn affect shareholders dividend and also in the long run affect the market value of the company’s shares.

Yeah, valuing inventories is a crucial work for organizations as it affects their gross margin and even how much they’ll charge their customers so as to recover the cost incurred. Also, a wrong valuation might chase customers away due to the high sales price charged and even affect the financial statement of the organization as the closing inventory on the SOFP might not reflect current economic realities if valued inappropriately.

For more detailed explanation on IAS 2 –Inventories, click below to view or download pdf.


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