Thursday, June 2, 2016

IFRS Questions and Solutions on IAS 2 –INVENTORIES

“A goal without a deadline is just a wish.”
                                                Ilori Oluwatosin


It’s another edition of IFRS is easy.

Few days ago, I had a chat with a friend of mine. He works in the Finance Department at Deloitte, Nigeria. He gave some amazing insights about the issue of IFRS in the corporate world. He made a catchy phrase that got my attention. In his words, “IFRS is more practical than theoretical in the corporate world.”

Yeah, little wonder it’s more than a big deal to get acquainted with not only the theories but the practicals also. Don’t worry, we’ll try as much as possible to offer both with equal hands on this platform.
Let me quickly share a few issues I discussed with my friend with respect to Inventories. This seems to be confusing to many readers of IAS 2.

You must have come across these three terms often: Replacement price, Fair value and Net Realizable Value. Often times, people find it difficult to create a disparity among them. Let me try and shed some light on them.
Imagine these three scenarios:

Company A’s factory got burnt and the manager decides to replace the factory by constructing a new one on it. The cost of clearing the debris is ₦1million while the construction proper is ₦25million.

Company B has been planning to get a large generating set to alleviate its lightning issues. He made enquiries and discovered that the generating set now costs £5million. He decides to get two of the generating sets for his company.

Company C has an operating arm of his organization that it considers to be less productive. The company wishes to dispose it at an estimated price of €2million. The company estimates that a cost of €0.3million will be incurred to make the operating arm saleable. It also estimates a sales commission on the asset of €0.1million

Let’s explain these scenarios with respect to the terms and in accordance with our subject matter.

Replacement price: this is the price at which an asset is carried at the amount of cash and cash equivalents that would have to be paid if the same or equivalent asset were acquired currently. It is simply the current cost/ present price (note: not present value) of the asset to the organization. In the above scenario, Company A would have to incur a cost of ₦26million in order to replace the burnt factory. Note that replacement cost is entity-specific as it relates solely to the entity in question. Some other organizations might have to incur only ₦0.2million in clearing their debris while the construction proper remains constant. Replacement price is simply the amount for which the firm can replace or pay for the asset if they were to buy it. Here, the replacement price totals ₦26million.

Fair value: this is the price to be received to sell an asset in an orderly transaction between market participants at the measurement date. Company B made enquiries so as to discover the market price of the generating set. Here, it is obvious that the price is not entity-specific, cos everyone has a general perfect knowledge of how much it will cost. Hence, the generating set has a fair value of £5million.

Realizable value: This is the estimated selling price of an asset in the ordinary course of business. Company C made an estimate to dispose one of its operating arm. This is entity-specific as some other organizations might make an estimate higher or lower than that amount where they have such a similar asset. Hence, realizable value is an estimate made independently by a firm for which the firm can sell the asset, though mostly in consideration of the market price/fair value. Net Realizable Value is then the deduction of estimated costs necessary to make the sale and the estimated cost of completion from the estimated selling price of the entity. Company C therefore has a net realizable value of €1.6million.

Yeah, so let’s test your understanding so far. Click below to view or download questions on IAS 2 and the solutions. Try and make attempts to solve them before scrolling to the solutions section.


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