Section 10 – Inventories

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Section 10 – Inventories

Summary

Inventories are defined as assets:

held for sale in the ordinary course of business
in the process of production for such sale; or
in the form of materials or supplies to be consumed in the production process or rendering of services.

Section 10 applies to all inventories with the exception of:

work in progress arising under construction contracts including directly related service contracts (Section 12);
biological assets related to agriculture and agricultural produce at the point of harvest (Section 27).

Section 10 deals with the recognition, measurement, costing, impairment of inventories and allocation of production overheads to inventory.

What is new when compared to FRSSE/old GAAP?

Section 10 specifically scoped out biological assets and agricultural produces, old GAAP/FRSSE did not specifically exclude these nor did it make specific reference to these.

Section 10.5 deals with non-exchange transactions and states that non exchange transactions (e.g. a donation, free products) should be allocated a cost and this cost should equate to the fair value at the date of acquisition which was not the case under old GAAP/FRSSE. SSAP 9/Section 8 of FRSSE did not deal with this, therefore it is more likely that these inventories would not have been valued.

Although not dealt with in Section 13, Section 12 which deals with property, plant and equipment (PPE) provides specific reference to the classification of spare parts. Previously there was no specific reference under old GAAP/FRSSE so spare parts were classified as: either inventories or property, plant and equipment. Under section 12.4, major spare parts and stand-by equipment are classified as property plant and equipment when they are expected to be used during more than one period or only used in connection with an item of property plant and equipment. This may require an adjustment on transition, if previously under old GAAP/FRSSE, these were included within inventory.

There is significantly less disclosures under FRS 105. Only required to provide disclose if inventory has been given as security in respect of its commitments, guarantees and contingencies. No requirement to split the stock out separately between raw materials, work in progress and finished goods and no requirement to split the stock figure out separately from current assets on the face of the balance sheet.

Under section 10.7, inventories purchased on deferred payment terms are deemed to contain a financing element. Old GAAP/FRSSE did not cater for such an instance, so, where purchases of stock is carried out on such terms an adjustment will need to be made on transition to exclude the interest cost as the finance element will have to be excluded from the cost (the finance element is essentially the difference between what the cost would be if the entity paid for this under normal credit terms/cash price as opposed to the additional price included for extended credit terms). The difference representing interest is charged to the income statement over the term of the financing on a straight line basis.

What is new when compared to FRS 102?

Section 14 of FRS 102 specifically deals with inventories held for distribution at no consideration or for a nominal consideration i.e. advertising, promotional leaflets etc. FRS 105 does not deal with such transactions. Under FRS 102 such items should be measured at cost adjusted where applicable for loss of service potential and held in stock (where it can be shown they will create future economic benefits). As this are not dealt specifically within FRS 105 entities will have to adopt a policy depending on materiality as to whether these are expensed as incurred or capitalised in stock.

Where an entity has previously included these within stock as required under FRS 102, it is likely that it will continue with this treatment under FRS 105 so no adjustments will be required on transition.

There is significantly less disclosures under FRS 105. Only required to provide disclosure if inventory has been given as security in respect of its commitments, guarantees and contingencies. No requirement to split the stock out separately between raw materials, work in progress and finished goods and no requirement to split the stock figure out separately from current assets on the face of the balance sheet.

What is different from FRSSE/old GAAP?

Old GAAP/FRSSE was not explicit on the inclusion of dismantling, removing and restoration costs within production overheads, whereas Section 10 specifically states that this is required. In practice this should not create major GAAP differences on transition.

Section 10.12 deals with costs which should be excluded from the cost of inventories. This section specifically states that selling costs should be excluded, however SSAP 9 (old GAAP)/ Section 8 of FRSSE, allowed costs to be included in the cost of inventories or services supplied to a customer specification. Hence this will require adjustment on transition depending on how this was treated previously.

Section 10 provides more detailed guidance than old GAAP/FRSSE on the costing techniques to use, however, it is unlikely to create differences in practice.

The scope of old GAAP (SSAP 9)/ FRSSE (Section 8) was wider as it included long term contracts within its scope. FRS 105 now deals with long term contracts within Section 18: Revenue.

Section 10 allows an entity use the latest purchase costs to value inventory which was not acceptable under old GAAP/FRSSE. Care must be used when applying this.

What is different from FRS 102?

FRS 105 requires the deemed interest cost which arises on the purchase of inventory on abnormal credit terms to released on a straight line basis over the term of the credit received. This compares with FRS 102 which requires it to be recognised on an effective interest rate basis over the term of the credit. Where there is a material difference, an adjustment will be required on transition to FRS 105.

Other standards impacting inventories where differences arise:

Section 12 – Property, plant and equipment – Change in treatment for the classification of spare parts as detailed above.

What are the key points?

Inventories are measured at the lower of cost and estimated selling price less cost to complete and sell;
Costs to be included in inventory is more prescriptive and provides more detailed guidance on the techniques for measuring cost;
Cost of inventories include all cost of purchases, cost of conversion and other costs incurred in bringing it to its present condition;
Non-exchange transactions to be valued at fair value;
Fixed production overheads to be allocated to inventory based on normal capacity;
Cost of conversion include directly attributable variable and fixed production overheads;
Selling costs, abnormal losses, storage costs and administration overheads not contributing to inventories are expensed as incurred;
FIFO/weighted average costs can be used. Standard cost, retail method or latest purchase price can also be used; and
Specific section to deal with impairments.

What do accountants need to do?

Be aware of the differences between old GAAP/FRSSE and Section 10 of FRS 105.

Be aware of the differences between FRS 102 and Section 10 of FRS 105.

Become familiar with the standard itself so that they can advise clients on the implications of the new standards and also complete transition exercises for clients.

Need to review the treatment of spare parts in client companies under old GAAP/FRSSE to ascertain if a transition adjustment is required to reclassify spare parts from inventory to PPE. Advise client on the impact of the additional depreciation charge going forward if it differs from the write off amount when it was included in inventory.

Need to assess if client companies have purchased inventory on deferred payment terms and calculate the likely impact on the profit and loss due to the finance element being released to interest in the profit and loss account.

What do companies need to do?

Ensure staff have been trained on FRS 105 and the differences that exist so that they can assess the impact on the entity’s profit line as a result of differences in the accounting standard.

For companies that hold spare parts and previously reported under old GAAP/FRSSE, assess whether the current accounting treatment is in line with the new Section 10 requirements.

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