Section 10 – Inventories

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Section 10 – Inventories

Section 10 considers what should be included within the cost of inventories, how inventories should be measured, the methods to be used to determine cost and any disclosure requirements.

Definition
Extract from FRS 102 – Section 13.1

13.1      Inventories are assets:

(a) held for sale in the ordinary course of business;

(b) in the process of production for such sale; or

(c) in the form of materials or supplies to be consumed in the production process or in the rendering of services.

OmniPro comment

Based on the above definition inventory includes all types of goods purchased and held for resale including merchandise purchased by retailers. It encompasses finished goods (including any directly related manufacturing or labour costs), work in progress, materials and supplies awaiting use in production. In relation to part (c) this would relate to spare parts which are used within the same accounting period. If not they should be accounted for as property, plant and equipment.

In relation to point (a) above, the important thing is that you consider whether the asset is held in the ordinary course of business. For example, if a construction company purchased land or property and the business of the company is to develop this, this is treated as inventories and not investment properties/property, plant and equipment.

Spare parts

Section 12.5 which is the standard that deals with property, plant and equipment makes it clear that -spare parts 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. Where this is the case the spare part is depreciated over its useful life which cannot be more than the useful life of the main asset for which the spare parts are utilised. Therefore, care needs to be had to ensure spare parts which are going to be used during more than one period or service equipment should be classified as PPE as opposed to inventory.

Example 1: Spare parts

A manufacturing company holds a significant stock of critical spare parts for its production equipment. Given that these spare parts are specific to the production equipment itself, and given that they will be used over more than one period, these assets are classified as PPE and depreciated over there expected useful life. In reality on transition the value if previously included in inventory should equal the cost to be transferred to PPE. A similar example would be where plastic boxes are used for carrying and distributing the main products which are used again and again and are not provided to customers on a long term basis. These are classified as fixed assets as opposed to spare parts.

Scope of this section

Extract from FRS 105 – Section 10.1 – 10.2

10.1      This section sets out the principles for recognising and measuring inventories.

10.2      This section applies to all inventories, except:

  1. work in progress arising under construction contracts, including directly related service contracts (see Section 18 Revenue); and
  2. biological assets related to agricultural activity and agricultural produce at the point of harvest (see Section 27 Specialised Activities).
OmniPro comment

Unlike old GAAP/FRSSE the rules for accounting for construction contracts are not within the inventory standard instead this is dealt with in Section 12 of this guide.

Measurement of inventories
Extract from FRS 105 – Section 10.3

10.3      A micro-entity shall measure inventories at the lower of cost and estimated selling price less costs to complete and sell.

OmniPro comment

The inventories are measured at lower of cost or estimated selling price less costs to complete and sell. The cost represents cost of purchase, cost of conversion and any other costs incurred in getting the inventory to its current location and condition.

Section 10 does not deal with inventories held for distribution at no or nominal consideration. This was not dealt with under old GAAP or FRSSE but it is dealt with in FRS 102. Examples of inventories held at no or nominal consideration would be promotional material which the company holds. No or nominal consideration means goods which are not invoiced to customers but instead given free of charge. Another example would be stationary stock.

As it is not specifically dealt with; entities have an option to expense these immediately or recognise them in stock at cost less impairment/loss of service potential. The policy chosen should be applied consistently

See an example where the entity decides to carry at cost less impairment.

Example 2:  inventories held for distribution

Company A holds stock of promotional material for entities main product; widgets. The cost of these materials was CU5,000 and none have been used since purchase. At year end the company could decide to recognise this as stock in the balance sheet or instead expense immediately.

The policy chosen should be applied consistently

Cost of purchase
Extract from FRS 105 – Section 10.4 – 10.7

10.4      A micro-entity shall include in the cost of inventories all costs of purchase, costs of conversion and other costs incurred in bringing the                    inventories to their present location and condition.

10.5      Where inventories are acquired through a non-exchange transaction, their cost shall be measured at their fair value at the date of                           acquisition.

10.6      The costs of purchase of inventories comprise the purchase price, import duties and other taxes (other than those subsequently                            recoverable by the micro-entity from the taxing authorities), and transport, handling and other costs directly attributable to the acquisition               of finished goods, materials and services. Trade discounts, rebates and other similar items are deducted in determining the costs of                       purchase.

10.7    If payment is deferred beyond normal credit terms, the purchase price is the cash price available at the date of purchase. Any excess of                the deferred payment amount over the cash price available at the date of purchase is recognised as interest and accounted for in                          accordance with paragraph 9.14(a).

OmniPro comment

The purchase prices of inventories include:

In relation to the inclusion of irrecoverable taxes in inventory, consideration should be given as to when they should be included in the cost where they are held in warehouses and the tax is not payable until they are taken out of this warehouse. In such situations, the tax should not be absorbed in the cost of stock until the goods are taken from the warehouse as it is at this point that the tax becomes payable. An example of such a situation would be stock of wine held in a customer free zone.

In relation to the absorption of rebates, the amount of rebates is allocated on a per unit basis to determine the value to be absorbed into stock. Note rebates or any other types of discount are not absorbed in stock until the likelihood of receipt of the rebate is certain i.e. it meets the definition of an asset under Section 16-Provisions.

Example 3: Cost of inventory – rebates

Company A received CU200,000 in rebates for purchases of particular products from a supplier. The company purchased 300,000 of the products from the supplier over the year and 20,000 of these products remain in stock. The total purchase cost of the stock before rebates is CU20 per unit. The level of rebates received to be absorbed in inventory is as follows:

CU200,000 / 300,000 units = CU1.50

 

Therefore for every unit purchased, CU1.50 of a rebate was received. The value to be absorbed in stock at the year-end is CU30,000 (CU20,000 * CU1.50). Stock should be valued at CU370,000 ((CU20-CU1.50)*20,000).

Example 4: Non exchange transactions

Company A received stock free of charge. The fair value of this stock was CU3,000. Therefore this must be recognised in stock at CU3,000. The journals required are:

 

CU

CU

Dr Inventory

3,000

 

Cr Cost of sales

 

3,000

Being journal to reflect this stock at fair value

Stock purchased on beyond normal credit terms

Where stock is purchased on deferred payment terms which are beyond normal credit terms, there is deemed to be a financing element included in the purchase cost. In this case the finance cost element of the item purchased is determined by taking the purchase price less the price that would have been paid if this was paid for straight away in cash. Where this cannot be determined then a market rate of interest would be charged i.e. a rate a third party i.e. a bank would charge for the extended credit. This deemed interest is released on a straight line basis over the life of the credit term.

Example 5: Purchase with unusual credit terms

Company A purchased goods worth CU50,000 with unusual credit terms on 01/12/13. The credit provided is for a period up to 31/12/15. The normal cash price for these goods would be CU35,000. The difference of CU15,000 is determined to be a financing transaction and should be accounted for under Section 9where the difference is material.

For the purchasing company the journals to post are:

 

CU

CU

Dr Inventory

50,000

 

Cr Trade Creditors

 

50,000

Being journal to reflect purchase of stock

 

 

CU

CU

Dr Trade Creditors

 

15,000

 

Cr Inventory

 

 

15,000

Being journal to reflect the deemed financing element of the sale so as to show the correct carrying amount under FRS105

 

CU

CU

Dr Finance Expense in P&L

(CU15,000/24 mths * 1 mth)       

625

 

Cr Trade Creditors

 

625

Being journal reflect the deemed interest expense in the profit and loss for the year for one month.        The same type of journal is posted for the other two years (i.e. CU7,500 in year 2 (CU15,000/24 mths * 12mths in second yr).

Cost of conversion including production overheads
Extract from FRS 105 – Section 10.8 – 10.11 and Section 10.13

10.8  The costs of conversion of inventories include costs directly related to the units of production, such as direct labour. They also 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 and equipment, 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.

10.9  Production overheads include the costs for obligations (recognised and measured in accordance with Section 16 Provisions and                             Contingencies) for dismantling, removing and restoring a site on which an item of property, plant and equipment is located that are incurred           during the reporting period as a consequence of having used that item of property, plant and equipment to produce inventory during that               period.

10.10 A micro-entity shall allocate fixed production overheads to the costs of conversion on the basis of the normal capacity of the production                   facilities. Normal capacity is the production expected to be achieved on average over a number of periods or seasons under normal                      circumstances, taking into account the loss of capacity resulting from planned maintenance. The actual level of production may be used if it            approximates normal capacity. The amount of fixed overhead allocated to each unit of production is not increased as a consequence of low            production or idle plant. Unallocated overheads are recognised as an expense in the period in which they are incurred. In periods of                      abnormally high production, the amount of fixed overhead allocated to each unit of production is decreased so that inventories are not                    measured above cost. Variable production overheads are allocated to each unit of production on the basis of the actual use of the                          production facilities.

10.11  A micro-entity shall include other costs in the cost of inventories only to the extent that they are incurred in bringing the inventories to their              present location and condition

Cost of inventories of a service power

10.13  To the extent that service providers have inventories, they measure them at the costs of their production. These costs consist primarily of              the labour and other costs of personnel directly engaged in providing the service, including supervisory personnel, and attributable                          overheads. Labour and other costs relating to sales and general administrative personnel are not included but are recognised as expenses            in the period in which they are incurred. The cost of inventories of a service provider does not include profit margins or non-attributable                 overheads that are often factored into prices charged by service providers.

OmniPro comment

Section 10 is very specific in what should be included in the cost of conversion. It includes all costs directly related to the cost of producing the inventory including direct labour, variable and fixed production overheads that are incurred in converting the material to finished goods.

Normal capacity should be reviewed on a regular basis. Normal capacity would be considered to be:

See below for how the above guidance is applied in practice.

Example 6: Allocation of overheads to production with overheads higher than normal:

Company A operate a construction timber company constructing wooden material for site boundaries. Details are as follows:

Normal level of activity is 100,000 machine hours per annum

Full capacity of the plant is 120,000 machine hours per annum

Actual machine hours incurred for the year was 110,000 hours

Total fixed overheads were CU2,000,000

Opening stock was 100,000 units and closing stock is 125,000 units.

Total produced in the year was 290,000 units and total sales in the year was CU265,000.

Using the above example the production overhead to be allocated to inventory is:

Production overheads/machine hours for normal capacity = CU2,000,000 / 100,000 = CU20

As stated in 10.10, overhead should be allocated on normal levels of activity which would be CU20 per hour in this example. Therefore, the total costs if this were allocated to all units produced would be CU5,800,000. As this is well in excess of the actual fixed overhead costs incurred, the entity would need to absorb the cost on the actual level of activity to ensure that stock is not overstated. i.e. 2,000,000 / 110,000 = CU18.18. The amount to be allocated to inventory at year end is therefore 125,000 units * CU18.18 = CU2,272,500.

Joint products and by-products

Section 10 does not specifically address joint products or by-products, therefore entities should assess whether the amount receivable should be absorbed when costing stock. It would appear reasonable that these would be absorbed in stock so that the amount stated as cost reflects the true cost. However an entity may decide not to do this.

Where as part of the production process a by-product emerges, the proceeds receivable from the sale of this by product should be absorbed into stock so as to reduce to cost of stock for the main product particularly where the proceeds obtained from by-product is small in proportion to the main product. An example of a by-product which would be absorbed into stock would be whey which is a by-product on the production of cheese.

Where two products are produced at the same time during the production process e.g. a factory which distributes milk and manufactures cheese has two products. In these circumstances cost is allocated to each product on a reasonable basis as possible based on the proportion of sales.

Costs excluded from inventories
Extract from FRS 105 – Section 10.12

10.12    Examples of costs excluded from the cost of inventories and recognised as expenses in the period in which they are incurred are:

  1. abnormal amounts of wasted materials, labour or other production costs;
  2. storage costs, unless those costs are necessary during the production process before a further production stage;
  3. administrative overheads that do not contribute to bringing inventories to their present location and condition; and
  4. selling costs.
OmniPro comment

Section 10 makes it clear that any selling costs, abnormal wasted material, labour and administration overheads not contributing to bringing the inventory to its saleable condition should not be absorbed.

Abnormal costs

An entity will need to ensure a detailed review is carried out on the costs included in fixed and variable production overhead to ensure no abnormal costs are included. Examples of abnormal costs would be;

Selling costs

No selling costs should be absorbed in stock which includes distribution costs to the customer. However, where an entity incurs costs in transporting stock from its factory to its sales depot, whether that be in the same country or another country, then such costs can be absorbed in the cost of inventory as it meets the definition of it being a cost of bringing the inventory to its present location. If this were transport to the customer site, it could not be absorbed. For large retailers where they move goods from a central distribution warehouse to points of sale this would usually be allowed to be absorbed in inventory.

Storage costs

In the majority of circumstances storage should not be absorbed within inventory as it does not contribute to bringing the inventory to its present condition and location. Hence warehousing of inventory or overheads of retail supermarkets could not be absorbed in inventory. However for some entities where storage is necessary to produce the final product, storage costs can be absorbed. Examples of this would include; whiskey which must be stored for long periods for it to mature, grain purchased directly from the field (undried grain) which has to be dried out for a number of months before it is ready for onward sale. In the case of grain, after a set period of months when the grain is dried, capitalisation must cease.

General and administrative overheads

When assessing whether any administrative overheads should be absorbed in inventory, care should be taken. The administrative overheads should be split into functions and an analysis provided of how the departments support the production process and an allocation made based on the contribution they make. An accounting department for example will normally support the following functions:

Generally, management costs cannot be allocated however in smaller entities where a lot of work is done by the same person then a reasonable allocation can be made.

Cost of agricultural produce harvested from biological assets
Extract from FRS 105 – Section 10.14

10.14     Section 27 requires that inventories comprising agricultural produce that a micro-entity has harvested from its biological assets should be               measured on initial recognition, at the point of harvest, at the lower of cost and estimated selling price less costs to complete and sell.                     This becomes the cost of the inventories at that date for application of this section.

OmniPro comment

Harvested agricultural produce will use the same rules as any other stocks. Section 27 deals with measuring biological assets. It states they should be measured at cost less depreciation (if applicable) and impairment.

Techniques for measuring cost such as standard costing, retail method and most recent purchase price
Extract from FRS 105 – Section 10.15-10.17

10.15  A micro-entity may use techniques such as the standard cost method, the retail method or most recent purchase price for measuring the               cost of inventories if the result approximates cost. Standard costs take into account normal levels of materials and supplies, labour,                         efficiency and capacity utilisation. They are regularly reviewed and, if necessary, revised in the light of current conditions. The retail method           measures cost by reducing the sales value of the inventory by the appropriate percentage gross margin.

10.16 A micro-entity shall measure the cost of inventories of items that are not ordinarily interchangeable and goods or services produced and                 segregated for specific projects by using specific identification of their individual costs. 

10.17 A micro-entity shall measure the cost of inventories, other than those dealt with in paragraph 10.16, by using the first-in, first-out (FIFO) or             weighted average cost formula. A micro-entity shall use the same cost formula for all inventories having a similar nature and use to the                   micro-entity. For inventories with a different nature or use, different cost formulas may be justified. The last-in, first-out method (LIFO) is not           permitted by this FRS.

OmniPro comment
Retail method

The retail method takes the selling price of the stock and reduces this by the gross margin for the product which then equates to cost. It is used by retail units and similar industries where there is a high volume of line items where similar margins are made on the products e.g. a clothing retailer where similar margin is made on the clothes. This is a quick and easy way to measure inventory. It is determined by taking all stock on hand and allocating the sales value to this inventory and then applying a set margin based on product categories.

Standard costs

Standard costing is usually used by large manufacturing organisations. It is based on budgeted costs for the coming years. All raw material inventory is measured at the standard cost. Then fixed and variable production overheads are absorbed based on budgeted figures. Difference between the actual purchase cost and the standard cost are posted as variances in cost of sales. Where applied it must be reviewed regularly to ensure the standard cost equates to actual. Usually at year end to ensure the carrying value of stocks equates to the actual cost, entities will absorb purchase price and material usage variances into the inventory number at each month/year end.

The absorption of these variances would usually be based on the average stock turn. As with any costing techniques, care must to be taken to ensure there were no abnormal costs posted to the purchase price and the material usage variances as abnormal costs are not permitted to be absorbed.

Most recent purchase price

Section 10 allows the most recent purchase price which was not allowed under old GAAP/FRSSE. By its name it values stock based on the last purchase invoice. Where this costing method is used care needs to be exercised to ensure that the last purchase invoice was not unusually high and therefore does not represent the cost for the rest of the items in stock therefore overstating inventory at year end.

Cost formulas

For non-interchangeable goods i.e. specific goods, and goods and services used for specific projects, these should be stated at the purchase cost. This type of formula is usually used for entities who prepare bespoke goods or services e.g. bespoke furniture, specific to customer circumstances. This method cannot be used where there is a large number of interchangeable items e.g. widgets and bolts.

Where goods and services are interchangeable then they should use the first-in first-out basis (FIFO) or the weighted average basis. The FIFO basis uses the logic that the first stock item purchased and put into stock/used in production is the first one that is sold. The weighted average method on the other hand uses the average cost of the period for the same types of goods. This is the simplest formula to use.

Last-in last-out is not permitted under Section 10.

An entity should use the same cost formula for the same types of inventory. It must have applied this consistently.

Impairment of inventories
Extract from FRS 105 – Section 10.18- 10.19

10.18  Implicit in the requirement for a micro-entity to measure inventories at the lower of cost and estimated selling price less costs to complete,              is a requirement that a micro-entity shall assess at the end of each reporting period whether any inventories are impaired, ie the carrying                amount is not fully recoverable (eg because of damage, obsolescence or declining selling prices). If an item (or group of items) of inventory            is impaired, the micro-entity shall recognise an impairment loss.

10.19 When the circumstances that previously caused inventories to be impaired no longer exist or when there is clear evidence of an increase in           selling price less costs to complete and sell because of changed economic circumstances, the micro-entity shall reverse the amount of the             impairment (ie the reversal is limited to the amount of the original impairment loss).

OmniPro comment

Inventories should be reviewed for impairment at the end of each reporting period. Indicators of impairment are:

Where an impairment is identified the cost should be written down to the selling price less cost to complete and sell. When assessing the selling price less cost to complete and sell, it should ideally be done on an individual level. However it is acceptable to do as a group where the inventories are similar in nature or relate to the same product. The impairment should be posted to cost of sales in the profit and loss.

Example 7: Impairments

Company A has inventory of CU100,000 at the year-end. In second month following year end it emerged that the market for the product slumped and as a result the selling price decreased significantly. At the time of preparing the financial statements on 1 February the entity should use the post year end selling price as a basis for assessing impairments. The company has a stock turn of 2 months. Given that the decline in the market has indicated an impairment, an impairment will be required to be booked in the year end accounts. The value of the impairment should equal the selling price after year end less the cost to sell and complete.  Given that in the first month after year end there was no issues, CU50,000 of the inventory would not have to be written down as it was sold above cost (CU50,000 as there is two months of stock on hand at year end) however the remaining CU50,000 will have to be impaired as this will be sold at the new lower price.

If we take this example and assume the selling price decreased in the second month of the year as above, but half way through that month it emerged that there was no longer a market for the product due to a new version being introduced. Therefore at the year-end, a provision would be made in full for the last part of the second month assuming there was no scrap value.

When assessing selling price less costs to sell, it should be done on a specific entity basis and be based on what the entity can sell these for. So where there are sales contracts in place then the selling price determined in those contracts should be considered regardless of the outside market.

Although FRS 105 does not specifically deal with issues where the raw material cost is below cost but the finished good in which the raw material is used can be sold in excess of its stated cost (which would include the raw material element). Old GAAP and IFRS made it clear that where this occurred no impairment is required to be booked in the financial statements. The same stance should be taken with FRS 105.

Example 8: Raw material less than cost but finished good not

Company A produces cattle feed. The company uses a number of raw materials to produce this, one of these being barley. At the year end the purchase cost of barley per tonne was CU10 in excess of its recoverable amount (selling price less cost to sell). However, the cattle meal which incorporates this barley cost is selling well in excess of the total cost to produce the finished good. On this basis no provision is required to be booked.

Example 9: Post balance sheet events and requirement for impairment  

Company A holds stock of CU500,000 at year end. Subsequent to the year-end there was a fire in the factory premises which destroyed the entire inventory. Although this means the CU500,000 stock is no longer saleable, this is seen as a non-adjusting post balance sheet event as the condition did not exist at the year-end date.

When assessing whether a post year end event should trigger impairment at the year-end consideration needs to be given as to whether the condition which impacted the impairment was known at or before the year end or whether it became known after the year end. This point was illustrated in example 10 above and example 10 below.

Example 10: Post balance sheet events and requirement for impairment  

A company has inventory of product X at year end worth CU500,000. Subsequent to year end the company made a decision to cease production of product X and instead sell a new updated product which is better than product X and does the same job. This has resulted in the full CU500,000 being irrecoverable. An assessment has to be made as to whether an impairment is required. In deciding whether a write down is required, one would have to assess if the company knew at year end that this change was going to happen even though it was not announced formally or if this decision was made post year end. If it was known pre year end, then an impairment is required to be booked.

Reversal of impairments

Impairments of inventory can be reversed once the conditions that caused the impairment has reversed or the market conditions have improved such that the selling price increased. A reversal of impairment cannot result in the asset increasing higher than its original cost.

The reversal is posted to cost of sales in the profit and loss.

Recognition as an expense
Extract from FRS 105 – Section 10.20 – 10.21

10.20   When inventories are sold, the micro-entity shall recognise the carrying amount of those inventories as an expense in the period in which               the related revenue is recognised. Financial Reporting Council 35

10.21   Some inventories may be allocated to other asset accounts, for example, inventory used as a component of self-constructed property,                   plant or equipment. Inventories allocated to another asset in this way are accounted for subsequently in accordance with the section of                   this FRS relevant to that type of asset.

OmniPro comment

Section 18, the revenue standard is the key basis for when inventory is derecognised. Usually for goods type sales, revenue is recognised when the risks and rewards of ownership pass to the purchaser which is usually when it is delivered to the customer or it can be based on legal title driven by shipping terms.  Once the risks and rewards transfer, a sale is recognised and at the same time the inventory is derecognised.

Where a company holds consignment stock, this stock is not recognised by the purchaser as the risks and rewards of ownership do not pass until the goods are used by the purchaser. Therefore by definition any sale on a consignment stock basis cannot be recognised by the seller and as the sale cannot be recognised, then the inventory is not derecognised from the sellers balance sheet.

Example 11: Derecognition of inventory

Company A delivered consignment stock to Company B’s premises. Company B uses this stock in the production process. Title does not transfer until Company B takes the stock from the warehouse. Company A could not recognise a sale on the transfer as the risk and rewards of ownership has not passed to Company B. Therefore Company A could not derecognise this inventory. Only when Company B takes some of the inventory from the consignment stock and once Company A is informed of this can revenue be recognised by Company A and therefore inventory can be derecognised by Company A and recognised as inventory by Company B.

Disclosure in the notes
Extract from FRS 105

10.22   A micro-entity shall disclose an indication of the nature and form of any items of inventory given as security in respect of its commitments,               guarantees and contingencies (see paragraph 6A.3).

OmniPro comment

There is limited disclosures required. See example disclosures below:

Example 12: Disclosures

AA Bank Limited holds a floating charge over all stock on the balance sheet.

OR
The company has committed to purchasing X tonnes of Product A for CUXXX at year end.

OR
The company has provided stock valued at XX as security on a loan and this stock can only be moved when approved by the bankers.

Transition exemptions

Section 28 provides no transition exemptions.

Principal transition adjustments

Section 12.5 which is the standard that deals with property, plant and equipment makes it clear that -spare parts 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. Where this is the case the spare part is depreciated over its useful life which cannot be more than the useful life of the main asset for which the spare parts are utilised. Old GAAP/FRSSE provided less guidance therefore, some entities would have classified such spare parts as inventory instead of PPE. As a result on transition to FRS 105, such entities will need to recognise a transition adjustment to correct this.

Example 13: Reclassification of spare parts from inventory to PPE (applicable to FRSSE and old GAAP only)

Company A, has a significant value of spare parts for the production equipment. Under old GAAP/FRSSE these spare parts were treated as inventory. The total value of these spare parts at the date of transition was CU500,000. At the date of transition, the company determines the useful life of the spare parts to be 10 years from the date of transition and the residual value is nil. Assume the date of transition is 1 January 2015 and the tax rate is 10%. The transition adjustment required on 1 January 2015 is (assume for the purposes of the example that the write off when it was classed as inventory differed to that from when it is classed as PPE (note this would be unlikely) :

 

CU

CU

Dr PPE

500,000 

 

Cr Inventory

 

500,000

In the 31/12/15 i.e. the comparative year for FRS 105, a journal adjustment would be required to account for the depreciation and the current tax impact. Assume deferred tax is recognised on transition for the tax deduction not allowed in the comparative year but will be allowed as part of transition adjustments in the tax computation going forward over 5 years. The journals required are:

 

CU

CU

Dr Profit and Loss – Depreciation

(500,000 / 10yrs)

50,000

 

Cr PPE – Spare Parts

 

 

50,000

Dr Balance Sheet – corporation Tax

(50,000 *10%)

5,000

 

Cr Profit and Loss – corporation Tax

 

5,000

 

 

  
Journals required in the 31 December 2016 year end assuming the above journals were posted to profit and loss reserves etc.

Assuming no movement has occurred no journals are required on top of what has already been posted to reserves. Even if there was movement in 2016, no current tax journal will be required for that movement as it would be included in the 2016 tax computation. The current tax of CU5,000 will be recovered over the next 5 years under the tax transition adjustments (i.e. a journal to derecognise CU1,000 (CU5,000/5 years) of this current tax asset required in the 2016 year and for the four years following this.

Dr Corporation tax in P&L

1,000

 

Cr Corporation tax in balance sheet

 

1,000

Being journal to reflect the additional deduction for 1/5th of the sale previously taxed up to 31/12/15 under old GAAP which has therefore fallen out on transition to FRS 105. Note this assumes that the tax journal posted will include the transition tax adjustment for the CU1,000 in tax terms when it is finally recognised. If there was no corporation tax in 2016, then the CU1,000 would still be released as a debit to the P&L as it would be no longer refundable from the tax authorities. As no deferred tax can be recognised under FRS 105 it cannot be held as deferred tax asset on the balance sheet as a timing difference. The remaining CU4,000 will still be included as an asset at the year end in the corporation tax nominal and released over the remaining 4 yrs

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