Section 13 – Inventories
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 13 applies to all inventories with the exception of:
- work in progress arising under construction contracts including directly related service contracts (Section 23);
- financial instruments (dealt with under Section 11 and section 12) and
- biological assets related to agriculture and agricultural produce at the point of harvest (Section 34).
Section 13 deals with the recognition, measurement, costing, impairment of inventories and allocation of production overheads to inventory.
What is new?
Section 13 specifically scoped out biological assets and agricultural produces, old UK GAAP did not specifically exclude these nor did it make specific reference to these.
Section 13.5A 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. SSAP 9 did not deal with this, therefore it is more likely that these inventories would not have been valued. Note there is specific guidance for public benefit entities which is dealt with in Section 24 – Specialist activities.
Although not dealt with in Section 13, Section 17 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 so spare parts were classified as: either inventories or property, plant and equipment. Under section 17.5, 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. This may require an adjustment on transition, if previously under old GAAP, these were included within inventory.
Section 14.4A deals with inventories held for distribution at no consideration or for a nominal consideration i.e. advertising, promotional leaflets etc. Such items should be measured at cost adjusted where applicable for loss of service potential. Under old GAAP this was not specifically dealt with and in practice these were most likely expensed as incurred. Under Section 13, these items should be shown as an asset on the balance sheet within inventory where it can be shown they will create future economic benefits, hence, may if material, create differences on transition.
Under section 13.7, inventories purchased on deferred payment terms are deemed to contain a financing element. Old GAAP 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 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 unless it specifically comes within the scope of Section 25 – Borrowing costs.
What is different?
Old GAAP was not explicit on the inclusion of dismantling, removing and restoration costs within production overheads, whereas Section 13 specifically states that this is required. In practice this should not create major GAAP differences on transition.
Section 13.13 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), 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 13 provides more detailed guidance than old GAAP on the costing techniques to use, however, it is unlikely to create differences in practice.
Section 13.22 requires similar disclosures to old GAAP but in addition requires companies to disclose impairment losses recognised or reversed in profit or loss for the period.
The scope of old GAAP (SSAP 9) was wider as it included long term contracts within its scope. FRS 102 now deals with long term contracts within Section 23: Revenue.
Section 13 allows an entity use the latest purchase costs to value inventory which was not acceptable under old GAAP. Care must be used when applying this.
Other standards impacting inventories where differences arise:
Section 17 – Property, plant and equipment – Change in treatment for the classification of spare parts as detailed above.
Section 35 – Transition to FRS 102 – This provides first time adopters with an exemption to allow the application of the standard prospectively. This will be useful for entities who adopt a policy of capitalising borrowing costs on qualifying assets e.g. companies that manufacture products with a long production cycle.
What are the key points?
- Inventories are measured at the lower of cost and estimated selling price less cost to complete and sell and includes inventories held for distribution;
- 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 costs, retail method or latest purchase price can also be used; and
- Specific section to deal with impairments. However, similar to old GAAP, impairment loss recognised or reversed are required to be disclosed.
What do accountants need to do?
Be aware of the differences between old GAAP and Section 13 of FRS 102.
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 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.
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 102 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, assess whether the current accounting treatment is in line with the new Section 13 requirements.