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They valued inventory at AED 7.52 million (23,500 unit X AED 320/ unit) in their SoP for the FY 2010. Market price for the product was AED 220/unit at closing date. When cost was analyzed it was found that due to economic recession the company remained unable to sell enough products to cover even their operational/production overheads. Finance Manager advised to reduce the inventory to their NRVs and charge the balance to Income statement. The debit treatment was advised by his team members as follow: 1.Julie :- charge the balance amount to "Cost of Sales" as these were operational/production overheads. 2.Pratab : - These should be charged to sales department as they could not sell the products. 3.Ali :- These should be considered as general expense or should be allocated to each reporting function on a fair basis. 4.Mark :- These are extra-ordinary expenses and shall not be treated as part of operations income/expense.
In according with the recognised accounting standards the same has to be charged expense.
But the same has to charged to General expenses, since does not qualify for extra ordinary expense if the production/ valuation accounting period differs or the same can be charged to COGS if the production/ and valuation pertains to same accounting period
I agree if his suggetions agree with the legislations that rules the affairs in establishments
Accorfing to IAS2 iventory should be measured at the lower of cost or NRV, in this case our NRV is low shot it should be recorded at NRV and difference should be charged to P&L. Julie is right and different should be charged to CGS, becaut it is related to core operations of the business
Your company will record AED2.35 million write down as a loss, thereby decreasing inventory and increasing cost of goods sold. Also, this needs to be included net profit or loss for the period in which it arises.
As per Accounting Standared IAS 2 Inventory: Inventory must be recorded subsequently at lower of Cost or NRV (Net realiseable Value).NRV is Selling Price Less Cost to sell.
As per given senario Original price is 320 but now assumed due to market recession Market Price per unit is 220 which is impaired by 100 (320-220).
Impairement loss Debit 2,350,000 (Income Statement Cost of Sale)
Inventory (Credit) 2,350,000 (Financial Position)
No Absolutely not.the financial statement should be prepared on true data base either of not selling goods on right prices or the loss occured due to any reason.
Based on generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS), inventory write-downs are recognized in a manner that reflects the loss's direct impact on the cost of sales. The loss from writing down the inventory to its net realizable value should be recognized in the income statement, therefore Julie is correct.
The decision on how to account for the reduction in inventory to its net realizable value (NRV) involves considerations about the nature of the expense and its impact on financial reporting. Let's assess each team member's suggestion:
Julie's suggestion (Charge to "Cost of Sales"): This approach aligns with the idea that the reduction in inventory is related to the cost of producing goods that could not be sold due to economic conditions. Charging this to "Cost of Sales" reflects the impact on operational/production overheads and is a common accounting practice.
Pratab's suggestion (Charge to sales department): While it may be tempting to assign the cost to the sales department due to unsold products, this approach might not accurately reflect the nature of the expense. The cost is incurred in the production process rather than the sales process.
Ali's suggestion (Considered as general expense or allocated to reporting functions): This suggestion recognizes that the expense might have a broad impact on the company and could be considered a general expense. Allocating it to reporting functions on a fair basis is a reasonable approach, as long as the allocation accurately reflects the impact on each function.
Mark's suggestion (Treat as extraordinary expenses): Treating the expense as extraordinary implies that it is unusual in nature and infrequent in occurrence. While economic recessions can be considered extraordinary events, the inability to sell products due to economic conditions might be considered part of normal business risk. Therefore, treating it as extraordinary may not be appropriate.
Opinion: I would agree with the Finance Manager and Julie's suggestion to charge the balance amount to "Cost of Sales." This aligns with the principle of matching expenses with revenues, reflecting the direct impact on operational/production overheads. It provides a clear and transparent representation of the financial impact of the economic recession on the company's operations. Treating it as an extraordinary expense or allocating it solely to the sales department may not accurately represent the economic reality of the situation.
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