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ACCOUNTING GUIDELINE
GRAP 12
Inventories
All rights reserved. No part of this publication may be reproduced, stored in retrieval system, or transmitted, in any form or by any means, electronic,
mechanical, photocopying, recording, or otherwise, without the prior permission of the National Treasury of South Africa.
Permission to reproduce limited extracts from the publication will not usually be withheld.
Though National Treasury (NT) believes reasonable efforts have been made to ensure the accuracy of the information contained in the guideline,
it may include inaccuracies or typographical errors and may be changed or updated without notice. NT may amend these guidelines at any time by
posting the amended terms on NT's Web site.
Note that this document is not part of the GRAP standard. The GRAP takes precedence while this guideline is used mainly to provide further
explanations on the concepts already in the GRAP.
GRAP 12 on Inventories
Issued February 2020 Page 3 of 38
Contents
1. Introduction .................................................................................................................. 4
2. Scope .......................................................................................................................... 5
3. Definition and Identification .......................................................................................... 6
4. Initial recognition .......................................................................................................... 9
5. Initial measurement .................................................................................................... 11
5.1 Purchase costs ................................................................................................. 11
5.2 Conversion costs .............................................................................................. 16
5.3 Other costs ....................................................................................................... 20
5.4 Cost of inventory of a service provider .............................................................. 21
5.5 Cost of agricultural produce harvested from biological assets ........................... 21
6. Cost Techniques and Cost Formulas ......................................................................... 22
7. Subsequent Measurement ......................................................................................... 26
7.1 Cost versus net realisable value ....................................................................... 26
7.2 Cost versus replacement cost ........................................................................... 28
7.3 Reversal of inventory write-down ...................................................................... 30
8. Recognition as an Expense ....................................................................................... 31
9. Recommended Controls ............................................................................................ 33
10. Inventory Systems ..................................................................................................... 33
11. Entity Specific Guidance ............................................................................................ 35
11.1 Accounting for water stock by municipalities ..................................................... 35
12. Useful links and references ........................................................................................ 38
GRAP 12 on Inventories
Issued February 2020 Page 4 of 38
1. Introduction
This document provides guidance on the accounting treatment for inventories. It also contains
guidance on the cost formulas used to assign costs to inventory.
The contents should be read in conjunction with GRAP 12. For purposes of this guide,
“entities” refer to the following bodies to which the standard of GRAP relate to, unless
specifically stated otherwise:
Public entities
Constitutional institutions
Municipalities and all other entities under their control
Trading entities and government components applying the standards of GRAP
Parliament and the provincial legislatures
TVET and CET colleges
Explanation of images used in manual:
Definition
Take note
Management process and decision making
Example
GRAP 12 on Inventories
Issued February 2020 Page 5 of 38
2. Scope
GRAP 12 is applicable to all entities who prepare financial statements based on the accrual
basis in accounting. The Standard does not apply to:
Work-in-progress within the scope of GRAP 11 on Construction Contracts;
Financial Instruments within the scope of GRAP 104 on Financial Instruments; and
Biological assets related to agriculture activity and agricultural produce at the point of harvest, which falls within the scope of GRAP 27 on Agriculture.
Work-in-progress of services to be provided through a non-exchange transaction directly in return from the recipients;
Heritage assets, refer to GRAP 103 on Heritage Assets;
The initial recognition and measurement of inventories acquired in a transfer of function or merger
The measurement principles of GRAP 12 should not be applied to:
Products relating to mining, forestry and agricultural industry which are measured at net realisable value in accordance with well-established practice of the relevant industry. Changes in the net realisable value of such inventory is recognised in surplus or deficit in the period of change; and
Inventories of commodity broker-traders which are measured at fair value less cost to sell. Any changes in the fair value less cost to sell should be recognised in surplus or deficit in the period of the change.
GRAP 12 on Inventories
Issued February 2020 Page 6 of 38
3. Definition and Identification
Inventories include:
goods purchased and held for resale;
finished goods produced, or work-in-progress, being produced by the entity;
materials and supplies awaiting use in the production process;
goods purchased or produced by an entity, which are for distribution for no charge or
for a nominal charge; and
inventories relating to provision of services rather than goods purchased and held for
resale or goods manufactured for sale.
Examples of inventory in the public sector:
ammunition held by the metro police;
consumable stores;
medical supplies held by the municipal clinics;
licensing stationery;
fuel, oil and gas;
maintenance materials;
spare parts for plant and equipment that qualifies as inventory;
water held by a municipality;
work-in-progress such as educational and course materials;
land or property held for sale.
Inventories are assets:
in the form of materials or supplies to be consumed in the production process;
in the form of materials or supplies to be consumed or distributed in the rendering of services;
held for sale or distribution in the ordinary course of operations; or
in the process of production for sale or distribution.
GRAP 12 on Inventories
Issued February 2020 Page 7 of 38
Inventory vs. Property, plant and equipment
In order for management to identify whether an item constitutes property, plant and equipment
or an inventory item, the following needs to be considered:
Criteria to recognise an asset in accordance with GRAP 12 on Inventories and GRAP 17 on
Property, Plant and Equipment:
Inventory Property, plant and equipment
Current asset Non-current asset
Used, consumed, distributed or sold within an entity’s operating cycle
Expected to be used during more than one reporting period
Assets:
Held for sale or distribution in the ordinary course of operations ;
In the process of production for sale or distribution; or
In the form of materials or supplies to be:
o consumed in the production process; or
o consumed or distributed in the rendering of services.
Assets held for :
Use in the production or supply of goods or services;
Rental to others; or
Administrative purposes.
Use of the specific item, e.g. spare parts or stand-by and maintenance equipment are usually
recognised as inventory and expensed once used, but when it is used to replace a major part
of property, plant and equipment (therefore a major spare part or servicing equipment) or it is
expected to be used for more than one reporting period, it will be treated as property, plant
and equipment and depreciated.
Specific operations of the entity, e.g. the fire brigade that maintains a large volume of various
types of fire extinguishers and treats them as inventory, while another entity may have a fire
extinguisher installed in their administration building and capitalise such an item as property,
plant and equipment. So too will certain items that may normally be considered items of
property, plant and equipment be inventory in the hands of the dealer therein, e.g. motor
vehicle dealers, IT dealers and property developers.
In accordance with GRAP 1 on Presentation of Financial Statements, current assets are expected to be realised in the entity’s normal operating cycle. The operating cycle of an entity is the time taken to convert inputs or resources into outputs.
Current assets include assets (such as taxes receivable, user charges receivable, fines and regulatory fees receivable, inventories and accrued investment revenue) that are either realised, consumed or sold, as part of the normal operating cycle even when they are not expected to be realised within twelve months of the reporting date.
GRAP 12 on Inventories
Issued February 2020 Page 8 of 38
Stationery and similar consumables
To assist management to determine whether stationery and similar consumables should be capitalised, i.e. treated as inventory or be expensed as incurred, the following needs to be considered:
Stationery and similar consumables will probably meet the definition of inventory; however, the standard does not need to be applied when the effect of applying it is immaterial. Most consumables are not material, but if the balance at year end is material, then the recognition thereof will be required;
The period of use should be taken into consideration when immediately expensing items purchased. Where items are kept for lengthy periods of time, it might be more appropriate to recognise them as inventory even though they may not be material at the date of purchase;
The probability that economic benefits or service potential will flow to the entity beyond the current reporting period.
Whatever the accounting treatment is for consumables, management is required to maintain proper control over these assets.
Land classified as inventory vs. property, plant and equipment vs. investment property
Inventory Property, plant and equipment
Investment property
Intention to develop land and to sell or transfer it to a third party (parties)
Own land which will be developed for future use in service delivery
Land held for strategic purposes
Intention to develop land for economic or housing development that will be held to generate future rental income
Land held for undetermined use
Where the entity controls the right to create and issue assets such as revenue stamps, these items are recognised as inventory and measured at their printing costs.
Strategic stockpiles of reserves maintained by the entity (e.g. fuel, food, medicines etc.), for use in emergency situations, are recognised as inventories and falls within scope of GRAP 12.
GRAP 12 on Inventories
Issued February 2020 Page 9 of 38
4. Initial recognition
Inventory is recognised as an asset when:
it is controlled by the entity;
as a result of a past event (acquisition1 or production thereof);
from which it is probable that future economic benefits or service potential associated
with the item will flow to the entity; and
the cost (or fair value) of the inventory can be measured reliably.
An entity should recognise inventory when control of the inventory is transferred to the entity.
This will normally be the date on which the inventory is delivered. However there are
exceptions, for example when inventory is shipped free on board (FOB), in which case control
is transferred to the buyer when the goods are loaded onto the ship, resulting in the buyer
recognising inventory on the FOB date.
Example: Initial recognition of inventory
Entity Z ordered 1 million units of special paper for R500,000 on 31 March 20X8. The invoice was received on 2 April 20X8. The paper was delivered on 5 April 20X8.
On 31 March 20X8, no entry is made. On date of delivery (5 April 20X8) the following journal entry would be made:
5 April 20X8 Debit Credit
R R
Inventory (paper) 500,000
Creditor 500,000
On 5 April 20X8, the paper was delivered to the entity’s premises. Entity Z has to recognise the inventory and relevant liability.
Assume the following additional information:
If Entity Z made a payment on 2 April 20X8, when the invoice was received, but inventory has yet to be received, the entity should recognise a prepayment on 2 April 20X8. On date of payment (2 April 20X8) the following journal entry would be made:
2 April 20X8 Debit Credit
R R
Prepayment 500,000
Bank 500,000
1 Includes acquisition by way of a non-exchange transaction
GRAP 12 on Inventories
Issued February 2020 Page 10 of 38
On date of delivery (5 April 20X8) the following journal entry would be made:
5 April 20X8 Debit Credit
R R
Inventory 500,000
Prepayment 500,000
Only once the inventory is delivered, should it be recognised as an asset (inventory), as that is when risks and rewards of ownership have been transferred.
When recognising an asset in the public sector, the focus would most likely be on service
potential rather than future economic benefits. These two concepts are discussed below.
Future economic benefits is usually in the form of future receipts of cash or cash equivalents,
however it may also have the capacity to lower cash outflows, such as when an alternative
process lowers the cost of providing a service.
Example: Economic benefits
An entity provides electricity to the public at Rx a unit. Therefore future economic benefits exist, as it is probable that the entity will receive payment for the electricity consumed by the public.
Service potential is the capacity of an asset, individually or in a group with other assets, to
contribute directly or indirectly to achieving the objectives of the entity. These objectives may
include delivering a service to the public without receiving any economic return. Therefore
assets that are used to deliver goods and services in accordance with an entity’s mandate but
do not directly generate net cash inflows are often described as embodying ‘service potential’.
Example: Service potential
An entity distributes vaccines for foot and mouth disease for free to farmers. In this case there is no direct economic benefit to the entity distributing the vaccines, but there is a service potential value (of containing and eradicating the disease) that can be associated with the vaccines.
The vaccines provide benefit to the entity that controls the vaccines and the distribution thereof supports service delivery. The vaccines also have a resale value (even though the entity’s mandate is to distribute them for free). The vaccines could be exchanged for something else that is useful to the entity and it may save the entity money in the future (costs associated with its distribution). The vaccines therefore have service potential.
GRAP 12 on Inventories
Issued February 2020 Page 11 of 38
5. Initial measurement
Inventories are initially recognised at cost which includes all costs of purchases, cost of
conversion and any other costs incurred to bringing the inventories to its present location and
condition.
Where inventories are acquired at no cost of for nominal consideration, it should be recognised
at fair value at the date of acquisition.
5.1 Purchase costs
Purchase costs include the purchase price of finished goods or raw materials, import duties
and other taxes that will not be refunded from taxing authorities, transport costs of getting the
inventory from the supplier to the entity’s premises, handling costs and any other costs directly
involved in the acquisition of finished goods, materials and supplies.
VAT, if applicable, is generally recoverable and is therefore not included in the cost of
inventory. If only a portion of the VAT is recoverable, then the portion which is not recoverable
should be included in the cost of inventory.
Example: Purchase costs
Entity B (a registered VAT vendor) bought inventory for R228,000 (including VAT) and paid cash. The inventory was transported to Entity B’s premises by truck and the total transport cost was R1,140 (including VAT). Entity B also insured the inventory while in transit and the insurance amounted to R2,280 (including VAT).
The total cost of the inventory will be calculated as follows:
R
Purchase price 228,000
Plus transport cost 1,140
Plus insurance cost
Sub-total (payable to suppliers)
Less VAT @15%
2,280
231,420
(34,713)
Total cost of inventory 196,707
Fair value is an approximation of cost where there was no actual cost incurred in acquiring the inventories.
For example, where inventory was donated to the entity, the inventory should be measured at its fair value at date when it was received. The value can be determined by obtaining the value of similar inventory in the same condition.
GRAP 12 on Inventories
Issued February 2020 Page 12 of 38
Inventory will be recorded as follows on transaction date:
Debit Credit
R R
VAT Input 34,713
Inventory 196,707
Bank (or payables if bought on credit) 231,420
Rebates, trade discounts and similar items and finance cost, if deferred settlement terms are
allowed by the supplier, should be deducted from the purchase costs. These are discussed in
more detail below.
Rebates
Rebates to be received from the supplier, which represent a refund of part of the purchase
price, should be estimated at the date of purchase of the inventories and should be deducted
from the cost of the inventories. If however, the rebates represent a refund of selling expenses
incurred by the buyer of the inventories, the rebates should not affect the cost of the
inventories.
Example: Rebates
Entity A purchases water at R9,000 per mega litre. The supplier has agreed to provide a 2.5% rebate if Entity A buys 1,000 mega litres of water in the financial period. The rebate is payable by the supplier at the end of the financial period.
Entity A should, based on past experience, determine the probability that they will purchase at least a minimum of a 1,000 mega litres in the financial period.
If it is likely that Entity A will purchase the minimum quantity of water, then each time a purchase is made, a mega litre at a cost of R8,775 (R9,000 x 97.5%) should be recognised with the resulting rebate of R225 being recognised as a receivable until date of receipt. Assume that Entity A purchased 120 mega litres in July.
Journal entries:
The following journal entry would be made on transaction date:
Debit Credit
R R
Inventory (Water) (120 x R8,775) 1,053,000
Receivable (rebate) 27,000
Bank/Payables (120 x R9,000) 1,080,000
Purchases in July and recognition of rebate receivable on purchases
GRAP 12 on Inventories
Issued February 2020 Page 13 of 38
Assume the following information:
On the other hand, if based on past experience it does not seem probable that the entity will buy the minimum quantity of water to receive the rebate, and then it should recognise a mega litre at a cost of R9,000.
Should it then at a later stage become probable that Entity A will buy the minimum quantity of water, then the portion of the rebate for water already sold should be recognised as an expense while the remainder should be deducted from inventory.
If we assume that in the beginning of the financial period, the entity did not anticipate buying the minimum of a 1,000 mega litres of water. During the first 6 months the entity purchased 550 mega litres of which it sold 500 mega litres.
However, after the first 6 months, the entity decided that it is now probable that they will purchase at least a minimum of a 1,000 mega litres. In month 7 the entity purchased another 110 mega litres.
Journal entries:
The journal entries will be as follows:
Debit Credit
R R
Inventory (Water) 4,950,000
Bank/Payables (550 x R9,000) 4,950,000
Purchase of inventory in first 6 months
Debit Credit
R R
Cost of sales (500 x R9,000) 4,500,000
Inventory (Water) 4,500,000
Recognise inventory as expense when it is sold
Debit Credit
R R
Receivable (rebate) (550 x R9,000 x 2.5%) 123,750
Cost of sales (500 x R9,000 x 2.5%) 112,500
Inventory (Water) (50 x R9,000 x 2.5%) 11,250
Adjust the expense and inventory amounts and recognise the rebate receivable for the first 6 months, as the entity now estimates that they will receive the rebate (treated as a change in estimate in terms of GRAP 3)
GRAP 12 on Inventories
Issued February 2020 Page 14 of 38
Debit Credit
R R
Inventory (110 x R8,775) 965,250
Receivable (rebate)* 24,750
Bank/Payables (110 x R9,000) 990,000
Purchases in month 7 and recognition of rebate receivable on purchases
*This could also be treated as a reduction in the payable to the supplier
Settlement discount
Any settlement discount to be received for prompt settlement of the purchase price due should
be estimated at the date of purchase of the inventories and should be deducted from the cost
of the inventories.
Example: Settlement discount
An entity buys inventory with a cost of R100,000 from supplier B, who offers a 10% discount if the amount due is settled within 15 days.
At initial recognition, the entity needs to determine if they will make use of the settlement discount. If so, the journal entry would be as follows on transaction date:
Debit Credit
R R
Inventory (R100,000 x 90%) 90,000
Payable (Supplier B) 90,000
Assume the following additional information:
If 15 days have passed and the entity did not make use of the settlement discount, the entity needs to reverse the rebate. The portion of the inventory already sold should be recognised as an expense, while the remainder should be reversed against inventory.
Assume that the entity already sold 15% of the inventory on hand.
The journal entries for the selling of inventory and the reversal of the rebate would be as follows:
Debit Credit
R R
Inventory consumed – finished goods (100,000 x 15%) 15,000
Inventory 15,000
Recognise inventory as expense when it is sold
GRAP 12 on Inventories
Issued February 2020 Page 15 of 38
Debit Credit
R R
Inventory [(R100,000 – R15,000) x 10%] 8,500
Inventory consumed – finished goods (R15,000 x 10%) 1,500
Supplier B (R100,000 x 10%) 10,000
Adjust the expense and inventory amounts and reverse the rebate, as the entity did not make use of the settlement discount
Deferred settlement terms
If an entity purchases inventories on deferred settlement terms or over an extended period
granted by the supplier, the effect of the time value of money should be taken into account, if
material.
This is done by discounting the future cash flows back to a present value. This present value
is then recognised as the cost of inventory. Any difference between this present value and
the amount actually paid is accounted for as interest over the period of the financing. Also
refer to GRAP 104 on Financial Instruments.
It should be noted that this treatment is to be followed even if the selling price has not been
inflated to compensate the seller for the effect of the extended payment period.
Example: Deferred settlement terms
An entity purchases inventory from a supplier for R110,000,000 and the payment is due in 3 months (which is considered to be beyond normal credit terms). The supplier does not charge the entity any interest. However, this transaction has a financing element due to the deferred settlement terms and therefore the purchase amount needs to be discounted to its present value.
Assuming a current market interest rate of 10% in similar circumstances, the present value is calculated as follows:
i = 10% p.a.
pmt = 0
n = 3
FV = R110,000,000
PV = R107,295,205 (to be calculated by using MS Excel or a financial calculator)
The interest to be recognised over 3 months amounts to R2,704,795 (R110,000,000 - R107,295,205).
GRAP 12 on Inventories
Issued February 2020 Page 16 of 38
Journal entries:
The journal entry at initial recognition will be:
Debit Credit
R R
Inventory 107,295,205
Payable 107,295,205
Interest to be recognised over 3 months:
Debit Credit
R R
Interest paid 2,704,795
Payable 2,704,795
On date of payment:
Debit Credit
R R
Payable 110,000,000
Bank 110,000,000
When inventory is imported and payable in a foreign currency, the cost of inventory is
determined using the exchange rate at the date of the transaction. Refer to the accounting
guideline on GRAP 4 for guidance on what exchange rate should be used and what is
considered the transaction date for a foreign currency transaction.
5.2 Conversion costs
Conversion costs are costs to convert items from raw materials into finished goods which are
mainly found in a manufacturing environment or for example the water purification process.
This would include costs directly related to the production such as direct labour, variable
production overheads and fixed production overheads based on normal capacity.
Variable productions overhead are indirect costs of production that vary with the volume of
production, e.g. indirect materials, water consumption, and electricity usage. These costs are
allocated to each unit of product based on actual usage.
GRAP 12 on Inventories
Issued February 2020 Page 17 of 38
Fixed production overheads are those indirect costs that will be incurred irrespective of the
volume of production, such as insurance of the factory building and depreciation of plant and
equipment.
Fixed production overheads are allocated based on the normal capacity of production.
Normal capacity as described by the standard is the normal 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.
If actual level of production approximates normal capacity, the actual capacity may be used.
Where there is abnormally high production, the fixed overhead allocated to each unit is
decreased, so that inventories are not measured above cost. If there are unallocated
overheads, such expenses are recognised in the period in which they are incurred in the
surplus or deficit.
GRAP 12 on Inventories
Issued February 2020 Page 18 of 38
Example: Allocation of fixed production overheads
Below normal capacity:
Assume that production overheads amount to R500,000 and normal capacity equals 50,000 units. The actual production during the period amounted only to 45,000 units.
The allocation of the overheads should be based on the normal capacity of 50,000 units, resulting in a cost of R10 per unit (R500,000 / 50,000). As the actual production only amounts to 45,000, the cost allocated to inventory is only R450,000 (45,000 x R10). The remaining R50,000 (under-recovery) should be recognised in surplus or deficit as part of cost of sales.
The following illustrates the disclosure that will be made in the annual financial statements of the entity:
Extract from Statement of financial
performance
Note 20X1 20X0
R R
Revenue XX XX
Cost of inventory 3 (500,000) (XX)
Surplus/deficit XX XX
Extract from Notes to the financial statements
20X1 20X0
R R
3. Cost of inventory
Cost of finished goods 3 450,000 XX
Fixed production overhead costs 450,000 XX
Opening inventory XX XX
Closing inventory (XX) (XX)
Under-recovery of fixed production overhead costs
50,000 XX
Total cost of inventory 500,000 500,000
Above normal capacity:
If the actual production during the period was 60,000 units (assume this as abnormally high), the fixed cost per unit must be reduced to R8.33 (R500,000 / 60,000) to ensure that only R500,000 is allocated to the cost of inventory.
GRAP 12 on Inventories
Issued February 2020 Page 19 of 38
The following illustrates the disclosure that will be made in the annual financial statements of the entity:
Extract from Statement of financial performance
Note 20X1 20X0
R R
Revenue XX XX
Cost of inventory* 3 (500,000) (XX)
Surplus/deficit XX XX
Extract from Notes to the financial statements
20X1 20X0
R R
Cost of inventory*
Cost of finished goods 3 500,000 XX
Fixed production overhead costs 500,000 XX
Opening inventory XX XX
Closing inventory (XX) (XX)
Total cost of inventory 500,000 500,000
A production process may result in more than one product being produced simultaneously.
This is the case, for example, when joint products are produced or when there is a main
product and a by-product. When the costs of conversion of each product are not separately
identifiable, they are allocated between the products on a rational and consistent basis.
The allocation may be based, for example, on the relative sales value of each product either
at the stage in the production process when the products become separately identifiable, or
at the completion of production.
Most by-products, by their nature, are immaterial. When this is the case, they are often
measured at net realisable value or current replacement cost and this value is deducted from
the cost of the main product. As a result, the carrying amount of the main product is not
materially different from its cost.
Net realisable value is the estimated selling price in the ordinary course of operations less the estimated costs of completion and the estimated costs necessary to make the sale, exchange or distribution.
Current replacement cost is the cost the entity would incur to acquire the asset on the reporting date.
These concepts are discussed in detail under subsequent measurement.
GRAP 12 on Inventories
Issued February 2020 Page 20 of 38
Example: Joint products
X Resources extracts chemical Y and chemical Z from liquid concentrate residue purchased. The depreciation on the machine used to extract chemical Y and chemical Z is R10,000 per day, while the machine operator is paid R1,000 per day.
The machine can process up to 100 litres of concentrate in a day. About 60% of what is extracted is chemical Y, 35% chemical Z and the rest is scrap. The selling prices of chemical Y and Z amounts to R500 and R1,250 per litre respectively. It is the entity’s policy to absorb the normal loss in the joint product based on their sales value.
Information and calculations based on above:
Sales value of chemical Y R30,000
(100ℓ x 60% x R500)
Sales value of chemical Z R43,750
(100ℓ x 35% x R1,250)
Total cost of extracting 1 litre of residue R110
(R10,000 / 100ℓ + R1,000 / 100ℓ)
Cost to be allocated to chemical Y R44.75 per ℓ
(R110 x (R30,000 / (R30,000+ R43,750)))
Co t to be allocated to chemical Z R65.25 per ℓ
(R110 x (R43,750 / (R30,000+ R43,750)))
5.3 Other costs
Other costs may only be included in the cost of inventories if they are incurred in bringing the
inventories to their present location and condition. Such cost may include packaging costs
incurred to prepare inventory for sale and borrowing costs that may be capitalised in terms of
GRAP 5 on Borrowing Costs. Refer to the accounting guideline on GRAP 5 for more detail.
Certain expenditures are excluded from the cost of inventories and should be recognised as
an expense in the period that it is incurred, such as:
abnormal amounts of wasted materials or labour;
storage costs, unless those cost are necessary in the production process before a
further production stage;
administrative expenses that were not required to bring inventories to their present
location and condition; and
selling expenses.
GRAP 12 on Inventories
Issued February 2020 Page 21 of 38
5.4 Cost of inventory of a service provider
Inventories of a service provider include the costs of service for which the related revenue has
not been recognised. The costs are primarily labour costs, cost of personnel directly involved
in providing the service as well as the attributable overheads.
Costs of labour that are not directly engaged in providing the service such as general
administrative personnel and sales costs should be excluded and recognised as an expense
when incurred. Profit margins and other overheads are excluded from the cost of inventory.
Example: Cost of inventory of a service provider
Entity A provides accounting services at a fixed rate per hour. The revenue for Entity A will be the service fee received or receivable and the inventory at year-end will be the cost of services rendered for which the related service has not yet been recognised.
The entity’s employees’ complete time sheets recording their time spent on specific projects. At 31 March 20X1 there was unbilled work-in-progress of 485 hours for various clients.
These hours should be valued as inventory at the cost of compensation to the employees. Assuming the cost is R100 per hour, the inventory at year-end is R485,000 (485 x R100).
The journal entry at reporting date will be as follows:
Debit Credit
R R
Inventory (work-in-progress)
(485 hours x R100)
485,000
Employee cost (liability) 485,000
5.5 Cost of agricultural produce harvested from biological assets
In terms of GRAP 27 on Agriculture, agricultural produce that have been harvested from
biological assets are measured on initial recognition at fair value less selling cost at the point
of harvest. This is the cost of the inventories at that date for application of GRAP 12.
Agricultural produce is accounted for in accordance with GRAP 27 on Agriculture, only up to the point of harvest, thereafter it is classified as inventory and accounted for in accordance with GRAP 12. The deemed cost of agricultural produce transferred to inventory is measured at fair value less selling cost at the point of harvest. For subsequent measurement, the inventory will be carried at the lower of its deemed cost and net realisable value or current replacement cost.
GRAP 12 on Inventories
Issued February 2020 Page 22 of 38
6. Cost Techniques and Cost Formulas
Now that we have discussed which types of costs can (and cannot) be included as part of the
total cost of inventory, it is important to know which type of cost formulas should be used in
order to measure inventory correctly in the statement of financial position.
The following types of costs formulas should be used in terms of GRAP 12:
Cost formula Circumstances in which the formula will be used
Specific identification Items which are not ordinarily interchangeable and goods or services produced and segregated for specific projects.
First-in, first out (FIFO) All other items apart from those that are required to use specific identification method.
Weighted average cost formula All other items apart from those that are required to use specific identification method.
Cost of inventories that are similar in nature and use to the entity should be determined by
using the same cost formula. Cost formulas should not be different simply as a result of
different geographical locations of inventories.
Selecting a cost formula(s) is an accounting policy choice. If an entity decides to change the cost formula used to measure its inventory (subject to compliance with the requirements of GRAP 3), it will result in a change in accounting policy and should be applied retrospectively in accordance with GRAP 3.
Specific identification of costs means that specific costs are attributed to identified items of inventory.
Specific identification of costs would not be suitable when there are large numbers of items of inventory that are ordinarily interchangeable.
Under the FIFO basis, inventories are valued with the assumption that items that were purchased or produced first, will be sold first.
Under the weighted average cost basis, the cost of an item is determined from weighted average of the cost of similar items at the beginning of a period and the costs of similar items purchased or produced during the period. It can be calculated on a periodic basis, or per consignment, depending on the situation of the entity.
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Issued February 2020 Page 23 of 38
Example: Applying the first-in-first-out or weighted average cost formulas
Applying the first-in-first-out formula
On 1 April 20X7 Entity A buys 1,000 units of product X at R2.00 per unit. On 1 December 20X7 Entity A buys another 500 units of product X at R2.50 per unit. At 31 March 20X7, 600 units were on hand, thus 900 units were sold during the year.
Calculations:
The 900 units sold were calculated as follows:
Units sold = Units on hand at beginning of reporting period + Purchases – Units on hand at end of reporting period
Units sold = 0 + 1,500 – 600
I.e. 900 units
Calculations:
The value of inventory on hand at year end will be calculated as follows:
R1,250 (500 x R2.50) + R200 (100 x R2.00) = R1,450
How do you determine how many units to use at which purchase price: There are 600 units on hand, FIFO assumes that items on hand were purchased last, therefore the last purchase price of R2.50 will be used for the first 500 units (also the maximum that can be used). There are still 100 units short, therefore the price should be taken from the second last purchase made, which was R2 per unit.
Applying the weighted average formula
On 1 April 20X7 Entity A buys 1,000 units of product X at R2.00 per unit. On 1 December 20X7 Entity A buys another 500 units of product X at R2.50 per unit. At 31 March 20X7, 600 units were on hand, thus 900 units were sold during the year.
On 1 April 20X7 Entity A buys 1,000 units of product X at R2.00 per unit. On 1 December 20X7 Entity A buys another 500 units of product X at R2.50 per unit. At 31 March 20X7, 600 units were on hand, thus 900 units were sold during the year.
Calculating cost of inventory sold at reporting date
Cost inventory sold = Opening balance of inventory on hand + Purchases – Closing balance of inventory on hand
Calculating closing balance of inventory on hand at reporting date
Closing balance of inventory on hand = Opening balance of inventory on hand + Purchases – Cost of inventory sold
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Issued February 2020 Page 24 of 38
Calculations:
The weighted average cost per unit is:
[R2,000 (1,000 x R2.00) + R1,250 (500 x R2.50)] / 1,500 = R2.17
The value of inventory on hand at year end will therefore be:
R2.17 x 600 = R1,300
For this example it was assumed that the weighted average cost per unit is calculated periodically, i.e. on a yearly basis (note that the weighted average cost can be calculated after each purchase or periodically, e.g. weekly, monthly, yearly, etc., consequently, depending on how it is done, it could result in different costs per unit).
To illustrate the concept above, assume that Entity A calculates the weighted average cost per unit after every purchase.
The following inventory transactions took place during the month of October 20X7:
Date Movement Units Cost / sale price per unit (R)
01 October Opening balance 200 20
02 October Sales (120) 40
05 October Purchases 300 24
15 October Sales (200) 48
20 October Purchases 150 30
25 October Sales (150) 50
31 October Closing balance 180 ?
The calculation of the weighted average cost per unit will be done as follows:
Date Movement Units Cost per unit (R)
01 October Opening balance 200 20
02 October Sales (120) 20
80 20
05 October Purchases 300 24
380 23.16 [(80x20) + (300x24)] / 380
15 October Sales (200) 23.16
Weighted average cost per unit is calculated by dividing inventory purchased by the sum of opening inventory plus purchases minus inventory sold.
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Issued February 2020 Page 25 of 38
Date Movement Units Cost per unit (R)
180 23.16
20 October Purchases 150 30
330 26.27 [(180x23.16) + (150x30)] / 330
25 October Sales (150) 26.27
31 October Closing balance 180 26.27
Calculations:
The value of inventory on hand at month end will therefore be:
R1, 250 (500 x R2.50) + R200 (100 x R2.00) = R1, 450. R26.27 x 180 = R4,729
Assume the following additional information:
If we take the same example, but calculate the weighted average on a yearly basis (as in our first example), the outcome will be as follows:
Units Cost price per unit (R) Total cost price
(R)
Opening balance 200 20 4,000
Purchases 300 24 7,200
Purchases 150 30 4,500
Total 650 15,700
Calculations:
The weighted average cost per unit is:
15,700 / 650 = R24.15
The value of inventory on hand at year end will therefore be:
R24.15 x 180 = R4,347
As can be seen from the previous calculations, the weighted average cost per unit and ultimately the value of inventory on hand will differ depending on the basis used to calculate the cost per unit.
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Issued February 2020 Page 26 of 38
7. Subsequent Measurement
Under subsequent measurement, the requirement of GRAP 12 is that inventory should be
measured at the lower of cost and net realisable value, with the following exception:
Inventory should be measured at the lower of cost and current replacement cost where
they are held for:
o distribution at no charge or for a nominal charge; or
o consumption in the production process of goods to be distributed at no cost or for
a nominal charge.
7.1 Cost versus net realisable value
Cost incurred on inventories may become irrecoverable if those inventories are damaged,
obsolete, selling prices declined due to market conditions, or the estimated costs incurred to
complete has increased.
To write down inventories to net realisable value is consistent with the view that assets should
not be reflected in excess of the future economic benefits or service potential expected to be
realised from their sale, exchange, distribution or use. Inventories that are held for distribution
at a market price are measured at the lower of cost and net realisable value upon subsequent
measurement.
Example: Inventory write-down to net realisable value
Entity Z’s reporting date is 30 June 20X7. During 2008, Entity Z, operating in South Africa, imports diesel from Iraq at R5 per litre which is sold at R7.5 per litre.
During 20X7, scientists and geologists discovered oil fields in Malawi. As from 20X7 diesel can be imported at R2 per litre from Malawi. This results in an announcement from the South African government that diesel can only be sold at a maximum of R4.5 per litre.
At the reporting date, Entity Z still holds 5,000 litres of diesel imported from Iraq during 20X6.
The net realisable value of diesel on hand at 30 June 20X7 is R4.5 per litre. The inventory carrying amount before any write-down at reporting date is R25,000 (5,000 x R5).
Net realisable value is the estimated selling price in the ordinary course of operations less the estimated costs of completion and the estimated costs necessary to make the sale, exchange or distribution.
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Issued February 2020 Page 27 of 38
Based on above:
Inventory must be written down to its net realisable value of R22,500 (5,000 x R4.5). The difference of R2,500 is recognised as an expense in surplus or deficit for the period.
Disclosure:
The following illustrates the disclosure that will be made in the annual financial statements of Entity Z.
Extract from Statement of financial position Note 20X7 20X6
R R
Current assets
Inventory 3 22,500 XX
Extract from Notes to the financial statements
20X7 20X6
R R
Inventory
Inventory consists of the following:
Finished goods 22,500 XX
At the end of the reporting period, finished goods were written down to their net realisable value due to a decrease in the selling price. The write-down amounted to R2, 500 which is recognised as part of the cost of inventory in the statement of financial performance.
Inventories can be written down to net realisable value on an item by item basis, or where
appropriate similar items may be grouped. The write-down should not be done based on a
classification of inventory (such as finished goods) or a particular operation or geographical
segment (such as all the inventories in a specific operation).
In most cases, service providers would accumulate cost for each service that has a separate
selling price charged. It would then be appropriate to treat each service as a separate item.
Estimates of net realisable value are based on the most reliable evidence available at the time
when estimates are made.
To estimate net realisable value, the following will be considered:
Fluctuations of price; and
Cost directly related to adjusting events (as defined in terms of GRAP 14 on Events
After The Reporting Date).
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Issued February 2020 Page 28 of 38
Management will also consider the purpose for which the inventory is held. In a situation where
an entity holds inventory for the purpose of satisfying a firm sale or in terms of a service
contract based on a fixed contract price, the net realisable value of those inventories required
to satisfy the contract would be the contract selling price. On the other hand, the net realisable
value of the excess quantity of inventory held will be based on the general selling price and
not the contract price.
Example: Net realisable value of inventory held for a firm sale
Entity A purchased 600 units of inventory with a cost of R200 per unit. A contract was entered into 2 days later whereby 500 units will be sold at R180 per unit in terms of contract entered into with entity B. These inventories are normally sold at R250 per unit.
The 500 units to which the contract relate, have a net realisable value of R180 per unit and should be written down from R200 to R180 per unit. The remaining 100 units should remain at cost, since the net realisable value is higher than cost.
Raw materials and supplies held to be used in the production of inventories will not be written
down if the finished goods are expected to be sold or exchanged at, or above cost. However,
when a decrease in the price of raw materials shows that the cost of finished goods will exceed
its net realisable value, raw materials should be written down to net realisable value. In a
situation like this, the replacement cost of the materials may be the best estimate of net
realisable value.
7.2 Cost versus replacement cost
In certain situations, an entity may hold inventories with future economic benefits or service
potential that are not directly related to their ability to generate net cash inflows, i.e. inventories
are distributed at no charge or for nominal value.
Therefore, where market rates are not applicable for distribution of inventories, they are
measured at the lower of cost and current replacement cost upon subsequent measurement.
Current replacement cost is the cost the entity would incur to acquire the asset on the reporting date.
Therefore, it is the value that the entity would need to pay to replace the inventory should the need arise.
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Issued February 2020 Page 29 of 38
Example: Current replacement cost of inventory that will be discharged at no cost
Entity B purchased 200 units of inventory X with a cost of R65 per unit, to be distributed to the various departments at no cost. At year end there were 20 units on hand and the cost to acquire inventory X is now R60 per unit.
Based on above:
As inventory is distributed it will be recognised as an expense. The remaining units on hand should be written down to their replacement cost of R60 per unit.
Journal entries:
The journal entries will be as follows:
At transaction date Debit Credit
R R
Inventory (200 x R65) 13,000
Bank 13,000
Purchase of inventory X
At date of distribution Debit Credit
R R
Inventory distributed/used (180 x R65) 11,700
Inventory 11,700
Recognise inventory X as expense when it is distributed/used
At year end Debit Credit
R R
Write-down of inventory to current replacement cost [20 x R5 (R65 - R60)]
100
Inventory 100
Inventory X on hand written down to its current replacement cost of R60 per unit
Disclosure:
The following illustrates the disclosure that will be made in the annual financial statements of Entity B.
Extract from Statement of financial position Note 20X7 20X6
R R
Current assets
Inventory 3 1,200 XX
GRAP 12 on Inventories
Issued February 2020 Page 30 of 38
Extract from Notes to the financial statements
20X7 20X6
R R
3. Inventory
Inventory consists of the following:
Consumables held for distribution 1,200 XX
At the end of the reporting period, consumables were written down to their current replacement cost. The write-down amounted to R100, which is recognised as part of the cost of inventory in the statement of financial performance.
7.3 Reversal of inventory write-down
At each subsequent period, a review is made of the net realisable value, if the inventory is still
on hand in those subsequent periods. If the conditions that previously resulted in a write down
of inventory below cost is no longer applicable, or there are new circumstances that results in
an increase of the net realisable value, the write-down will be reversed to reflect the new
carrying amount at the lower of cost and net realisable value. It is important to bear in mind
that the reversal of the write-down is limited to the original amount of the write-down.
Example: Reversal of inventory write-down
During the 20X7 financial period, the Malawian government announces new legislation to limit the exporting of diesel to South Africa. This results in an increase of diesel cost to R3.5 per litre, after which the South African government makes a new amendment allowing diesel to be sold at a maximum of R5.5 per litre. At 30 June 20X7 Entity Z still holds 2,000 litres of diesel from the previous period.
Based on above:
The net realisable value of diesel has now increased to R5.5 per litre. As a result the write-down in 20X7 is reversed. The difference between the current net realisable value and the carrying amount is R1 per litre; however, as the write-down in 20X7 was R0.5 per litre, the reversal will be limited to the write-down in 20X7.
Calculations:
The inventory carrying amount before any reversal of write-down at reporting date is R9,000 (2,000 x R4.5).
The reversal for 20x9 to adjust the carrying amount of inventory is R1,000 (2,000 x R0.5) which is recognised as a reduction in the amount recognised as an expense in surplus or deficit for the period.
The new carrying amount will therefore be R10,000 (R9, 000 + R1, 000).
GRAP 12 on Inventories
Issued February 2020 Page 31 of 38
Disclosure:
The following illustrates the disclosure that will be made in the annual financial statements of Entity Z.
Extract from Statement of financial position Note 20X8 20X7
R R
Current assets
Inventory 3 10,000 22,500
Extract from Notes to the financial statements
20X8 20X7
R R
Inventory
Inventory consists of the following:
Finished goods 10,000 22,500
At the end of the reporting period, a write-down recognised in the previous period was reversed due to an increase in the selling price. The reversal of the write-down amounted to R1, 000 which is recognised as a reduction in the cost of inventory in the statement of financial performance.
8. Recognition as an Expense
Once inventories are sold, exchanged or distributed, the carrying amount of those inventories
should be recognised as an expense in the same period in which the corresponding revenue
was recognised. Where there is no related revenue, the expense is recognised when the
goods are distributed, or related services are rendered.
Any inventory write-down to net realisable value or current replacement cost and any losses
of inventory should be recognised as an expense in the period which the write-down or loss
occurs. In periods where the inventory write-downs are reversed, it will be recognised as a
reduction in the amount of inventories recognised as an expense in that period.
In certain situations inventories may be included in other asset accounts, for example
inventory used as a component of property, plant and equipment. Such inventory is recognised
as an expense over the useful life of that asset.
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Issued February 2020 Page 32 of 38
Example: Recognition as expense
1,000,000 units of paper were purchased for R500, 000 on 5 April 20X8. At 28 June 20X8, the entity sells 300,000 units of paper. The entity’s reporting date is 30 June.
Journal entries:
The journal entries would be as follows:
5 April 20X8 Debit Credit
R R
Inventory (asset) 500,000
Bank 500,000
28 June 20X8 Debit Credit
R R
Stationery (expense) 150,000
Inventory (asset) (300,000 x R0.5) 150,000
Disclosure:
The disclosure in the statement of financial performance will be as follows.
Extract from Statement of financial performance
Note 20X8 20X7
R R
Cost of inventories
Consumables 150,000 -
In the statement of financial position, the value of the paper on hand (R350,000) will be included in the inventory note as a separate line item.
GRAP 12 on Inventories
Issued February 2020 Page 33 of 38
9. Recommended Controls
The following are examples of controls or procedures an entity can implement to assist in
inventory management:
Appoint or designate an inventory manager;
Have an inventory management policy;
Implement controls over the safeguarding of assets;
Ensure there is maintenance of records over inventory movement;
Perform inventory counts periodically to ensure that actual inventory agrees with
theoretical inventory records and to ensure inventory is still in the condition as intended
by management (i.e. not obsolete); and
Annual review of inventory management policy.
Approval of write-offs due to obsolescence or damage
10. Inventory Systems
There are two types of inventory systems, periodic inventory system and perpetual inventory
system. The main differences between the two systems are as follows:
Perpetual inventory system Periodic inventory system
Purchased item is recorded in inventory account Purchased item is recorded in a purchase account
When goods sold, inventory account is reduced Purchase account is not adjusted when goods are sold
When goods are returned to supplier, the inventory account is adjusted
A purchase return account is used for goods returned
When goods are returned by the customers, the cost of sale account is reduced
When goods are returned by the customer, the purchase account is increased
Cost of sale amount is available all the time Cost of sale is only determined when the physical inventory count is performed
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Issued February 2020 Page 34 of 38
Under the periodic inventory system, the cost of sales for the period can be calculated by using this formula:
inventory at the beginning of the period + purchases during the period – inventory at the end of the period = cost of sales
The inventory account is only updated once the physical stock count is performed.
Assume that the opening balance of inventory on hand as at 30 June 20x7 was R55,000. During the period, the entity purchased inventory to the value of R215, 000.
The physical stock count as at 30 June 20x8 reflected 30,000 units on hand at R6 per unit, therefore R180,000.
The cost of sales for the period ending 30 June 20x8 will be:
R55,000 + R215,000 – R180,000 = R90,000
As can be seen, no matter which inventory system is used, the amount for cost of sales (R90, 000) will be the same, the method of calculation is the only difference.
Under the perpetual inventory system, the inventory on hand at year end can be calculated by using this formula:
inventory at the beginning of the period + purchases during the period – cost of sales = inventory at the end of the period
This balance can then be verified by performing a stock count, any difference between the physical stock count and theoretical amount (determined by the formula or on an entity’s system) will most likely be as a result of theft and/or losses and/or calculation errors.
Assume that the opening balance of inventory on hand as at 30 June 20x7 was R55,000. During the period, the entity purchased inventory to the value of R215, 000.
The physical stock count as at 30 June 20x8 reflected 30,000 units on hand at R6 per unit.
Assume that the 15,000 units were sold during the period at R7 per unit.
Cost of inventory sold (cost of sales): R90,000 (15,000 x R6)
Value of sales: R105,000 (15,000 x R7)
The closing balance of inventory on hand (theoretical) as at 30 June 20x8 will be:
R55,000 + R215,000 – R90,000 = R180,000
Units on hand will be 30,000 at R6 per unit.
GRAP 12 on Inventories
Issued February 2020 Page 35 of 38
11. Entity Specific Guidance
Entity-specific guidance has been included where appropriate to provide specific guidance on
a subject that only relates to those types of entities.
11.1 Accounting for water stock by municipalities
Water stock must be accounted for as inventory. This will include water purchased and not yet
sold at reporting date insofar as it is stored (controlled) in reservoirs and pipes at year end.
Water stock also includes any water purification costs incurred for non-purchased water.
The cost of water purchased and not yet sold at reporting date comprises the purchase price,
import duties and other taxes (other than those subsequently recoverable by the municipality
from the taxing authorities, such as VAT) and transport, handling and other costs directly
attributable to the acquisition of finished goods, materials and services. Importantly, trade
discounts, rebates and other similar items are deducted in determining the costs of purchase.
Valuation of purchased and purified water stock
GRAP 12 on Inventories
Issued February 2020 Page 36 of 38
Further detail on step 1:
Detailed plans of the municipality’s water reticulation systems needs to be obtained which
indicate the length and diameter of the water pipes used in the reticulation system. The
volume of water stored in the pipes needs to be calculated based on these detailed plans.
If detailed plans of the municipality’s water reticulation system are not available, then the
municipality’s engineering department or a consulting firm needs to be appointed for the
re-measurement and drafting of these plans.
All reservoirs of the municipality need to be identified and each reservoir’s capacity should
be determined.
Dip readings should be taken at every reservoir as at 30 June each year.
Further detail on step 2:
The municipality should ensure that systems are in place to determine what percentage
of water on hand at year end has been purchased and what percentage has been
produced (purified).
Water stock that was purchased should be disclosed at cost in the annual financial
statements.
Purified, non-purchased water should be disclosed at purification cost in the annual
financial statements.
Further detail on step 4: The production cost per unit must be based on:
Cost directly related to the units of production such as direct materials and direct labour.
This could include expense items such as wage costs of plant workers and chemicals
used in the production process. Another example is the DWAF monthly fee paid for the
volume of water purified.
A systematic allocation of fixed production overheads, which are indirect costs of
production that remain relatively constant, provided the level of production approximates
normal capacity, such as depreciation of manufacturing equipment and the production
facility (water purification plant).
A systematic allocation of variable production overheads, which are indirect costs of
production that vary in accordance with variances in the volume of production. Examples
are indirect labour such as the salary of a factory foreman, and also indirect materials.
GRAP 12 on Inventories
Issued February 2020 Page 37 of 38
Further detail on step 5:
The FIFO method will most likely present the most accurate cost calculation for purchased
water as water that is purchased first is also sold first.
Thus value purchased water at year end by utilising the FIFO methodology and multiplying
purchased water on hand at year-end with the latest purchase price.
GRAP 12 on Inventories
Issued February 2020 Page 38 of 38
12. Useful links and references
Reference Location of reference
Frequently Asked Questions (FAQs)
on the Standards of GRAP
ASB website:
http://www.asb.co.za/frequently-asked-questions/
IGRAP 16 on Intangible Assets –
Website Costs
ASB website:
http://www.asb.co.za/interpretations-approved-
and-effective/ IGRAP 18 on Recognition and
Derecognition of Land
Guideline on The Application of
Materiality to Financial Statements
ASB website:
http://www.asb.co.za/guidelines/
Standard Chart of Accounts for Local
Government (mSCOA)
National Treasury website:
http://mfma.treasury.gov.za
(mSCOA – Municipal Standard Chart of Accounts)
Illustrative Financial Statements for
local government
National Treasury website:
http://mfma.treasury.gov.za
(mSCOA – Municipal Standard Chart of Accounts)