Accounting for Inventories
One of the most important lines on a diamond or jewellery company’s assets on it balance sheet is its inventory.
In order to understand the approach of International Accounting Standard 2, IAS 2, on inventories, one should refer to the IAS Framework for the Preparation and Presentation of Financial Statements. An asset is defined as “a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise.” This basically means that an asset is expected to give an economic benefit such as sales revenues.
Inventories are defined in Para 2.6 as:
assets held for sale in the ordinary course of business (finished goods),
assets in the production process for sale in the ordinary course of business (work in process), and
materials and supplies that are consumed in production.
IAS 2 does not deal with construction contracts, financial instruments and biological assets which are covered by other standards.
The fundamental principle of IAS 2 is that inventories are valued at the lower of cost and net realisable value, NRV.
Para 10 prescribes that costs should include
costs of purchase (including taxes, transport, and handling) net of trade discounts received
costs of conversion (including fixed and variable manufacturing overheads) and
other costs incurred in bringing the inventories to their present location and condition
However, the following costs must not be excluded:
administrative overheads unrelated to production
foreign exchange differences arising directly on the recent acquisition of inventories invoiced in a foreign currency
interest cost when inventories are purchased with deferred settlement terms
For items that are specifically identifiable and interchangeable, such as larger items of jewellery and large diamonds, specific costs should be attributed to the items, while for items that are interchangeable, IAS 2 allows the weighted average or first in first out, FIFO, methods. The last in first out, LIFO, method is no longer allowed.
The same cost formulae should be used, and any variations should be justified.
Net realisable value is the estimated selling price in the ordinary course of business less the estimated cost of completion and the estimated costs necessary to make the sale. [IAS 2.6] Any write-down to NRV should be recognised as an expense in the period in which the write-down occurs. Any reversal should be recognised in the income statement in the period in which the reversal occurs. [IAS 2.34].
When inventories are sold, revenue is recognised and those inventories sold are recognised as an expense in the cost of sales. Any write-down to NRV and any inventory losses are also recognised as an expense when they occur. [IAS 2.34]
Required disclosures: [IAS 2.36]
accounting policy for inventories.
carrying amount, generally classified as merchandise, supplies, materials, work in progress, and finished goods. The classifications depend on what is appropriate for the enterprise.
carrying amount of any inventories carried at fair value less costs to sell.
amount of any write-down of inventories recognised as an expense in the period.
amount of any reversal of a write down to NRV and the circumstances that led to such reversal.
carrying amount of inventories pledged as security for liabilities.
cost of inventories recognised as expense (cost of goods sold).
The major difference between IFRS and US GAAP is that US GAAP permits LIFO.
Relevance for Diamond Companies
Appendix BC7 to IAS2 exceptionally allows the higher of cost and net realisable value for biological and agricultural products, mineral ores and broker-dealers’ inventories of commodities. US GAAP also allows the higher of cost and net realisable value for specific products, such as precious metals. If there was a significant increase in the value of specific goods in diamond dealer’s inventory and the price increase can be documented, then the diamonds can be recorded in the books at the higher net realisable value.
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