Question

The Green Ltd is an established company operating in the highly competitive business of manufacturing domestic appliances. It makes home and office furniture. The following are costs related to the make office:

Direct labour and materials   £140

Bought-in components           £60

Factory overhead costs          £ 40

Royalty on sale payable          £14

For 1000 offices, the other overhead costs are £21,000 made up as follows:

Salary and office costs of production director    £6000   

General office administration                              £5000

Selling and distribution costs                              £10000

The selling and distribution costs include a fixed commission of £6 per office payable to the salesmen.

The advertised selling price of this model has recently been reduced to £260 due to increased competition.

Required:

(a) IAS 2 Inventories states that the cost of inventory includes production overheads and other overheads. Explain the principle on which the inclusion of these costs is based and how these costs should be allocated to units of inventory.

(b) Calculate the unit value of closing inventory for the Green Ltd on the basis of IAS 2 Inventories. State any assumptions you have made.

Answer 1

(A) As per IAS 2 Inventories, cost of inventory shall include the following

i. Purchase cost

ii. Cost of Conversion

iii. Other costs

The following costs shall excluded from the cost of inventories

i. Abnormal amount of waste material, labour cost

ii. Administrative overheads that do not contribute to bringing inventories to their present location and condition and

iii. Selling Costs

In the present case,

All selling and administrative overheads shall be excluded from cost of inventory. General administrative costs also be excluded from cost of inventory.

All direct expenses shall be added to cost of inventory i.e

Direct labour and materials   £140

Bought-in components           £60

Factory overhead costs          £ 40

Total £ 240

For 1000 office, the other overhead costs are allocated

Salary and office costs of production director    £6000   

General office administration 0

Selling and distribution costs 0

Total £6000

(b) Unit value of Inventory

Direct cost   £ 240 per unit

Overheads(6000/1000) £ 6 per unit

Total: £ 246 per unit