International Accounting Standards - Report Example

International Accounting Standards (IAS) 2: Inventories History of IAS 2 In October 1975, the very first IAS 2 d Valuation and Presentation of Inventories in the Context of the Historical Cost System was issued. The title of this standard was later on shortened to Inventories in 1991. In December 1993, due to the “Comparability of Financial Statements project” (Deloitte, 2010) of the International Accounting Standards Council or IASC, a revised IAS 2 was published. This revised IAS 2 took effect in January of 1995. In December 2003, the International Accounting Standards Board or IASB issued a revised IAS 2. This latest version took effect on January 1, 2005 (Deloitte, 2010). The IASB made the necessary revisions in light of its project on “Improvements to International Accounting Standards” (IAS 2, 2003). Objectives and General Summary of the Standard The main objective of the standard is to set forth how inventories should be treated in the financial statements or in the accounting world. As the amount of inventories affect two major statements: the statement of financial position and the statement of comprehensive income, IAS 2 aims to provide the needed guidance on what comprises the cost of the inventories and how these inventories will be subsequently recognized in the statement of comprehensive income. IAS 2 also guides the users or readers on what cost formulas should be used to account for the costs of the inventories. Scope and Measurement of IAS 2 Paragraph 2 of IAS 2 specifies the scope of this standard. Notably and consistent with other standards, IAS 2 specifically excludes those items that are already covered by other standards (such as construction contracts, financial instruments and biological assets). The same paragraph also specifically stated where IAS 2 is not applicable when measuring the inventories of the companies in the agriculture and forest products industry. Paragraphs 9 to 22 of IAS 2 discuss how inventories should be measured. Paragraph 9 emphasised that the measurement of inventories should be at the “lower of cost and net realisable value” (IAS 2, 2003). Cost, according to Paragraph 10, should include all related costs in order to bring the inventories to their current state and location. The purchase cost relates to, more or less, those who are in the business of trading while the conversion cost relates to those entities that are in manufacturing. On the other hand, net realisable value means that the outstanding balances of the inventories should be written down if the company believes such cost is no longer realisable. This requirement is based on the accounting principle that assets “should not be carried in excess of amounts expected to be realised from their sale or use” (Par. 28, IAS 2, 2003). IAS 2 also provides guidance on the various cost formulas a company can use in valuing its inventories. The standard allows several cost formula. One is the “specific identification method”, for goods that are “not ordinarily interchangeable and goods or services produced and segregated for specific projects” (Par. 23, IAS 2, 2003). Another cost formula allowed by IAS 2 is the first – in, first – out method or FIFO and weighted average cost formula (Par. 25, IAS 2, 2003). The standard allows different formulas to be used if the inventories maintained by a company have different nature or uses. Presentation and Disclosure Requirements Inventories are usually presented as part of the company’s current assets and are recognised as part of the expense when these are sold or written down to their realisable values. This presentation recognises the fact that inventories, under normal circumstances, are disposed of during the operating cycle of the company. Par. 35 of IAS 2 provides an exception to this presentation. This paragraph states that inventories may actually form part of other assets account (i.e., as part of property, plant or equipment that was constructed by the company). In this case, the said inventories will be recognised as expense not when they are sold but when the related asset is depreciated. IAS 2 requires companies to disclose, in relation to its inventories, the accounting policy adopted in terms of measuring the inventories. It also requires the companies to disclose the outstanding balances of the inventories, classified accordingly. If there are inventories recognised at fair value less cost to sell, these are also required to be disclosed. Other required disclosures are the amount that was expensed out and the amount of inventories written down by the company. If there is a write – down or a reversal of the same, IAS 2 also requires disclosures on the circumstances that led to these write – downs or reversals. Lastly, IAS 2 also requires the amount of pledged inventories to be disclosed. Comparison with US GAAP There are a lot of similarities between IAS 2 and its equivalent standard in the U. S. Generally Accepted Accounting Principles or GAAP. The definition of inventories under both of these standards is the same, that is, inventories are those that are either ordinarily held for sale by the business, used in production or inventories that are still work in progress or undergoing production. The disclosures are almost similar between the two principles. Most cost formulas are found in both of the standards and write – downs of inventory costs are also allowed under IFRS and the US GAAP. There are, however, some differences also between IFRS or IAS 2 and the US GAAP. According to Deloitte’s pocket comparison of IFRS and the US GAAP (2008), there are several differences between IAS 2 and its equivalent US GAAP standard. For one, IAS 2 does not allow the last – in, first – out (LIFO) cost formula for inventories. Under US GAAP, this cost formula is permitted. Another difference lies in how the carrying amounts of inventories are measured. Companies that apply IAS 2 will use the “lower of cost and net realisable value” (Par. 9, IAS 2, 2003) concept. Companies that apply US GAAP, on the other hand, will use the “lower of cost and market concept” (Deloitte, 2008), with market being defined as current replacement cost. Another difference lies on how asset retirement obligations (AROs) that arose during the production of the inventories should be treated. Under IAS 2, the ARO is accounted for as part of the inventory cost. However, under the US GAAP, the ARO is accounted for as part of the cost of the property, plant and equipment that were “used to produce the inventory” (Deloitte, 2008). Lastly, under IAS 2, write – downs can be reversed, provided certain criteria are met. On the other hand, under US GAAP, this is specifically prohibited. How IAS 2 is Applied In this section, the annual report chosen is the one issued by the BP Group. BP p.l.c. is “one of the largest energy companies” (BP, 2010) in the world. Its brands (among others) include Aral, Arco and Castrol. BP p.l.c. is a publicly listed company domiciled in England and Wales. According to the 2009 Annual Report issued by BP, its inventories as of December 31, 2009 amounted to US$22,605 million. Page 119 of the Annual Report describes BP’s accounting policies as far as its inventories are concerned. According to this page, BP has three kinds of inventories: inventories held for trading, inventories not held for trading and supplies. Inventories held for trading are stated at “fair value less costs to sell”. Inventories not held for trading are carried at the “lower of cost and net realizable value”. The FIFO method is used by the group for its inventory costing while its net realizable value is “determined by reference to prices existing at the balance sheet date”. Supplies, on the other hand, are valued at the lower of cost (using the average method) or net realizable value. Note 26, found in page 150 of the Annual Report, discloses the carrying values of each classification of inventories of the company and how much of these inventories were recognised as expense in the income statement. The same note also disclosed that BP recognised a provision of US$46 million in 2009 and US$1,412 million in 2008 and the inventory valuation as presented is already net of these amounts. Final Discussion Since its first publication and subsequent revisions, IAS 2 had been applied by several companies not only in Europe, where the standard originated, but in other parts of the world as well. After its revision in 2003, the standard was further amended to take into account the provisions of the new standards (particularly IFRS 8, Operating Segments) and the ongoing improvements of existing standards as undertaken by the IASB. The provisions of IAS 2 are relatively simple and less complex than other standards. However, in light of the fact that, for trading and manufacturing companies, the inventories are the most major of their assets, the proper application of IAS 2 is crucial to ensure that not only the balance sheet accounts are properly stated but also the income statement accounts as well. References BP (2010). BP at a Glance. [Online] Available at: http://www.bp.com/sectiongenericarticle.do? categoryId=3&contentId=2006926 (Accessed: April 6, 2010). BP 2009 Annual Report. [Online] Available at: http://www.bp.com/assets/bp_internet/ globalbp/globalbp_uk_english/set_branch/STAGING/common_assets/downloads/pdf/BP_Annual_Report_and_Accounts_2009.pdf (Accessed: April 6, 2010). Cadbury, p.l.c. Annual Report and Accounts 2008. [Online] Available at: http://cadburyar2008. production.investis.com/en/financial-statements/group-financial-record.aspx (Accessed: April 6, 2010). Deloitte (2010). ‘IAS Plus: IAS 2, Inventories’. [Online] Available at: http://www.iasplus.com/ standard/ias02.htm (Accessed: April 5, 2010). Deloitte (2008). IFRSs and US GAAP: A Pocket Comparison. [Online] Available at: http://www.iasplus.com/dttpubs/0809ifrsusgaap.pdf (Accessed April 3, 2010). FASB (2010). Accounting Standards Codification: Section 330, Inventory. [Online] Available at: http://asc.fasb.org/subtopicviewall&trid=2126999 (accessed April 4, 2010). IAS 2: Inventories (2003). Available at: http://eifrs.iasb.org/eifrs/bnstandards/en/ias2.pdf - IAS 2 (Accessed: April 5, 2010). Read More