FOR DEPARTMENTS

Issued December 2019

ACCOUNTING MANUAL

FOR DEPARTMENTS

CHAPTER 12

Inventories

Chapter 12: Inventories

Issued September 2021

Chapter Content

1 Overview ....................................................................................................................................... 3

2 Key Learning Objectives ............................................................................................................... 3

3 Scope ............................................................................................................................................ 4

4 Identification .................................................................................................................................. 5

5 Recording and Measurement of Inventory.................................................................................... 6

5.1 Recording of inventory ........................................................................................................ 7

5.2 Initial measurement ............................................................................................................ 9

5.2.1 Costs of purchase .................................................................................................... 9

5.2.2 Costs of conversion .................................................................................................. 9

5.2.3 Other costs ............................................................................................................. 11

5.2.4 Cost of inventories of a service provider ................................................................ 11

5.2.5 Cost formulas ......................................................................................................... 11

5.3 Subsequent measurement ............................................................................................... 13

5.3.1 Cost vs. net realisable value .................................................................................. 13

5.3.2 Cost vs. current replacement cost .......................................................................... 14

6 Recommended Controls ............................................................................................................. 16

7 Summary of Key Principles ......................................................................................................... 17

7.1 Scope ................................................................................................................................ 17

7.2 Definition and identification ............................................................................................... 17

7.3 Recording and measurement ........................................................................................... 17

7.4 Disclosure ......................................................................................................................... 18



1 Overview

The purpose of this Chapter is to provide guidance on how to identify and report on inventories.

The Office of the Accountant-General has compiled a Modified Cash Standard (MCS) and this manual serves as an application guide to the MCS which should be used by departments in the preparation of their financial statements.

Any reference to a “Chapter” in this document refers to the relevant chapter in the MCS and / or the corresponding chapter of the Accounting Manual.

Explanation of images used in the manual:

2 Key Learning Objectives

• Understanding what is inventory

• Understanding inventory transactions and what needs to be recorded and disclosed

Definition

Take note

Management process and decision making

Example



3 Scope

This Chapter applies to inventory including:

• ammunition;

• maintenance materials;

• spare parts for plant and equipment other than those that qualify as capital assets;

• strategic stockpiles;

• work-in-progress related to inventories;

• harvested biological produce (fruit, vegetables);

• certain biological assets;

• educational / training course materials;

• land and structures held for sale; and

• other capital assets held for distribution, in the ordinary course of operations.

The Chapter on Inventories in the MCS, and consequently this guide does not apply to:

• The accounting requirements in respect of the primary financial information (i.e. the expenditure relating to the acquisition of inventory etc.). This is dealt with in Chapter 8 on Expenditure.

• Financial instruments. This is dealt with in Chapter 9 on General Departmental Assets and Liabilities.

• Biological assets related to agricultural activity and agricultural produce at the point of harvest. This is dealt with in Chapter 11 on Capital Assets (unless it meets the definition of inventory)

• Work-in-progress of services to be provided through a non-exchange transaction directly in return from the recipients.

• Heritage assets. This is dealt with in the Chapter 11 on Capital Assets.

• Consumables. This is dealt with in the Chapter 8 on Expenditure.

• The initial recognition and initial measurement of inventories acquired in a transfer of functions (see Chapter 19 on Transfer of Functions) or a merger (see Chapter 20 on Mergers)

This chapter only applies to those goods that are essential for satisfying the service delivery obligation of a department. Accordingly, the following items, depending on the service delivery mandate of the departments, may be excluded from the scope of this chapter:

• items that are considered to be consumables; and

• stationery and printing

Consumable items are accounted for as consumables in accordance with Chapter 8 on Expenditure.

The recording of inventory (Rand value of balance and number of items on hand at year end), which is currently disclosed in an annexure to the financial statements, will be recorded as secondary financial information from issued date to be determined by the Accountant-General in a Treasury Instruction.

Irrespective of an item being inventory or consumable it is important that is managed and controlled. Departmental policies and procedures should address this.



4 Identification

[MCS Chapter 12.07 – 12.09]

As indicated earlier, inventories are those goods purchased / produced and held and are essential to the execution of the service delivery mandate of the department. Inventories can include finished goods produced, or work-in-progress being produced, by the department. Inventories also include materials and supplies awaiting use in the production process and goods purchased or produced by a department, which are held for distribution to other parties through a non-exchange transaction or for sale to other parties; for example, educational books purchased by a department of education for distribution to schools.

Examples of inventory in the public sector:

• learning and teaching support materials - Department of Education (DoE);

• certain items bought for distribution, e.g. school furniture bought by a department of education to be distributed to schools;

• certain library materials;

• medicine, e.g. medicine purchased by a department of health to be distributed/sold to a patient;

• strategic stockpiles for example fuel;

• uniforms and protective clothing bought for the use of department staff, e.g. police uniforms;

• work-in-progress related to inventories e.g. houses being built;

• agricultural produce harvested such as meat resulting from slaughter;

• crops harvested after the growing season being fruit, vegetables, etc.;

• live animals being reared for slaughter over the short term such as chickens; and

• goods held for the benefit of the community as a whole e.g. ammunition.

The definition of inventory per the MCS and SCOA are aligned even though different wording is used, but the meaning and the intent are the same.

To make it less onerous for departments, consumables have been excluded from the reporting requirements but not the management requirements thereof. A department needs to assess each item and conclude whether it is essential for service delivery or not. Different departments will split the different line items differently depending on their service delivery mandate, for example stationery has been deemed to be a consumable item for most departments due to it being used for administration purposes. However in the case of the department of Home Affairs, some stationery would be used to produce identity documents, birth certificates and death certificates which are all closely related to their service delivery mandate and as a result that stationery will become inventory. Where an item fulfils a

Inventories are assets:

• in the form of materials or supplies to be consumed in the production process (for example, cement purchased by DPW when constructing a building); or

• in the form of materials or supplies to be consumed or distributed in the rendering of services (for example, medication in the health sector environment, or animals procured and reared specifically to be consumed in the delivery of the department’s mandate such as, day old chicks bought and raised for slaughter and consumption in the short term, three weeks or three months even while harvesting eggs in between); or

• held for sale or distribution in the ordinary course of operations (for example, furniture bought by the department of education for the schools; or

• in the process of production for sale or distribution (for example, work-in-progress when Human Settlement is construction RDP house to be distributed).



dual role as in the case of stationery an estimate needs to be made on the percentage of stationery used for administrative purposes, based on judgement and prior experience and budgeted for accordingly.

All the items that meet the definition of inventory shall be classified as such irrespective of their value. This includes those items that are purchased as once-off, those purchased for distribution as well as those delivered directly to the beneficiary. Items are considered as issued out once the department no longer has control over those items, i.e. the point where the department will not be held responsible if those items were to be lost.

Where a department rears animals for slaughter, the animals will be biological assets. During this rearing period the biological transformation is managed by feeding, dipping, etc. to ensure the health and growth of the asset. The point of slaughter can extend beyond a year, for example cattle are slaughtered when they are five years old whereas chickens are slaughtered when they are three weeks or three months old. The biological transformation process/ period to the point of slaughter thus vary greatly. This should be taken into account when applying the definition of a capital asset or inventory to a biological asset.

As a practical example, the chickens above will be managed by number (measured per unit) as inventory until ready to slaughter and issued for slaughter in the same measurement. The resulting slaughtered chickens (raw meat) will be taken up as inventory in a mass unit measurement such as kilogram and issued for consumption in the same measurement.

The following table gives an overview of different types or classes items that may fall within the definition of inventory:

Class Example

Raw material • Sand, bricks, cement (for construction)

• Powders and liquids (to mix for medicine)

• Wood, glue, varnish, nails (make of furniture)

Work in progress • Houses being built (foundations, structure at window or roof height)

• Medicine partly mixed

• Partly completed furniture

Finished goods • Completed houses (ready for handover)

• Mixed medicine ready for use

• Completed furniture ready to distribute/sell

• Food items ready for use (tinned food, raw items ready to cook)

Consumable items are those that are not essential to the department’s service delivery mandate. These items must still be managed however to ensure the maximum benefit is derived from the funds expended thereon.

Examples of consumables in the public sector may include the following:

• Medicine in a first-aid kit for use by employees;

• Stationery used for administration of the department;

• Cleaning materials used to clean office space;

• Toilet paper bought in bulk – for use by employees of a department;

• Sand, cement, bricks used by an internal maintenance unit for repairs to office space;

• Uniforms for additional ad hoc security personnel e.g. at a treasury;

• Fertiliser e.g. for a garden surrounding office space or facility.

Every item carried in stores should be assessed in terms of the service delivery mandate of the department to distinguish consumables from inventory. It is unlikely that a programme or project performed or run by a department would not be related to its service delivery mandate but assessment should be done. For example, toilet paper or cleaning materials bought for a health facility would be inventory rather than consumable as it would be used mainly for the safety and convenience of patients visiting the health the facility not employees.



Sand, cement and bricks used for construction of human settlements will be inventory whereas if a department runs a maintenance unit to ensure its office space is well maintained these items will be consumables as the mandate of the department is not the maintenance of facilities.

5 Recording and Measurement of Inventory

[MCS Chapter 12.10 – 12.27]

5.1 Recording of inventory

For the purposes of recording inventory, a department should maintain processes in place which could include an electronic system and manual processes (such as the use of bin cards) that will enable it to comply with the disclosure that needs to be made in the financial statements - refer to the Section on Disclosure which sets out the disclosure required.

Inventories should be recorded as part of the secondary financial information if, and only if:

• it is probable that future economic benefits or service potential associated with the item will flow to the department; and

• the cost or fair value of the item can be measured reliably.

A department should record inventory on the day when the risk and rewards of ownership of the inventory have been transferred to the department. 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), which indicates when the risk and rewards are transferred to the buyer. This could be at ‘origin’ when the goods are loaded onto the ship, resulting in the buyer recognising inventory on the FOB date as in-transit, or it could be at the ‘destination’ in which case the risks and rewards will only transfer on arrival at the destination harbour.

Service potential is the capacity of an inventory item, individually or in a group with other inventory items, to contribute directly or indirectly to achieving the objectives of the department. These objectives may include delivering a service to the public without receiving any economic return. Therefore inventory items that are used to deliver goods and services in accordance with a department’s mandate, but do not directly generate net cash inflows are often described as embodying ‘service potential’.

Sometimes the bulk stock/inventory stored in a warehouse is often referred to as ‘consumable’ as it could include items such as toilet paper for use in a health facility, cleaning materials for the hospital, or food supplies for a place of safety, bandages for patients, or paper for the printing of workbooks. These items are all essential to the service delivery mandate of a department of health, social services or education and as such represents ‘inventory’ and should be accounted for as such.

Guidance on completion of inventory note (or Annexure) in the financial statements (To be repeated for every major line of inventory on hand)

Opening balance

The opening balance is represented by the inventory closing balance as at the end of the previous financial year, the closing balance disclosed in the annexure to the financial statements of the previous financial year.

Adjustments to opening balance

This represents adjustments to prior year inventory as a result of prior period errors that are only identified in the current year. The following can give rise to adjustments:

• Surpluses and shortages: A record of all inventory surpluses or shortages must be kept. The surpluses or shortages will represent the difference between recorded inventory amounts and actual inventory levels. Adjustment to the



opening balance will be made if an error is discovered in the current year relating to the prior year closing balance.

• Reclassification as capital or minor assets: All inventories previously classified as inventory and reclassified as capital or minor assets need to be accounted for and transferred from the inventory register to the major or minor asset register.

• Reclassification as inventory: All inventory previously classified as capital or minor assets and reclassified as inventory need to be accounted for and transferred from the asset register to the inventory register.

• Reclassification as consumables: All items previously classified as inventory and reclassified as consumables under the new classification categories in the Standard Chart of Accounts (SCOA) need to be accounted for and transferred from the inventory register to the consumables register.

Additions / Purchases – Cash

All additions for the year should be reflected. The cash additions must be reconciled to the amounts reflected in goods and services in the statement of financial performance.

Additions – Non-cash

The fair value of inventory received in-kind or donated from sources outside government during the financial year is disclosed on this item. This also includes when inventory is transferred from another government department for no value. There should be adequate and appropriate substantiating records to support the transfer. The recipient department should take on the inventory at the same value as in the transferor’s books.

Disposals

All approved disposals of inventory, should be recorded here. These amounts will represent obsolete, lost or damaged inventory which is unable to be issued into production or for distribution.

Issues

All inventory issued to cost centres or external stores for production, distribution or consumption must be recorded.

Adjustments

This represents correction of errors that occurred in the current financial year that relate to inventory. This also represents the difference between the initial recognition amount (e.g. cost for inventory purchased) and weighted average.

Closing balance

In an accrual environment this amount is shown as a current asset in the statement of financial position. The closing balance of inventory for the current financial year will be the opening balance for the following financial year. A stocktake at year end or close to year end will assist with verifying the accuracy of inventory numbers and amounts reported in the annexure.

Quantity

The quantity is required to reconcile the actual units counted to the units as per the inventory system and determine the measurement units for calculation of the value.



5.2 Initial measurement

Inventories are initially measured at cost, e.g. costs of purchase.

Where inventories are acquired through a non-exchange transaction, their cost must be measured at their fair value as at the date of acquisition.

5.2.1 Costs of purchase

The costs of purchase of inventories comprise the purchase price, import duties and other taxes (other than those subsequently recoverable by the department from the taxing authorities), and transport, handling and other costs directly attributable to the acquisition of finished goods, materials and supplies. Trade discounts, rebates and other similar items are deducted in determining the costs of purchase.

5.2.2 Costs of conversion

The costs of converting work-in-progress inventories into finished goods inventories are incurred primarily in a manufacturing environment. The costs of conversion of inventories include costs directly related to the units of production, such as direct labour. Also included is a systematic allocation of both fixed and variable production overheads.

• Variable production overheads are those indirect costs of production that vary directly, or nearly directly, with the volume of production, such as indirect materials and indirect labour.

Capital assets acquired for distribution fall within the definition of inventory. The SCOA chart has a posting level under inventory for such acquisitions. Due to the system control over item records for capital assets the assets will still appear in the LOGIS asset register reports and should be manually extracted from the report before reporting on capital assets.

For the purposes of preparing the inventory reconciliations and disclosure, the LOGIS team has prepared a presentation on the reports available for the reconciliation and reporting requirements for inventory. This document can be found on either the LOGIS website (http://logis.pwv.gov.za/logisweb/ ) or on the OAG website.

Example 1: Inventory acquired through a non-exchange transaction

An international aid agency donates medical supplies to a department in the aftermath of a natural disaster. The department did not pay anything for it but has received the stock which cannot be taken on at zero value. The department will then need to determine the fair value at receipt date and the determination thereof will have to comply with the department’s inventory management policy. This could include getting quotations of similar items in the market.

Example 2: Exchange transactions

Department ABC purchases 100 boxes (each box consisting of 40 units inside) of ammunition for R200 000.

The total cost price for this stock will be the amount charged when acquiring it which is R200 000; R2 000 (R200 000 / 100) per box; R50 (R2 000 / 40) per unit of ammunition.

http://logis.pwv.gov.za/logisweb/



• Fixed production overheads are those indirect costs of production that remain relatively constant regardless of production volume, such as the maintenance of factory building and equipment or factory management and administration.

The allocation of fixed production overheads is usually based on the normal capacity of the facilities, where normal capacity is the expected average production levels including allowing for loss of capacity during planned maintenance.

For example, the allocation of costs, both fixed and variable, incurred in the development of undeveloped land held for sale into residential or commercial landholdings, could include costs relating to landscaping, drainage, pipe laying for utility connection, etc.

Example: Conversion Costs

Department A manufactures furniture (Tables) and sells this furniture to other government departments at more reasonable prices compared to other suppliers.

In order to manufacture furniture, the department acquires raw material (Wood, screws, glue, etc.) to be used in the manufacturing process – Direct material. Let’s assume that the total costs relating to direct material amounted to R50 000 (10 items purchased and 6 issued to the production process)

The labour costs payable to the officials directly involved in the manufacturing process of this furniture based on the time it takes to complete one table – Direct labour. Let’s assume that this remuneration amounted to R20 000 in total.

Variable production overheads would include supervisor’s labour costs based on the time he spent on the production process. Let’s assume that this amounted to R4 000 in total.

Fixed manufacturing overheads would be included to represent the costs of electricity, rent and so on used during the manufacturing process which could be allocated according to the units produced. Let’s assume that these costs amounted to R6 000

Furthermore, let’s assume that there was no opening WIP at the beginning of the period under review as the department only had finished goods in the previous period (All the raw materials had been fully processed in the manufacturing process to form the finished furniture)

Direct labour (R20 000), variable production overheads (R4 000) and fixed manufacturing overheads (R6 000) are in combination called conversion costs (R30 000)

The disclosure will be as follows at year end

Units/ Quantity

Amount

R

Inventory – Materials and supplies (Raw Material) (50 000/10*4 not issued)

4 20 000

Inventory – Other supplies (WIP) (50 000/10*6 issued = (R30 000)+ conversion costs = R30 000 )

60 000

Total 80 000

The six items manufactured thus cost R10 000,00 each. At the reporting date they were finished goods on hand.



5.2.3 Other costs

Other costs are included in the cost of inventories only to the extent that they are incurred in bringing the inventories to their present location and condition. For example, it may be appropriate to include non-production overheads or the costs of designing products for specific customers in the cost of inventories.

Example of costs excluded from the cost of inventories are abnormal amounts of wasted material and labour or administrative overheads that do not contribute to bringing inventories to their present location and condition as well as costs of selling or distribution.

5.2.4 Cost of inventories of a service provider

To the extent that service providers have inventories they measure them at the costs of their production. These costs consist primarily of the labour and other costs of personnel directly engaged in providing the service, including supervisory personnel, and attributable overheads. The costs of labour not engaged in providing the service are not included. Labour and other costs relating to general administrative personnel are not included in the cost of inventory and neither is a profit margin or non-attributable overheads that are often factored into the prices charged by the service provider.

5.2.5 Cost formulas

The cost of inventories of items that are not ordinarily interchangeable and goods or services produced and segregated for specific projects must be assigned by using specific identification of their individual costs.

Specific identification of costs means that specific costs are attributed to the identified items of inventory. This is the appropriate treatment for items that are segregated for a specific project. However, specific identification of costs is inappropriate when there are large numbers of items of inventory that are ordinarily interchangeable. In such circumstances, the method of selecting those items that remain in inventories could be used to obtain predetermined effects on the surplus or deficit for the period.

The cost of inventories which are not specifically identified must be assigned by the weighted average cost formula. A difference in geographical location of inventory by itself is not sufficient to justify the use of different cost formulae.

Under the weighted average cost method, the cost of each item is determined from the weighted average of the cost of similar items at the beginning of the period and the cost of similar items purchased or produced during the period. The average may be calculated on a periodic basis or on receipt of each new shipment.

Example: Cost of inventory of a service provider

Department A provides specialised services at a fixed rate per hour of R350. The revenue for Department 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 revenue has not yet been recognised.

The department’s employees’ complete time sheets recording their time spent on specific projects. At 31 March 2015 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 not the rate charged to the client. Assuming the cost is R100 per hour, the inventory at year-end is R48 500 (485 x R100).

Debit Credit

Inventory (work-in-progress)

(485 hours x R100)

48 500

Employee cost (liability) 48 500



The manner and timing for the calculation must be included in the department’s inventory management policy.

Applying the weighted average formula

On 1 April 20x1 Department A buys 1,000 units of product X at R2.00 per unit. On 1 December 20x1 Department A buys another 500 units of product X at R2.50 per unit. At 31 March 20x2, 600 units were on hand, thus 900 units were sold during the year.

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 (closing balance) at year end will therefore be:

R2.17 x 600 = R1 300

For the above example it was assumed that the weighted average cost per unit is calculated annually, i.e. only at end of the period (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 Department A calculates the weighted average cost per unit after every purchase. This is usually how inventory systems would update the value.

The following inventory transactions took place during the month of October 20x1:

Date Movement Units Cost / sale price per unit (R)

01 October Opening balance 200 20

02 October Sales (price per unit) (120) 40

05 October Purchases 300 24




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 (cost per unit) (120) 20

Balance 80 20


Balance 380 23.16 [(80x20) + (300x24)] / 380

15 October Sales (cost per unit) (200) 23.16

Weighted average cost per unit is calculated by dividing value of inventory (purchased during the year plus opening value) by the sum of quantities of opening inventory plus purchases.

The cost per unit calculated is applied to the quantity on hand at year end to determine the value of the closing balance.

Note that internal movements do not affect the weighted average cost.



Date Movement Units Cost per unit (R)

Balance 180 23.16


Balance 330 26.27 [(180x23.16) + (150x30)] / 330

25 October Sales (cost per unit) (150) 26.27

31 October Closing balance 180 26.27

The value of inventory on hand at month end will therefore be:

R26.27 x 180 = R4 729

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

The weighted average cost per unit is:

15 700 / 650 = R24.15

The value of inventory on hand (closing balance) 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 frequency of calculating the cost per unit. It is important to note that the weighted average cost is not influenced by the issues/ sales transactions. The ‘cost’ of the item issued changes to the latest average but does not impact the calculation of the average itself. In a normal trading entity, the profit will be negatively impacted where the weighted average cost is increasing all the time. Eventually adjustments need to be made to the selling price to ensure the profit margin remains the same.

5.3 Subsequent measurement

This section only applies to inventory recorded in the financial statements as secondary financial information. Thus, inventory on hand at year-end.

Inventories are subsequently measured at the lower of cost and net realisable value, except where the following applies.

Inventories are measured at the lower of cost and current replacement cost where they are held for:

• distribution through a non-exchange transaction; or

• consumption in the production process of goods to be distributed at no charge or for a nominal charge.

5.3.1 Cost vs. net realisable value

The cost of inventories may not be recoverable if those inventories are damaged, if they have become wholly or partially obsolete, or if their selling prices declined due to market conditions, or the estimated costs incurred to complete has increased.

The practice 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

Department Z’s reporting date is 31 March 20x3. During the previous financial year, 20x2, Department Z, imported diesel from Iraq at R5 per litre which is sold at R7.5 per litre.

Towards the end of 20x3, scientists and geologists discovered oil fields in Malawi. As from the discovery date, 20x3, 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, Department Z still holds 5 000 litres of diesel imported from Iraq during 20x2 (assume that in 20x3 and 20x2 no other changes took place).

The net realisable value of diesel on hand at 31 March 20x3 is R4.5 per litre. The inventory carrying amount before any write-down at reporting date is R25 000 (5 000 x R5).

Inventory at year end (the 5000 litres from Iraq) must be written down to its net realisable value of R22 500 (5 000 x R4.5). The difference of R2 500 is recorded as part of the movement in inventory as a result of the find during this reporting period.

There will be no impact on the opening balance of inventory as the drop in value happened during this reporting period and did not exist at the previous reporting date.

The following illustrates the disclosure that will be made in the financial statements of Department Z:

Extract from Notes to the financial statements

Quantity 20x3 Quantity 20x2

Inventory R R

Opening balance 5 000 25 000 - -

Adjustment to opening balance - - - -

Add: Additions / Purchases - Cash - - 5 000 25 000

Add: Additions - Non-cash - - - -

(Less): Disposals - - - -

(Less): Issues - - - -

Add / (Less): Adjustments - (2 500) - -

Closing balance 5 000 22 500 5 000 25 000

5.3.2 Cost vs. current replacement cost

In certain situations, a department 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.

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.



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. This will be in the instance where a department will have to replace (buy) the inventory should it be destroyed before use e.g. the department has slaughtered six thousand chickens resulting in 12000kg of meat, to ensure food supply in-line with its service delivery mandate. Should an electricity outage render the meat unusable the department will have to go to the market to buy the required amount of meat to enable food supply.

Example: Current replacement cost of inventory that will be discharged at no cost

Department B purchased 200 units of inventory X with a cost of R65 per unit, to be distributed to various departments and the public at no cost. At year end there were 20 units on hand and the cost to acquire inventory X is now R60 per unit.

As inventory is distributed it will be removed from the inventory records and shown as “issues” in the financial statements. The remaining units on hand should be written down to their replacement cost of R60 per unit. Therefor an amount of R100 (20 units x R5) will be shown as part of the movement in inventory.

The following illustrates the disclosure that will be made in the financial statements of Department B:

Extract from Notes to the financial statements

Quantity 20x3 Quantity 20x2

Inventory R R

Opening balance - - - -

Adjustments to opening balance - - - -

Add: Additions / Purchases - Cash 200 13 000 - -

Add: Additions - Non-cash - - - -

(Less): Disposals - - - -

(Less): Issues (180) (11 700) - -

Add / (Less): Adjustments - (100) - -

Closing balance 20 1 200* - -

* Test to make sure closing balance is accurately valued:

At year end there were 20 units on hand and the current replacement cost at which the inventory should be measured is R60 per unit, therefore 20 units x R60 = R1 200.

Inventory is therefore accurately valued as year-end.

Current replacement cost is the cost the department would incur to acquire the inventory on the reporting date.

Therefore, it is the value that the department would need to pay to replace the inventory should the need arise.



6 Recommended Controls

The following are examples of controls or procedures a department should implement to assist in inventory management:

• appoint or designate an inventory manager or management team;

• have a documented inventory management policy and procedures;

• implement controls over the safeguarding of inventory;

• ensure there is maintenance of records for all inventory movement;

• keep manual records where no electronic system is available such as bin cards to aid control;

• keep an overall inventory register for the department as well as individual registers for each separate location and reconcile them on a regular basis, at least monthly;

• perform inventory counts periodically to ensure that actual inventory agrees with theoretical inventory per records and to ensure inventory is still in the condition as intended by management (i.e. not obsolete);

• structure the warehouse or stock room to aid in control such as using shelves, keeping it tidy, dedicated space for receipts and issues, etc. and

• annually review inventory management policy and procedures.



7 Summary of Key Principles

7.1 Scope

Includes: Excludes

• inventories held for sale or distribution in the ordinary course of operation or rendering of services;

• material or supplies to be consumed in the production process; and

• inventories to be consumed in the ordinary course of operations.

• work-in-progress from construction contracts (e.g. if the department is the contactor physically constructing the item; such services are not outsourced)

• services to be provided through a non-exchange transaction;

• financial instruments;

• biological assets at the point of harvest;

• heritage assets; and

• consumables.

Inventories are those goods purchased / produced and held specifically for executing the service delivery mandate of the department.

7.2 Definition and identification

To classify an item as inventory, management should consider the definition, nature, timing and materiality of the item.

Inventory types:

Items held for sale or distribution in the ordinary course of business

E.g. school furniture, library materials

Items in the production process for sale or distribution

E.g. work-in-progress of houses being constructed for members of community

Materials and supplies consumed in production process

E.g. raw materials such as bricks, cement stones, etc. or spare parts for maintenance

Materials and supplies consumed or distributed in the rendering of services

E.g. ammunition and security supplies

7.3 Recording and measurement

Inventory is recorded and disclosed as inventory in the financial statements when it meets the recognition criteria:

• it is probable that future economic benefits or service potential will flow to the department; and

• its cost or fair value can be measured reliably.

Inventory is recognised at cost, except when it is acquired at no cost in which case it is recognised at fair value.

Costs include:

• Cost of purchase;

• Cost of conversion;

• Other cost; but

• Excludes abnormal spillages, selling expenses, admin overheads, etc.



After initial recording, , inventory is recorded at the lower of cost and net realisable value or the lower of cost and current replacement cost where inventory is held for distribution at no or nominal charge for purposes of secondary information..

Net realisable value:

• Selling price less cost to sell

Current replacement cost:

• Cost department would incur to acquire inventory on reporting date

All inventory items at year-end are reflected using the specific identification of their individual costs or weighted average cost formula. Work in progress is reflected at the cost to date.

7.4 Disclosure

Inventory purchased is recognised as expenditure under goods and services in the statement of financial performance at the actual cost of purchase.

Inventory movement is also reported in the notes to the financial statements where more detail is provided, such as inventory quantities, opening balance, movements and closing balance on hand for each major category of inventory.

FOR DEPARTMENTS

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