Q1. A metal fabrication process generates a small quantity of scrap metal as a by-product. In the current period, the estimated cost of collecting, sorting and disposing of this scrap metal (CU850) actually EXCEEDS the amount the business could realistically obtain for it as recyclable scrap (CU300), meaning the scrap has a NEGATIVE net realisable value of CU550 (CU300 less CU850). How should this negative-value by-product be reflected in the accounting records, and why can it not simply be recognised as inventory with a zero value? Incorrect

A) The scrap should be recognised as inventory at zero value, since inventory can never be recognised at a negative amount under IAS 2, and the CU550 net cost should simply be disregarded and not recorded anywhere
B) The scrap should be recognised as inventory at a value of CU300 (its gross recoverable amount before disposal costs), ignoring the disposal costs entirely since they relate to a future period
C) The scrap should be recognised as a reduction in the cost of the main product from which it arose, reducing the main product's inventory value by CU550, regardless of whether the main product is still on hand or has already been sold
D) Because the net realisable value of the scrap is negative (the cost of disposing of it exceeds any amount recoverable from it), it does not qualify for recognition as an asset (inventory) at all -- inventory, as an asset, must be expected to provide a net future economic benefit, which a negative-value item by definition does not; instead, the CU550 net expected cost of disposal should be recognised as a liability/provision (or, if not yet incurred, disclosed and accrued as the obligation to dispose of the scrap becomes probable and estimable), reflecting the genuine future cash outflow the business expects to incur, rather than being ignored or presented as a zero-value asset

Your answer: B  |  Correct answer: D

Inventory, like any other asset, must be expected to provide the entity with a net future economic benefit in order to be recognised at all -- a by-product whose net realisable value is negative (where the estimated cost of disposal exceeds any amount recoverable from selling or recycling it) does not meet this basic definition, since holding and eventually disposing of it will result in a net cost to the business, not a net benefit. Rather than recognising it as an asset at a value of zero and simply ignoring the underlying economics (which would fail to reflect a genuine future obligation), the more faithful treatment is to recognise the expected net cost of disposal as a liability or provision (where the recognition criteria for a provision are met, i.e., a present obligation, probable outflow, and a reliable estimate), reflecting the genuine future cash outflow the business expects to incur to deal with the by-product. This differs from the more commonly tested scenario of a by-product with a small POSITIVE net realisable value (which is typically deducted from the joint costs of the main products, as already covered elsewhere in this topic), since a positive-value by-product genuinely reduces the net cost the main products need to bear, whereas a negative-value by-product represents an additional net cost the business must plan and provide for.

IAS 2/IAS 37 - a by-product with negative net realisable value recognised as a liability rather than as inventory

Q2. A manufacturer produces a batch of goods built to a specific customer's unique technical specification under a confirmed purchase order. Before delivery, the customer unexpectedly cancels the order, and given the highly specific, bespoke nature of the goods, management concludes there is no realistic prospect of finding an alternative buyer willing to purchase them as originally specified; the only realistic recovery is their scrap or salvage value. How should the net realisable value of this batch be estimated at the year end? Incorrect

A) Given that no realistic alternative buyer exists for these specific, bespoke goods following the order's cancellation, net realisable value is estimated based on the best available evidence of the amount actually recoverable, which here is their scrap or salvage value, less any estimated costs necessary to realise that scrap or salvage value
B) Net realisable value continues to be estimated using the general market selling price for similar, standard (non-bespoke) products, on the assumption that all inventory of a broadly similar type shares the same net realisable value regardless of its actual specification
C) The goods are removed from inventory entirely and treated as having no value or place in the financial statements at all, since a cancelled, bespoke order with no alternative buyer is treated as though the goods physically no longer exist
D) Net realisable value continues to be estimated using the original confirmed contract's selling price, since that price was genuinely agreed at one point and remains the most recent reliable evidence of the goods' value

Your answer: C  |  Correct answer: A

Net realisable value under IAS 2 is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale, and must be based on the most reliable evidence available at the time the estimate is made, reflecting the purpose for which the inventory is actually held. Where a bespoke, specification-built batch of goods loses its intended customer and no realistic alternative market exists for goods of that specific, unique configuration, the original contract price and any general market price for standard products both cease to be relevant or reliable evidence of value; the best available evidence of net realisable value becomes the amount genuinely recoverable, which here is scrap or salvage value, reduced by any costs necessary to actually realise that value. Option D wrongly clings to a contract price that has been overtaken by events; option B wrongly substitutes an irrelevant general market price for a genuinely bespoke item; option C wrongly derecognises inventory that still physically exists and retains some recoverable (if much reduced) value.

IAS 2 Inventories, net realisable value estimation based on the most reliable evidence available

Q3. Mr Hassan, a sole trader, prepared draft profit of CU 84,000. During the year he took goods for his own use that cost CU 3,200 and would normally sell for CU 4,800. The goods were recorded in purchases and are excluded from closing inventory, and no entry was made when he took them. What is his corrected profit and the effect on his capital account? Incorrect

A) Profit stays at CU 84,000 because drawings affect only the capital account, with the goods left in cost of sales as in the draft
B) Profit falls to CU 80,800 as the CU 3,200 cost of the goods is charged as an expense, and drawings also reduce the capital account
C) Profit rises to CU 88,800 as sales are credited with the CU 4,800 selling price, and drawings of CU 4,800 reduce the capital account
D) Profit rises to CU 87,200 as purchases are credited with the CU 3,200 cost, and drawings of CU 3,200 reduce the capital account

Your answer: B  |  Correct answer: D

The goods are inventory held for the business, and when the owner takes them they leave the business at cost, not at selling price, and no revenue arises because there is no sale. The correcting entry is debit drawings CU 3,200 and credit purchases CU 3,200. The goods were in purchases but excluded from closing inventory, so cost of sales was overstated and profit understated by CU 3,200, making corrected profit CU 87,200. Drawings are not an expense, they reduce the owner's capital.

IAS 2.9; Conceptual Framework (owner distributions)

Q4. At the reporting date, a company holds a batch of finished goods with a cost of 60,000. These goods are not covered by any firm sales contract. Shortly after the year end, but before the financial statements are authorised for issue, the entire batch is actually sold in the ordinary course of business for net proceeds (after all selling costs) of 52,000, with no significant change in market conditions between the reporting date and the sale. What amount should be used as the net realisable value of this inventory at the reporting date? Correct

A) The average of the original cost and the actual post year-end proceeds, as a compromise estimate
B) A figure based purely on budgeted selling prices prepared before the year end, ignoring the actual subsequent sale entirely
C) 52,000, using the actual post year-end selling price (net of selling costs) as the best available evidence of the net realisable value that existed at the reporting date, since no significant change in conditions occurred between the two dates
D) 60,000, the original cost, since NRV can only be estimated using information available strictly as at the reporting date itself

Your answer: C  |  Correct answer: C

Estimates of net realisable value are based on the most reliable evidence available at the time the estimate is made, including events occurring after the reporting date to the extent they confirm conditions existing at that date, consistent with the general principle also reflected in the treatment of adjusting events. Where inventory is actually sold shortly after the year end, in the ordinary course of business and with no significant intervening change in conditions, the actual net proceeds achieved are normally the best available evidence of net realisable value as at the reporting date itself. Here, the inventory would be written down to its net realisable value of 52,000, below the cost of 60,000, resulting in a write-down of 8,000. Option D ignores highly relevant, reliable evidence that became available shortly after the year end. Option B prefers a less reliable, budgeted estimate over actual, realised evidence. Option A introduces an arbitrary averaging approach with no basis in the standard.

IAS 2 Inventories, paragraph 30

Q5. A food and beverage manufacturer operates an internal quality-certification laboratory. The laboratory performs mandatory batch testing directly required before specific production batches can be released for sale, and it also performs general administrative compliance testing and reporting unrelated to any specific batch of inventory. How should the laboratory's overhead costs be allocated? Incorrect

A) The entire cost is allocated based on the laboratory's own floor space as a percentage of total factory floor space, regardless of what activities are actually performed
B) All laboratory overheads are expensed as a period cost, since testing is an administrative rather than a production function
C) The portion of laboratory overhead directly attributable to mandatory batch testing necessary to bring specific inventory batches to a saleable condition is included in the cost of those batches, while the portion relating to general administrative compliance and reporting activity unrelated to specific batches is expensed as a period cost
D) All laboratory overheads are capitalised into inventory cost, since the laboratory exists because of the production process

Your answer: B  |  Correct answer: C

IAS 2 includes in the cost of inventory only costs incurred in bringing the inventory to its present location and condition, including directly attributable production overheads. Where an internal function like a quality laboratory serves a mixed role, its overhead must be split according to what it actually does: the batch-specific mandatory testing cost necessary before goods can be sold is a cost of bringing that inventory to a saleable condition and is capitalised, while general administrative compliance activity not tied to specific inventory is a period cost, consistent with the broader principle that general administrative overheads not attributable to production are excluded from inventory cost.

IAS 2 Inventories - costs of bringing inventory to its present condition, allocation of mixed-function overheads

Q6. A manufacturer consigns 1,000 units to an agent. Each unit costs CU 80 to make and CU 5 to deliver to the agent, paid by the manufacturer. The agent will earn commission of 10% of the selling price of CU 130, payable on sale. At the year end the agent holds 400 unsold units. At what amount does the manufacturer carry the consignment inventory? Correct

A) CU 34,000, being 400 units at CU 85, which is the cost of production plus delivery to the agent, but excluding commission
B) CU 52,000, being 400 units at the selling price of CU 130, because the agent holds them on the manufacturer's behalf
C) CU 32,000, being 400 units at the cost of production of CU 80, because transport is a selling cost that is expensed
D) CU 39,200, being 400 units at CU 98, which adds the agent's CU 13 commission to cost as part of bringing the units to sale

Your answer: A  |  Correct answer: A

The consignor keeps the units in its own inventory because control has not passed to a customer. Cost includes costs of bringing the inventory to its present location (IAS 2.10), so the delivery to the agent of CU 5 is included: 80 + 5 = CU 85, and 400 x 85 = CU 34,000. The agent's commission arises only on sale and is a selling cost (IAS 2.16), and selling price is not cost.

IAS 2.10, 2.16; IFRS 15.B77-B78

Q7. Coral Manufacturing Ltd purchases specialised machinery components from an overseas supplier under terms that allow settlement 18 months after delivery, materially longer than the supplier's normal 30-day credit terms. The cash price equivalent for immediate settlement would have been $940,000; the amount actually payable after 18 months is $1,060,000. How should the components be initially recognised as inventory? Incorrect

A) At the full contractual amount of $1,060,000, since this is the amount the entity is legally obliged to pay
B) At the present value of $1,060,000 discounted using the supplier's own weighted average cost of capital, rather than the stated cash price equivalent
C) At the cash price equivalent of $940,000, with the $120,000 difference recognised as a finance cost over the 18-month credit period
D) At $940,000, with the $120,000 difference credited immediately to profit or loss as a purchase discount

Your answer: —  |  Correct answer: C

Where inventory is purchased on deferred settlement terms that extend materially beyond normal credit terms, the arrangement contains an implicit financing element. IAS 2 requires the inventory to be recognised at the cash price equivalent at the date of purchase, with the difference between this amount and the total payment recognised as a finance/interest expense over the period of the financing, not capitalised into the cost of inventory. Option A overstates the cost of inventory by including a financing charge that does not relate to bringing the inventory to its present location and condition. Option D wrongly recognises the difference as income immediately, rather than spreading it as a finance cost over time. Option B substitutes an inappropriate discount rate rather than using the stated cash price equivalent as the recognition basis.

IAS 2 Inventories, paragraph 18

Q8. A manufacturing business calculates the cost of a batch of finished goods inventory by including: direct materials CU12,000; direct labour CU8,000; variable production overheads CU3,000; fixed production overheads allocated on the basis of normal production capacity CU4,000; storage costs of finished goods awaiting sale CU1,500; and selling costs (sales commission) CU900. The accountant includes all six items in the cost of the inventory. Assess whether this is consistent with IAS 2. Incorrect

A) The accountant is incorrect, but only because fixed production overheads can never be included in inventory cost under IAS 2, regardless of the basis of allocation used
B) The accountant is incorrect, but only because direct labour should be excluded from the cost of inventory, since it is treated as a period cost rather than a product cost
C) The accountant is incorrect; direct materials (CU12,000), direct labour (CU8,000), variable production overheads (CU3,000) and fixed production overheads allocated on a normal capacity basis (CU4,000) are all correctly included in the cost of conversion under IAS 2 (total CU27,000), but storage costs of finished goods awaiting sale (CU1,500) and selling costs such as sales commission (CU900) are specifically EXCLUDED from the cost of inventory by IAS 2, and should instead be expensed as incurred rather than added to the inventory valuation
D) The accountant is correct; IAS 2 requires all costs incurred in getting the goods ready for sale and selling them to be included in the cost of inventory, so all six items are properly included

Your answer: —  |  Correct answer: C

IAS 2 defines the cost of inventories as comprising costs of purchase, costs of conversion (direct materials, direct labour, and a systematic allocation of fixed and variable production overheads incurred in converting materials into finished goods, with fixed overheads allocated based on normal production capacity), and other costs incurred in bringing the inventories to their present location and condition. IAS 2 explicitly identifies certain costs as EXCLUDED from the cost of inventories and to be recognised as expenses in the period incurred, including storage costs (unless necessary in the production process before a further production stage) and selling costs. Here, the CU27,000 of materials, labour and production overheads is correctly includible, but the CU1,500 storage costs (of finished goods merely awaiting sale, not a necessary part of a further production process) and the CU900 selling costs (sales commission) must be excluded from inventory cost and expensed as incurred.

IAS 2 Inventories, paras 10-16 (costs of purchase, conversion, and costs excluded from inventories)

Q9. A company's opening inventory is CU 120,000 and closing inventory is CU 180,000. Revenue is CU 1,500,000 and cost of sales is CU 900,000. Using a 365-day year, what is the average inventory holding period? Incorrect

A) 73 days, being closing inventory of CU 180,000 divided by cost of sales of CU 900,000 and multiplied by 365
B) 37 days, being average inventory of CU 150,000 divided by revenue of CU 1,500,000 and multiplied by 365
C) 61 days, being average inventory of CU 150,000 divided by cost of sales of CU 900,000 and multiplied by 365
D) 44 days, being closing inventory of CU 180,000 divided by revenue of CU 1,500,000 and multiplied by 365

Your answer: —  |  Correct answer: C

Inventory is valued at cost, so it is compared with cost of sales, the like-for-like measure. Average inventory is (120,000 + 180,000) / 2 = CU 150,000, so the holding period is 150,000 / 900,000 x 365 = 60.8, or 61 days. Using revenue mixes cost with selling price, and closing inventory alone is distorted by the year-end level when inventory has grown during the year.

IAS 2; IAS 1.134

Q10. A company reported profit of CU 200,000 for Year 1 and CU 260,000 for Year 2. It is later discovered that closing inventory at the end of Year 1 was overstated by CU 30,000 because of a counting error, while closing inventory at the end of Year 2 was counted correctly. What were the corrected profits for Year 1 and Year 2? Incorrect

A) Year 1 CU 170,000 and Year 2 CU 260,000, because the correction affects only the year in which the counting error occurred and does not carry into the cost of sales of the following year
B) Year 1 CU 170,000 and Year 2 CU 290,000, because the overstated Year 1 closing inventory also overstated Year 2's opening inventory, so the error reverses in Year 2
C) Year 1 CU 170,000 and Year 2 CU 230,000, because the CU 30,000 correction is deducted from Year 1 profit and then deducted again from Year 2 as the error is carried into opening inventory
D) Year 1 CU 230,000 and Year 2 CU 230,000, because the overstatement is corrected by adding CU 30,000 to the Year 1 profit and deducting CU 30,000 from the profit of Year 2

Your answer: —  |  Correct answer: B

Overstated closing inventory understates cost of sales, so Year 1 profit was overstated by CU 30,000 (corrected to CU 170,000). The same figure is Year 2's opening inventory, so Year 2 cost of sales was overstated and Year 2 profit was understated by CU 30,000 (corrected to CU 290,000). Over the two years total profit is unchanged at CU 460,000, since the error is self-correcting. The other answers either ignore the carry-forward or apply the adjustment in the wrong direction or twice.

IAS 2 / IAS 8 - effect of an inventory counting error on two consecutive reporting periods