Provisions for impairment of inventory

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To access provisions for impairment of inventory, in the IFRS accounting section, click Inventory provisions.

Accounting for inventory provisions

Net realizable value is a selling price minus estimated costs of finished products (services) completion and inventory sale.

In accordance with IAS 2 "Inventories", inventory under IFRS is measured at the lowest of two values: the cost of production or purchase (inventory net book value) and the net realizable value.

If the inventory's net realizable value becomes less than the net book value, IAS 2 "Inventories" requires reducing the inventory value to the net realizable value.

Inventory value is reduced to the net realizable value either by reducing the value of inventories in the warehouse or by making provisions.

RAS 5/01 does not require measuring inventories at the lowest of cost and net realizable value. However, this RAS states that inventories that become obsolete, lose their original quality, or whose current market value decreased, must be recorded in the balance sheet less provisions for cost reduction.

As the requirements of national and international accounting standards differ, it is usually required to adjust inventory provisions or calculate them separately for IFRS reporting.

Costs of raw and other materials intended for inventory production are not reduced below the cost if the finished products they will be included in are expected to be sold at a price equal to or higher than the cost.

Net realizable value of inventories may differ from the fair value less selling costs, since this is the net amount that the company expects to gain from inventory sale throughout its activities. This cost is specific for the company.

The fair value reflects the market price of similar inventories no matter what a company is. To determine the impairment of inventory, you cannot just take the market price. You need to determine the price at which these inventories can really be sold.

The net book value of inventories may be overstated as a result of processes that cause impairment of inventory:

• Damage, complete or partial obsolescence or decrease in the inventory selling price.
• Increase in estimated costs for production completion or sale.

Several approaches to inventory impairment estimation are often combined. For example, if it is possible to determine the net realizable value for a specific product range, it is estimated at the lowest of the net realizable value (common term is NRV test) and the cost in accordance with the standard.

If it is impossible to determine such price (for example, by raw materials and materials used for further production and not for sale, whose replacement cost is unknown, or by work in progress when it is impossible or time-consuming to determine the costs of production completion, inventories are analyzed by their turnover. A common term is by inventory turnover.

You can also analyze and then write-off stale, obsolete, and damaged inventories. This is in accordance with IAS 2 "Inventories" and the "Conceptual Framework for Financial Reporting" document. The document states that an asset can only be a resource from which future economic benefits are expected.

You can take advantage of inventory provision calculation both by the NRV test and by turnover. Usually, the NRV test is applied to finished products as the selling price is usually calculated for them. Sometimes this method is also applied to raw materials and materials, for which, for example, the replacement cost is known to determine the net realizable value. However, it can be difficult to determine the replacement cost and the production completion cost of work in progress, raw materials and materials used in in-house production. These inventory groups are estimated by turnover.

Moreover, IAS 2 "Inventories" provisions prescribe to monitor the further use of inventories by the company and consider it when determining impairment. For example, in case of impairment of raw materials and materials whose net book value exceeds a net realizable value, test the products consisting of these materials for impairment. If these finished products were not impaired, no impairment is recognized for the related raw materials and materials. In addition, turnover analysis can show that inventories are stale and provisions should be accrued. You also need to estimate whether it is possible to sell these inventories, and if they are expected to be sold, revise the estimation of provisions. This all relates to qualitative analysis of inventory provisions and is not considered when calculating provisions. You can take advantage of automated inventory provision calculation, but further analysis and revision of estimations are outside the system scope. Make all necessary adjustments manually after the calculation.

If the method of calculating inventory provisions under NAS differs from the method adapted under IFRS, NAS provision entries are not translated, and inventory provisions under IFRS are calculated and recorded in the application on the reporting date separately from NAS data. Under the transformational approach, all inventory provision entries are received from NAS since the entire NAS trial balance is translated. The subsystem also calculates IFRS provisions on the reporting date separately from NAS and reverses all NAS inventory provision entries. Perpetual inventory is not maintained but calculated on each reporting date based on the available balances on the inventory accounts. So under both approaches, the amount of the provisions accrued under IFRS is reversed on the first day of the month following the reporting period.

The system automatically records both the accrual and the recovery of provisions under IFRS. It also applies to provisions of accounts receivables and advances issued.

The provisions can be recovered due to:

• Sale of previously impaired inventories at their net book value or higher, resulting in disposal of the provisions.
• Increase in the price of the previously impaired but not yet sold inventory.

The first recovery option is generated automatically in case of the decrease in the product range provisions at the end of the period. The second recovery option is tracked outside the system and entered manually. The use of the provision (the provision account write-off in correspondence with the inventory account) is also recorded manually if it is clear that the price of the impaired product range will not increase, and it will not be sold. The analysis is made outside the system.

In the application, inventory provision calculation under IFRS is broken down by product range, but the same calculation approach can be applied to a product range group. The detail level is a configurable parameter and depends on the company specifics.

Net realizable value is calculated outside the system. If the estimated costs of production completion and the estimated costs for sale or production completion are significant, they are also calculated outside the system. If they are insignificant, the estimated selling price throughout regular activities is considered the net realizable value and registered in the infobase.

Depending on the company specifics, the source of the net realizable value can be:

• Company's approved price list used for sales in the period.
• External sources and databases that determine a market price for a particular product range.
• Company's database. It keeps records of sales based on which you can determine the latest selling price of a particular product range. To determine this price, the latest selling price of the product range is used.
• Other sources for determining the market value.

Based on the net realizable value received for each product range (for which the NRV test is conducted), the inventory value is calculated by multiplying the quantity for this product range by the received price. Next, this value is compared with the product range cost in the balance sheet, and the amount of provisions is determined. If the cost exceeds the net realizable value, provisions are made for the difference between the two values. If there is no such excess, the provisions are not recognized.

All payment amounts must be VAT exclusive.

Setting up inventory accounting parameters in accordance with the accounting policy

The application allows you to set up inventory provisions accounting for:

• Companyy's IFRS accounting policy
• Product range prices
• Provision calculation parameters

Setting up at the accounting policy level

Settings are specified in the company's IFRS accounting policy.

In the Source for net selling price of inventory field, select the Product range price type catalog item. This item will be used to determine Net realizable value of inventories.

Setting up product range prices

To calculate the net realizable value, register selling prices of inventory items in the system.

To register product range selling prices and currencies, use the Product range pricing document in the Product range and warehouse section.

In the Price type field, select a price type applicable to a specific product range item or a group. Price types are determined by the company.

These can be prices from price lists, market prices of this product range, or prices determined based on other sources reflecting the company-specific realizable value of this product range. If the costs of sale and/or production completion are significant, the selling price of the inventory is registered minus the estimated amount of sales costs for calculating the net realizable value in accordance with IFRS.

To determine price types, in the Product range and warehouse section, in the Product range price type catalog, create the existing selling price types.

Provision calculation parameters

In the Inventory provisions calculation parameters catalog, create inventory provision calculation parameters.

In the Provision evaluation method drop-down list of the created item, select a method for calculating inventory provisions.

The system introduces the following provision calculation methods:

• Do not use. It is used when a product range does not require measurement to create a provision for impairment. It happens when a net book value of the product range is lower than a net selling price and there is no need to analyze turnover. This data is obtained outside the system. Select this method if a product range has very high turnover and does not become obsolete, the costs of its sale or production completion do not increase, and selling prices do not decrease.
• NRV test. It is used when you know a net realizable value or a selling price minus estimated costs of sale and production completion (if they are insignificant). In this case, the product range is measured at the lowest of the net realizable value and the net book value. If the latter is higher, the difference is recorded as provisions and represents an adjustment to the cost of impairment of inventories.
• By turnover. It is used if you cannot determine a net realizable value of the product range but you need to analyze the turnover as it can vary from period to period and lead to obsolescence and deterioration of goods. If you select this method, the Standard turnover field becomes available. In this field, specify a standard turnover for the product range to be used to measure the provision amount.
• NRV test, if no – turnover. It is used when a turnover test is required for certain product range kinds if the NRV test does not reveal their impairment.

For example, it is necessary for the inventories subject to significant fluctuations in selling prices, estimated costs of sale and production completion, changes in turnover periods, physical deterioration and obsolescence.

If the net realizable value is not set for all product range items, the NRV test may not create provisions for impairment of inventory. The method of calculating provisions according to the established turnover rates is automatically applied to this product range.

If you select this method, the Standard turnover field becomes available. In this field, specify a standard turnover of this product range. If the NRV test registered the impairment of this product range, the turnover test is not applied.

For each catalog item, in the Expense account field, specify an expense account for inventory provisions and the respective cost item.

This is required to allocate the costs of creating inventory provisions to different cost accounts for different product ranges.

The created items of the Inventory provisions calculation parameters catalog are mapped to the product range items of the Product range catalog.

To do this, in each item of the Product range catalog, in the Provision calculation parameters field, select how to calculate provisions for this product range item.

In the GL accounts of inventory and provisions information register, records with inventory GL accounts are created. For each of these accounts, a balance GL account for inventory provisions is set.

In the Provision calculation parameters field, select how to calculate a provision for this account.

Inventory provisions document

Use the Inventory provisions document to calculate and record the reduction of the inventory value down to the net realizable value on IFRS accounts.

The document has the following tabs: IFRS accrual and NAS accrual.

The IFRS accrual tab displays the initial data and IFRS accrual amounts. All fields on the tab are filled automatically.

The provision amounts are calculated for each Product range catalog item based on the settings specified in the Inventory provisions calculation parameters catalog.

The document generates the following types of entries:

• Inventory provision creation.
• For transactional accounting: inventory provision reversal as of the first date of the next reporting period.
• For transformational accounting: reversal of inventory provisions accrued under NAS.

The decrease in the inventory value amount (deductions to provision) is calculated automatically according to the following algorithm:

1. Balances on the IFRS inventory GL accounts of the Inventory provision accounts register are extracted as quantities and amounts as of the end date of the reporting period broken down by product ranges and GL accounts.
2. The provision amounts are calculated for each product range item as of the reporting date in accordance with the provision calculation parameters.
3. Depending on the provision calculation method, the total amount of the inventory (inventory provision) value reduction is calculated for all product range items for which impairment was recognized. An adjustment (entry) is automatically created for this amount.

The NAS accrual tab displays information on how to create and recover inventory provisions under NAS. This information is used to reverse provision amounts. In transactional accounting, NAS data is imported from the accounting system. To ensure correct data import, check whether the mapping of inventory and provision GL accounts is correct in the translation template. In transformational accounting, data is imported from the input form.

NAS provision records are broken down by each product range item.

At the bottom of the document, click Details to see detailed information for creating provisions. Use this data to check the amounts to be accrued under IFRS.

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