Inventory Write-Down Where a Post-Year-End Order Is Cancelled
Chikondi Hardware closes its accounts on 31 December. The inventory count at 31 December 2024 showed cost of MWK 12,400,000. The accountant has since gathered the following. Cement: 400 bags costing MWK 18,000 each; they can be sold for MWK 20,000 per bag but selling and transport costs are MWK 2,500 per bag. Paint: 150 tins costing MWK 12,000 each; the tins were damaged in a leak and can be sold as seconds for MWK 6,000 each after repackaging at MWK 1,000 per tin. Wire: 200 rolls costing MWK 9,000 each; a customer placed an order after the year end at MWK 11,000 per roll but cancelled before delivery; the current market price is MWK 8,500 per roll. The remaining inventory costing MWK 1,600,000 has a net realisable value of MWK 1,750,000. The sales manager argues that the post-year-end order for wire proves the inventory is worth more than cost and no write-down is needed.
1. Calculate the value of closing inventory at 31 December 2024 in accordance with IAS 2, showing the write-down for each class.
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IAS 2 requires inventory to be measured at the lower of cost and net realisable value (NRV), item by item. NRV is estimated selling price less costs to complete and sell.
- Cement: cost 18,000; NRV = 20,000 - 2,500 = 17,500. Write down 500 per bag x 400 = 200,000.
- Paint: cost 12,000; NRV = 6,000 - 1,000 = 5,000. Write down 7,000 x 150 = 1,050,000.
- Wire: cost 9,000; NRV = 8,500. Write down 500 x 200 = 100,000.
- Remaining: cost 1,600,000; NRV 1,750,000; no write-down.
Total write-down = 200,000 + 1,050,000 + 100,000 = 1,350,000. Closing inventory = 12,400,000 - 1,350,000 = MWK 11,050,000.
2. Discuss whether the cancelled post-year-end order is an adjusting event and how it affects the NRV of the wire.
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The order was placed after the year end and cancelled before delivery. Under IAS 10 it is not an adjusting event for the existence of the order, because the order did not exist at 31 December. However, the cancellation and the current market price of 8,500 are evidence of the NRV at the reporting date. The sales manager is wrong to use 11,000: an order that was cancelled before delivery is not evidence that the inventory could be sold for 11,000 at year end. The relevant NRV is the market price at year end, 8,500, less any selling costs. The write-down of 100,000 is required. If the cancellation revealed that the wire was damaged at year end, that would be additional evidence, but on the facts the market price alone drives the NRV.
3. Prepare the journal entry to record the write-down and explain its effect on profit and the statement of financial position.
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Journal: Dr cost of sales (inventory write-down) 1,350,000; Cr inventory 1,350,000. Profit for the year falls by 1,350,000. Inventory in the statement of financial position falls by the same amount, so net assets and retained earnings fall. The write-down is not a prior period adjustment; it is recognised in profit or loss in the year the NRV fall occurs. If the inventory is later sold for more than its written-down value, the excess is recognised as a reduction in cost of sales in the period of sale, not as a reversal of the write-down above original cost.