Accounting for Inventories According SFAS 14
Inventories accounting is very important for trading companies or manufacturing companies because it affects the measurement of company performance including the amount of gross profit, gross profit margin, net profit and total assets, especially current assets, thus accounting for inventories must follow Indonesian Statements of Financial Accountings Standards 14 or PSAK 14 (SFAS 14).
Accounting for Inventories According to PSAK 14
Some of the issues in inventory accounting include the following:
What kind of costs should or should be recorded as inventory?
How to allocate overhead cost to be recorded as inventory?
The effect of production capacity in the allocation of inventory costs, how to record the cost of inventory?
How to make an inventory accounting process that involves many components and complex production activities into a simple but precise accounting process?
PSAK 14 (SFAS 14) Inventories in Brief
PSAK 14 (Accounting Standards for Inventories) determines how companies record the amount of costs recognized as assets (inventories), the measurement of inventories in the statement of financial position, and the accounting treatment of inventories when they are sold. PSAK 14 latest amendment, when this article was written, was in 2014 and effective as of 1 January 2017.
Scope of PSAK 14 (SFAS 14)
PSAK 14 (SFAS 14) applies to all inventories, except:
Work in progress arising in construction contracts, including directly related service contracts (regulated in PSAK 34: Construction Contracts)
Financial instruments (regulated in PSAK 50: Financial Instruments: Presentation and PSAK 55: Financial Instruments: Recognition and Measurement)
PSAK 14 (SFAS 14) does not apply to the measurement of inventories held by:
Producers of agricultural and forestry products, post-harvest agricultural products, and minerals and mineral products, provided that such inventories are measured at net realizable value in accordance with industry practice. Changes in net realizable value are recognized in profit or loss in the period in which they occur.
Commodity traders who measure their inventories at fair value less costs to sell. Changes in fair value less costs to sell are recognized in profit or loss in the period in which they occur.
What are inventories?
Inventories according to PSAK 14 (SFAS 14) are assets that have the following criteria:
available for sale;
in the production process for the sale;
in the form of materials or equipment for use in the production process or in the rendering of services.
Types of Costs that can be Recognised as Inventory
Cost of inventories based on cost includes:
Other costs incurred until the inventory is in a condition and place ready for sale or use.
The cost of purchasing inventories according to PSAK 14 (SFAS 14) includes the purchase price, import duties and other taxes, except those that are refundable to the tax office.
Conversion costs include costs directly related to units produced and fixed & variable manufacturing overhead costs that are allocated on a systematic basis.
Allocating Overhead Costs To Inventory Costs
Fixed overhead costs include depreciation, maintenance of factory buildings & equipment, and factory management & administration costs.
To determine fixed overhead costs according to PSAK 14 (SFAS 14), fixed overhead costs must be calculated based on the capacity of normal production facilities. For example, a factory machine whose normal production capacity is 1000 units per month and depreciation per month is IDR 10,000,000. At normal capacity, the fixed overhead cost per unit of inventory is Rp. 10,000,000 divided by 1000 units, which is Rp. 10,000 per unit of inventory.
If the capacity produced is only 100 units per month, then the fixed overhead costs charged to each unit are Rp. 10,000, so the depreciation costs allocated to fixed overhead costs are Rp. 10,000 x 100 units = Rp. 1,000,000.
This means that there is a depreciation expense of Rp. 9,000,000 which has not been allocated due to the low level of production capacity. An expense of Rp 9,000,000 must be allocated to expenses in the income statement in the period in which it is incurred.
If the production level is higher than the normal capacity, for example 1500 units, then the amount of fixed overhead costs allocated per unit will be smaller than the first example, which is Rp 10,000,000 / 1500 = Rp 6,667.
Costs that should not be recorded as Inventory under PSAK 14
According to PSAK 14, the following are examples of costs that are removed from inventory and recognized as an expense in the period in which they are incurred:
Abnormal amount of wasted raw materials, labor or other production costs
Storage costs unless they are needed in the production process before the next stage of production
General and administrative expenses that do not contribute to creating inventory
For service providers, the value of inventories is recorded at production costs which consist of labor costs and other personnel costs directly handling the provision of services, including supervisory personnel, and attributable overhead. Labor costs and other costs related to sales and general administration are recognized as expenses in the period in which they are incurred.
Cost Measurement Techniques
PSAK 14 provides several options to facilitate the calculation of inventory costs, provided the results are close to the actual costs. Measurement of inventory costs according to PSAK 14 can be done by following techniques:
The standard cost method is to calculate the value of inventory using the components of the normal capacity level, use of materials, equipment, labor, efficiency and capacity utilization, and
The retail method can be used for retail trading companies to measure their inventory quantities. The retail method calculates the inventory value for each product group that has the same profit margin by using a certain percentage of the sales value.
An entity calculates inventory using the following cost formula:
Products that are unique per unit, goods/services for special projects and cannot be replaced with one another, then use a special identification cost formula. Specific identification costs are costs incurred specifically to obtain the said goods/services; Or
If these criteria do not meet, the inventory costs can be calculated using the first-in, first-out (FIFO) or weighted average formula. An entity must use the same cost formula for all inventories of the same nature and use.
Measurement of inventory at financial statement date
At the date of the financial statements, Inventories are measured using the lower of cost or net realizable value. Net realizable value or net realizable value is the estimated selling price of inventories in the ordinary course of business deducted with the estimated costs of completion and the estimated costs required to make the sale.
Any write-down of inventories below cost to net realizable value and all losses on inventories are recognized as an expense in the period in which the write-down or loss occurs. Any reversal of the decline in the value of inventories due to an increase in net realizable value is recognized as a reduction to the total cost of inventories in the period in which the recovery occurs.
Accounting treatment of inventory when inventory is sold
If inventories are sold, the carrying amount of the sold inventories should be recognized as an expense, i.e. the cost of goods sold in the period in which the revenue is recognized.
This article is written by Venna Priscilla, SE, Ak, CA - Partner Accounting Services
Venna has nearly 10 years of professional experience in accounting, tax and auditing, in the service, trade, manufacturing, non-profit sector and government agencies. Her certifications include CA, Chartered Accountant of Indonesia. She is an active member of the Indonesian Institute of Certified Public Accountants and the Indonesian Institute of Accountants. Venna holds a bachelor's degree in economics and professional accountant degree from the University of Indonesia.