Example: Cost of purchase

X Ltd buys inventory for $171 000 (VAT inclusive) and pays cash in order
to make use of a 5% cash discount offered by the supplier. The inventory
is transferred to X Ltd’s premises by train, and the total railage amounts to
$500 (VAT exclusive). Costs incurred to insure the inventory while in
transit, amounts to $900 (VAT exclusive).

The cost of the inventory is calculated as follows:

$
Purchase price 171 000
VAT (171 000 x14.5/114.5) (21 655)
Cash discount (171 000 x 5% x 100 /114.5) (7 467)
Railage 500
Insurance 900
143 278

Example: Rebates
X Ltd sells shoes and these shoes are bought from B Ltd at $300 per pair.
B Ltd has agreed to grant X Ltd a rebate of 2% on all purchases if X Ltd
buys at least 200 pairs during a period of twelve months. The rebate will
be settled in cash at the end of the twelve month period.

If, based on past experience, it is very likely that X Ltd will meet this target,
each pair of shoes should be recognised at a cost of $294 (300 x 98%),
with a receivable of $6 being recognised for the anticipated rebate. On the
other hand, if it is not probable that the target will be reached, each pair of
shoes should be recognised at a cost of $300. Should the receipt of the
rebate then become probable at a subsequent date, the effect thereof
should be recognised subsequently. Any portion of the rebate that relates
to shoes already sold should then be recognised in cost of sales, while the
remainder should be deducted from inventory.

Example: Settlement discounts

X Ltd buys inventory with a cost of $100 000 from supplier A, who offers a
10% discount if the amount due is settled within 15 days.

If X Ltd intends to settle the amount within 15 days, the cost of the
inventory would amount to $90 000 (debit inventory and credit supplier
with $90 000). However, if X Ltd intends not to settle within 15 days, the
cost of the inventory would amount to $100 000 (debit inventory and credit
supplier with $100 000).
Example: Deferred settlement terms
X Ltd buys inventory, with a cost of $250 000, from B Ltd. Due to cash flow
problems experienced by X Ltd, it is agreed that the amount due will be
settled after nine months, even though the normal credit period granted by
B Ltd is only three months. A fair discount rate is 12% per annum,
compounded monthly.

As payment is deferred for nine months, the cost of the inventory should
be the present value of $250 000, discounted over a period of nine months,
at a rate of 1% per month. This will amount to $228 585 (FV = 250
000; i = 12/12; n =9).

An alternative view is that the discounting should be done for a period of

six months only, as the normal credit period is extended by six months
if the practical expedient rule as per IFRS 15 is not applied, otherwise if
the practical expedient rule is applied, there won't be any need to discount
as any period less than 12 months is deemed immaterial.

Example: Conversion Costs

Motoro Ltd, a motor vehicle manufacturer and dealer, is in the process of preparing its
financial statements for the year ended 31 December 20X0.

The following extract was taken from the trial balance at 31 December 20X0:

$’000

Sales 1 800 000

Purchases – raw materials (components) 300 000
Purchases – second-hand vehicles 32 360
Labour costs – hourly paid employees
Factory staff 360 000
Administration and selling staff 100 000
Salaries and commissions
Factory staff 140 000
Administrative and sales staff 285 000
Depreciation 159 000
Interest paid 128 000
Dividends received 49 000
Other expenses 121 000
Retained earnings at 31 December 20X9 320 000
Manufacturing process

The normal capacity of the factory is 10 000 motor vehicles per year. As a result of
significant labour stayaways during the second half of the year, actual production for
the year was 80% of normal production levels. The company has a “no work no pay”
policy for employees paid at hourly rates. Staff who were paid salaries on a monthly
basis did not take part in the stayaways.

Inventories at 31 December 20X9 20X0

$’000 $’000

Raw materials, at cost 15 000 24 500

Work in progress, at cost 80 000 See note 1

Note 1: The company values spare parts, raw materials and work in progress on a
FIFO basis.

The cost of work in progress at 31 December 20X0 has not yet been calculated.
Detailed production records indicate that only 24% of this year’s allocated production
expenditure and material used (you may assume that there were no raw material
spillages which incurred during the year) relate to motor vehicles that were still under
production at the year-end. The demand for the product is so high that all
manufactured vehicles are sold as soon as the production process is completed.

Dealerships

The following information relates to second-hand vehicles traded:

Motor Date of Purchase Estimated selling price
Vehicle purchase price at year-end
Number (excluding (excluding VAT)
VAT) Date of sale

20X9 20X0
$’000 $’000 $’000

216 30/10/20X9 80 - 70 80
217 30/04/20X9 110 30/06/20X0 130 -
218 30/11/20X9 160 - 180 170
219 – 425 During 20X0 32 000 During 20X0 - -
426 30/06/20X0 155 - - 170
427 25/11/20X0 205 - - 250

The only second-hand motor vehicle inventories on hand at 31 December 20X9 were
vehicle numbers 216, 217 and 218.
Sales staff earn a commission of 10% of the selling price (excluding VAT).

Accounts receivable

The debtors listing reflected accounts receivable of $125 million at 31 December 20X9
and $226 million at 31 December 20X0. The allowance for credit losses was
$11 million at 31 December 20X9 and the balance amounted to $21 million at 31
December 20X0. The Zimbabwe Revenue Authority grants a doubtful debt deduction
amounting to 25% of the company’s provision. Bad debts of $1 million were written off
during the year ended 31 December 20X0.
These costs are included in other expenses.

Property, plant and equipment

The asset clerk has finalised schedules relating to the carrying amounts and tax bases
of property, plant and equipment. The information has been summarised as follows:

Plant and Office Distribution

machinery equipment vehicles Total
$’000 $’000 $’000 $’000
Carrying amount
31 December 20X9 550 000 3 000 40 000 593 000
31 December 20X0 700 000 2 000 42 000 744 000
Depreciation for 20X0 150 000 1 000 8 000 159 000

Tax base
31 December 20X9 450 000 3 000 40 000 493 000
31 December 20X0 550 000 2 000 42 000 594 000
Capital deductions for 20X0 200 000 1 000 8 000 209 000

Depreciation is written off on the straight-line basis over the useful life of the assets.
Distribution vehicles are used to transport manufactured inventory to customers.

Additional information
There are no temporary differences other than those arising from the information
presented above. The tax rate is 24.72%.

REQUIRED
Marks
(a) Prepare the journal entries to recognise the cost of sales for the
year ended 31 December 20X0. 18

(b) Calculate the deferred tax balance for Motoro Ltd at 31 December
20X0, together with the comparative amount. 4

(c) Calculate the tax expense figure that should appear in profit or
loss of Motoro Ltd for the year ended 31 December 20X0. 13
(QE/ITC - adapted)

Suggested solution
(a)

Dr Cr
$’000 $’000
J1. Cost of sales (P/L) 982 360
Purchases - raw materials (P/L) 300 000
Labour costs - factory staff (P/L) 360 000
Salaries - factory staff (P/L) 140 000
Depreciation - plant and machinery (P/L) 150 000
Purchases - second hand vehicles (P/L) 32 360
(Transfer of purchases to cost of sales)
J2. Cost of sales (P/L) 95 333
Inventory - raw materials (SFP) 15 000
Inventory - work-in-progress (SFP) 80 000
Inventory - second hand vehicles [C1] (SFP) 333
(Transfer of opening inventory to cost of sales)
J3. Inventory - raw materials (SFP) 24 500
Cost of sales (P/L) 24 500
(Recognising raw materials at year-end)
J4. Inventory – work-in-progress [C2] (SFP) 211 800
Cost of sales (P/L) 211 800
(Recognising work-in-progress at year-end)
J5. Inventory - second hand vehicles [C3] (SFP) 583
Cost of sales (P/L) 583
(Recognising of finished goods on hand)
(b) Deferred taxation
Tax Temporary Deferred
Carrying base difference tax
amount $’000 $’000 $’000
$’000

20x0
Allowance account for credit losses (21 000) (5 250) 150 000 (4 410)
Plant and machinery 700 000 550 000 (15 750) 42 000
Deferred tax liability 37 590

20x9
Allowance account for credit losses (11 000) (2 750) (8 250) (2 310)
Plant and machinery 550 000 450 000 100 000 28 000
Deferred tax liability 25 690

c) Tax calculation

MOTORO LTD

PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20x0

$’000
Revenue 1 800 000
Cost of sales (982 360 + 95 333 – 24 500 – 211 800 – 583) (840 810)
Gross profit 959 190
Other income 49 000
Administrative expenses (100 000 + 285 000) (385 000)
Other expenses (121 000 + *9 000) (130 000)
Finance cost (128 000)
Profit before tax 365 190

* (1 000 + 8 000 depreciation on office equipment and distribution

vehicles)

Tax calculation
Profit before tax 365 190
Dividends received (49 000)
Taxable temporary differences ((37 590 – 25 690) / 24.72 x 100) (48 139)
Taxable income 268 051

Current taxation (268 051x 24.72%) 66 262

Deferred taxation (37 590 – 25 690) 11 900
78 162
CALCULATIONS

C1. Opening inventory - second hand vehicles

(Lower of cost or NRV)

Cost NRV Carrying

$’000 2019 amount
$’000 2019
$’000
216 80 63* 63
217 110 117# 110
218 160 162@ 160
333

* (70 – (10% x 70))

# (130 – (10% x 130))
@ (180 – (10% x 180))

C2. Work-in-progress

Material (15 000 + 300 000 - 24 500) x 24% 69 720

Labour cost (360 000 x 24%) 86 400
Salaries (140 000 x 80% x 24%) 26 880
Depreciation (150 000 x 80% x 24%) 28 800
211 800

C3. Secondhand vehicles

Cost NRV Carrying

$’000 2020 amount
$’000 2020
$’000
216 80 72* 72
218 160 153# 153
426 155 153# 153
427 205 225@ 205
583

* (80 000 – (10% x 80 000))

# (170 000 – (10% x 170 000))
@ (250 000 – (10% x 250 000))
C4. Closing balances (Alternative calculation)

Description Raw WIP Finished Second hand vehicles

materials products
Opening balances 15 000 80 000 - [C1] 333 000
216 63 000
217 110 000
218 160 000
Purchases 300 000 32 360 000
Overheads
Fixed
Salaries
(140 000 x 80%) 112 000
Depreciation
(150 000 x 80%) 120 000
Variable 360 000
To WIP (balancing) (290 500) 290 500
To finished products
(balancing) (750 700) 750 700
Sold (750 700) 217 (110 000)
219-425 (32 000 000)

Closing Balances 24 500 211 800 - 583 000

Given [C2] Given [C3]

Diagram

Example: Allocation of fixed production overheads

Assume that fixed production overheads amount to $100 000 and normal
capacity equals 10 000 units. The actual production during the year
amounted to only 7 000 units.

The allocation of the overheads should be based on the normal capacity of

10 000 units, resulting in a cost of $10 per unit. As the actual production
was less than expected, only $70 000 (7 000 x 10) of the overheads will
thus be allocated to the cost of the inventory. The remaining $30 000 should
be recognised in profit or loss as part of cost of sales.

If actual production is however 15 000 units (abnormally high), the fixed

cost per unit must be reduced to $6,67 (100 000 / 15 000) to ensure that
only $100 000 is allocated to the cost of inventory.

Example 3.6: Joint products

X Ltd manufactures diet supplements, including Omega 3 and Omega 6
capsules. The basic ingredient for both of these capsules is marine oil, which
costs $36 per litre. A machine is used to extract the Omega 3 and Omega
6 from the marine oil. The depreciation on the machine amounts to $1 000
per day, while the machine operator is paid $200 per day. The machine can
process 10 litres of marine oil in one day. One litre of marine oil is used to
produce ten Omega 3 capsules and eight Omega 6 capsules. The selling
price per capsule amounts to $8 for Omega 3 and $12 for Omega 6.

One litre of marine oil produces ten Omega 3 capsules and eight Omega 6
capsules. The relative sales value of these Omega 3 capsules is $80 (10 x
$8), and that of the Omega 6 capsules, $96 (8 x $12). The total costs of
converting one litre of marine oil amount to $156 ($36 + $1 000 / 10 litres
+ $200 / 10 litres). For every one litre of marine oil used,
$71 [156 x 80 / (80 + 96)] will be allocated to the Omega 3 capsules ($7,09
per capsule), and $85 [156 x 96 / (80 + 96)] to the Omega 6 capsules
($10,63 per capsule).

Example 3.7: By-products

X Ltd is a supplier of canned meats. Ten kilograms of raw meat is required
to produce 20 cans of processed meat. The raw meat costs $20 per
kilogram, while the conversion costs amount to $10 per kilogram.

During the canning process all visible fat is removed from the raw meat,
after which it is sold to a dog food manufacturer, at a price of $5 per
kilogram.

Ten kilograms of raw meat usually have only 0,5 kilograms of fat.
The processed meat will be valued at $14,88 per can. This is calculated as
follows:

$
Cost of 10 kg of meat ($20 x 10kg) 200,00
Costs to process 10 kg of meat ($10 x 10kg) 100,00
Net realisable value of fat (0,50kg x $5) (2,50)
297,50
Cost per can (297,50/20) $14,88

Any unsold fat will be valued at $5 per kilogram.

Example 3.8: Costs excluded

X Ltd employs 10 factory workers at a rate of $15 per hour. These
employees were on strike for one entire month, during which production
ceased completely. After negotiations with the trade union, X Ltd agreed to
pay these workers a total amount of $15 000 for the month during which
they were on strike. The total wage bill in respect of these employees
amounted to $280 000 for the year.

Labour costs incurred during the month of the strike action may not be
capitalised to the cost of inventory. Consequently the $15 000 paid to the
workers for the month during which they were on strike should be expensed
in profit or loss (as part of cost of sales). The remaining $265 000 should
be capitalised to the cost of inventory.