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Module 5
Depreciation &
Inventory
Management Accounting. Dr. Varadraj Bapat, IIT
Mumbai
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Index
• Goodwill and its Amortization
• Valuation and Accounting for
Inventory
• Window Dressing
Management Accounting - Dr. Varadraj Bapat, IIT Mumbai
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Goodwill
Goodwill is the benefit and
advantage
of
good
name,
reputation and connections of an
entity. It is a thing which
distinguishes
an
established
business from new business.
Management Accounting - Dr. Varadraj Bapat, IIT Mumbai
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Goodwill
It is the attractive force which brings
in customers/ suppliers/ employees.
An established business earns more
than normal profits because of its
reputation, while newly established
business has to strive hard just to earn
normal profit.
Management Accounting - Dr. Varadraj Bapat, IIT Mumbai
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Goodwill
Goodwill of a business is a
composite thing influenced by:
i) Location (s) of business
ii) The way in which business is
conducted
Management Accounting - Dr. Varadraj Bapat, IIT Mumbai
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Goodwill
iii) The personality of the people
conducting the business.
iv) customer relationship and
service quality
v) good relation with employees
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Goodwill
vi) No. of years the business or
entity exists
vii)
track-record
of
benevolent
management
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Goodwill
• Goodwill is an intangible asset.
• Self-generated goodwill is not
recognised
in
financial
statements.
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Goodwill
• Goodwill is recognised in the
business as an asset only if it is
purchased from third party.
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Goodwill
If some business is purchased and
the
purchase
consideration
exceeds the value of net assets
taken over, then loss suffered is
treated as goodwill. (AS-14, Ind
AS 38, IAS 38)
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Goodwill
Example
A Ltd. took over B Ltd.
Purchase consideration paid
by A Ltd. is 150 crores and
assets of B Ltd. are as
follows:
Management Accounting - Dr. Varadraj Bapat, IIT Mumbai
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Goodwill
Net Assets of B Ltd
Taken Over by A Ltd.
Book Value
(crores)
Market Value
(crores)
Machinery
60
50
Land
10
70
Net Current Assets
50
40
Liabilities
30
20
Management Accounting - Dr. Varadraj Bapat, IIT Mumbai
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Goodwill
Solution
Purchase
Consideration
150 Crs
Net Assets (MV)
140 Crs
Goodwill
10 Crs
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Amortisation
of Goodwill

The depreciable amount of an
intangible
asset
should
be
allocated on a systematic basis
over its estimated useful life.
(known as amortisation)
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Amortisation
of Goodwill
Amortisation should commence
when the asset is available for
use.
 Estimation of the useful life of an
intangible asset generally

Management Accounting - Dr. Varadraj Bapat, IIT Mumbai
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Amortisation
becomes less reliable as the length
of
the
useful
life
increases.
Therefore as per AS-26 adopts the
presumption that the useful life of
an intangible asset is unlikely to
exceed ten years.
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Amortisation


Therefore goodwill is amortised
over maximum of 10 year.
A variety of amortisation methods
can be used to allocate the
depreciable amount of an asset on a
Management Accounting - Dr. Varadraj Bapat, IIT Mumbai
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Amortisation

systematic basis over its useful
life.
These method includes the
straight line method, reducing
balance
method,
unit
of
production method.
Management Accounting - Dr. Varadraj Bapat, IIT Mumbai
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Amortisation


Goodwill
arising
on
business
purchases represents the payment
made in anticipation of future
income.
It is appropriate to treat it as an
asset to be amortised to income on a
systematic basis over its useful life.
Management Accounting - Dr. Varadraj Bapat, IIT Mumbai
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Amortisation

Due to nature of goodwill, it is
considered appropriate to amortise
goodwill over period not exceeding
5 years unless somewhat longer
period can be justified. (AS-14)
Management Accounting - Dr. Varadraj Bapat, IIT Mumbai
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Amortisation
Example
Goodwill 10 Crs
Say, company expects that during
next 4 years such goodwill should
be written off as per straight line
method.
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Amortisation
Therefore, amortisation of
goodwill will be 2.5 lakhs per
year.
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Inventory
Inventory is tangible current asset
it includes finished goods, work in
progress, and raw materials.
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Inventory
 Inventories include assets held for sale
in the ordinary course of business
(finished
goods),
assets
in
the
production process for sale in the
ordinary course of business (work in
process), and materials and supplies
that are consumed in production (raw
materials). [IAS 2.6]
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Inventory
Valuation
Valuation of inventory is crucial
because of its direct impact in
measuring profit/loss and also
on financial position.
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Inventory
Cost
Cost of inventories should include
only those cost which are expected
to generate future expected benefits.
Such cost include the cost of
acquisition and cost that change
either (i) location of the inventory
e.g. freight, carriage, import duty or
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Inventory
Cost
(ii) condition of the inventory,
e.g. costs incurred to convert
the raw materials into finished
goods.
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Inventory
Cost
• Cost should include all: [IAS 2.10]
• costs of purchase (including taxes, transport,
and handling) net of trade discounts received
• costs of conversion (including fixed and
variable manufacturing overheads) and
• other costs incurred in bringing the
inventories to their present location and
condition
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Inventory
Valuation
Inventories should be valued at
cost
or
net
realisable
value
whichever is lower. (AS-2/ IAS 2.9)
This is based on view that no asset
should be carried at a value which
is in excess of the value realisable
by its sale or use.
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Inventory
Valuation
Net realisable value is the
estimated selling price in the
ordinary course of business less
the estimated cost of completion
and estimated cost necessary to
make sale.
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Inventory
Valuation
Example
Cost of semi-finished products at
the end of the 2011-12 is Rs.
70000. This products can be
finished in the next year by further
expenditure of Rs. 10000.
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Inventory
Valuation
This products can be sold at Rs.
60000
subject
to
selling
commission of 5% on selling price.
Determine the value of inventory
for the year ended 2011-12.
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Inventory
Valuation
Solution:
Selling Price
Less: Estimated cost of
completion
Less: Commission
Net realisable value
Management Accounting - Dr. Varadraj Bapat, IIT Mumbai
60000
10000
3000
47000
33
Inventory
Valuation
NRV : Rs. 47000
Cost : Rs. 70000
Therefore, value of inventory
(lower of cost and NRV): 47000
Management Accounting - Dr. Varadraj Bapat, IIT Mumbai
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Techniques
of Inventory
Valuation
Specific identification method
First in First Out (FIFO)
Last in First Out (LIFO)
Weighted Average Price
Adjusted selling price
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Specific
Identification
Method
Pricing under this method is based
on actual physical flow of goods.
It attributes specific cost to
identified goods.
This method is generally used to
ascertain the cost of inventories of
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Specific
Identification
Method
items that are not ordinarily
interchangeable or having high
value.
Cost of inventory will be determined
on the basis of their specific
purchase price or production cost.
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FIFO
The goods are assumed to be
issued from the earliest lot on
hand. The stock of goods on hand
therefore, consist of the latest
purchases.
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FIFO
Example:
Following are the purchases for the
month of Jun 2012.
Date
12
17
20
Units
5000
3000
6900
Price p.u.
7
9
9
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FIFO
Date
22
27
Units
8000
2000
Price p.u.
11
13
20000 units were issued during the
month. Determine the value of
closing stock at the end of month
Management Accounting - Dr. Varadraj Bapat, IIT Mumbai
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FIFO
The closing stock is 4900 units
and would consist of:2000 units purchased on 27th and
2900 units purchased on 22nd as
per FIFO method
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FIFO
2000 X 13=
2900 X 11=
Value of Closing Stock
26000
31900
57900
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LIFO
Under this method good issued are
valued at price paid for the latest lot of
the goods. In other words stock of goods
on hand will be valued at a price paid for
earliest lots. LIFO method is based on an
irrational assumption that entering last in
stores are consumed first.
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LIFO
LIFO method is not permitted for
valuing inventories. AS- 2, IAS –
2, Income Tax Act
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LIFO
Example:
Following are the purchases for the
month of Jul 2011.
Date
Units
Price p.u.
11
3000
16
14
6000
20
18
2500
15
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LIFO
Date
25
30
Units
7000
9000
Price p.u.
14
19
22000 units were issued during the
month. Determine the value of closing
stock at the end of month as per LIFO.
Management Accounting - Dr. Varadraj Bapat, IIT Mumbai
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LIFO
The closing stock is 5500 units and
would consist of:3000 units purchased on 11th and
2500 units purchased on 14th as per
LIFO method
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LIFO
3000 X 16=
2500 X 20=
Value of Closing Stock
48000
50000
98000
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Weighted
Average Price
Under this method value of inventory
is determined by weighted average
price per unit. Weighted average price
is calculated by using quantity
purchased in a lot as weights.
Management Accounting - Dr. Varadraj Bapat, IIT Mumbai
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Weighted
Average price
per unit =
Total cost of goods
available for sale during
the period
Total number of units
available for sale during
period
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Example:
Compute value of closing stock as per
weighted average method
Quantity
Price p.u.
Amount
900
10
9000
400
14
5600
600
18
10800
Management Accounting - Dr. Varadraj Bapat, IIT Mumbai
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Quantity
500
800
3200
Price p.u.
16
12
Total
Amount
8000
9600
43000
3000 units were issued during the
period
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Weighted Average
price per unit =
43000
3200
= 13.44
Hence value of closing stock is
200 X 13.44= Rs. 2688
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Adjusted
selling price
 This is also known as retail inventory
method
 This method is used where inventory
comprises of items, the individual
costs of which are not readily
ascertainable.
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Adjusted
selling price
The cost of stock is determined
by
reducing
appropriate
percentage of gross margin from
sales value of the inventory.
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Adjusted
selling price
Example:
Compute value of closing
month ended 30th Jun 2011.
stock
Particulars
Goods purchased
for
Amount
25000
Transportation cost
5000
Storage cost
2000
Management Accounting - Dr. Varadraj Bapat, IIT Mumbai
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Adjusted
selling price
Particulars
Sales during period
Selling price of closing
stock
Amount
50000
10000
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Adjusted
selling price
Solution
Particulars
Sales during period
Selling price of closing
stock
Total
Amount
50000
10000
60000
Management Accounting - Dr. Varadraj Bapat, IIT Mumbai
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Adjusted
selling price
Solution
Particulars
Less: Goods purchased
Less :Transportation cost
Less: Storage cost
Gross Profit
Amount
25000
5000
2000
28000
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Gross Profit Margin: 28000/60000 = 46.67%
Particulars
Selling price of closing stock
Less: Gross profit margin
Value of inventory
Management Accounting - Dr. Varadraj Bapat, IIT Mumbai
Amount
10000
4667
5333
60
Window
Dressing
• Window Dressing means something
done to make a better impression,
and implies dishonest or deceptive.
• Window Dressing refers to attempts
to
mis-represent
and
present
financials in the better light.
Dr. Varadraj
Bapat
Management Accounting
- Dr. Varadraj
Bapat, IIT Mumbai
61
Window
Dressing
• Window dressing is an unethical
practice
• Deliberate
deception
in
the
financial statements is fraud.
• Enron - Arthur Anderson
• Satyam - PWC
Dr. Varadraj
Bapat
Management Accounting
- Dr. Varadraj
Bapat, IIT Mumbai
62
Window Dressing
• Examples
• Delay major payment (and not
making provision)
• Include
large
injection
of
cash/assets
• Hiding sales return
• Overstatement of stock /debtors
Dr. Varadraj
Bapat
Management Accounting
- Dr. Varadraj
Bapat, IIT Mumbai
63