Manufacturing accounting: the key IFRS issues

Why is manufacturing accounting different?

A manufacturer's profit depends on matching the cost of making each product with the revenue from selling it. That puts inventory costing at the centre: deciding which costs go into stock, how overheads are spread across units, and what happens when production is unusually low or wasteful. Large investments in plant, tooling and development, and promises to customers such as warranties and rebates, add further judgements.

Which IFRS issues matter most in manufacturing accounting?

How is manufactured inventory costed?

Under IAS 2, the cost of manufactured inventory includes direct materials, direct labour and a systematic allocation of fixed and variable production overheads. Administrative overheads, selling costs and abnormal waste are excluded. Most manufacturers use standard costs for day-to-day costing, which IAS 2 allows if the standards reflect normal levels of materials, labour, efficiency and capacity and are regularly reviewed. See standard costing and variances.

Why does normal capacity matter?

Fixed production overheads, such as factory rent and supervision, are allocated to units based on the normal capacity of the plant. When production is low, the unabsorbed overheads are expensed rather than loaded onto fewer units, so inventory is not overstated. When production is unusually high, the rate per unit falls. See overhead absorption and normal capacity.

How is obsolete stock dealt with?

Inventory is measured at the lower of cost and net realisable value, so slow-moving, obsolete or damaged stock is written down. Manufacturers usually combine specific write-downs for discontinued products with an ageing-based estimate for slow-moving items. Raw materials are not written down if the finished goods they go into will still sell at a profit. See obsolete and slow-moving inventory.

How are warranties accounted for?

A standard warranty that the product works as specified is an assurance-type warranty, provided for under IAS 37 when the product is sold. An extended warranty that customers can buy separately, or one that provides a service beyond assurance, is a separate performance obligation under IFRS 15, with revenue deferred and recognised over the warranty period. See warranties: assurance or service.

How is plant depreciated?

Under IAS 16, major components with different useful lives, such as a furnace lining and the furnace itself, are depreciated separately. Major overhauls are capitalised and depreciated until the next overhaul. Useful lives reflect expected use and technical obsolescence, and the units of production method can suit plant whose wear follows output.

What other issues arise?

• Government grants for investment or employment, under IAS 20.
• Customer-funded tooling and moulds, which may be revenue, a reduction in cost or a separate asset, depending on who controls the tooling.
• Development costs for new products, capitalised under IAS 38 only once the criteria are met.
• Commodity purchases, which may be outside IFRS 9 under the own-use exemption, or hedged.
• Volume rebates to customers, variable consideration under IFRS 15.
• Environmental and restoration provisions for factory sites.

How does US GAAP differ for manufacturers?

US manufacturers may use LIFO, and measure most other inventory at the lower of cost and net realisable value; write-downs cannot be reversed. The rules on overhead absorption at normal capacity are similar. See IAS 2 vs ASC 330.

Which manufacturing guides come next?

Further guides in this series cover plant useful lives, government grants, customer-owned tooling, development costs, plant impairment, commodity hedging, customer rebates, environmental provisions and idle capacity.

This guide is general information. It is not tax or legal advice for your situation.