Inventories are assets held for sale, distribution, or consumption in the production process or rendering of services. In the public sector, this includes items like medical supplies, textbooks for schools, and strategic food reserves.

• Measurement:
  • Inventories must be measured at the lower of cost and net realizable value (NRV).
  • Special Rule for Public Sector: For inventories held for distribution at no charge or for a nominal charge (e.g., relief food, free vaccines), they are measured at the lower of cost and current replacement cost.
• Cost Formulas:
  • First-In, First-Out (FIFO) or Weighted-Average Cost methods are permitted.
  • The Last-In, First-Out (LIFO) method is not permitted.

Example: Inventory Held for Distribution (IPSAS 12)

The Ministry of Health, through the Kenya Medical Supplies Authority (KEMSA), holds a stockpile of vaccines for a public immunization campaign. These vaccines are to be distributed to county hospitals at no charge.

• Purchase Date: April 1, 2024
• Quantity Purchased: 100,000 doses
• Cost per Dose: Ksh 500
• Total Cost of Inventory: 100,000 doses × Ksh 500 = Ksh 50,000,000

At the financial year-end on June 30, 2024, all 100,000 doses are still in stock.

Rule: Under IPSAS 12, inventories held for distribution at no charge are measured at the lower of cost and current replacement cost.

We will consider two separate situations at year-end.

Situation A: Fall in Market Price

At June 30, 2024, due to increased global supply, the Ministry can now purchase the same vaccine for Ksh 480 per dose.

Step 1: Determine the Correct Measurement

1. Cost: The original cost is Ksh 50,000,000.
2. Current Replacement Cost: 100,000 doses × Ksh 480/dose = Ksh 48,000,000.

The inventory must be measured at the lower of these two values, which is Ksh 48,000,000.

Step 2: Calculate and Record the Write-Down

The inventory must be written down from its cost to its current replacement cost.

• Inventory Write-Down: Cost – Current Replacement Cost
  • Ksh 50,000,000 – Ksh 48,000,000 = Ksh 2,000,000

This write-down is recognized as an expense for the period.

Journal Entry (at June 30, 2024):

• Dr Inventory Write-Down Expense (Surplus/Deficit) Ksh 2,000,000
• Cr Inventory (Vaccines) Ksh 2,000,000 (To write down inventory to its current replacement cost)

The inventory is now reported on the Statement of Financial Position at Ksh 48,000,000.

Situation B: Inventory Expiration

Assume instead that at June 30, 2024, an inspection reveals that 5,000 doses of the vaccine have expired and must be destroyed.

Step 1: Determine the Correct Measurement for the Expired Doses

1. Cost of Expired Doses: 5,000 doses × Ksh 500/dose = Ksh 2,500,000.
2. Current Replacement Cost of Expired Doses: The replacement cost for expired and unusable items is zero. They have no remaining service potential.

The expired inventory must be measured at the lower of these two values, which is Ksh 0.

Step 2: Calculate and Record the Write-Down

The full cost of the expired doses must be written off as an expense.

• Inventory Write-Down: Cost of Expired Doses
  • Ksh 2,500,000

Journal Entry (at June 30, 2024):

• Dr Inventory Write-Down Expense (Surplus/Deficit) Ksh 2,500,000
• Cr Inventory (Vaccines) Ksh 2,500,000 (To write off the cost of expired vaccines)

The remaining non-expired inventory (95,000 doses) would be valued at its cost of Ksh 47,500,000 (assuming its replacement cost has not fallen). The total inventory reported would be Ksh 47,500,000.

Question: Inventory Accounting for County Department of Agriculture & Public Works

You are the Accountant for a County Department preparing financial statements for the year ended 30 June 2026. The Department holds three distinct categories of inventory. The following transactions occurred during the year:

1. Fertilizer (Goods Held for Distribution):
   • Opening Balance: Nil.
   • Purchases: The Department purchased fertilizer worth Kshs 20,000,000 for free distribution to farmers.
   • Distribution: Fertilizer costing Kshs 15,000,000 was distributed to farmers during the planting season.
   • Valuation Adjustment: At year-end, the global price of fertilizer dropped. The replacement cost of the remaining stock on hand is lower than its original cost by Kshs 250,000.
2. Seedlings (Agricultural Produce):
   • Opening Balance: Kshs 500,000. (Note: In the previous year, these were written down by Kshs 50,000 due to drought).
   • Harvest: The Department harvested new seedlings from its forest. At the point of harvest, their Fair Value less costs to sell was Kshs 2,000,000.
   • Distribution: Seedlings valued at Kshs 1,200,000 were issued to community projects.
   • Physical Loss: A localized pest infestation destroyed a batch of seedlings valued at Kshs 80,000. The Accounting Officer has approved this write-off as it is within the authorized limit.
   • Reversal: Due to the end of the drought, market prices for seedlings have recovered. The accountant determines the previous year’s write-down of Kshs 50,000 is no longer required and should be reversed.
3. Architectural Design Services (Service Provider WIP):
   • Opening Balance: Kshs 200,000 (Unbilled work from prior year).
   • Costs Incurred: The team incurred Kshs 1,500,000 in direct labor and attributable overheads on new designs.
   • Completion: Designs costing Kshs 1,000,000 were completed and handed over to the construction department.

Required:

Prepare the Consolidated Inventory Movement Schedule and the Disclosure Notes for the year ended 30 June 2026, ensuring compliance with IPSAS 12 and distinguishing between physical losses and valuation adjustments.

Part 2: The Solution

Note X: Consolidated Inventory Movement Schedule (FY 2025/2026)

Description	Fertilizer(Goods for Dist.)	Seedlings(Agri. Produce)	Arch. Design(Service WIP)	Total
Opening Balance	–	500,000	200,000	700,000
Additions:
Purchases (at Cost)	20,000,000	–	–	20,000,000
Harvested Assets (Fair Value)	–	2,000,000	–	2,000,000
Service Costs Incurred	–	–	1,500,000	1,500,000
Inventory Expensed:
Distributed / Issued / Billed	(15,000,000)	(1,200,000)	(1,000,000)	(17,200,000)
Losses (Physical):
Write-off (Theft/Destruction)	–	(80,000)	–	(80,000)
Valuation Adjustments:
Write-down (NRV/Replacement Cost)	(250,000)	–	–	(250,000)
Reversal of Write-down	–	50,000	–	50,000
Closing Balance	4,750,000	1,270,000	700,000	6,720,000

Note Y: Significant Accounting Policies & Disclosures

1. Valuation Policy

• Fertilizer: Measured at the lower of cost and current replacement cost, as these are held for distribution at no charge.
• Seedlings: Measured at fair value less costs to sell at the point of harvest.
• Services: Measured at the cost of production (direct labor and overheads).

2. Carrying Amounts

• The total carrying amount of inventories is Kshs 6,720,000.
• The carrying amount of inventories carried at fair value less costs to sell (Seedlings) is Kshs 1,270,000.

3. Analysis of Expenses and Losses Total inventory expense recognized in the Statement of Financial Performance was Kshs 17,480,000. This comprises:

• Usage: Kshs 17,200,000 for goods distributed and services rendered.
• Physical Loss: Kshs 80,000 for seedlings destroyed by pests.
  • Regulatory Note: As this loss is below the Kshs 100,000 threshold, it has been authorized by the Accounting Officer in accordance with Section [X] of the PFM Regulations.
• Valuation Write-down: Kshs 250,000 for fertilizer due to a decline in replacement cost.

4. Reversal of Write-Down A reversal of Kshs 50,000 was recognized for Seedlings. This is due to a recovery in market prices following the end of the previous year’s drought conditions, which had originally caused the write-down.
5. Security No inventory was pledged as security for liabilities during the year.

Grey areas.

1. The “Spare Parts” Trap (Inventory vs. PPE)

This is the most common classification error. You might buy expensive spare parts for a generator or a grader. Are they Inventory or Property, Plant, and Equipment (PPE)?

• The Rule (IPSAS 12 Para 11): Inventory includes spare parts “other than those dealt with in standards on Property, Plant and Equipment”.
• The Contention:
  • Consumable Spares (Inventory): Oil filters, brake pads, bolts. These are used up regularly. You treat them as inventory and expense them when used.
  • Major Spares (PPE): A replacement engine for a specific truck that will last more than one year. If you classify this as inventory, the auditor will query it because it meets the definition of a fixed asset (IPSAS 17).
• The Risk: If you list a Kshs 2,000,000 engine as “Inventory,” you are overstating your current assets and avoiding depreciation.

2. The “Strategic Stockpile” Confusion

Governments often hold large reserves (like the maize in your Strategic Grain Reserve or oil reserves) for emergencies.

• The Rule (IPSAS 12 Para 14): Strategic stockpiles (e.g., energy reserves) held for use in emergencies are recognized as inventories.
• The Contention: Sometimes accountants argue, “We have held this maize for 3 years; it’s a non-current asset!” or “We hold it for national security, not consumption.”
• The Audit Point: IPSAS 12 is clear—even if you hold it for a long time, if its ultimate purpose is consumption (distribution to citizens), it remains Inventory. You must check it for expiry/weevils (impairment) every year, which is harder to do if you hide it in PPE.

3. The “Normal Capacity” Trap (Allocating Overheads)

If you are manufacturing items (e.g., a county asphalt plant making road tar or a furniture workshop), you cannot just take the total electricity/rent bill and divide it by the number of units produced.

• The Rule (IPSAS 12 Para 21): You must allocate fixed overheads based on “normal capacity”.
• The Scenario:
  • Your asphalt plant usually produces 10,000 tons (Normal Capacity).
  • This year, due to budget cuts, it only produced 1,000 tons (Low Production).
  • Total Factory Rent = Kshs 1,000,000.
• The Trap: A lazy accountant will divide Kshs 1M by 1,000 tons = Kshs 1,000 per ton allocated to inventory. This artificially inflates the value of the asphalt.
• Correct Treatment: You can only allocate Kshs 100 per ton (1M / 10,000 normal capacity). The remaining Kshs 900,000 must be expensed immediately as “unallocated overheads”.
• The Risk: Auditors look for this during years of low activity. If you capitalize all your rent into the few items you made, your inventory value is dangerously overstated.