Other Related Documents

3.3 Inventories

Introduction

Two types of inventories are used by departments:

1- Consumable Inventories are items of tangible property that are to be consumed in a future year directly or indirectly in the delivery of program outputs. They include all items such as equipment, spare parts and material that are held in stores and warehouses for issue at a later date to be used in future program delivery. They also include inventories held for resale within the Government of Canada. Consumable inventories exclude purchases that meet the capitalization criteria specified in TBAS 3.1 Capital Assets.

2- Inventories held for resale are physical items that will be sold (or used to produce a product which will be sold, e.g. raw materials) in the future in the ordinary course of business to parties outside of the Government reporting entity.

The majority of departments will have consumable inventories. There may be some revolving funds and a handful of departments that have inventories for resale.

Determining Inventory Quantities

The physical quantities in inventory may be determined by means of a periodic inventory system or a perpetual inventory system.

(a) Periodic Inventory System

An actual physical count of goods on hand is taken at the end of each period for which financial statements are to be prepared. The goods are counted, weighed or measured, then extended at unit costs to derive the inventory valuation. When a periodic inventory system is used, end-of-the period entries are required for (a) transferring opening inventory to expense and (b) recording the ending inventory.

For inventories held for resale, where the inventory records are maintained on a periodic inventory system, typically a purchases accounting is used to record acquisition. The balance in the inventory account (which represents the beginning inventory) is unchanged during the period. At the end of the accounting period a closing entry is made that debits the Inventory account for the ending inventory amount and credits the Inventory account for the beginning inventory amount. Cost of goods sold is determined by using the following calculation: Beginning Inventory + Net Purchases - Ending Inventory.

For consumable inventories, acquisitions of inventory throughout the year may be charged to an expense account. At the end of the year, the ending inventory would be recorded with an equivalent reduction in expenses.

It would not be practical for departments with sizeable inventories to do a physical count every year for the purpose of determining ending inventory. Where amounts are significant, central agencies need to know the expenses associated with inventory usage more frequently than annually. It is strongly recommended that departments maintain their records on a perpetual inventory system (see below)

(b) Perpetual Inventory System

It is particularly useful (a) to control and safeguard inventory and (b) to facilitate preparation of monthly statements. Furthermore, it is considered to be one of the essential characteristics of a good cost accounting system.

Purchases are debited directly to the inventory control account and concurrently entered into the detailed inventory records. As items of inventory are issued, the transaction is recorded in the accounts so that it carries a perpetual or continuing balance of the goods that should be on hand at each date.

Physical counts are usually made at least annually or on a continuous rotation basis (using sampling) when large inventories are involved to verify if there is any loss or error in the record keeping.

Discrepancies in Inventory Count

Regardless of the inventory control and records in place, loss and errors are always present. When a difference exists between the count and the perpetual inventory account balance, an entry is needed for reconciliation.

Note that in the periodic inventory system, the Inventory Over and Short account does not exist because there are no accounting records available against which to compare the physical count. Consequently, overages and shortages are buried in cost of goods sold (for inventories held for resale) or operating expenses (for consumable inventories).

References

• TBAS 3.4 Inventories
• CICA Handbook Sections 1520.04, 3030.05-.06, 3030.09-.10
• PS 1500-47, 1500.49

Scenario A - Purchasing and Issuing Inventory Under a Perpetual Inventory System

Department purchases spare parts for vehicles for $50,000. Freight charges of $500 are included on the invoice. Assuming the Department uses a perpetual system, purchases & issues are recorded directly in the inventory account as they occur.

Journal Entries

1) To record the purchase of inventories

See the Accounts Payable section of the manual to see related entries required for the settlement of the accounts payable. See the GST/HST section of the manual to see related entries required for the settlement of the GST.

FRA coding rationale: The purchase of consumable inventories is recorded as a debit to Inventories -Consumables. Delivery cost should be capitalized as part of the cost of the inventories. At this point the Department is being charged GST on the purchase of inventories, and must pay it. However, the Department will eventually recover this amount from Canada Customer and Revenue Agency (CCRA) and should record it as "13392 GST/HST Refundable advance accounts". The cost of the consumable inventories plus 7% GST would be set up as an accounts payable in the period since costs were incurred but not yet paid. Note: if the inventory had been held for resale, FRA "15120 - Inventories held for resale" would be used instead of 15110.

Authority coding rationale: B11/B12* Since this is a legitimate charge against an operating appropriation, it would be recorded against either B11A or B12A depending on whether the department has a program vote (B11A) or an operating vote (B12A). Please note that if the entity is a revolving fund the charge to the appropriation would be to A5XX. Since GST is not to be charged to a departmental appropriation, it is set up as an advance under a special authority, G111. There is no impact on authorities for the accounts payable so the code to be used would be "R300-All other assets and liabilities"

Object coding rationale: Object 1267 is used in this example since spare parts were purchased for the Department's vehicles. The appropriate object is used depending on the nature of the purchase. "0210 - Transportation of things not elsewhere specified" is used to record the freight charges. If a department's system cannot handle the use of more than one object code per asset, the freight charges may be charged to the same code as the asset. Since there is GST/HST payable, the GST must be reflected by using, "8171 - Payment of GST on purchases". " 6299 - Accounts Payable/Accrued Charges" is used to establish the accrual of the amount owing.

2) To record inventory issuances of $10,000 from inventory

FRA coding rationale: The charge to 51321 - "Operating Expense" reflects the consumption of inventories used for program delivery and the reduction of 15110 - "Inventories held for consumption" is required to remove the items that have been consumed. Note if the inventory had been held for resale, the appropriate FRA would be "15210 - Inventories for resale" for the credit entry and "51324 - Cost of goods sold" for the debit entry.

Authority rationale: There is no impact on the authorities with respect to issuance of inventory since the appropriations was charged when the inventory was purchased in journal entry 1). Therefore, F codes are used in this transaction. "F112 - Inventory charged to program expenses" would be used for operating expenses. "F312 - reductions from (increases to) inventory balances" is used for the inventory account.

Object coding rationale: There is no impact on the objects with respect to the issuance of inventory since the objects were impacted at the time inventory was purchased in Journal entry 1). "3452 - Usage of inventory" is used on both sides of the entry.

Scenario B - Purchasing and Issuing Inventory Under a Periodic Inventory System

Department purchases spare parts for vehicles for $50,000. Freight charges of $500 are included on the invoice. Assuming the Department uses a periodic system, purchases & issues are recorded directly in the inventory account as they occur.

Journal Entries

1a) To record the purchase of consumable inventories

See the Accounts Payable section of the manual to see related entries required for the settlement of the accounts payable. See the GST/HST section of the manual to see related entries required for the settlement of the GST.

FRA coding rationale: The purchase of consumable inventories is recorded as a debit to operating expenses. Alternatively, the inventories account (FRA 15110) could be debited to record the purchase of inventories.

Authority rationale: Same as Scenario A, entry 1).

Object coding rationale: Same as Scenario A, entry 1).

1b) To record the purchase of inventories held for resale

FRA coding rationale: The purchase of inventories held for resale is recorded as a debit to cost of goods sold. Alternatively, the inventories account (FRA 15210) could be debited to record the purchase of inventory.

Authority rationale: Same as entry 1a).

Object coding rationale: Same as entry 1a).

No entry performed.

3a) To adjust consumable inventory balance after an inventory count; inventory balance determined to be $5,000 (assume opening balance was $2,000)

FRA coding rationale: The ending balance of inventory is recorded as an asset while the opening balance is removed (alternatively entry could be done on a net basis). The operating expense is reduced to reflect inventory items previously expensed but not actually consumed. In the case where purchases of inventory were recorded to the inventory account (FRA 15110) instead of operating expense, the same FRAs would be used but the direction of the transactions would change. The inventory account would be credited and the operating expense debited to reflect the inventories consumed during the period.

Authority rationale: Same as Scenario A, entry 2).

Object coding rationale: Same as Scenario A, entry 2).

3b) To adjust inventory held for resale balance after an inventory count; inventory balance determined to be $5,000 (assuming opening inventory balance $2,000)

FRA rationale: The ending balance of inventory is recorded as an asset while the opening balance is removed (alternatively entry could be done on a net basis). The cost of goods sold is reduced to reflect inventory items previously expensed but not actually sold. In the case where purchases of inventory were recorded to the inventory account (FRA 15210) instead of cost of goods sold, the same FRAs would be used but the direction of the transactions would change. The inventory account would be credited and the cost of goods sold debited to reflect the inventories sold during the period.

Authority rationale: Same as Scenario A, entry 2).

Object coding rationale: Same as Scenario A, entry 2).

Scenario C - Inventory Count is lower than records indicate - Write-off required

A department performs a physical count of its inventory under a perpetual inventory system and determines that there are fewer inventory items present than there should be according to the records. In this case the department must write off the portion of the inventory that is no longer available to it. Note that shortages would not be detected under a periodic inventory system as a current record of the inventory balance is not maintained. Any lost inventory would be charged to cost of goods sold (for inventories for resale) or operating expense (for consumable inventories) as part of the year-end adjustment to record the ending inventory balance.

A physical count determined that the count was lower than the perpetual inventory records balance by $1,000.

Journal Entries

1) To record the write-off

FRA coding rationale: Since there were fewer items found as a result of the inventory count, a loss (expense) will result. When a discrepancy is found between the inventory count and inventory records, the perpetual inventory records must be adjusted for the shortages (loss). If the inventory had been held for resale, the appropriate FRA would be 15210.

Authority rationale: This is strictly and accrual accounting entry, there is no impact on authorities, therefore F codes are used.

Object coding rationale: This is strictly and accrual accounting entry, there is no impact on objects, therefore 3452 is used on both sides of the transaction.

Scenario D - Inventory Count is higher than records indicate - Record Overage

When the department performs a physical count of its inventory, occasionally there is more inventory present than there should have been according to the Perpetual Inventory account balance. Such overages are usually the result of a record keeping error. Note that overages would not be detected under a periodic inventory system as a current record of the inventory balance is not maintained. Any excess inventory would be result in a reduction to cost of goods sold (for inventories for resale) or operating expense (for consumable inventories) as part of the year-end adjustment to record the ending inventory balance.

A physical count determined that the count was higher than the perpetual inventory account balance by $800.

Journal Entries

1) To record the overage

FRA coding rationale: Since there were more items found as a result of the inventory count, a reduction in operating expenses would be recorded. The perpetual inventory records must be increased to reflect the overage. If the inventory had been held for resale, the debit entry would be to FRA "15210 - inventories held for resale" with the credit entry to FRA "51325 - Cost of goods sold".

Authority rationale: This is strictly and accrual accounting entry, there is no impact on authorities, therefore F codes are used.

Object coding rationale: This is strictly and accrual accounting entry, there is no impact on objects, therefore 3452 is used on both sides of the entry.

Scenario E - Inventory Obsolescence - Write-off required

A physical count determined that the items worth $2,000 were obsolete.

Journal Entries

1) To record inventory obsolescence for both periodic and perpetual inventory systems

FRA Coding Rationale: When inventory is determined to be obsolete, it should be written off. To record inventory obsolescence, the inventories account must be reduced by the dollar amount of the obsolescence and a loss recorded. If the inventory was held for resale, the credit entry would be to FRA 15210.

Authority rationale: This is strictly and accrual accounting entry, there is no impact on authorities, therefore F codes are used.

Object coding rationale: This is strictly and accrual accounting entry, there is no impact on objects, therefore 3452 is used on both sides of the entry.

Departmental Financial Statement Presentation and Disclosure Requirements

Inventories are to be classified as a non-financial asset on the Statement of Financial Position. If a department has a significant value of inventories held for resale, it may choose to report these as a financial asset.

3.4 Prepayments (including Prepaids and Deferred Charges)

Introduction

Prepayments

Prepayments are comprised of contract payments before the receipt of the goods and /or services, advance payments under the terms of contribution agreements, prepaid expenses and deferred charges.

Contract Payments

Contract advances made prior to the receipt of goods and services shall be charged to expense in the period in which all the eligibility criteria have been met or the goods and services received as applicable.

Advance Payments under Contribution Agreements

In accordance with the Policy on Transfer Payments, advance payments of the government's share of allowable expenditures under a contribution agreement may be made where it is essential to the achievement of the program objectives and is specifically provided for in the agreement. As the disbursement is for expenses to be incurred in the future, the payment is recorded as a prepayment and is recognized as an expense once the eligible costs have been incurred.

Prepaid Expenses and Deferred Charges

A prepaid expense or a deferred charge is an allocation to current and/or future periods of past costs where benefits will occur in the current and/or future periods. The distinction between the two is the duration of the benefits to be realized; prepaid expenses provide future benefits over a shorter period of time than do deferred charges.

It should be noted that all research and development costs will be expensed in the period in which they are incurred. Costs related to in-house developed software will be accounted for in accordance with the provisions of Treasury Board Accounting Standard 3.1.1 on Software and not as a component of research and development costs.

Amortization

Government departments have many expenses that they incur on a regular basis. Rent, utilities, subscriptions, payments in lieu of taxes and many other expenses must be paid monthly, or on some other cyclical basis. When expenses are prepaid, an asset is recognized for the amount paid. This is charged to expenses gradually as the prepaid expense is consumed.

Where appropriate, amortization of any deferred charge or prepaid expense will be charged as an expense on a systematic and rational basis related to use.

Write-offs

The balance of any prepaid expense or deferred charge shall be written off to expense in the period that no future benefits remain.

References

• TBAS 3.3 Prepayments
• TBAS 3.1.1 Software
• CICA 3040, 3070, 3450
• Section 34(b) of the FAA

Scenario A - Prepaid Expenses

A government department rents space in an office building for $25,000 per month. However, the owner of the building demands that all tenants of the building prepay at least a year's rent. At the time the department pays the owner the desired amount of prepaid rent, there are four months left in the fiscal year.

Journal Entries

1) To record the cost of the prepaid rent.

FRA Coding Rationale: Since the department paid for a years' rent, it must record an asset for the amount that it paid. "14110 - Prepaid Expenses" is used to record the asset. A payable is set up for the amount owing. GST is payable on rent (excludes rent paid to PWGSC) or is included as part of rent charges and hence should be recorded to the GST refundable advance account.

Authority Coding Rationale: It is assumed that the rent expense will be charged to the Operating Vote (B12A), but it could also be charged to the Program Vote (B11A) depending on the Department's vote structure. Since Accounts Payable does not affect appropriations, R300 is used. Since GST is not to be charged to a departmental appropriation, it is set up as an advance under a special authority, G111.

Object Coding Rationale: The objects are affected when the transaction is made, so "0511 Rental of office buildings" is used to record the prepaid rent, because the rent is for an office building. "6299 - Net Increase or Decrease to Other Liability Accounts" is used to establish an account payable for the amount owing. The GST must be reflected by using, "8171 - Payment of GST on purchases"

2) To record the rent consumed by the end of the fiscal year.

FRA Coding Rationale: At year-end, the department must record an expense equivalent to 4 months of rent $100,000 (4 months x $25,000) and reduce the prepaid expense (asset) by an equivalent amount. Please note if the monthly rent is material to the operations of the Department the expense could be recorded on a monthly basis. In this case the Rent expense would be debited for $25,000 every month with a corresponding credit to Prepaid expenses.

Authority Coding Rationale: This is a strictly an accrual transaction, there is no impact on the appropriations. Therefore, F codes are used.

Object Coding Rationale: This is strictly an accrual transaction with no impact on the objects as they are impacted in the previous transaction. Standard object 12 does not impact good, services or transfer payments therefore, either "3459 - Amortization of other asset accounts" or "0511 Rental of office buildings" may be used on both sides of the entry.

Scenario B - Advance Payment under a Contribution Agreement

On April 1, the Department makes an advance payment to an individual for research and development in the amount of $50,000. The contribution is to cover eligible expenses that will be incurred over the next 4 months.

Journal Entries

1) To record the prepayment.

FRA Coding Rationale: Since the payment was made in advance of the period for which the eligible costs are to be incurred, the payment must be recorded as an asset. A payable is set up for the amount owing.

Authority Coding Rationale: In this example, the grant could be charged to either B15A(*) - Grant and Contribution vote or B11A - Program Vote. Since Accounts Payable does not affect appropriations, R300 is used.

Object Coding Rationale: "2041 Transfer Payments to persons for research and development (incl. Scholarships)". "6299 - Net Increase or Decrease to Other Liability Accounts" is used to establish an account payable for the amount owing.

2) Eligible costs are incurred

FRA Coding Rationale: Once the eligibility criteria are met an expense is recorded and the prepayment (the asset) is reduced.

Authority Coding Rationale: This is strictly an accrual transaction. Since the applicable appropriation was previously charged when the payment was made, there is no further effect on appropriations. Consequently, "F" codes are used.

Object Coding Rationale: This is strictly an accrual transaction with no impact on the objects as they are impacted in the previous transaction. Standard object 12 does not impact good, services or transfer payments therefore, either "3459-Amortization of other asset accounts" or "2041 Transfer Payments to persons for research and development (incl. Scholarships)" is used on both sides of the entry.

Alternative Journal Entries

Departments may also account for a prepayment by recording the full charge as an expense and then calculating the prepayment at each month or year-end.

1) To record the transfer payment.

2) To record the prepayment at month-end or year-end

FRA, Authority and Object coding rationale same as above.

Scenario C - Payments made in advance of receiving goods.

The Department enters into a contract for goods where by they are required to make a payment in advance of receiving those goods in accordance with section 34(b) of the FAA. The amount of the prepayment is $21,400 (including GST).

Journal Entries

1) To record the prepayment.

FRA Coding Rationale: Since the department paid for goods in advance, it must record an asset for the amount that it paid. "14110-Prepaid Expenses" is used to record the asset. A payable is set up for the amount owing. GST is recorded to the GST refundable advance account.

Authority Coding Rationale: It is assumed that the prepaid expense will be charged to the Operating Vote (B12A), but it could also be charged to the Program Vote (B11A) depending on the Department's vote structure. Since Accounts Payable does not affect appropriations, R300 is used. Since GST is not to be charged to a departmental appropriation, it is set up as an advance under a special authority, G111.

Object Coding Rationale: The objects are affected when the transaction is made, depending on the nature of the good the appropriate code would be used. "6299-Net Increase or Decrease to Other Liability Accounts" is used to establish an account payable for the amount owing. The GST must be reflected by using "8171-Payment of GST on purchases"

2) Goods are received.

FRA Coding Rationale: Once the goods are received the department must record an expense $20,000 and reduce prepaid expense (asset) by an equivalent amount.

Authority Coding Rationale: This is a strictly an accrual transaction. Since the applicable appropriation was previously charged when the payment was made, there is no further effect on appropriations. Consequently, "F" codes are used.

Object Coding Rationale: This is strictly an accrual transaction with no impact on the objects as they are impacted in the previous transaction. Standard object 12 does not impact good, services or transfer payments therefore, "3459-Amortization of other asset accounts" is used on both sides of the entry.

Departmental Financial Statement Presentation and Disclosure Requirements

Prepaid expenses, deferred charges and prepayments will be reflected on the Statement of Financial Position as non-financial assets under the heading Prepayments. Major items should be shown separately. Please note that this in variance with the current PS 3410 which records transfer payments in advance as a financial asset.