The costs of purchase comprise the purchase price, import duties and other taxes (other than those subsequently recoverable), transport, handling and other costs directly attributable to the acquisition of finished goods, materials and services. Trade discounts, rebates and other similar items are deducted in determining the costs of purchase.
Terms of sale: In identifying the costs of purchase, consideration must be given to the terms of sale relating to inventory items because such terms determine the treatment of transport costs associated with purchase. If goods are sold FOB (free on board) shipping point, freight costs incurred from the point of shipment are paid by the buyer, and are included in the costs of purchase. If goods are sold FOB destination, the seller pays all freight costs.
Transaction taxes: Many countries levy taxes on transactions involving the exchange of goods and services, and require entities engaging in such activities to collect and remit the tax to the government. If such a ‘goods and services tax -GST’ or ‘value added tax-VAT’ exists, care must be taken to exclude these amounts from the costs of purchase if they are recoverable by the entity from the taxing authorities.
Trade and cash discounts: Trade discounts are reductions in selling prices granted to customers. Such discounts may be granted as an incentive to buy, as a means to quit ageing inventory or as a reward for placing large orders for goods. Because the discount reduces the purchase cost, it is deducted when determining the cost of inventory. Cash or settlement discounts are offered as incentives for early payment of amounts owing on credit sales. Credit terms appear on invoices or contracts and often take the form ‘2/7, n/30’, which means that the buyer will receive a 2% discount if the invoice is paid within seven days of the invoice date or will get 30 days to pay without discount. Some entities may also impose an interest penalty for late payment.
Divergent accounting practices have arisen over time in respect of settlement discounts, with some countries treating the discount as a reduction in the cost of inventories and others treating the discount as revenue. This issue was settled when the IFRI stated that ‘settlement discounts should be deducted from the cost of inventories’ (IASB 2004). Thus, discounts received are to be treated as a deduction from the cost of inventories rather than as discount revenue. On the other hand, rebates that specifically and genuinely refund selling expenses are not to be deducted from the cost of inventories.
Deferred payment terms: Where an item of inventory is acquired for cash or short-term credit, determination of the purchase price is relatively straightforward. One variation that may arise is that some or all of the cash payment is deferred. In this case, as noted in paragraph 18 of IAS 2, the purchase cost contains a financing element — the difference between the amount paid and a purchase on normal credit terms — which must be recognized as interest expense over the period of deferral.
