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CFA Level I · CFA Level I Exam · Analysis of Inventories

A manufacturer's normal capacity is 100,000 units per year with fixed production overhead of 400,000. In the current year it produced only 80,000 units, and actual fixed overhead was 400,000. Under IFRS, the fixed overhead per unit capitalised into inventory and the treatment of the remainder is most likely:

Fixed overhead is allocated at 4 per unit, based on normal capacity of 100,000 units. Only 320,000 is capitalised for the 80,000 units produced, and the unallocated 80,000 is expensed in the period. Allocating on actual output would wrongly inflate inventory cost during low production.

  1. A4 per unit, with 80,000 of unallocated overhead expensed in the periodCorrect
  2. B4 per unit, with the unallocated overhead added to inventory cost
  3. C5 per unit, with all overhead of 400,000 capitalised into inventory

Explanation

Under IAS 2, fixed overhead is allocated on normal capacity: 400,000 / 100,000 = 4 per unit. Allocated overhead is 80,000 x 4 = 320,000, so 80,000 is unallocated and expensed. Using actual production gives 5 per unit, which inflates inventory cost in a low-output period.

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