QUESTION 1 (30 MARKS)
Ignore VAT
Sleep Sound Ltd (“Sound Sleep”) is a company that manufactures and sells mattresses.
Their main focus is the production of standardised mattresses which contain 500 coils each.
The most important part of a mattress is the innerspring unit. This unit is made of a series of
coils that are attached to each other with wire. Sleep Sound buys the innerspring units from
a local company specialising in making springs. The upholstery layers are fixed to this
innerspring. The first layer is called the insulator. One insulator is manually fitted directly
onto one innerspring by labourers and prevents the next layer, the cushioning, from
moulding to the coils. One insulator and one spring make up one mattress structure.
In another part of the factory, the decorative cover (quilts) that will serve as the exterior for
the top, bottom and sides is being made. This cover is made on a giant quilting machine,
which controls a multitude of needles that stitch the cover to a layer of backing material. The
stitching chosen serves both useful and ornamental purposes, as it must prevent the
mattress cover from slipping or creeping over the layers of cushioning in addition to creating
a visually pleasing exterior. Once the fabric is quilted, it is cut into panels that will fit the top
and bottom as well as the sides of the mattress. The quilts cannot be sold separately.
The next component is the flanges; connecting panels that are attached to the mattress’s
quilted cover with large, round staples called hogs rings. Specially modified sewing
machines are used to attach the flanges to the top and bottom panels, and the hogs rings
are stapled to the flanges. Each mattress uses eight flanges and four hogs rings.
To complete the mattress, a movable sewing machine is used to seal the mattress and give
it a professional and high quality look.
The thread used in the sewing of the mattresses as well as the sewing of the quilts can vary
depending on the thickness of the layers and the smooth operation of the sewing machine.
Some thread losses are considered a normal part of production.
The following information relating to the year ended 29 February 2016 is provided to you:
Items Number of units Total cost (R)
Innerspring units (Purchased) 13 000 ?
– 28 February 2016 ? ?
Insulators – 1 March 2015 5 000 2 250 000
– Purchased (including inferior 15 000 7 350 000
units)
– 28 February 2016 6 500 ?
Cushioning – 2cm (used) 10 000m 5 000 000
Cushioning – 3cm (used) 7 000m 4 150 000
Cushioning – 5cm (used) 6 000m 4 600 000
Material for covers (used) 23 000m 1 920 000
Backing material (used) 23 000m 345 000
Industrial thread (used) 69 000m 55 200
Finished Quilts – 1 March 2015 250 37 500
(not yet fitted to mattresses)
Finished Quilts – 29 February 2016 100 16 500
(not yet fitted to mattresses)
Flanges (used) 76 000 460 000
Hogs rings (used) 38 000 92 000
Finished mattresses – 1 March 2015 45 180 000
(including demos)
Finished mattresses – 29 February 2016 50 ??
(including demos)
Costs for the year Rand
Direct labour 550 000
Electricity for the factory (20% fixed) 25 000
Mattress delivery cost 10 000
Factory rates and taxes 16 000
Factory cleaning staff 65 000
Additional information:
• There were no innerspring units on hand at the beginning of the year. Due to this
fact, a large order was placed with the manufacturer of the innerspring units. It was
agreed that the invoice price per unit would be R2 500, but due to the large number
of units ordered a discount of 5% will be granted immediately. It was also agreed that
payment will only be made on 3 March 2016 even though delivery of the units took
place on 3 March 2015. The time value of money is material. The market interest rate
is 10.5%.
• 4 000 insulators units were of inferior quality and sent back to the supplier.
• Cushioning, cover material, backing material, industrial thread, flanges and hogs
rings are ordered as needed and no inventory is kept on hand.
• Sleep Sound makes use of the weighted average cost formula for valuation of
inventory.
• Quilts that have not yet been attached to mattresses are seen as work in progress.
There were no unfinished mattresses at the beginning or the end of the year, except
for the quilts.
• The normal production capacity of the factory is 8 600 mattresses.
• Sound Sleep uses a percentage of mattresses manufactured as demo models for
customers to see, touch and even lie on. These mattresses are usually included in
the closing balance of finished mattresses, if there are any on hand at the end of the
year. Given the economic climate, there are always customers who opt to buy demo
models since they are a bit cheaper. The average selling price of mattresses in the
2015 financial year was R5 500 and R6 000 in the 2016 financial year. Selling prices
for 2017 are projected at R6 600. The demo mattresses are usually sold at a
discount of 40% on the selling price. On 28 February 2015 there were 10 demo
mattresses on hand with a cost of R4 000 each.
• For the financial year ended 28 February 2015, there were no net realisable value
write downs, except for the information provided above.
• On 29 February 2016 there were 12 demo mattresses on hand with a cost of R4 400
each.
• Sound Sleep is concerned about prices increasing significantly in the 2017 financial
year. The price increase in raw materials seems to have the biggest impact.
Discussions with the cost accountant of Sound Sleep revealed that the cost of
completing the mattresses for which only the quilts are finished, could likely increase
to R6 440 per mattress in 2017. However, the raw materials on hand at the end of
the 2016 financial year have a bigger net realisable value than cost.
REQUIRED MARKS
Sub total Total
(a) By making use of the following T-accounts, calculate the 28
value of closing inventory as per the statement of financial
position as at 29 February 2016.
• Raw material
• Work in progress
• Fixed manufacturing overheads
• Finished goods
(b) With reference to the definition of an asset in the 2 30
Conceptual framework, discuss briefly why IAS 2 -
Inventory states that inventory should be carried at the
lower of the cost or net realisable value.