ICAP PRC-1 Depreciation and inventories: practice questions with answers

Question 1

Prices of the cement that Butt Building Supplies of Multan buys have risen steadily. Mr Butt proposes valuing inventory using last-in, first-out (LIFO) because it would report a lower profit. Which statement is correct under IAS 2?

1. A LIFO is permitted provided it is applied consistently each year and the method is disclosed.
2. B LIFO is not permitted; he must use FIFO or weighted average for interchangeable items like cement.
3. C LIFO is permitted for a sole trader, as IAS 2 restricts the cost formulas for companies only.
4. D LIFO is permitted under a periodic system but not under a perpetual system of recording.

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Answer: B. IAS 2 allows specific identification for items that are not ordinarily interchangeable (para 23) and, for other items, either first-in, first-out (FIFO) or weighted average cost (para 25). LIFO was removed in the 2003 revision of IAS 2 because it does not faithfully represent inventory flows and can leave inventory in the statement of financial position at very out-of-date costs. Cement is interchangeable, so Mr Butt must use FIFO or weighted average, applied consistently.

Question 2

Saleem Shoes prepares accounts to 30 June. Its closing inventory at 30 June 2026 was overstated by Rs 360,000 because a count sheet was added twice. The error was not found, so the same figure became opening inventory for the year to 30 June 2027. Ignoring all other items, what is the effect of the error on net profit?

1. A 2026 profit understated by Rs 360,000; 2027 profit overstated by Rs 360,000
2. B 2026 profit overstated by Rs 360,000; 2027 profit is not affected
3. C 2026 profit overstated by Rs 360,000; 2027 profit understated by Rs 360,000
4. D 2026 profit overstated by Rs 360,000; 2027 profit overstated by Rs 360,000

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Answer: C. Cost of sales = opening inventory + purchases − closing inventory.

- 2026: closing inventory too high by Rs 360,000 → cost of sales too low → gross and net profit overstated by Rs 360,000.
- 2027: opening inventory too high by Rs 360,000 → cost of sales too high → profit understated by Rs 360,000.

Over the two years the errors cancel out, so capital at 30 June 2027 is correct, but capital and inventory at 30 June 2026 are both overstated by Rs 360,000.

Question 3

Gulbahar Antiques of Peshawar deals in antique brass and copper pieces. Each piece is unique, is bought separately and carries its own purchase invoice and tag. Which cost formula should Gulbahar use to measure its closing inventory under IAS 2?

1. A First-in, first-out (FIFO) for all the pieces held
2. B Specific identification of the cost of each piece
3. C Weighted average cost of all the pieces bought in the year
4. D The current replacement cost of each piece at the year end

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Answer: B. IAS 2 para 23 requires the cost of items that are not ordinarily interchangeable to be assigned by specific identification of their individual costs. Para 24 explains that this is inappropriate for large numbers of interchangeable items, which use FIFO or weighted average (para 25). Unique antiques, each with its own invoice, are a clear case for specific identification, and each piece is still compared with its NRV.

Question 4

Khan Plastics of Lahore installed a new moulding machine. Directly attributable costs, including Rs 90,000 spent testing whether the machine functioned properly, total Rs 3,750,000. Sample buckets produced during testing were sold for Rs 60,000. Applying IAS 16 as amended in 2022, at what amount is the machine initially recognised, and how are the sale proceeds treated?

1. A Rs 3,690,000; proceeds of Rs 60,000 deducted from the machine's cost
2. B Rs 3,660,000; testing costs expensed, proceeds in profit or loss
3. C Rs 3,750,000; proceeds of Rs 60,000 recognised in profit or loss
4. D Rs 3,750,000; proceeds of Rs 60,000 held as deferred income until use

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Answer: C. IAS 16 para 17(e) includes the costs of testing whether the asset is functioning properly in its cost, so the full Rs 3,750,000 is capitalised. Since the 2022 amendment (Property, Plant and Equipment: Proceeds before Intended Use), para 20A requires the proceeds from selling items produced while bringing the asset to its intended condition, and the cost of producing those items, to be recognised in profit or loss. So the machine is recognised at Rs 3,750,000 and the Rs 60,000 of sales is recognised in profit or loss.

Question 5

Farooq Packaging bought equipment on 1 January 2022 for Rs 2,400,000. It was depreciated straight-line over 8 years with nil residual value. When reviewing its estimates for the year ended 31 December 2025, Farooq decided that from 1 January 2025 the equipment had only 3 years of useful life remaining. Residual value is still nil. What is the depreciation charge for the year ended 31 December 2025?

1. A Rs 300,000
2. B Rs 400,000
3. C Rs 500,000
4. D Rs 700,000

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Answer: C. A change in useful life is a change in accounting estimate, applied prospectively (IAS 16 para 51; IAS 8).

- Annual charge 2022–2024 = Rs 2,400,000 ÷ 8 = Rs 300,000
- Carrying amount at 1 January 2025 = Rs 2,400,000 − 3 × Rs 300,000 = Rs 1,500,000
- Charge for 2025 = Rs 1,500,000 ÷ 3 remaining years = Rs 500,000

Question 6

Sheikh Brothers, a partnership, is considering moving its shop buildings from the cost model to the revaluation model in IAS 16. Which statement about the revaluation model is correct?

1. A An increase on revaluation is normally credited to a revaluation surplus in equity, not to profit for the year.
2. B Buildings carried under the revaluation model are no longer depreciated once they have been revalued.
3. C The firm may revalue only those buildings that have risen in value and keep the others at cost.
4. D Revaluations must be carried out every year, however little the fair values have changed.

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Answer: A. Under the revaluation model (IAS 16 para 31) an item is carried at fair value at the revaluation date less later depreciation. Revaluations are made regularly enough that the carrying amount stays close to fair value; annual revaluation is needed only where values change significantly. The whole class must be revalued (para 36). An increase is recognised in other comprehensive income and accumulated in equity as a revaluation surplus, except to the extent it reverses a decrease previously recognised in profit or loss (para 39). Revalued assets continue to be depreciated. PRC-1 tests the model only at this level; revaluation calculations come later in the CA syllabus.