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Chapter 17: Changes in inventories
Introduction
17.1 Changes in inventories is defined to include changes in:
- goods for sale, whether of own production or purchased for resale;
- raw materials and stores.
Work put in place on structures, including dwellings, and on other forms of construction (e.g. roads, dams, ports) is excluded from inventories and included in gross fixed capital formation. However, work on incomplete heavy machinery and equipment (e.g. shipbuilding) is included in changes in inventories. Land and financial assets are not regarded as inventories.
Valuation of changes in inventories
17.2 The value of inventories recorded in business accounts at the end of each accounting period is known as the book value. Period to period changes in the book value of inventories can be calculated by deducting the book value of inventories at the end of the previous accounting period from the book value at the end of the current accounting period.
17.3 For national accounting purposes, the physical change in inventories during a period should be valued at the prices prevailing at the time that inventory changes actually occur. In practice, many businesses adopt historical cost measurement whereby inventories are valued at the lower of cost or market prices. Beginning-of-period inventories are valued at costs or prices prevailing at the beginning of the accounting period, and end-of-period inventories are valued at costs or prices prevailing at the end of the period. As a result, in periods of rising prices the book value of inventories will frequently include an element of capital gain, even if there has been no change in the physical quantity of inventories held. Conversely, if prices are falling, the book value of inventories will include an element of capital loss even with no change in the quantity of inventories on hand. Therefore, in times of rising prices, the change in the book value measured on a historical cost basis will include both the value of the physical increase or decrease in inventories and an increase in value due to the effect of rising prices on the value of inventories held. The latter effect is an element of holding gain (or holding loss if prices are falling), which should be excluded from changes in inventories and included in revaluations.
17.4 In the ASNA, the inventory valuation adjustment (IVA) is made to remove the effects of such gains or losses from book values of changes in inventories. As initial estimates of gross operating surplus incorporate the effect of the value of inventories derived on a historical cost basis, the IVA is also deducted from those estimates.
17.5 There are several methods used to measure inventories in business accounts. These include:
- First in first out (FIFO) - items held in store for the longest time are assumed to be the first to be drawn from store, so that inventories will consist of the most recently acquired items.
- Last in first out (LIFO) - this system uses the opposite assumption to FIFO. The most recently acquired items are assumed to be the first drawn from store, so that inventories consist of the items first purchased.
- Average cost - running totals are held of the value and volume of inventories. The average price of goods held in inventories is recalculated periodically, e.g. when new goods are received. Any subsequent withdrawal from inventories is then made at that price until the average is recalculated.
- Standard cost - under a standard cost system, items held in stock are each given a unit value, which may be based on recent costs, current costs, or expected future costs. Once this standard has been set, the value of a company's inventories is determined by multiplying the quantity of each commodity in stock by its standard cost. The standard is generally maintained for a fixed period (usually a company's financial year) or until changing prices make the standard inappropriate for current conditions.
17.6 The current methodology underlying the derivation of the IVA in the ASNA is based on the assumption that businesses generally value their inventories at historical cost and employ the FIFO method assumption.
17.7 In general, the IVA is calculated in three basic steps:
(1) an estimate is made of the value of inventories at constant prices at the end of each quarter by revaluing end of quarter book values to base year prices using price indexes; the value of changes in inventories at constant prices is then derived as the difference between successive end of quarter levels;
(2) the estimates of the values of changes in inventories at constant prices are multiplied by price indexes that reflect current quarter average prices; this calculation gives an estimate of the physical change in inventories at average current quarter prices; and
(3) the IVA is represented by the difference between the value of changes in the book value of inventories obtained from business accounting records and the value of changes in inventories estimated in (2).
An example of the calculation of the IVA is provided in Appendix A.
17.8 Beside the assumption that book values are based on historical cost and FIFO conventions, the method used to estimate the IVA rests on four other assumptions:
- sales prices for finished goods held in inventories can be used to adjust inventory levels valued at cost, i.e. the selling price of finished goods is established as a fixed mark-up on the costs incurred in the current quarter;
- each commodity (or group of commodities) held in inventories has a fixed turnover period, i.e. the ratios 'inventory level of materials to value of purchases' and 'inventory level of finished goods to value of sales' remain constant for each commodity;
- the commodity composition of inventories held by any particular industry remains fixed; and
- the rate of physical increase (or decrease) in inventories is constant throughout the quarter.
Sources and methods - current price estimates
17.9 The quarterly values of changes in inventories published in the national accounts are derived by interpolating annual benchmarks with quarterly estimates. From 1994-95 to the latest year but one, annual benchmarks are derived in supply and use tables. The sources and methods used to obtain these annual benchmarks are described in Chapter 12. For all other years, annual estimates of the changes in inventories are essentially an aggregation of the quarterly estimates described below. A quarterly value of the changes in inventories is obtained by deducting the IVA from the corresponding quarterly value of the changes in the book value of inventories. The quarterly values of changes in inventories are calculated separately for three sectors: private non-farm; farm; and public authorities. The sources and methods relating to each of these sectoral categories and the IVA are discussed under the headings that follow.
Private non-farm inventories
17.10 The quarterly Survey of Inventories, Sales and Services (SISS) provides the basic data for estimating changes in private non-farm inventories. This survey actually collects estimates of the book value level of inventories from which changes are derived. The levels are also used in deriving the estimates of the inventories to sales ratio that are published in the quarterly national accounts.
17.11 The SISS provides the quarterly movements in inventories for mining; manufacturing; wholesale trade; retail trade; electricity and gas; and accommodation, cafes and restaurants. The survey does not include some non-farm industries with only minor inventory holdings. For these industries, data from the periodic economic censuses and Taxation Statistics are used to estimate annual changes, which are extrapolated and interpolated using the estimates for in-scope industries.
Farm inventories
17.12 Changes in farm inventories includes changes in (i) inventories held on farms (including wool, wheat, barley, oats, maize, sorghum, hay, fertiliser, apples and pears, and livestock); (ii) wool held in store awaiting sale; and (iii) produce (e.g. vegetables) held in cold store where ownership remains with the primary producer. Farm inventories do not include inventories held by marketing authorities (e.g. wheat held by the Australian Wheat Board), which are included under either 'Public authorities' or 'Private non-farm'.
17.13 Annual and quarterly changes in the book value of inventories of wool are estimated as the difference between inventory levels derived from information provided monthly by the National Council of Wool Selling Brokers. Annual and quarterly changes in the book value of inventories of apples and pears are estimated as the difference between inventory levels derived from information provided monthly by the Tasmanian Department of Agriculture.
17.14 Annual changes in the book value of inventories of grain crops held on farms are derived as the difference between the value of production and disposals, i.e. exports and domestic usage of the various commodities. Annual values of gross value of farm production of crops are obtained from Agricultural Commodities, Australia (Cat. no. 7121.0). Disposals are estimated from export statistics, marketing authority statements, estimates of seed purchased or retained on farms for use as seed or fodder, and materials used in manufacturing statistics from the annual ABS Manufacturing Survey. Although exports data are available quarterly from ABS trade statistics, various indicators must be used to derive quarterly data relating to production of grain crops. For example, annual data on gross value of production and on seed and fodder use are allocated to quarters according to fixed proportions based on harvest and planting seasons and assumed seasonal requirements for fodder.
17.15 In general, animals reared for slaughter are regarded as work-in-progress. The estimates are derived from numbers of sheep and beef cattle collected annually by the ABS and prices from the Australian Bureau of Agricultural and Resource Economics (ABARE). Animals reared for breeding purposes or recurrent production (such as dairy cattle and sheep reared for wool production) are regarded as gross fixed capital formation.
Public authorities inventories
17.16 Changes in public authorities inventories includes estimates for both public marketing authorities and other public authorities.
17.17 Quarterly estimates of changes in the book value of marketing authorities inventories are derived from information supplied by the authorities concerned.
17.18 Other public authorities comprise public corporations and general government. Recorded inventories include stockpiles of raw materials and the work in progress and finished goods of commercial activities such as the work of the Sydney Organising Committee for the Olympic Games (SOCOG), demonetised gold transactions (gold sales and gold loans) by the Reserve Bank of Australia and the construction of military equipment for export.
17.19 Annual estimates of changes in the book value of other public authorities inventories are derived from information used to compile annual ABS Government Finance statistics. They are derived from a detailed analysis of annual reports and Auditors'-General Reports, together with Commonwealth and State government budget papers and other financial statements.
17.20 Quarterly data are obtained from a quarterly collection covering all significant public corporations and from the Department of Finance and Administration's quarterly Ledger.
Inventory valuation adjustment
17.21 The IVA is compiled each quarter from survey information, and annual estimates are derived by aggregating the quarterly estimates. The sources and methods relating to each of the major sectoral categories are discussed below.
17.22 The book values of private non-farm inventories are disaggregated into 22 industry groups (mining; nine within manufacturing; six within wholesale trade; retail trade; cafes and restaurants; electricity and gas; construction; transport and storage; and other private non-farm). The inventories held by manufacturing industries are further split into materials, and work in progress plus finished goods, while mining inventories are classified as either materials or finished goods, making a total of 32 'estimation cells'. An IVA is derived for each estimation cell in the manner and using the assumptions described in paragraphs 17.5 to 17.8.
17.23 In contrast to private non-farm inventories, an IVA is generally not necessary for farm inventories because the values of changes in inventories at average current quarter prices can be estimated directly from detailed quantity and price data. However, a special adjustment is required for the estimates of changes in inventories of wheat and wool. The value of changes in inventories for these two commodities is calculated by subtracting from their respective sales the value of receivals by the Australian Wheat Board and wool selling brokers respectively. Receivals are valued at the price realised (or expected to be realised on the eventual sale of the commodities received). However, these prices normally differ from the current quarter sale price and, therefore, a production valuation adjustment (PVA) is calculated for these commodities, based on the quantities of inventories and average current quarter prices. As the gross value of farm production (estimated in deriving farm income) is calculated using the value of receivals described above, this PVA is deducted from it in order to estimate farm income on a national accounts basis.
17.24 An IVA is calculated for the marketing authorities component of public authority inventories, using book values and price indexes in the same way that IVAs are calculated for private non-farm. Due to the relatively low level of inventories and the lack of information on the commodity dissection involved, no IVA is calculated for other public authority inventories.
Sources and methods - chain volume estimates
Private non-farm inventories
17.25 The general techniques used for calculating chain volume measures are described in Chapter 10. These are also used in calculating chain volume estimates of changes in private non-farm inventories. However, it should be emphasised that the most successful means of deriving chain volume changes in inventories has been found to be differencing chained estimates of the levels. The steps involved are as follows:
(1) Revalue quarterly book value levels to levels valued in the prices of the previous year.
(2) Sum to the required level of aggregation.
(3) Calculate quarter to quarter indexes which show the volume growth in levels between the present and previous quarter.
(4) Compound these indexes to form a chained index.
(5) Reference the chained index to the June quarter book value level of the reference year to give a chain volume series of levels.
(6) Difference the resultant values to derive the chain volume estimates of changes in inventories.
17.26 The price indexes that are used to revalue book value levels of inventories are formed by weighting together component price indexes from Consumer Price Index (Cat. no. 6401.0), Price Index of Articles Produced by Manufacturing Industry (Cat. no. 6412.0), Import Price Index (Cat. no. 6414.0) and Price Indexes of Materials Used in Manufacturing Industry (Cat. no. 6411.0), and wage rate indexes from Wage Cost Index (Cat. no. 6345.0). The regimen and weights for these price and wage rate indexes are derived using data from the various censuses and surveys conducted by the ABS.
17.27 Chain volume estimates of changes in private non-farm inventories are published in the following detail in the national accounts:
- other non-farm industries.
It is noteworthy that, unlike other national accounts aggregates, quarterly chaining and annual chaining of changes in inventories produce identical annual chain volume estimates of changes in inventories. This is because chain volume estimates of changes in inventories are derived by differencing the chain volume estimates of the levels of inventories which relate to the end of quarterly and annual periods and coincide for the June quarter.
Farm and public authorities inventories
17.28 The techniques used to calculate chain volume estimates of changes in farm inventories and changes in public authorities inventories are only slightly different to those shown above for private non-farm. The difference is that for many of the detailed components of the former it is difficult to obtain true book value levels. Use is therefore made of the constant price estimates of changes in inventories that preceded the introduction of chain volume estimates and which are still calculated. The sources and methods used to derive constant price estimates of changes in inventories for farm and public authorities were described in the previous edition of this manual. The steps followed are:
(1) Derive constant price levels of inventories for each component by accumulating the constant price changes over time and add these to a base level (i.e. the level at a particular time for which there is an estimate). The base level is often only an approximation of the true level and is sometimes only derived as a figure which will ensure that subsequent levels remain positive. These constant price levels are then converted to levels valued in the prices of the previous year.
(2) - (6) As outlined above for changes in private non-farm inventories.
17.29 For farm commodities the price indexes used to convert constant price levels into levels valued in the prices of the previous year are calculated using production unit values. For the other public authority inventories component a price index is constructed in a similar way to that described above for private non-farm inventories.
Appendix A
Example of the calculation of the inventory valuation adjustment
 | (1) Change in book value | |
|
| |
| Book value of inventories at end of quarter (t) | = | 51,000 | |
| Book value of inventories at end of quarter (t+1) | = | 55,056 | |
| Change in book value | = | 4,056 | |
| Base of price index | = | 100 | |
| Price index at end of quarter (t) | = | 120 | |
| Price index at end of quarter (t+1) | = | 124 | |
| Average price index for quarter (t+1) | = | 122 | |
|
| |
| (2) Revaluation to constant prices | |
|
| |
| Constant price level | = | book value ÷ price index x 100 | |
| End quarter (t) | = | 51,000 ÷ 120 x 100 | = | 42,500 | |
| End quarter (t+1) | = | 55,056 ÷ 124 x 100 | = | 44,400 | |
| Constant price change in inventories | = | 44,400 - 42,500 | = | 1,900 | |
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