Handout: Inventories_Intro FAR0_1st Sem_AY2019-20

INVENTORIES refer to assets that are held for sale in the ordinary course of business, in the process of production for such
sale or in the form of materials or supplies to be consumed in the production process or in the rendering of services (PAS 2).

Classes of Inventories
Type of Operation Class/ Account Title Brief Description
1. Service Supplies Inventory Unused portion of supplies available for use in the rendering
of services
2. Merchandising Merchandise inventories Goods held for sale by a trading concern
a. Finished goods Completed products which are ready for sale
b. Goods in process Partially completed products requiring further process before
they can be sold
3. Manufacturing c. Raw (Direct) materials Goods that are to be used in the production process and are
directly traceable to the finished product
d. Factory or manufacturing supplies Goods that are to be used in the production process but are
not directly traceable to the finished product

Goods Includible in Inventories

As a rule, all goods to which the entity has title (legal test) shall be included in the inventory, regardless of location.
Accordingly, an entity may be considered the legal owner of the goods even if the same are not yet physically held by the
former.

The following inventory items must be included in inventory:

1. Goods owned and on hand 4. Goods out on consignment
2. Goods in transit and sold FOB destination 5. Goods in the hands of salesmen or agents
3. Goods in transit and purchased FOB shipping point 6. Goods held by customers on approval or trial

Accounting for Freight Charge (buyer’s point of view)

Owner of the goods in transit/
Party that initially pays
Freight Terms Party liable to shoulder the cost Pro-forma entry
the cost of freight
of freight
FOB Shipping Point, Purchases xx
Freight Collect Freight in xx
Buyer Buyer
Accounts payable xx
Cash xx
FOB Destination, Purchases xx
Seller Seller
Freight Prepaid Accounts payable xx
FOB Shipping Point, Purchases xx
Freight Prepaid Buyer Seller Freight in xx
Accounts payable xx
FOB Destination, Purchases xx
Freight Collect Cash xx
Seller Buyer
Accounts payable xx

Other Shipping Terms

Maritime
Seller’s Responsibility Buyer’s Responsibility Point of Transfer of Ownership
Shipping Terms
FAS or free Seller bears all expenses and risk Buyer bears the cost of loading When the carrier takes possession
alongside related to delivering the goods to and shipment of the goods
the DOCK next to or alongside
the vessel
CIF or cost, Seller bears the cost of loading Buyer agrees to pay in lump-sum Upon delivery of the goods to the
insurance and the cost of the goods, insurance carrier
freight cost and freight charge
Ex-ship Seller bears all expenses and risk Buyer pays for the cost of the When goods are UNLOADED
of loss until the goods are goods from the ship
UNLOADED from the ship

CONSIGNMENT – an agreement whereby the owner of the goods, called the CONSIGNOR, transfers physical possession of
goods to an agent, called the CONSIGNEE, who sells them on behalf of the former.

Salient Features of Consignment

1. Consigned goods shall be included in the CONSIGNOR’s inventory and excluded from the CONSIGNEE’s inventory.
2. Freight and other handling charges on goods out on consignment are part of the cost of goods consigned.
3. Freight and other distribution costs incurred by the CONSIGNEE in selling the goods of the CONSIGNOR shall be treated
as selling expenses of the former. However, the parties may agree that the costs of distribution shall be reimbursed by the
CONSIGNOR to the CONSIGNEE, in which case, the costs shall be treated as selling expenses of the CONSIGNOR.
4. The CONSIGNOR shall recognize a sale only upon actual sale by the CONSIGNEE to customers which also triggers the
recognition of commission income by the latter.
Handout: Inventories_Intro FAR0_1st Sem_AY2019-20

ACCOUNTING FOR INVENTORIES

Transactions Periodic Method Perpetual Method
1. Purchase of merchandise on Purchases xx Merchandise inventory xx
account Accounts payable xx Accounts payable xx
2. Payment of freight on Freight in xx Merchandise inventory xx
purchase Cash xx Cash xx
3. Return of merchandise to Accounts payable xx Accounts payable xx
suppliers Purchase returns xx Merchandise inventory xx
4. Payment of accounts payable Accounts payable xx Accounts payable xx
within the discount period Purchase discounts xx Cost of sales xx
Cash xx Cash xx
5. Sale of goods to customers on Accounts receivable xx Accounts receivable xx
account Sales xx Sales xx

Cost of sales xx
Merchandise inventory xx
6. Return of merchandise from Sales return xx Sales return xx
account customers Accounts receivable xx Accounts receivable xx

Merchandise inventory xx
Cost of sales xx
7. Collection of customer’s Cash xx Cash xx
account within the discount Sales discount xx Sales discount xx
period Accounts receivable xx Accounts receivable Xx
8. Adjustment at year – end Merchandise inventory, end xx Inventory shortage xx
Income summary xx Merchandise inventory xx

(To set-up the cost of unsold (To recognize the difference

goods at year-end) between the inventory per count and
per record, where RECORD >
COUNT)

Merchandise inventory xx
Inventory overage xx

(To recognize the difference

between the inventory per count and
per record, where RECORD <
COUNT)

Methods of Recording Credit Purchases

1. Gross Method – The accounts payable and purchases accounts are recorded at the gross amount of the invoice (before
deducting any offered cash discount)
2. Net Method – The accounts payable and purchases account are recorded at the net amount of the invoice (after deducting
any offered cash discount). Any discount foregone shall be recorded as “Purchase Discount Lost” and classified among
other expense items.

Types of Discounts
1. Trade discounts – are offered to encourage transactions in high volume and/or to reward customer patronage
2. Cash discounts – are offered to encourage prompt collection/payment of accounts

COST OF INVENTORIES
1. Cost of purchase – comprises the purchase price, import duties and irrecoverable taxes, freight, handling and other costs
directly attributable to the acquisition of finished goods, materials and services.
a. Trade discounts, rebates and other similar items are deducted in determining the cost of purchase
b. Foreign exchange differences on inventory transactions denominated in foreign currency are excluded from
the cost of purchase
c. Financing costs (interest) related to the acquisition of inventories on a deferred settlement basis is excluded
from the cost of purchase and is recognized as interest expense over the period of financing
2. Cost of conversion – includes costs that are necessary in the conversion of materials into finished products such as direct
labor and systematic allocation of fixed and variable production overhead.
a. Direct labor pertains to the cost of labor of workers and employees who have a direct involvement in the
production of goods and/or services (e.g salary of workers in the factory)
b. Fixed production overhead refers to the indirect cost of production that remains relatively constant regardless of
the volume of production (e.g. rent of factory building). It is allocated based on the normal capacity of the
production facilities.
c. Variable production overhead refers to the indirect cost of production that varies directly with the volume of
production (e.g. indirect labor and indirect materials).It is allocated based on the actual use of the production
facilities.
3. Other costs incurred in bringing the inventories to their present location and condition.

Cost of Inventories of a Service Provider - consists of the labor and other costs of personnel directly engaged in the provision
of the service, including supervisory personnel and attributable overhead.