UL CPA REVIEW CENTER

FINANCIAL ACCOUNTING & REPORTING - INVENTORIES

Inventories are assets:

(a) held for sale in the ordinary course of business;
(b) in the process of production for such sale; or
(c) in the form of materials or supplies to be consumed in the production process or in the rendering of
services.

Net realisable value is the estimated selling price in the ordinary course of business less the estimated costs
of completion and the estimated costs necessary to make the sale.

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date. (See PFRS 13 Fair Value Measurement.)

Inventory recording system

 A perpetual inventory system provides a means for generating up-to-date records related to
inventory quantities. Under this inventory system, data are available at any time relative to the
quantity of material or type of merchandise on hand. In a perpetual inventory system, purchases and
sales of goods are recorded directly in the Inventory account as they occur. A Cost of Goods Sold
account is used to accumulate the issuances from inventory. The balance in the Inventory account
at the end of the year should represent the ending inventory amount.
 When the inventory is accounted for on a periodic inventory system, the acquisition of inventory
is debited to a Purchases account. Cost of goods sold must be calculated when a periodic inventory
system is in use. The computation of cost of goods sold is made by adding beginning inventory to
net purchases and then subtracting ending inventory. Ending inventory is determined by a physical
count at the end of the year under a periodic inventory system. Even in a perpetual inventory system,
a physical inventory count at year-end is normally taken due to the potential for loss, error, or
shrinkage of inventory during the year.

Basic Issues in Inventory Valuation. Determination of the:

 goods to be included in inventory,
 the costs to be included in inventory, and
 the cost flow assumption to be adopted.

Goods to be Included in Inventory:

 Technically, purchases should be recorded when legal title passes to the buyer. The following items
require careful judgment:

 Goods in Transit: If the goods are shipped f.o.b. shipping point, title passes to the buyer when
the seller delivers the goods to the common carrier. If the goods are shipped f.o.b. destination,
title passes when the buyer receives the goods.
 Consigned Goods: Goods out on consignment remain the property of the consignor.
 Sales with repurchase agreements. In essence, the “seller” finances the cost of the inventory
by transferring legal title to a third party and receiving “payment.” The “seller” then agrees to
“buy” the inventory back at a specified price over a specified future period. These transactions
are often referred to as “parking transactions” because the seller simply parks the inventory
on another firm’s statement of financial position and uses it as a financing device. In these
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FINANCIAL ACCOUNTING & REPORTING - INVENTORIES

arrangements, the inventory and related liability from the repurchase agreement should remain
on the “seller’s” books. No sale should be recorded.
 Sales with rights of return. When the amount of returns can be reasonably estimated, the goods
should be considered sold. If returns are unpredictable, the goods should not be removed from
the seller’s inventory accounts.

Costs to be Included in Inventory and Costs Flow Assumptions:

PAS 2 FOCUS NOTES
Measurement of inventories
 Inventories shall be measured at the lower of cost and net realisable value.
 The cost of inventories shall comprise all costs of purchase, costs of conversion and other costs
incurred in bringing the inventories to their present location and condition.
 The costs of purchase of inventories comprise the purchase price, import duties and other taxes
(other than those subsequently recoverable by the entity from the taxing authorities), and transport,
handling and other costs directly attributable to the acquisition of finished goods, materials and
services. Trade discounts, rebates and other similar items are deducted in determining the costs of
purchase.
 The costs of conversion of inventories include costs directly related to the units of production, such
as direct labour. They also include a systematic allocation of fixed and variable production overheads
that are incurred in converting materials into finished goods.
 Joint and by-products. When the costs of conversion of each product are not separately identifiable,
they are allocated between the products on a rational and consistent basis. The allocation may be
based, for example, on the relative sales value of each product either at the stage in the production
process when the products become separately identifiable, or at the completion of production. Most
by-products, by their nature, are immaterial. When this is the case, they are often measured at net
realisable value and this value is deducted from the cost of the main product.
 Other costs are included in the cost of inventories only to the extent that they are incurred in bringing
the inventories to their present location and condition. For example, it may be appropriate to include
non-production overheads or the costs of designing products for specific customers in the cost of
inventories.
 PAS 23 Borrowing Costs identifies limited circumstances where borrowing costs are included in the
cost of inventories.
 An entity may purchase inventories on deferred settlement terms. When the arrangement effectively
contains a financing element, that element, for example a difference between the purchase price for
normal credit terms and the amount paid, is recognised as interest expense over the period of the
financing.
 In accordance with PAS 41 Agriculture inventories comprising agricultural produce that an entity has
harvested from its biological assets are measured on initial recognition at their fair value less costs
to sell at the point of harvest. This is the cost of the inventories at that date for application of PAS 2.

Cost formulas
 The cost of inventories of items that are not ordinarily interchangeable and goods or services
produced and segregated for specific projects shall be assigned by using specific identification of
their individual costs.
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FINANCIAL ACCOUNTING & REPORTING - INVENTORIES

 The cost of inventories, other than those to be assigned by specific identification, shall be assigned
by using the first-in, first-out (FIFO) or weighted average cost formula. An entity shall use the same
cost formula for all inventories having a similar nature and use to the entity. For inventories with a
different nature or use, different cost formulas may be justified.

Techniques for the measurement of cost

 Techniques for the measurement of the cost of inventories, such as the standard cost method or the
retail method, may be used for convenience if the results approximate cost. Standard costs take into
account normal levels of materials and supplies, labour, efficiency and capacity utilisation. They are
regularly reviewed and, if necessary, revised in the light of current conditions.
 The retail method is often used in the retail industry for measuring inventories of large numbers of
rapidly changing items with similar margins for which it is impracticable to use other costing methods.
The cost of the inventory is determined by reducing the sales value of the inventory by the
appropriate percentage gross margin. The percentage used takes into consideration inventory that
has been marked down to below its original selling price. An average percentage for each retail
department is often used.

Net realizable value

 The cost of inventories may not be recoverable if those inventories are damaged, if they have
become wholly or partially obsolete, or if their selling prices have declined. The cost of inventories
may also not be recoverable if the estimated costs of completion or the estimated costs to be incurred
to make the sale have increased. The practice of writing inventories down below cost to net realisable
value is consistent with the view that assets should not be carried in excess of amounts expected to
be realised from their sale or use.
 Inventories are usually written down to net realisable value item by item. In some circumstances,
however, it may be appropriate to group similar or related items. This may be the case with items of
inventory relating to the same product line that have similar purposes or end uses, are produced and
marketed in the same geographical area, and cannot be practicably evaluated separately from other
items in that product line. It is not appropriate to write inventories down on the basis of a classification
of inventory, for example, finished goods, or all the inventories in a particular operating segment.
 Materials and other supplies held for use in the production of inventories are not written down below
cost if the finished products in which they will be incorporated are expected to be sold at or above
cost. However, when a decline in the price of materials indicates that the cost of the finished products
exceeds net realisable value, the materials are written down to net realisable value. In such
circumstances, the replacement cost of the materials may be the best available measure of their net
realisable value.
 A new assessment is made of net realisable value in each subsequent period. When the
circumstances that previously caused inventories to be written down below cost no longer exist or
when there is clear evidence of an increase in net realisable value because of changed economic
circumstances, the amount of the write-down is reversed (ie the reversal is limited to the amount of
the original write-down) so that the new carrying amount is the lower of the cost and the revised net
realisable value. This occurs, for example, when an item of inventory that is carried at net realisable
value, because its selling price has declined, is still on hand in a subsequent period and its selling
price has increased.
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FINANCIAL ACCOUNTING & REPORTING - INVENTORIES

Recognition as an expense
 When inventories are sold, the carrying amount of those inventories shall be recognised as an
expense in the period in which the related revenue is recognised. The amount of any write-down of
inventories to net realisable value and all losses of inventories shall be recognised as an expense in
the period the write-down or loss occurs. The amount of any reversal of anywrite-down of inventories,
arising from an increase in net realisable value, shall be recognised as a reduction in the amount of
inventories recognised as an expense in the period in which the reversal occurs.
 Some inventories may be allocated to other asset accounts, for example, inventory used as a
component of self-constructed property, plant or equipment. Inventories allocated to another asset
in this way are recognised as an expense during the useful life of that asset.

MULTIPLE CHOICE QUIZZER (CPA EXAM ADAPTED)

1. Ryan Distribution Co. has determined its December 31, 2015 inventory on a FIFO basis at P250,000.
Information pertaining to that inventory follows:
Selling price P255,000
Cost to sell 10,000
Cost to complete 30,000
Ryan records losses that result from applying the lower-of-cost-or-net realizable value rule. At December
31, 2015, the loss that Ryan should recognize is
a. P0.
b. P5,000.
c. P25,000.
d. P35,000.

2. Keen Company’s accounting records indicated the following information:

Inventory, 1/1/15 P 600,000
Purchases during 2015 3,000,000
Sales during 2015 3,800,000
A physical inventory taken on December 31, 2015, resulted in an ending inventory of P700,000. Keen’s
gross profit on sales has remained constant at 25% in recent years. Keen suspects some inventory may
have been taken by a new employee. At December 31, 2015, what is the estimated cost of missing
inventory?
a. P50,000.
b. P150,000.
c. P200,000.
d. P250,000.

3. Data relating to the computation of the inventory at July 31, 2015, are as follows:
Cost Retail
Inventory, 2/1/15 P 200,000 P 250,000
Purchases 1,000,000 1,575,000
Markups, net 175,000
Sales 1,750,000
Estimated normal shoplifting losses 20,000
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FINANCIAL ACCOUNTING & REPORTING - INVENTORIES

Markdowns, net 110,000

Under the lower-of-cost-or-net realizable value method, Henke’s estimated inventory at July 31, 2015 is
a. P72,000.
b. P84,000.
c. P96,000.
d. P120,000.

4. At December 31, 2015, the following information was available from Kohl Co.’s accounting records:
Cost Retail
Inventory, 1/1/15 P147,000 P 203,000
Purchases 833,000 1,155,000
Additional markups 42,000
Available for sale P980,000 P1,400,000
Sales for the year totaled P1,050,000. Markdowns amounted to P10,000. Under the lower-of-cost-or-net
realizable value method, Kohl’s inventory at December 31, 2015 was
a. P294,000.
b. P245,000.
c. P252,000.
d. P238,000.

5. How should the following costs affect a retailer's inventory valuation?

Freight-in Interest on Inventory Loan
a. Increase No effect
b. Increase Increase
c. No effect Increase
d. No effect No effect

6. The following information applied to Howe, Inc. for 2015:

Merchandise purchased for resale P300,000
Freight-in 8,000
Freight-out 5,000
Purchase returns 2,000
Howe's 2015 inventoriable cost was
a. P300,000.
b. P303,000.
c. P306,000.
d. P311,000.

7. The following information was derived from the 2015 accounting records of Perez Co.:
Perez 's Goods
Perez 's Central Warehouse Held by Consignees
Beginning inventory P130,000 P 14,000
Purchases 575,000 70,000
Freight-in 10,000
Transportation to consignees 5,000
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FINANCIAL ACCOUNTING & REPORTING - INVENTORIES

Freight-out 30,000 8,000

Ending inventory 145,000 20,000
Perez's 2015 cost of sales was
a. P570,000.
b. P600,000.
c. P634,000.
d. P639,000.

8. Dole Corp.'s accounts payable at December 31, 2015, totaled P800,000 before any necessary year-end
adjustments relating to the following transactions:
 On December 27, 2015, Dole wrote and recorded checks to creditors totaling P350,000 causing
an overdraft of P100,000 in Dole's bank account at December 31, 2015. The checks were mailed
out on January 10, 2016.
 On December 28, 2015, Dole purchased and received goods for P150,000, terms 2/10, n/30.
Dole records purchases and accounts payable at net amounts. The invoice was recorded and
paid January 3, 2016.
 Goods shipped f.o.b. destination on December 20, 2015 from a vendor to Dole were received
January 2, 2016. The invoice cost was P65,000.
At December 31, 2015, what amount should Dole report as total accounts payable?
a. P1,362,000.
b. P1,297,000.
c. P1,050,000.
d. P950,000.

9. The balance in Moon Co.'s accounts payable account at December 31, 2015 was P700,000 before any
necessary year-end adjustments relating to the following:
 Goods were in transit to Moon from a vendor on December 31, 2015. The invoice cost was
P40,000. The goods were shipped f.o.b. shipping point on December 29, 2015 and were
received on January 4, 2016.
 Goods shipped f.o.b. destination on December 21, 2015 from a vendor to Moon were received
on January 6, 2016. The invoice cost was P25,000.
 On December 27, 2015, Moon wrote and recorded checks to creditors totaling P30,000 that were
mailed on January 10, 2016.
In Moon's December 31, 2015 statement of financial position, the accounts payable should be
a. P730,000.
b. P740,000.
c. P765,000.
d. P770,000.

10. Kerr Co.'s accounts payable balance at December 31, 2015 was P1,500,000 before considering the
following transactions:
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FINANCIAL ACCOUNTING & REPORTING - INVENTORIES

 Goods were in transit from a vendor to Kerr on December 31, 2015. The invoice price was
P70,000, and the goods were shipped f.o.b. shipping point on December 29, 2015. The goods
were received on January 4, 2016.
 Goods shipped to Kerr, f.o.b. shipping point on December 20, 2015, from a vendor were lost in
transit. The invoice price was P50,000. On January 5, 2016, Kerr filed a P50,000 claim against
the common carrier.
In its December 31, 2015 statement of financial position, Kerr should report accounts payable of
a. P1,620,000.
b. P1,570,000.
c. P1,550,000.
d. P1,500,000.

11. Walsh Retailers purchased merchandise with a list price of P50,000, subject to trade discounts of 20%
and 10%, with no cash discounts allowable. Walsh should record the cost of this merchandise as
a. P35,000.
b. P36,000.
c. P39,000.
d. P50,000.

12. On June 1, 2015, Penny Corp. sold merchandise with a list price of P20,000 to Linn on account. Penny
allowed trade discounts of 30% and 20%. Credit terms were 2/15, n/40 and the sale was made f.o.b.
shipping point. Penny prepaid P400 of delivery costs for Linn as an accommodation. On June 12, 2015,
Penny received from Linn a remittance in full payment amounting to
a. P10,976.
b. P11,368.
c. P11,376.
d. P11,196.

13. Groh Co. recorded the following data pertaining to raw material X during January 2015:
Units
Date Received Cost Issued On Hand
1/1/15 Inventory P8.00 3,200
1/11/15 Issue 1,600 1,600
1/22/15 Purchase 4,000 P9.40 5,600
The moving-average unit cost of X inventory at January 31, 2015 is
a. P8.70.
b. P8.85.
c. P9.00.
d. P9.40.

14. During periods of rising prices, a perpetual inventory system would result in the same dollar amount of
ending inventory as a periodic inventory system under which of the following inventory cost flow methods?
FIFO Average
a. Yes No
b. Yes Yes
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FINANCIAL ACCOUNTING & REPORTING - INVENTORIES

c. No Yes
d. No No

15. Hite Co. was formed on January 2, 2015, to sell a single product. Over a two-year period, Hite's acquisition
costs have increased steadily. Physical quantities held in inventory were equal to three months' sales at
December 31, 2015, and zero at December 31, 2016. Assuming the periodic inventory system, the
inventory cost method which reports the highest amount of each of the following is

Inventory Cost of Sales

December 31, 2015 2016
a. Average FIFO
b. Average Average
c. FIFO FIFO
d. FIFO Average

16. Keck Co. had 450 units of product A on hand at January 1, 2015, costing P42 each. Purchases of product
A during January were as follows:
Date Units Unit Cost
Jan. 10 600 P44
18 750 46
28 300 48
A physical count on January 31, 2015 shows 600 units of product A on hand. The cost of the inventory
at January 31, 2015 under the FIFO method is
a. P25,500.
b. P26,700.
c. P28,200.
d. P24,600.