CHAPTER 10 (INVENTORIES)

Inventories – assets held for sale in the ordinary course – covers all materials used in the manufacturing
of business operations

– in the process of production for such sale
– in the form of materials
– supplies to be consumed in the prod. process
– are frequently restricted to materials that will
be physically incorporated in the production of
other goods and which can be traced directly to
the end product of the production process

– in the rendering of services. Factory or manufacturing supplies – are similar to raw

Inventories encompasses the following:
a. goods purchased and held for resale
1. merchandise purchased by a retailer
and held for resale
2. land and other property held for resale
by a subdivision entity and real estate
developer
b. finished goods produced
c. goods in process
d. material and supplies awaiting use in the
production process
CLASSES OF INVENTORIES
materials but their relationship to the end
product is indirect
– may be referred as indirect materials
– it is indirect because they are not physically
incorporated in the products being
manufactured
GOODS INCLUDIBLE IN THE INVENTORY
As a rule, all goods to which the entity has title shall be
included in the inventory, regardless of location.
Passing of title – is a legal term which means “the point
of time at which ownership changes”.

trading Legal test

concern
Inventories entity = owner ???
manufacturing
concern
Legal Test affirmative = INCLUDED
Trading concern – one that buys and sells goods in the
same form purchased negative = EXCLUDED

– term generally used is “merchandise a. Goods owned and on hand;

inventory”
Manufacturing concern – one that buys goods which
are altered or converted into another form
before they are made available for sale
Inventories of a manufacturing concern are:
- Finished goods (FG)
- Goods in process or Work in process (WIP)
- Raw materials (M)
- Factory or manufacturing supplies
Finished goods – are completed products which are
ready for sale
– have been assigned their full share of
manufacturing costs
Goods in Process – are partially completed products
which require further process or work before
they can be sold
Raw material – are goods that are to be used in the
production process
– no work or process has been done on them as
yet by the entity inventorying them
b. Good in transit and sold FOB destination;
c. Goods in transit and purchased FOB shipping
point;
d. Goods out on consignment;
e. Goods in the hands of salesmen or agents; and
f. Goods held by customers on approval or on
trial.
Installment sales (exception to the legal test)
Following the legal test, the goods sold on
installment basis are still the property of the
seller and therefore includible in his inventory.
However, it is an accepted accounting
procedure to record the installment sale as a
regular sale involving deferred income on the
part of the seller and as a regular purchase on
the part of the buyer. Thus, the goods sold on
installments are included in the inventory of
the buyer and excluded from that of the seller.
WHO IS THE OWNER OF GOODS IN TRANSIT?
Goods in transit (under FOB destination)
– ownership of goods purchased is only
transferred when received by the buyer at the
point of destination
 – seller shoulders the freight and charges
Goods in transit (under FOB shipping point)
– ownership is transferred upon shipment of
goods
– buyer shoulders the freight and charges
FREIGHT TERMS
Freight collect
– freight charge on the goods shipped is not yet
paid
– freight charge is actually paid by the buyer
Freight prepaid
– freight charge on the goods shipped is already
paid by the seller
FOB … = ownership of the goods & party who’s
supposed to pay the expenses from point of
shipment
Freight … = party who actually paid the freight charge
but not the party supposed to legally pay
CONSIGNED GOODS
Consignment
– marketing goods where owner transfers
physical possession of goods to an agent (not
ownership, only possession)
– consignor: owner
– consignee: agent who sells the goods on the
consignor's behalf
Inventory Consignor Consignee
CONSIGNED GOODS Included Excluded
– Freight and other handling charges on goods
out on consignment are part of the cost of
goods consigned.
– only memorandum entry
– accounting entry will only be recorded when
goods are sold by consignee
Cost on Sale formula:
Inv beg. + purchases + freight - purchase returns -
purchase discount – inv end
STATEMENT PRESENTATION
- Inventories are generally classified as current assets
- shall be presented as one-line-item in the statement of
financial position but the details or composition of the
inventories shall be disclosed in the notes to financial
statements.
ACCOUNTING FOR INVENTORIES
Periodic
System
Two Systems
Perpetual
System
a. periodic system
- calls for the physical counting of goods on
hand at the end of the accounting period to
determine quantities.
- gives actual or physical inventories
- generally used when the individual
inventory items have small peso investment
b. perpetual system
- requires the maintenance of records called
“stock cards” that usually offer a running
summary of the inventory inflow and
outflow.
- gives book or perpetual inventories
- commonly used where the inventory items
treated individually represent or relatively
large peso investment
- stock cards are kept to reflect and control
both units and costs
- a physical count of the units on hand should
at least be made once a year to confirm the
balances appearing on the stock cards
INVENTORY SHORTAGE OR OVERAGE
If at the end of the accounting period, a physical count
indicates a different amount, an adjustment is
necessary to recognize any inventory shortage or
overage
After adjustment, if the physical count is…
Lesser = inventory shortage
Greater = inventory overage
TRADE DISCOUNTS AND CASH DISCOUNTS
Trade discounts
– are deductions from the list or catalog price in
order to arrive at the invoice price which is the
amount actually charged to the buyer. Trade
discounts are not recorded.
Cash discounts
– are deductions from the invoice price when
payment is made within the discount period. Cash
discounts are recorded as purchase discount by the
buyer and sales discount by the seller.
Purchase discounts
 – are deducted from the purchases and sales ALLOCATION OF VARIABLE PRODUCTION OVERHEAD
discount are deducted from sales to arrive at net
VPO is allocated to each unit of production on the basis
sales revenue.
of the actual use of the production facilities

METHODS OF RECORDING PURCHASES

1. Gross method – purchases and accounts payable are

OTHER COSTS
recoded at gross.
Other costs is included in the cost of inventories only to
2. Net method – purchases and accounts payable are
the extent that it is incurred in bringing the inventories
recorded at net.
to their present location and condition
COST OF INVENTORIES
The following costs are excluded from the costs of
inventories and are recognized as expense:
Cost of Purchase
a. Abnormal amounts of wasted materials, labor,
Cost of Cost of Conversion and other costs
Inventories
b. Storage costs, unless necessary
Other Costs - Goods in process = capitalized
- Finished goods = expensed
Cost of Purchase c. Administrative overheads that do not
contribute to bringing inventories to their
- usually merchandising business present location
- raw materials purchased d. Distribution or selling costs
- comprises of purchase price, import duties
and irrecoverable taxes, freight, handling, COST OF INVENTORIES OF A SERVICE PROVIDER
and other costs directly attributable - Consists primarily of the labor and other
- trade discounts and other similar items are costs of personnel directly engaged in
deducted to get the cost of purchase providing the service, including supervisory
- shall not include foreign exchange personnel and attributable overhead
differences (only applicable if there are - Labor and other costs relating to sales and
imported goods) general administrative personnel are not
- recognize as interest expense when included but recognized as expense
inventories are purchase with deferral
terms

Cost of Conversion

- only manufacturing business

- includes cost directly related to the units of
production such as direct labor
- also includes systematic allocation of fixed
and variable production overhead incurred
in converting materials into FG
- Fixed production overhead (FPO) and
variable production overhead (VPO) are
indirect costs of production

ALLOCATION OF FIXED PRODUCTION OVERHEAD

Allocation of FPO to the cost of conversion is based on

the normal capacity of the production facilities

Normal capacity

– is the production expected to be achieved on

average

The amount of FOH allocated to each unit of production

is not increased as consequence of low production.

Unallocated Fixed Overhead - recognized as expense

 CHAPTER 11 (INVENTORY COST FLOW)

NOTA BENE

First in, First out Note well that under FIFO-periodic and FIFO-perpetual,
(FIFO) the inventory costs are the same. In both cases, January
Cost 31 inventory is P152,000
Formulas
Weighted Average The cost of goods sold is determined from the stock card
as follows:
The standard does not permit anymore the use of the
Last in, First out (LIFO) as alternative formula in cost of
inventories.

FIRST IN, FIRST OUT (FIFO)

– The FIFO assumes that “the goods first

purchased are first sold” and consequently the
goods remaining in the inventory at the end of
the period are those most recently purchased
or produced

– “first come, first sold”

– goods are sold in the order they are purchased

– inventory is expressed in terms of recent or

new prices

– cost of goods sold is representative of earlier

or old prices

– Accordingly, in a period of inflation or rising

prices, the FIFO method would result to the
highest net income. However, in a period of
deflation or declining prices, the FIFO method
would result to the lowest net income WEIGHTED AVERAGE - PERIODIC
– inflation = highest net income Beg inv cost xxx
Add: Total Cost of purchases xxx
– deflation = lowest net income
Total xxx
Divide: Total Units purchased + Beg
inv units xxx

WEIGHTED AVERAGE UNIT COST XXX

OR

Total cost of GAS xxx

Divide: Total units of GAS xxx

WEIGHTED AVERAGE UNIT COST XXX

Weighted Average Unit Cost xxx

Units on hand xxx

INVENTORY COST XXX


WEIGHTED AVERAGE – PERPETUAL
Weighted Average Method (moving average method)
– PAS 2 provides that the weighted average may
be calculated on a periodic basis or as its
original shipment is received depending upon
the circumstances of the entity.
– Under this method, a new weighted average
unit cost must be computed after every
purchase and purchase return.
– The total cost of goods available after every
purchase and purchase return is divided by total
units available for sale at this time to get a new
weighted average unit cost.
– Such new weighted average unit cost is then
multiplied by the units in hand to get the
inventory cost.
– This method requires the keeping of inventory
stock card in order to monitor the “moving”
unit cost every after purchase.
LAST IN, FIRST OUT (FIFO)
Last in, First out (LIFO)
– “the goods last purchased are first sold”
– the goods remaining in the inventory at the
end of the period are those first purchased or
produced
– inventory is expressed in terms of earlier or
old prices
– cost of goods sold is representative of recent
or new prices.
– inflation = lowest net income
– deflation = highest net income
Note: Under LIFO-periodic, the January 31 inventory is
P140,000 and under LIFO-perpetual, the January 31
inventory is P150,000
SPECIFIC IDENTIFICATION
Specific identification
– specific costs are attributed to identified items
of inventory
– cost of inventory is determined by multiplying
units on hand by their actual unit cost
– requires records which will clearly determine
the actual costs of goods on hand
– PAS 2 provides that this method is
appropriate for inventories that are segregated
for a specific project and inventories that are
not ordinarily interchangeable.
STANDARD COSTS
Standard costs
– are predetermined product costs established
on the basis of normal levels of materials and
supplies, labor, efficiency and capacity
utilization
– it is predetermined
– once determined, it is applied to all inventory
movements
– PAS 2 states that the standard cost method
may be used for convenience if the results
approximate cost.
RELATIVE SALES PRICE METHOD
Relative sales price method
– when different commodities are purchased at
a lump sum, the single cost is apportioned
among the commodities based on their
respective sales price
– this is based on the philosophy that cost is
proportionate to selling price
 CHAPTER 12 (LCNRV)

MEASUREMENT OF INVENTORY Direct Method – inventory is recorded at the lower of

cost or NRV
- PAS 2 provides that inventories shall be measured at
the lower of cost and net realizable value or LCNRV – also known as COGS method because any loss
on inventory writedown or gain on reversal of
NET REALIZABLE VALUE
inventory writedown is not accounted for
Net realizable value (NRV) – is the estimated selling separately but “buried” in the COGS.
price in the ordinary course of business less the
Allowance Method – inventory is recorded at cost and
estimated cost of completion and the estimated
any loss on inventory writedown is accounted
cost of disposal.
for separately
Cost of inventory may not be recoverable under the ff:
– also known as “loss method” because a loss
a. Inventories are damaged account “loss on inventory writedown” is
b. Inventories have become wholly or partially debited and a valuation account “allowance for
obsolete inventory writedown” is credited
c. Selling prices have declined
– This allowance account is adjusted upward or
d. Estimated cost of completion or the estimated
downward depending on the difference
cost of disposal has increased
between the cost and net realizable of the
*The practice of writing inventories down below cost to inventory at year-end.
NRV is consistent with the view that assets shall not be
– If the required allowance increases, an
carried in excess of amounts expected to be realized
additional loss is recognized.
from the sale or use
– If the required allowance decreases, a gain or
DETERMINATION OF NRV
reversal of inventory writedown is recorded.
- Inventories are usually written down to net realizable
Illustration: Inventory data on December 31, 2020
value on an item by item individual basis.
Cost NRV LCNRV
Catergory 1
- It is not appropriate to write down inventories based A 110,000 100,000 100,000
on a classification of inventory B
C
690,000
600,000
750,000
640,000
690,000
600,000
Subtotal 1,400,000 1,490,000
- It may only be appropriate to group similar or related
Category 2
items D 2,000,000 1,900,000 1,900,000
E 1,500,000 1,560,000 1,500,000
Subtotal 3,500,000 3,460,000
- Materials are written down ONLY when a decline in
Category 3
the price of materials indicates that the cost of the FG F 1,500,000 1,460,000 1,460,000
G 1,600,000 1,690,000 1,600,000
exceeds NRV Subtotal 3,100,000 3,150,000
Grand Total 8,000,000 8,100,000 7,850,000
- in such case, replacement cost of materials may be the LCNRV indiv. 7,850,000

best evidence of the NRV Cost NRV LCNRV

Category 1 1,400,000 1,490,000 1,400,000
Category 2 3,500,000 3,460,000 3,460,000
ACCOUNTING FOR INVENTORY WRITEDOWN Category 3 3,100,000 3,150,000 3,100,000
LCNRV category 7,960,000
- cost < NRV = no accounting problem because Cost NRV LCNRV
inventory is measured at cost and the increase in value LCNRV Total 8,000,000 8,100,000 8,000,000

is not recognized

- cost > NRV = inventory is measured at NRV and *The inventory is measured at the lower of cost and
decrease in value is recognized NRV applied on an individual basis

METHODS OF ACCOUNTING FOR INVENTORY

WRITEDOWN

Direct Method or
COGS method
Methods
Allowance Method
or loss method