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
entity = owner ???
Inventories
manufacturing
concern Legal Test affirmative = INCLUDED

Trading concern – one that buys and sells goods in the negative = EXCLUDED
same form purchased

– 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:
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.

- Finished goods (FG) Installment sales (exception to the legal test)

- 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
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
discount are deducted from sales to arrive at net
sales revenue.
 METHODS OF RECORDING PURCHASES
1. Gross method – purchases and accounts payable are
recoded at gross.
2. Net method – purchases and accounts payable are
recorded at net.
COST OF INVENTORIES
Cost of Purchase
Cost of Cost of Conversion
Inventories
Other Costs
Cost of Purchase
- usually merchandising business
- raw materials purchased
- comprises of purchase price, import duties
and irrecoverable taxes, freight, handling,
and other costs directly attributable
- trade discounts and other similar items are
deducted to get the cost of purchase
- shall not include foreign exchange
differences (only applicable if there are
imported goods)
- recognize as interest expense when
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
ALLOCATION OF VARIABLE PRODUCTION OVERHEAD
VPO is allocated to each unit of production on the basis
of the actual use of the production facilities
OTHER COSTS
Other costs is included in the cost of inventories only to
the extent that it is incurred in bringing the inventories to
their present location and condition
The following costs are excluded from the costs of
inventories and are recognized as expense:
a. Abnormal amounts of wasted materials, labor,
and other costs
b. Storage costs, unless necessary
- Goods in process = capitalized
- Finished goods = expensed
c. Administrative overheads that do not
contribute to bringing inventories to their
present location
d. Distribution or selling costs
COST OF INVENTORIES OF A SERVICE PROVIDER
- Consists primarily of the labor and other
costs of personnel directly engaged in
providing the service, including supervisory
personnel and attributable overhead
- Labor and other costs relating to sales and
general administrative personnel are not
included but recognized as expense
 CHAPTER 11 (INVENTORY COST FLOW)

NOTA BENE

First in, First out Note well that under FIFO-periodic and FIFO-perpetual,
the inventory costs are the same. In both cases, January
(FIFO)
Cost 31 inventory is P152,000
Formulas
Weighted Avergae 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)

WEIGHTED AVERAGE - PERIODIC
– The FIFO assumes that “the goods first
Beg inv cost xxx
purchased are first sold” and consequently the
Add: Total Cost of purchases xxx
goods remaining in the inventory at the end of Total xxx
the period are those most recently purchased or Divide: Total Units purchased + Beg
produced inv units xxx
– “first come, first sold”
WEIGHTED AVERAGE UNIT COST XXX
– goods are sold in the order they are purchased

– inventory is expressed in terms of recent or OR

new prices Total cost of GAS xxx
– cost of goods sold is representative of earlier or Divide: Total units of GAS xxx
old prices
WEIGHTED AVERAGE UNIT COST XXX
– 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 Weighted Average Unit Cost xxx
would result to the lowest net income Units on hand xxx

– inflation = highest net income INVENTORY COST XXX

– deflation = lowest net income

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
Specific identification
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.
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
LAST IN, FIRST OUT (FIFO)
– PAS 2 states that the standard cost method
Last in, First out (LIFO)
may be used for convenience if the results
– “the goods last purchased are first sold” approximate cost.

– the goods remaining in the inventory at the end

of the period are those first purchased or
RELATIVE SALES PRICE METHOD
produced
Relative sales price method
– inventory is expressed in terms of earlier or old
prices – when different commodities are purchased at
a lump sum, the single cost is apportioned
– cost of goods sold is representative of recent or
among the commodities based on their
new prices.
respective sales price
– inflation = lowest net income
– this is based on the philosophy that cost is
– deflation = highest net income proportionate to selling price

Note: Under LIFO-periodic, the January 31 inventory is

P140,000 and under LIFO-perpetual, the January 31
inventory is P150,000