Review Materials

Prepared by:
Junior Philippine Institute of
Accountants UC-Banilad Chapter
F.Y. 2019-2020
INVENTORIES
OVERVIEW

PAS 2 sets out the accounting treatment for inventories, including the determination of cost, the
subsequent recognition of an expense and any write-downs to net realizable value.

SCOPE

Applies to all inventories except:

a.Financial instruments (IAS 32 and IFRS 9); and
b. Biological assets and agricultural produce at the point of harvest (IAS 41)

Does not apply to the measurement of inventories held by:

a. Producers of agricultural and forest products, and minerals and mineral products, that are
measured at net realisable value in accordance with well-established practices in those industries;
and
b. Commodity broker-traders who measure their inventories at fair value less costs to sell.
Changes in the above inventory values are recognized in profit or loss in the period of the change.

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KEY TERMS AND CONCEPTS TO REMEMBER:
PAS 2 defines inventories as the 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

Examples of inventories:
a. Merchandise purchased by a trading entity and held for resale
b. Land and other property held for sale in the ordinary course of business
c. Finished goods, goods undergoing production, and raw materials and supplies awaiting use in
the production process by a manufacturing entity

RECOGNITION

Inventories are recognized when:

• They meet the definition of inventory
• They qualify for recognition as assets, such as when legal title is obtained by the buyer
• Recognition does not require a transfer of title

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KEY TERMS AND CONCEPTS TO REMEMBER:
Goods in transit
FOB shipping point
▪ Ownership over the goods is transferred upon shipment. Therefore, the goods in transit are
included in the buyer’s inventories
FOB destination point
▪ Ownership over the goods is transferred only upon receipt of goods by the buyer. Therefore,
the goods in transit are excluded from buyer’s inventories

Consigned Goods
▪ Consigned goods are included in the consignor’s inventory and are excluded from the
consignee’s inventory
▪ Costs incurred in transferring the consigned goods to the consignee are included as cost of the
consigned goods

Inventory financing agreements

▪ Goods sold under a product financing agreement whereby the seller is obligated to repurchase
the goods sold at a future date is not considered sale. Therefore, the goods are included in
seller’s inventory
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KEY TERMS AND CONCEPTS TO REMEMBER:

Installment sale
▪ Inventories sold under installment sale whereby the seller retains title solely to protect
the collectability of the amount due are included in the buyer’s inventory (and are
excluded from the seller’s inventory) at the time of sale

STATEMENT PRESENTATION
▪ Inventories are generally classified as current assets
▪ The inventories shall be presented as one line item in the statement of financial
position but the details of the inventories shall be disclosed in the notes to financial
statements

ACCOUNTING FOR INVENTORIES

Two systems are offered in accounting for inventories:
1. Periodic system
2. Perpetual system
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KEY TERMS AND CONCEPTS TO REMEMBER:
Periodic System
• Calls for the physical counting of goods on hand at the end of the accounting period to determine
quantities
• Generally used when the individual inventory items have small peso investment, such as
groceries, hardware and auto parts.
• Increases and decreases in inventory during the period are recorded in the purchases, freight-in,
purchase returns, and purchase discounts accounts, as appropriate
• Cost of good sold is not recorded
• Requires the use of the following formula in determining the COGS
Beg. Inventory xxx
Net purchase xxx
Total Goods Available for Sale xxx
Ending inventory xxx
Cost of Goods Sold xxx

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KEY TERMS AND CONCEPTS TO REMEMBER:

Perpetual System
• Requires the maintenance of records called stock cards that usually offer running a summary of
the inventory inflow and outflow
• Commonly used where the inventory items treated individually represent a relatively large peso
investment such as jewelry and cars
• All increases and decreases in inventory are recorded in the inventory account
• Cost of goods sold is debited when inventory is sold and credited for sales returns
• Physical count of the units on hand should atleast be made once a year to confirm the balance
appearing on the stock cards

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ILLUSTRATION:

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KEY TERMS AND CONCEPTS TO REMEMBER:

MEASUREMENT
▪ Inventories are measured at the lower of cost and net realizable value (NRV)

COST
The cost of inventories shall comprise:
1. Cost of Purchase
The following comrpises the cost of purchase:
• Purchase price
• Import duties, and non-refundable or non-recoverable purchase taxes
• Transport, handling and other costs directly attributable to the acquisition of the
inventory

Trade discounts, rebates and other similar items are deducted in deteining the purchase cost

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KEY TERMS AND CONCEPTS TO REMEMBER:

2. Cost of Conversion
The cost of conversion of inventories includes:
• Cost directly related to the units of production such as direct labor
• Fixed production overhead
- The indirect cost of production that remains relatively constant regardless of the
volume of production
- Examples: Depreciation and maintenance of factory building, and the cost of factory
management and administration
Allocation:
- The allocation of fixed production overhead to the cost of conversion is based on the
normal capacity of the production capacity
• Variable production overhead
- The indirect cost of production that varies directly with the volume of production
- Examples: Indirect labor and indirect materials
Allocation:
- Variable production overhead is allocated to each unit of production on the basis of the
actual use of the production facilities

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KEY TERMS AND CONCEPTS TO REMEMBER:

3. Other Costs
• These are costs necessary in bringing the inventories to their present location and
condition

The following costs are excluded from the cost of inventories and recognized as expenses in
the period when incurred:
a. Abnormal amounts of wasted materials, labor and other production costs
b. Storage costs, unless these costs are necessary in the production process prior to a further
production stage
c. Administrative overheads that do not contribute to bringing inventories to their present
location and condition; and
d. Distribution or selling costs

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Example #1

F&F Company, a VAT payer, imported goods SOLUTION:

from a foreign supplier and incurred the
following costs: Purchase price P175,000
Import duties 15,000
Purchase price P175,000 Transportation amd handling costs 7,000
Import duties 15,000 Commission to broker 3,000
Value added tax 18,000 Total cost P200,000
Transportation and handling costs 7,000
Commission to broker 3,000
P218,000

How much is the cost of purchase of the

imported goods?

Note:
If the purchaser is not a VAT payer, the VAT paid forms part of the cost of inventory. For non- VAT
business, any VAT paid is non-refundable/non-recoverable

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Example #2

Dong Jules Company had the following SOLUTION:

transactions during December:
Inventory shipped on consignment P1,200,000
Inventory shipped consignment P1,200,000 to Onin Company
to Onin Company Freight of consigned inventory 70,000
Freight paid by Dong Jules 70,000 Total Cost P1,270,000
Inventory received on consignment 1,150,000
from Alpha Company
Freight paid by Alpha 45,000
P2,465,000

No sales of consigned goods were made in

December.

What amount should be included in inventory

on December 31?

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KEY TERMS AND CONCEPTS TO REMEMBER:

COST FORMULAS
1.) Specific Identification
▪ This shall be used for inventories that are not ordinarily interchangeable
▪ Cost of sales represents actual costs of specific items sold while ending inventory represents
the actual costs of the specific items
▪ Specific costs are attributed to identified items of inventory under this formula
▪ This is not appropriate when inventories consist of large number of items that are
ordinarily interchangeable

2.) First-In, First-Out (FIFO)

▪ In this formula, it is assumed that inventories that were purchased or produced first are
sold first, and therefore unsold inventories at the end of the period are the most recently
purchased or produced.
▪ Costs of sales represents costs from earlier purchases while the cost of ending inventory
represents costs from the most recent purchases

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KEY TERMS AND CONCEPTS TO REMEMBER:

3. Weighted Average
▪ Cost of sales and ending inventory are determined based on the weighted average cost of
beginning inventory and all inventories purchased or produced during the period

Note:
PAS 2 does not permit the use of a last-in, first-out (LIFO) cost formula

Net Realizable Value

▪ It is the estimated selling price in the ordinary course of business less the estimated cost
of completion and the estimated costs necessary to make the sale
▪ Measuring inventories at the lower of cost and NRV is in line with the basic accounting
concept that an asset shall not be carried at an amount that exceeds its recoverable
amount

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KEY TERMS AND CONCEPTS TO REMEMBER:

The cost of an inventory may exceed its recoverable amount if:

▪ The inventory is damaged
▪ The inventory becomes obsolete
▪ Prices have declined; or
▪ The estimated costs to complete or sell the inventory have increased

Inventories are usually written down to NRV on an item by item basis

Written-down of inventory
▪ Write-downs of inventories are normally charged to costs of goods sold
▪ Raw materials and manufacturing 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
▪ Reversals of inventory write-downs should not exceed the amount of write-downs
previously recognized

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 End of Topic
Please see complementary test bank for
practice problems and theories.

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 Dear, you.
Always be in pursuit for
the one you have not yet
become. Keep going!
Love,
Your UCB-JPIA family

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References:
Milan, Z. (2018). Intermediate Accounting (2018 Edition). Bandolin
Enterprise

Valix, C. et al. (2019). Intermediate Accounting 2019 (Volume 1). GIC

Enterprises & Co., Inc.

Randhawa, W. (n.d.). IAS 2 Inventory. Retrieved on August 8, 2020 from 20

https://www.academia.edu/11529450/IAS_2_Inventories