CJ ALLAUIGAN

DEFINITIONS
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.
Test of Ownership
Legal Test and Exception to the Legal Test
ü Title is not synonymous with possession of goods on hand.
Goods on hand may not be owned.
Goods not on hand may be owned.
ü The following matters causes confusion in ownership
1.Goods in transit
2.Consignment sales
3.Goods held by customers on approval or trial basis
 Include Exclude
a.
Goods displayed in the store √

b.
Goods stocked in the warehouse, not covered by any sales contract √

c.
Goods purchased, in transit, shipped FOB sHIPPING point √

d.
Goods purchased, in transit, shipped FOB destination √

e.
Freight cost on goods received, goods are still unsold √

f.
Goods held on consignment √

g.
Goods out on consignment √

h.
Goods out to customers on approval √

i.
Goods in the hands of traveling salesmen √

j.
Goods sold with a buyback arrangement for the full selling price and other costs incurred by √

the buyer
k.
Unused factory supplies and indirect materials √

l.
Goods which require additional processing √

m.
Direct materials stocked in the warehouse √

n.
Storage costs of goods completed √

o.
Insurance premiums paid on stocked goods √

p.
Goods completed, manufactured to customer’s specification, awaiting instruction for delivery √

by the customer
q.
Freight paid on goods sold √

r.
Unused supplies for administrative purposes √

s.
Unused store supplies √

t.
Goods sold with a right to return granted to buyers, amount of return is reasonably predictable. √

u.
Goods sold under FAS, at the port designated by the buyer √

v.
Goods at the port, purchased CIF √
MEASUREMENT OF INVENTORIES :
Inventories shall be measured at the lower of cost and net realizable value.

Cost of inventories
a.Costs of purchase
§ purchase price
§ import duties and other taxes (other than those subsequently recoverable by the entity from the taxing authorities)
§ Transport
§ Handling
§ other costs directly attributable to the acquisition of finished goods, materials and services
v Trade discounts, rebates and other similar items are deducted in determining the costs of purchase.
MEASUREMENT OF INVENTORIES :
Inventories shall be measured at the lower of cost and net realizable value.

Cost of inventories
b.Costs of conversion
direct labor
fixed and variable production overheads
c.Other costs (non-production overhead such as costs of designing products for specific customers
Cost excluded from the cost of inventories:
ü abnormal amounts of wasted materials, labor or other production costs
ü storage costs, unless those costs are necessary in the production process before a further production stage
ü administrative overheads that do not contribute to bringing inventories to their present location and
condition
ü Selling costs
ü Finance cost
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 recognized as interest expense over the period of the financing.
Inventory Systems
A.Periodic inventory system
• Numerous inventory items with low unit costs
• Uses purchases and freight in terms
• Physical count is required at year end

B.Perpetual inventory system

• Inventories in small quantities with high unit costs
• Inventory account is use for purchase (and returns) including freight
• Cost of goods sold is readily determinable
• Physical may be taken at least once a year to confirm inventory balance
Cost formulas
v Once chosen, the cost formula has to be applied consistently, unless the change is justified under IAS 8.

v Inventories similar in nature should be treated with similar cost formula. Differences in geographical area do not justify
the use of a different cost formula.
Cost formulas
1.Specific identification method
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.
-Generally impractical!
2.First-in, First-out (FIFO)
The FIFO formula assumes that the items of inventory that were purchased or produced first are sold first, and
consequently the items remaining in inventory at the end of the period are those most recently purchased or produced.
3.Weighted average
Under the weighted average cost formula, the cost of each item is determined from the weighted average of the cost of
similar items at the beginning of a period and the cost of similar items purchased or produced during the period. The
average may be calculated on a periodic basis, or as each additional shipment is received, depending upon the
circumstances of the entity.
Net Realizable Value
When is cost unrecoverable?
Damaged
Obsolete
> cost to complete or > cost to sell

What about raw materials, do we write them down to NRV?

Net Realizable Value

Writing down of inventories to their net realizable value must be done

ü Is consistent with the view that assets should not be carried in excess of amounts expected to be realized from their sale
or use.
ü On ITEM BY Item basis

ü Do not write down on the basis of CLASS

ü Assessment of NRV is done in each subsequent period

ü When the previous cause of the reduction in inventory value no longer exists, reversal of write-down is made.
ü reversal is limited to the amount of the original write-down
ü reversal of write-down reduces cost of sales
(Crossings Company)

Invoice price (150,000 x 0.80 x 0.90) P 108,000

Freight charge 2,500
Total cost of merchandise purchases P 110,500
(Jane, Inc.)

Reported units on April 30, 2019 10,200

Adjustments:
No. 1 item – Purchased FOB shipping point
still in transit not included in purchases 250
No. 3 item – Sold FOB destination still in transit not
included in inventory 500
Correct inventory quantity 10,950
Orient Trading)

Reported inventory P9,500,000

Merchandise in transit purchased FOB destination (420,000)
Goods held on consignment (500,000)
Mark up on goods out on consignment
Sales price 600,000
Cost (600,000÷ 1.5) 400,000 (200,000)
Merchandise in transit to customers FOB destination
400,000 x (100% - 40%) 240,000
Merchandise purchased in transit FAS 150,000
Correct inventory P8,770,000
§ P216,000
§ P677,500
§ FIRST IN-FIRST OUT (PERIODIC/PERPETUAL)
§ AVERAGE (PERIODIC)
§ MOVING AVERAGE (PERPETUAL)
Average-Perpetual (Moving Average)
Average-Periodic (Average)
If Inventory balance is understasted, what is the effect on COGS?

If Inventory balance is overstated, what is the effect on COGS?

 TGAS COGS PROFIT
BEG (UNDER) U U OVER
BEG (OVER) O O UNDER
END(UNDER) NE O UNDER
END (OVER) NE U OVER
(City Company)

Cost (under FIFO basis) P26,000

Net realizable value (40,000 – 12,000) P28,000
Lower of cost and net realizable value P26,000

NET REALIZABLE VALUE= ESTIMATED SELLING PRICE- ESTIMATED COST TO SELL- ESTIMATED COST TO COMPLETE
How much is the cost of the Inventory? 200,000

How much is the NRV? 194,000

NRV=Estimated SP- Estimated CTC- Estimated CTS

LOSS 6,000
Determine cost of goods sold using the cost measurement.

Beg Bal xx
Purchases xx
TGAS xx
End Bal (xx)
COGS xx
Determine cost of goods sold using the cost measurement.
COGS 6,800,000
MERCH INV 6,800,000
Beg Bal xx 1,400,000
Purchases xx 6,600,000
LOSS 200,000
TGAS xx 8,000,000
ALLOWANCE... 200,000
End Bal (xx) (1,200,000)
COGS xx P6,800,000

INV END BAL-COST 1,200,000

ALLOWANCE (200,000)

How much is ENDING INVENTORY? LCNRV 1,000,000

PRODUC COST NRV LCNRV QTY TOTAL
T

A 102 105 102 4,000 408,000

B 45 42 42 6,000 252,000
C 24 22 22 5,500 121,000
D 9 10 9 7,200 64,800
845,800
Recognize decline based on LCNRV. No loss due to
NO
decline is
recognized
Is COST >= NRV?

Loss due to decline

YES
is recognized in the
I/S
COST (END BAL) 1, 200,000
NRV (END BAL) 1, 000,000 LOSS 200,000
To record the loss:
Loss from decline xx
Allowance to reduce inventory xx

To record the reversal loss in the subsequent period:

Allowance to reduce in ventory xx
Gain from Recovery xx
 2019 2018
BEG 500,000 380,000
PURCHASES 1,400,000 1,200,000
TGAS 1,900,000 1,580,000
END 660,000 500,000
COGS 1,240,000 1,080,000

ALLOWANCE 2019 2018 2017

BEG BALANCE 20,000 80,000 0
LOSS 40,000 (60,000) 80,000
(RECOVERY)
END BALANCE 60,000 20,000 80,000
ALLOWANCE 2019 2018
Sales P3,200,000 P2,900,000
Cost of goods sold
Gross profit P1,960,000 P1,820,000
Selling expenses (450,000) (330,000
General and administrative expenses (300,000) (310,000)
Decline in NRV (40,000)
Gain on adjustment of allowance __________- 60,000
Profit P 1,170,000 P 1,240,000

Cost of goods sold:

Beginning inventory P 500,000 P 380,000
Purchases 1,400,000 1,200,000
Total cost of goods available for sale P1,900,000 P 1,580,000
Ending inventory (660,000) 500,000
Cost of goods sold
 2019 2018
BEG 480,000 300,000
PURCHASES 1,400,000 1,200,000
TGAS 1,880,000 1,500,000
END 600,000 480,000
COGS 1,280,000 1,020,000
DIRECT 2019 2018
Sales P3,200,000 P2,900,000
Cost of goods sold (1,280,000) (1,020,000)
Gross profit P1,920,000 P1,880,000
Selling expenses (450,000) (330,000)
General and administrative expenses (300,000) (310,000)
Profit P 1,170,000 P 1,240,000
Cost of goods sold:
Beginning inventory P 480,000 P 300,000
Purchases 1,400,000 1,200,000
Total cost of goods available for sale P1,880,000 P 1,500,000
Ending inventory 600,000 480,000
Cost of goods sold P1,280,000 P 1,020,000
Inventory Estimation
When do we use inventory approximation or estimation?
a.When inventories are destroyed by catastrophe, fire, and theft
b.To prove reasonableness of physical count
c.Interim reports
Inventory Estimation
A.Gross Profit Method
Gross profit ratio is assumed to be approximately the same from period to another.

Total Goods Available for Sale (TGAS) xx

Less: Cost of Goods Sold (COGS) xx
Ending Inventory (approximate) xx

Where COGS is computed:

Net Sales x COGS Ratio (if GP rate given is based on sales)
Net sales ÷ Sales Ratio (if GP rate given is based on cost)
Inventory Estimation
B.Retail Method
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 it s original selling price.
An average percentage for each retail department is often used.
Inventory Estimation
B.Retail Method
Total Goods Available for Sale (TGAS) @ selling or retail price xx
Less: Net Sales xx
Ending Inventory @ selling price xx
Multiply by Cost Ratio xx%
Ending Inventory @ cost (approximate) xx

Where Cost Ratio is computed:

TGAS @Cost ÷ TGAS @ Selling Price
Gross profit on sales:

Sales 100% 100% 1,000,000 4,200,000 (100%)

COGS xx% (80%) 800,000 2,520,000 (60%)
Gross Profit xx% 20% 200,000 1,680,000 (40%)

Gross profit on cost:

Sales xxx% 120% 1,000,000 100.00% 4,200,0000 (140%)

COGS 100% 100% 833,333 83.33% 3,000,000 (100%)
Gross Profit xx% 20% 166,667 16.67% 1,200,000 ( 40%)
Gross profit on sales:
Gross profit on cost:

Sales 100%
Sales ???
COGS ???
COGS 100%
Gross Profit 40%
Gross Profit 40%
Gross profit on sales:
Gross profit on cost:

Sales 100%
Sales 140%
COGS 60%
COGS 100%
Gross Profit 40%
Gross Profit 40%
(DEC Company)

(a) Gross profit is 40% based on sales

Merchandise inventory, January 1, 2019 P 450,000
Purchases for the year 3,150,000
Cost of goods available for sale P 3,600,000

Less estimated cost of goods sold (4,200,000 x 60%) 2,520,000

Estimated cost of ending inventory P 1,080,000
Physical inventory on December 31, 2019 500,000
Estimated cost of the missing inventory P 580,00
(DEC Company)

(b) Gross profit is 40% based on cost of sales

Merchandise inventory, January 1, 2019 P 450,000
Purchases for the year 3,150,000
Cost of goods available for sale P3,600,000
Less estimated cost of goods sold (4,200,000/1.40) 3,000,000
Estimated cost of ending inventory P 600,000
Physical inventory on December 31, 2019 500,000
Estimated cost of the missing inventory P 100,000
(Herminia Company)
INVENTORY ESTIMATION:
Inventory, January 1 P 200,000
Purchases P5,000,000
Purchase returns (80,000) 4,920,000
Total Goods Available for Sale P5,120,000
Estimated cost of goods sold (7,380,000 – 180,000) x 60%) 4,320,000
Estimated cost of ending inventory P 800,000
Goods in transit ( 100,000)
Estimated cost of ending inventory on hand P 700,000
(USTFU Company)

(a)
December 31, 2019

Loss on Purchase Commitments 50,000

Estimated Liability on Purchase Commitments 50,000
1,000 x (1,200 – 1,150)

February 28, 2020

Purchases 1,150,000
Estimated Liability on Purchase Commitments 50,000
Accounts Payable 1,200,000
(b)
December 31, 2019

Loss on Purchase Commitments 50,000

Estimated Liability on Purchase Commitments 50,000

February 28, 2020

Purchases 1,100,000
Estimated Liability on Purchase Commitments 50,000
Loss on Purchase Commitments 50,000
Accounts Payable 1,200,000

(c)
December 31, 2019

Loss on Purchase Commitments 50,000

Estimated Liability on Purchase Commitments 50,000

February 28, 2020

Purchases 1,200,000
Estimated Liability on Purchase Commitments 50,000
Accounts Payable 1,200,000
Recovery of Loss on Purchase Commitments 50,000