METRO MANILA COLLEGE

COLLEGE OF BUSINESS AND ACCOUNTANCY

INVENTORIES - Part 1
1. Definition of inventories -these are assets that are (1) Held for sale in the normal course of business, or
(2) In the process of production for such sale, or (3) In the form of materials or supplies to be
consumed in the production process or in the rendering of services

2. Classification of inventories:
a. Merchandising business
1. Merchandise inventory or Inventory – goods purchased by a trading company for resale in the
enterprise’s ordinary course of business
b. Manufacturing business:
1. Raw materials inventory- tangible goods purchased for direct use in the manufacture of goods for
sale
2. Work in process inventory – manufactured items requiring further processing
3. Finished goods inventory - manufactured goods completed and ready for sale
4. Manufacturing supplies inventory – items purchased for indirect use in the manufacture of goods for
resale
c. Service provider business
1. Work in process inventory – the cost of the service.

3. Measurement of inventories
A. Initial measurement – inventories are initially measured at historical cost. The cost of inventories
should include all costs of purchase, costs of conversion and other costs incurred in bringing the
inventories to their present location and condition.
1. Cost of purchase includes the purchase price plus all directly attributable costs of purchase such as
import duties and purchase taxes (other than those subsequently recoverable by the enterprise
from the taxing authorities), transport and handling costs and freight insurance minus trade
discounts (if any), rebates (if any) and other similar allowances and goods and service taxes paid.
The cost of inventory also includes the costs of unloading, unpacking and preparing the
merchandise inventory for sale or for raw materials for use.

Costs that relate generally to the purchase, such as salaries of purchasing officers in the
administrative department and all selling costs and administrative overheads of an entity shall not
be included.
2. For manufacturing companies – their finished goods shall include the conversion costs of labor and
production overheads. PAS 2 generally requires application of the full absorption costing principle
to inventories and this will invariably require a systematic allocation of variable and fixed production
overheads that are incurred in converting raw materials into finished product.
Some other costs which are non-production in nature shall also be included in the cost of
inventories if they are incurred in bringing the inventories to their present location and condition.
These costs may include costs of designing products for specific customers and borrowing costs
incurred to bring the inventories to their condition for sale (such as borrowing costs of development
projects of property developers).
3. Cost of agricultural produce harvested from biological assets (in accordance with IAS 41)- are
measured on initial recognition at their fair value less estimated point of sale costs at the point of
harvest.
4. Cost of inventories of a service provider- the labor and other costs of personnel directly engaged in
providing the service, including supervisory personnel and attributable overhead cost excluding any
profit margins or non-attributable overheads.

The following are excluded from the cost of inventories:

a. Abnormal amounts of wasted materials, labor, or 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. Selling costs

B. Balance sheet measurement- should be measured at the lower of cost or net realizable value. This
basis is basically an application of the prudence principle, which requires that inventories shall be
carried at cost generally, and if a loss on sale is foreseeable, it shall be written down to the net
realizable amount immediately.

The net realizable value is the net selling price in the course of the business less the estimated cost of
completion and the estimated costs necessary to make the sale. Inventories are usually written down
to net realizable value on an individual basis. However, in the circumstance where items of inventory
relate to the same product line, have similar purposes and uses, and are produced and marketed in the
same geographical area, the group of similar items basis may be more appropriate. Whichever basis is
used shall be consistently applied.

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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 cost or above
cost. However, when a decline in the price of materials indicates that the cost of the finished products
exceeds net realizable value, the materials are written down to net realizable value. In such
circumstances, the replacement cost of the materials may be the best available measure of their net
realizable value. (PAS 2 par. 32)

When an item of inventory has been written-down to its net realizable value, and if in subsequent
balance sheet period the same item of inventory still on hand, a new assessment of net realizable value
should be made. If there is a clear evidence of an increase in net realizable value because of change in
economic condition the amount of the write-down should be reversed. The amount of reversal should
not exceed the original amount of write-down that was recognized previously.

5. Establishment of the year-end inventory – the periodic system of recording inventories calls for the physical
counting of goods while the perpetual system provides a record of the cost and units remaining as of a
particular date, however, physical counting is necessary to determine the reasonableness of the records.

However, when physical count is not possible or practicable it would be necessary to estimate the value of
the inventory.

Include in the year-end inventory, all item of inventories own and controlled by the enterprise that are in
good, usable and salable condition with in the enterprise’s premises and adjust the count by including those
items of inventories that are also own and controlled by the entity. Therefore, the following items of
inventories should be considered:
a. Merchandise in transit – if the term of shipment is shipping point, include as inventory of the buyer but
if the term is destination, include as inventory of the seller.
b. Goods on consignment – include as inventory of the consignor.

c. Sales on approval - goods sent on approval to a potential buyer should remain as inventory on the
seller until payment is received for items kept by the buyer
d. Special sales contract:
1. Product-financing (Sale with a buyback agreement) – also known as a park sale because the seller
parks (transfers) its inventory in the buyer’s premises thru sales contract that clearly specifies to
purchase back the same inventory over a specified period of time at a specified amount. Include as
inventory of the seller.

2. Sale but buyer given the right to return – the revenue from the sales transaction shall be
recognized at of sale only if all the following conditions are met: (a) the seller’s price to the buyer is
substantially fixed or determinable at the date of sale, (b) the buyer has paid the seller, or the
buyer is obligated to pay the seller and the obligation is not contingent on resale of the product, (c)
the buyer’s obligation to the seller would not be changed in the event of theft or physical
destruction or damage of the product, (d) the buyer acquiring the product for resale has economic
substance apart from that provided by the seller, (e) the seller does not have significant obligations
for future performance to directly about the resale of the product by the buyer, and (f) the amount
of future returns can be reasonably estimated.

If the above conditions are not met, the seller should continue to recognize the inventory.

3. Installment sales – goods should be considered sold or removed from inventory, even though legal
title has yet to pass to the buyer. Include as inventory of the buyer.
e. Segregated goods – mere segregation does not exclude such inventory, however, if the segregation is
due to sales contract such as special order, such inventory is excluded in the inventory of the seller.

6. Techniques for the measurement of Cost:

The retail method or standard cost method may be used for convenience if the results approximate cost.
Standard costs take into account normal levels of materials and supplies, labor efficiency and capacity
utilization, but a regular review is a requirement 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
inventory is determined by reducing the sales value of the inventory by the appropriate percentage of gross
margin.

7. The cost formulas for inventory:

The cost of inventory that are not ordinarily interchangeable and goods or services produced and
segregated for specific projects shall be assigned using specific identification of their individual costs. The
cost of inventories that are ordinarily interchangeable shall be assigned by using the FIFO or weighted
average method. An entity shall use the same cost formula for all inventories having a similar nature and
use. For inventories with a different nature or use, different cost formulas maybe justified.

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8. The financial statements shall disclose

a) the accounting policies adopted in measuring inventories, including the cost formula used
b) The total carrying amount of inventories and the carrying amount in classifications appropriate to the
entity
c) The carrying amount of inventories carried at fair value less cost to sell
d) The amount of inventories recognized as an expense during the period
e) The amount of any write-down of inventories recognized as an expense int the period
f) The amount of any reversal of any write-down that is recognized as a reduction in the amount of
inventories recognized as expense in the period
g) The carrying amount of inventories pledged as security for liabilities

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01. Which of the following inventories carried by a manufacturer is similar to the merchandise inventory of a
retailer?
a. Raw materials.
b. Work-in-process.
c. Finished goods.
d. Supplies.

02. Where should raw materials be classified on the statement of financial position?
a. Prepaid expenses.
b. Inventory.
c. Equipment.
d. Not on the statement of financial position.

03. Which of the following accounts is not reported in inventory?

a. Raw materials.
b. Equipment.
c. Finished goods.
d. Supplies.

04. Complex Company is a retailer specializing in selling computers and related equipment. Which of the
following would not be reported in the merchandise inventory account reported on the statement of
financial position for Complex Company at December 31, 2019?
a. Computer purchased for resale during November 2019.
b. Shelving materials purchased during December 2019.
c. Freight costs related to the computers purchased in November.
d. All of the choices are included in the merchandise inventory account at December 31, 2019.

05. Culver Company purchases the majority of its inventory from three primary suppliers for re-sale to
customers around the world. Culver Company’s statement of financial position will include
a. Finished goods inventory.
b. Work-in-process inventory.
c. Merchandise inventory.
d. All of the choices are correct.

06. Companies must allocate the cost of all the goods available for sale (or use) between
a. The cost goods on hands at the beginning of the period as reported on the statement of financial
position and the cost of goods acquired or produced during the period.
b. The cost of goods on hand at the end of the period as reported on the statement of financial
position and the cost of goods acquired or produced during the period.
c. The income statement and the statement of financial position.
d. All of the choices are correct.

07. Mineral Makers (MM) Company keeps its inventory records using a perpetual system. At December 31,
2020, the unadjusted balance in the inventory account isP64,000. Through a physical count on December
31, 2020, MM determines that its actual merchandise inventory at year-end is P62,500. Which of the
following is true regarding the statement of financial position and the income statement of MM at
December 31, 2020?
a. Inventory is increased and cost of goods sold is decreased byP1,500.
b. Inventory is decreased and cost of goods sold is increased by P1,500.
c. Inventory is increased and cost of goods sold is increased by P1,500.
d. Inventory is decreased and cost of goods sold is decreased by P1,500.

08. Why are inventories included in the computation of net income?

a. To determine cost of goods sold.
b. To determine sales revenue.
c. To determine merchandise returns.
d. Inventories are not included in the computation of net income.

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09. Which of the following is a characteristic of a perpetual inventory system?

a. Inventory purchases are debited to a Purchases account.
b. Inventory records are not kept for every item.
c. Cost of goods sold is recorded with each sale.
d. Cost of goods sold is determined as the amount of purchases less the change in inventory.

10. How is a significant amount of consignment inventory reported in the statement of financial position?
a. The inventory is reported separately on the consignor's statement of financial position.
b. The inventory is combined with other inventory on the consignor's statement of financial position.
c. The inventory is reported separately on the consignee's statement of financial position.
d. The inventory is combined with other inventory on the consignee's statement of financial position.

11. Where should goods in transit that were recently purchased f.o.b. destination be included on the
statement of financial position?
a. Accounts payable.
b. Inventory.
c. Equipment.
d. Not on the statement of financial position.

12. If a company uses the periodic inventory system, what is the impact on net income of including goods in
transit f.o.b. shipping point in purchases, but not ending inventory?
a. Overstate net income.
b. Understate net income.
c. No effect on net income.
d. Not sufficient information to determine effect on net income.

13. If a company uses the periodic inventory system, what is the impact on the current ratio of including
goods in transit f.o.b. shipping point in purchases, but not ending inventory?
a. Overstate the current ratio.
b. Understate the current ratio.
c. No effect on the current ratio.
d. Not sufficient information to determine effect on the current ratio.

14. What is consigned inventory?

a. Goods that are shipped, but title transfers to the receiver.
b. Goods that are sold, but payment is not required until the goods are sold.
c. Goods that are shipped, but title remains with the shipper.
d. Goods that have been segregated for shipment to a customer.

15. When using a perpetual inventory system,

a. no Purchases account is used.
b. a Cost of Goods Sold account is used.
c. two entries are required to record a sale.
d. All of these are correct.

16. Goods in transit which are shipped f.o.b. shipping point should be
a. included in the inventory of the seller.
b. included in the inventory of the buyer.
c. included in the inventory of the shipping company.
d. None of these are correct.

17. Goods in transit which are shipped f.o.b. destination should be

a. included in the inventory of the seller.
b. included in the inventory of the buyer.
c. included in the inventory of the shipping company.
d. None of these are correct.

18. Which of the following items should be included in a company's inventory at the statement of financial
position date?
a. Goods in transit which were purchased f.o.b. destination.
b. Goods received from another company for sale on consignment.
c. Goods sold to a customer which are being held for the customer to call for at his or her
convenience.
d. None of these are correct.

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Use the following information for questions 19 and 20

During 2020 Davis Corporation transferred inventory to Green Corporation and agreed to repurchase
the merchandise early in 2021. Green Corporation then used the inventory as collateral to borrow from
Metro Bank, remitting the proceeds to Davis Corporation. In 2021 when Davis Corporation repurchased
the inventory, Green Corporation used the proceeds to repay its bank loan.
19. This transaction is known as a(n)
a. consignment.
b. installment sale.
c. assignment for the benefit of creditors.
d. product financing arrangement.
20. On whose books should the cost of the inventory appear at the December 31, 2020 statement of financial
position date?
a. Davis Corporation
b. Green Corporation
c. Metro Bank
d. Green Corporation, with Davis Corporation making appropriate note disclosure of the transaction

21. Valuation of inventories requires the determination of all of the following except
a. the costs to be included in inventory.
b. the physical goods to be included in inventory.
c. the cost of goods held on consignment from other companies.
d. the cost flow assumption to be adopted.

22. Which of the following costs should not be included on the statement of financial position as part of the
cost of inventory?
a. Abnormal freight.
b. Import duties.
c. Conversion costs.
d. All of the choices are included on the statement of financial position as part of the cost of inventory.
23. James, Inc. manufactures cruise ships for sale. Each ship costs approximately P25,000,000 to build and
takes 3 years to fully construct. During the time it takes to construct one cruise ship, Jarvis incurs
P2,400,000 in interest cost related to the construction. The interest cost is incurred evenly throughout the
construction period. During the first year of construction, James, Inc. builds a shell that can be
customized for any purchaser according to specifications; construction during the final 2 years is all based
on client specification. The International Accounting Standards Board requires that James, Inc. account
for this interest cost as
a. P2,400,000 is recorded as interest expense as incurred.
b. P2,400,000 is capitalized to the cruise ship.
c. P800,000 incurred in 1st year is expensed as incurred; the remaining amount is capitalized to the
cruise ship.
d. P800,000 is capitalized to the cruise ship; the remaining amount is expensed as
24. Jackson Company is a retailer specializing in selling computers and related equipment. During 2020,
Jackson Company sells P200,000 of merchandise to Sand, Inc. Jackson Company incurs P24,000 of
freight costs associated with these sales. Which of the following is true regarding how this P24,000 is
treated on the financial statements?
a. Jackson Company will report the P24,000 as part of merchandise inventory on the statement of
financial position.
b. Sand, Inc. will report the P24,000 as part of merchandise inventory on the statement of financial
position.
c. Jackson Company will report the P24,000 as part of operating expenses on the income statement.
d. Sand, Inc. will report the P24,000 as an accounts receivable on the statement of financial position.
25. Which of the following is included in inventory costs?
a. Product costs.
b. Period costs.
c. Product and period costs.
d. Neither product or period costs.
26. Which of the following is correct?
a. Selling costs are product costs.
b. Manufacturing overhead costs are product costs.
c. Interest costs for routine inventories are product costs.
d. All of these are correct.

27. Costs which are inventoriable include all of the following except
a. costs that are directly connected with the bringing of goods to the place of business of the buyer.
b. costs that are directly connected with the converting of goods to a salable condition.
c. buying costs of a purchasing department.
d. selling costs of a sales department.

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28. Lawson Manufacturing Company has the following account balances at year end:
Supplies P 4,000
Raw materials 27,000
Work-in-process 59,000
Finished goods 92,000
Prepaid insurance 6,000
What amount should Lawson report as inventories in its statement of financial position?
a. P 92,000.
b. P 96,000.
c. P178,000.
d. P182,000.

29. Bell Inc. took a physical inventory at the end of the year and determined that P650,000 of goods were on
hand. In addition, Bell, Inc. determined that P50,000 of goods that were in transit that were shipped
f.o.b. shipping were actually received two days after the inventory count and that the company had
P75,000 of goods out on consignment. What amount should Bell report as inventory at year end?
a. P650,000.
b. P700,000.
c. P725,000.
d. P775,000.

30. Bell Inc. took a physical inventory at the end of the year and determined that P475,000 of goods were on
hand. In addition, the following items were not included in the physical count. Bell, Inc. determined that
P60,000 of goods were in transit that were shipped f.o.b. destination (goods were actually received by the
company three days after the inventory count). On the last day of the year, the company sold P25,000
worth of inventory f.o.b. destination. What amount should Bell report as inventory at the end of the year?
a. P475,000.
b. P535,000.
c. P500,000.
d. P560,000.

31. On January 1, 2019 the entity purchased raw materials to be consumed in the production process for
P550,000, including P50,000 refundable purchase taxes. The purchase price was funded by raising a loan
of P555,000 (including P5,000 loan-raising fees). The loan is secured by the inventories. During January
2019 the entity designed the corporate gifts for the customer, the design costs included: Cost of external
designer, P7,000 and labor cost, P3,000. During February 2019, the entity’s production team developed
the manufacturing technique and made further modifications necessary to bring the inventories to the
conditions specified in the agreement. The following costs were incurred in the testing phase; Material,
net of P3,000 recovered from the sale of the scrapped output, P21,000; Labor, P11,000 and depreciation
of plant used to perform the modifications, P5,000. During February 2019 the entity incurred the
following additional costs in manufacturing the customized corporate gifts; consumable stores, P55,000;
labor, P65,0000 and depreciation of plant used to perform the modifications, P15,000. The customized
gifts were ready for sale on March 1, 2019. No abnormal wastage occurred in the development and
manufacture of the corporate gifts.
What is the cost of the finished inventory of customized gifts?
a. P555,000
b. P645,000
c. P682,000
d. P692,000

32. On October 1, 2019, Act Company consigned 50 freezers at a unit cost of P15,000 to King Company for sale
at P20,000 each and paid P20,000 in transportation cost. On December 31, 2019, King reported the sale
of the 25 freezers and returned 10 units. Cost paid by the consignee on the returned units was P4,000.
Amount due to consignor was remitted on the same date. Commission rate as agreed upon was 15%.
What amount of inventory on consignment and net income related to the sold units, respectively,
should Act report on December 31, 2019?
a. P225,000 and P36,000
b. P231,000 and P32,000
c. P235,000 and P40,000
d. P375,000 and P44,000

33. On December 1, 2019, Looney Store received 1,000 units of windbreakers on consignment from Tune Co.
Tune’s cost for the windbreakers was P1,600 each, and they were priced to sell at P2,000. Transportation
cost of P2,000 was paid by Looney. As of December 31 50 units were returned to the consignor and 200
units are still held by the consignee. Commission rate as agreed upon between contracting parties was
12% on all sales to be made by Tune Co. In its December 31, 2019 balance sheet, what amount should
Looney report as payable for consigned goods?
a. P1,318,000
b. P1,320,000
c. P1,500,000
d. P2,000,000

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