CHAPTER 7: INVENTORIES
- Held for resale in the ordinary course of the
business (finished goods)
- In the process of production for such sale
(work in process)
- In the form of materials or supplies to be
consumed in the production process or in
rendering of services (raw material and
manufacturing supplies)
EXAMPLE OF INVENTORIES
- Merchandise purchased by a trading entity
and held for resale
- Land and other property held for sale in the
ordinary course of business
- Finished goods, goods undergoing
production, and raw materials and supplies
of waiting used in the production process by
a manufacturing entity
CLASSES OF INVENTORIES
- Inventories of trading or merchandising
concern
o An entity buys and sells the goods
purchased in the same form
o Merchandise inventory
- Inventories of manufacturing concern
o An entity buys goods and alter
(converts) them into another form
before they are made available for
sale
o Raw or direct materials, work in
process, finished goods
TYPES OF INVENTORIES
- Finished goods – completed goods ready
for sale
- Work in process – partially completed
goods which required further or additional
processing before they ca be sold
- Raw materials – goods to be used in
production
- Direct materials – goods that are already
issued in production
- Factory or manufacturing supplies – are raw
material issued t production
o Do not form a part of the finished
product
o If they form part of the finished
product, they cannot be
economically, directly or easily
identifiable or that their cost is
insignificant
GOODS INCLUDIBLE IN INVENTORY
- Installment contracts
o Retention of the titles by the seller
until the selling price is fully
collected (included in the seller)
o Treated as a regular sale where
income is deferred on the part of the
seller (excluded from the seller)
- Goods in transit
o FOB destination where goods sold is
transferred only upon receipt of
goods (included in the seller)
o FOB shipping point where goods
sold is transferred upon shipment
(excluded from the seller)
- Others
o Goods out on consignment –
included in the seller
o Goods consigned in – excluded from
the seller
o Goods held by customers on
approval or trial – included in the
seller
FREIGHT TERMS
Freight Term Interpretation
Freight collect Paid by the buyer
Freight prepaid Paid by the seller
FOB destination Seller is responsible for
freight
FOB shipping point Buyer is responsible for
freight
PRESENTATION
- Inventories are classified as current assets
- It shall be presented as one-line items with
the details disclosed in the notes to the
financial statements
ACCOUNTING FOR INVENTORIES
- Periodic system – calls for the physical
counting of goods on hand at the end of the
accounting period to determine quantities
o The quantities at the end of the
period are multiplies by its unit cost
to determine the inventory value of
financial statement purposes
o Used when inventory have small
peso investment and are fast
moving
- Perpetual system – requires the
maintenance of stock cards that shows the
running balance of the inventory including
its movements
 o An inventory count is conducted at period
the end of the period to verify
quantities reflected in the records
COST OF INVENTORY
o It is used for inventory items with a
relatively large peso investment - Purchase cost, purchase price, import
o The inventory quantity and value is duties, non-happy refundable or non-
known at any time recoverable purchased assets, and
transport, handling and other costs directly
attributable to the acquisition of the
INVENTORY SHORTAGE/OVERAGE inventory
o Trade discounts are directly
- The difference between the physical
deducted
inventory and amount recorded in the stock
o Foreign exchange gains or loss are
records is accounted for as inventory short
excluded
or over which requires an adjustment to the
o The difference between the
inventory account
purchase price for normal credit
o Inventory shortage – physical
terms and the amount paid is
inventory is less than the amount
recognized as interest expense
recorded in the books
- Conversion cost refers to the costs
o Inventory overage – physical
necessary in converting raw materials into
inventory is greater than the amount
finished goods which included direct labor
recorded in the books
and production overhead
- Other costs are necessary in bringing the
inventories to their present location and
INVENTORY DISCOUNTS
condition
- Trade discounts – deductions from the list - Abnormal amounts of waste material, labor
or catalog prices in order to arrive at the or other production costs
invoice prices which is the amount - Storage costs, unless this costs are
chargeable to the buyer necessary in the production process before
o Trade discounts are not recorded a further production stage
o Its purpose is to encourages trading - Administrative overhead that do not
or increase sales contribute to bringing inventory so their
o It suggests the price at which the present location and condition
goods may be resold - Selling costs
- Cash discounts – deductions from the
invoice price when payment is made within
the discount period COST OF INVENTORIES OF A SERVICE PROVIDER
o Its purpose is to encourage prompt
- Includes primarily of the labor and other
payment or early payment of costs of personnel directly engaged in
account providing the service (supervisory personnel
o Purchase discount/sales discount and overhead)
METHOD OF RECORDING PURCHASES - Generally, they are classified as work in
progress
- Gross method – both the purchase and - Labor and other costs relating to sales and
account payable are recorded at gross general administrative personnel are
(100%) excluded (classified as expense)
- Net method – both the purchases and
accounts payable are recorded at net of
discount COST FORMULAS
Transaction Gross Net - Cost formulas deal with the computation of
Purchase Purchase and Purchase and cost of inventories that are charged as
AP at gross AP at net
expense and when the related revenue is
Payment AP Accounts
recognized as well as the cost of unsold
withing the Cash payable and
inventories at the end of the period that are
discount Purchase cash at net
period Discount recognized as an asset
Payment Accounts AP o Specific identification – specific
outside the Payable and PD costs are attributed to identifies
discount cash at gross Cash items of inventory
  Characteristics:
 The cost of inventory
is determined by
multiplying the units
on hand by their
actual unit cost
 This should be used
for inventories that
are not ordinarily
interchangeable and
those that are
segregated for
specific projects
 The flow of inventory
corresponds with the
actual physical flow
 It is very costly to
implement
o First-in, First-out – it is assumed that
inventories that were purchased or
produced first are sold first or issued
to production
 Characteristics
 The costs of sales
represent costs from
earlier purchases
 The cost of ending
inventory represents
costs from the most
recent purchases
 It favors balance
sheet presentation
 There is improper
matching of costs
against revenue
because the COGS is
stated as an earlier
purchase price
- Inventories shall be measured at lower cost
 In rising prices, FIFI
produces the highest
- Net realizable value refers to the estimated
net income
o Weighted average – the cost of sales
and ending inventory are determined
based on the weighted average cost
of beginning inventory and all
- Assets shall not be carried in excess of
inventories purchase or produced
during the period
 Characteristics
 The weighted average
unit cost is computed
by dividing the total
costs available for - If the inventories are damaged, wholly or
sale by the total
number of units
available for sale - If the estimated cost of completion or the
 The weighted average
unit costs is
multiplied with the
inventory quantity on
hand to arrive at the
cost of the ending
inventory
 It is relatively easy to
apply, especially with
the use of computers
 It produces inventory
valuation that
approximates current
value if there is rapid
turn over of inventory
 There may be
considerable lag
between current cost
and inventory
valuation since it
includes early
purchases
 In rising prices,
inventory valuation
will be less than
current cost
 Moving average – the terms
used in computing the
weighted average unit cost of
inventory under the perpetual
method
 A new weighted
average cost per unit
is computed after
every purchase or
purchase return
NET REALIZABLE VALUE
and net realizable value
selling price in the ordinary course of
business less the estimated cost of
completion and the estimated costs
necessary to make the sale
amounts expected to realized from their
sale or use
UNRECOVERABLE INVENTORIES
partially obsolete, or if the selling prices
have declined
estimated cost of disposal has increased
DETERMINATION OF NET REALIZABLE VALUE made – loss (other expense) is recorded in
the period of the price decline
- Inventories are written down to net
- Entry:
realizable value on an item per item or
o Loss on purchase commitment
individual basis
 Estimated liability for
- It is not appropriate to write down
purchase commitment
inventories based on classification of
- If the market price rises at the time of the
inventory (finished goods or all inventories
purchase – gain on purchase commitment
in a particular industry or geographical
is recorded that is limited to the loss on the
segment)
purchase commitment previously recorded
- Materials and other supplies for production
are not written down to NRV if the related
finished products are expected to be sold at
or above cost
- If the price of the material and other
supplies declines and the cost of the related
finished products exceeds NRV, the material
and other supplies are written down to NRV
using its replacement cost

ACCOUNTING FOR INVENTORY WRITEDOWN

- If the cost is lower than NRV – no

adjustment
- If the NRV is lower than cost – inventory is
measured at NRV
o Direct method or the COGS method
– the inventory is recorded at lower
of cost or NRV
 Any loss on inventory write-
down is not accounted for
separately but absorbed or
buried in the COGS
 Ending inventory is recorded
opposite the income and
expense summary account at
the lower of cost or NRV
o Allowance method – the inventory is
recorded at cost and any loss is
accounted for separately
 Gain or loss in inventory
write-down is recorded as an
adjustment to the COGS
 Allowance for inventory
write-down is a reduction in
the cost of the inventory

PURCHASE COMMITMENTS

- Obligations of the entity to acquire certain

goods sometime in the future at a fixed
price and fixed quantity
o When purchase commitments are
significant or unusual – disclosure is
required
o Losses from firm and non-
cancellable commitments shall be
recognized
- Decline in the purchase price after a non-
cancellable purchase commitment has been