Inventories

(Determining Inventory Quantity & Ownership)

Inventories
 assets held for sale in the ordinary course of business, in the process of
productions for such sale or in the form of materials or supplies to be
consumed in the production process or in the rendering of services.
 Inventories encompass goods purchased and held for resale.

Classifications of Inventory
Merchandising Company Manufacturing Company
 Merchandise Inventory  Finished Goods
 Goods/Work-inprocess
 Raw Materials
 Factory or manufacturing
supplies
Regardless of the classification, companies report all inventories
under Current Assets on the balance sheet.

Definitions:
 Finished Goods - Completed products which are ready for sale.
 Goods in process - Partially completed products which require further
process or work before they can be sold.
 Raw materials - Direct materials that are to be used in the production process;
no work or process has been done on them yet.
 Factory/Manufacturing Supplies - materials or supplies to be used in
production; similar to raw materials but their relationship to the end product
is indirect.

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
Applying this legal test, the following are includible in inventory:
 Goods owned and on hand;
 Goods in transit and sold FOB destination;
 Goods in transit and purchased FOB shipping point
 Goods out on consignment;
 Goods in the hands of salesmen or agents;
 Goods held by customers on approval or on trial

Exception to the legal test.

Goods on installment are included in the inventory of the buyer and excluded
from that of the seller, the legal test to the contrary notwithstanding

Determining Ownership of Goods

Goods in Transit
 Purchased goods not yet received.
 Sold goods not yet delivered.

Goods in transit should be included in the inventory of the company that

has legal title to the goods. Legal title is determined by the terms of sale.

FOB Shipping Point (Buyer pays the freight cost)

 Ownership of the goods passes to the buyer when the public carrier accepts
the goods from the seller.
FOB Destination (seller pays freight cost)
 Ownership of the goods remains with the seller until the goods reach the
buyer

Consigned Goods
 Goods held for sale by one party.
 Ownership of the goods is retained by another party… the consignor.

 Merchandise is included in the inventory of the consignor, the owner of the

inventory.

 Freight and handling charges on goods out on consignment are part of the
cost
 Accounting for Inventories
Periodic System Perpetual System
 Calls for physical counting of  Requires the maintenance of
goods on hand at the end of the records called stock cards (running
accounting period to determine summary of inventory inflow and
quantities. outflow)
 Generally used when the  Used for where the items treated
individual items have small peso individually represent a large peso
investment (groceries, hardware, investment.
auto parts)  Would be able to know the
inventory on hand a particular
moment in time (jewelry and cars)

Purchases Inventory
Accounts payable Accounts payable

Freight-in Inventory
Cash Cash

Accounts payable Accounts payable

Purchase returns Inventory

Accounts receivable Accounts receivable

Sales Sales
Cost of Goods Sold
Inventory

Sales returns Sales returns

Accounts Receivable Accounts Receivable
Inventory
Cost of Goods Sold

Inventory, end
Income Summary As a rule, no adjustment
Trade and Cash Discounts
 Trade (quantity) discounts are deductions or markdown from listed prices to
encourage buyers to purchase products
 Trade discounts are not recorded.
 Cash (sales) discounts are inducements to customers for prompt payment of
amounts billed
 Cash discounts are normally recorded and appear in books as a reduction of
sales revenue.

Accounting for Cash Discount

Gross method – the Purchases and Accounts payable are recorded at gross
amount of the invoice.
This is the common and widely used method.
Net method – the Purchases and Accounts Payable are recorded at net amount
of the invoice (invoice price less the cash discount)

Gross Method Net Method

Record purchases at gross amount Record purchases at gross amount less
When the entity takes the discount, cash discount
record cash discounts When the entity forfeits discount, record
Cash discounts reduce gross purchase discount lost;
purchases Report purchase discount lost as other
expense

Cost of Inventories
 Cost of Purchase
 Cost of Conversion
 Other costs incurred in bringing the inventories to their present location and
condition
Include all expenditures necessary to bring an item to a salable condition and location.
Other cost is included only to the extent that it is incurred in bringing the
inventories to their present location and condition.
Ex. Cost of designing product for specific customers.

Other Costs
do not include…
 Abnormal amount of wasted materials, labor and other production cost;
 Storage costs, unless those costs are necessary in the production process prior
to a further production stage;
 Administrative overheads that do not contribute to bringing the inventories
to their present location and condition;
 Distribution or Selling costs
These are recognized as expense in the period when incurred

Cost of Inventories –
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
recognized as expense in the period incurred.

Determining Inventory Quantities

Taking a Physical Inventory

Involves counting, weighing, or measuring each kind of inventory on hand.
Taken
 when the business is closed or business is slow.
 at end of the accounting period.
Reasons for taking Physical Inventory
Perpetual System
1. Check accuracy of inventory records.
2. Determine amount of inventory lost (wasted raw materials, shoplifting, or
employee theft).

Periodic System
1. Determine the inventory on hand.
2. Determine the cost of goods sold for the period

INVENTORY COST FLOW

(Inventory Costing)

Inventory Cost Flow Assumptions

Management decisions in accounting for inventory involve the following:
1. Items included in inventory and their costs.
2. Costing method (specific identification, FIFO, or weighted average).
3. Inventory system (perpetual or periodic).

First-In, First-Out Assumes costs flow in the order

FIFO incurred

Last-In, First-Out Assumes costs flow in the reverse order

LIFO incurred

Assumes costs flow at an average of the

Weighted Average
cost available
First-In, First-Out (FIFO)
Oldest cost Cost of Goods Sold
Recent Costs Ending Inventory
 Earliest goods purchased are first to be sold.
 Often parallels actual physical flow of merchandise.
 Generally good business practice to sell oldest units first.

Last-In, First-Out (LIFO)

Recent cost Cost of Goods Sold
Oldest Costs Ending Inventory
 Latest goods purchased are first to be sold.
 Seldom coincides with actual physical flow of merchandise.

Weighted Average - Periodic

When a unit is sold, the average cost of each unit in inventory is assigned to cost
of goods sold.
Total Cost of Goods Available for Sale
Total Number of Units Available for Sale

 Allocates cost of goods available for sale on the basis of weighted-average

unit cost incurred.
 Assumes goods are similar in nature.
 Applies weighted-average unit cost to the units on hand to determine cost of
the ending inventory.

Weighted Average - Perpetual

 Popularly known as moving average method
 When a unit is sold, the average cost of each unit in inventory is assigned to
cost of goods sold.
Total Cost of Goods Available for Sale
Total Number of Units Available for Sale

 A new weighted average cost must be computed after every purchase and
purchase return.
Specific Identification
 Specific identification means that specific costs are attributed to identified
items of inventory.
 Appropriate for inventories that are segregated for a specific project and
inventories that are not ordinarily interchangeable.
Major argument for this method is that the flow of inventory cost corresponds
with the actual physical flow of goods.
 Practiced in Perpetual system
 In Periodic system, it’s practice is relatively rare