DHVSU BSA 1N/ CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS/ KS

PAS 2 INVENTORIES
It prescribes accounting treatment for inventories.
Primary Issue: The determination of cost to be recognized as asset and carried forward until it is
expensed.
Excluded in PAS 2:
1. Assets accounted for under other standards:
a. Financial Instruments (PAS 32 and PFRS 9)
b. Biological Assets and Agricultural produce at the point of harvest (PAS 41)
2. Assets not measured under the lower of cost or net realizable value (NRV) under PAS 2
a. Inventories of producers of agricultural, forest, and mineral products measured at net
realizable value in accordance with well-established practices in those industries.
b. Inventories of commodity broker-traders measured at fair value less cost to sell.
INVENTORIES
Assets:
1. Held for Sale in the ordinary course of business (FINISHED GOODS)
Ordinary Course- necessary, normal or usual business activities of an entity.
2. In the process of production for such sale (WORK IN PROCESS)
3. In the form of materials or supplies to be consumed in the production process or in the
rendering of services (RAW MATERIALS AND MANUFACTURING SUPPLIES)
MEASUREMENT
-measured at LOWER OF COST AND NET REALIZABLE VALUE
COST
a. Purchase Cost
✓ Purchase Price net of trade discounts and other rebates
✓ Import duties
✓ Non-refundable or non-recoverable purchase taxes
✓ Transport
✓ Handling and other costs directly attributable to the acquisition of the inventory

b. Conversion Costs
Necessary in converting Raw Materials into Finished Goods
✓ Costs of direct labor
✓ Production Overhead

c. Other Costs necessary in bringing the inventories to their present location and condition.

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EXCLUDED FROM THESE COSTS OF INVENTORIES:

-are treated as an expense in the period it was incurred
a. abnormal amounts of wasted materials, labor or other production costs
b. storage costs, unless those costs are necessary in the production process before
a further production stage
c. administrative overheads that do not contribute to bringing the inventories to
their present location and condition
d. selling costs
K Company acquires inventories and incurs the following costs:

Purchase price, gross of trade discount 250,000.00

Trade discount 25,000.00
Non-refundable purcahse tax, not included in the purchase price
7,000.00
above
Freight In (Transportation Costs) 20,000.00
Commission to broker 3,000.00
Advertisement costs 15,000.00

Determine the cost of inventories purchased:

Solution:

Purchase price, gross of trade discount 250,000.00

Trade discount - 25,000.00
Non-refundable purcahse tax, not included in the purchase price
7,000.00
above
Freight In (Transportation Costs) 20,000.00
Commission to broker 3,000.00
255,000.00

Advertising costs are SELLING COSTS and are expensed in the period in which they are incurred.
COST FORMULA
1. SPECIFIC INDENTIFICATION
- Shall be used for inventories that are not ordinarily interchangeable and those segregated
for specific projects
- Specific costs are attributed to identified items of inventory
- Cost of Sales- represents actual costs of the specific items sold
- Ending Inventory- represents actual costs of the specific items on hand
- Not appropriate when inventories consist of large number of items that are ordinarily
interchangeable
- Simply multiply UNITS on HAND by ACTUAL UNIT COST

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 DHVSU BSA 1N/ CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS/ KS

2. FIRST-IN, FIRST-OUT (FIFO)

- Inventories purchased or produced first are sold first, the unsold inventories at the end of
the period are those most recently purchased or produced
- Cost of Sales - represents actual costs from earlier purchases
- Ending Inventory- represents actual costs from the most recent purchases

Example:

K Trading Company buys and sells Product A. Movements in the inventory of Product A
during the period are as follows:

DATE TRANSACTION UNITS UNIT COST TOTAL COST

SEPT. 8 BEGINNING INVENTORY 200 12.00 2,400.00
16 PURCHASE 400 15.00 6,000.00
20 SALE 420
22 PURCHASE 300 17.00 5,100.00

SOLUTION:

STEP 1: COMPUTE FOR ENDING INVENTORY IN UNITS

TRANSACTION UNITS
8 BEGINNING INVENTORY 200
16 PURCHASE 400
20 SALE 420
22 PURCHASE 300
Ending inventory ( in units) 480

STEP 2: COMPUTE FOR ENDING INVENTORY AT COST.

TRANSACTION UNITS UNIT COST TOTAL COST
FROM SEPT. 22 PURCHASE 300 17.00 5,100.00
FROM SEPT. 16 PURCHASE (480
Ending Inv.-300 last puchase) 180 15.00 2,700.00
ENDING INVENTORY (AT COST) 7,800.00

Unit cost of First Purchase Sept. 16

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 DHVSU BSA 1N/ CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS/ KS

STEP 3: COMPUTE FOR COST OF SALES.

DATE TRANSACTION UNITS UNIT COST TOTAL COST

SEPT. 8 BEGINNING INVENTORY 200 ₱12 2,400.00
16 PURCHASE 400 15 6,000.00
22 PURCHASE 300 17 5,100.00
Total goods available for sale 900 13,500.00
Less: Ending Inventory -480 - 7,800.00
Cost of Sales 420 5,700.00

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.
Example:
A. Calculated on a PERIODIC Basis
STEP 1: COMPUTE FOR THE TOTAL GOODS AVAILABLE FOR SALE IN UNITS AND AT COST
DATE TRANSACTIONS UNITS UNIT COSTS TOTAL COSTS
Sept. 8 BEGINNING INVENTORY 200 ₱12 2,400.00
16 PURCHASE 400 ₱15 6,000.00
22 PURCHASE 300 ₱17 5,100.00
TOTAL GOODS AVAILABLE FOR SALE 900 ₱13,500.00

STEP 2: COMPUTE FOR WEIGHTED AVERAGE UNIT COST

FORMULA:

Weighted Total goods available for sale (TGAS) in pesos

Average Cost Total goods available for sale (TGAS) in units

Weighted average unit cost = Php 13,500 / 900 =Php 15.00

STEP 3: COMPUTE FOR ENDING INVENTORY AT COST

Ending Inventory in units 480

Weighted Average unit cost Php 15.00
Ending inventory at cost Php 7,800.00
STEP 4: COMPUTE FOR COST OF SALES

Total goods available for sale (at cost) Php 13,500.00

Less: Ending inventory, at cost 7,800.00
Cost of Sales Php 5,700.00

FOR CLASS BSA 1N/ CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS / MA’AM KS
 DHVSU BSA 1N/ CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS/ KS

B. Calculated AS EACH ADDITIONAL PURCHASE IS MADE or Moving Average

DATE TRANSACTION UNITS UNIT COST TOTAL COST

Moving Average Cost =
SEPT. 8 BEGINNING INVENTORY 200 12.00 2,400.00
TGAS at Cost 8,400
16 PURCHASE 400 15.00 6,000.00 TGAS in Units 600
600 14.00 8,400.00
20 SALE -420 - 5,880.00 =P14.00
22 PURCHASE 300 17.00 5,100.00
480 7,620.00

Cost of Sales = 420 units sold X 14.00 moving ave. cost = PhP 5,880

NET REALIZABLE VALUE (NRV)

- Per PAS 2.6, this is the estimated selling price in the ordinary course of business less the
estimated costs of completion and the estimated costs necessary to make the sale.
- Refers to the net amount that an entity expects to realize from the sale of inventory in the
ordinary course of business.
- This is entity-specific value. It may not equal to fair value less costs to sell.
- The use of lower of cost and NRV in measuring inventories is in line with the basic
accounting concept that an asset shall not be carried at an amount that exceeds its
recoverable amount.
- If the cost of an inventory is written down to NRV due to damage, obsolescence, declined
prices or estimated costs to complete or sell have increases, the write down is recognized
as an expense.
- If the NRV subsequently increases, the previous write down is reversed, and said reversal
shall not exceed its original write down so that the new carrying amount is lower of the
cost and revised NRV.
- Write down of inventories are usually carried out on an item-by-item basis.
To illustrate, K Company has the following inventories:

Case 1

Product A Product B
Cost 200,000.00 400,000.00
Estimated Selling Price 240,000.00 420,000.00
Estimated Costs to Sell 30,000.00 40,000.00

Compute PRODUCTS A and B Value in the K Company’s Statement of Financial Position.

FOR CLASS BSA 1N/ CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS / MA’AM KS
 DHVSU BSA 1N/ CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS/ KS

Solution:

Product A Product B
Cost 200,000.00 400,000.00 Total Inventory in
Estimated Selling Price 240,000.00 420,000.00 Statement of Financial
Estimated Costs to Sell - 30,000.00 - 40,000.00 Position is PhP 580,000
Net Realizable Value 210,000.00 380,000.00 (Product A 200,000 cost +
Product B 380,000 nrv)
Lower 200,000.00 380,000.00
Amount of Write-Down - 20,000.00 Write Down 20,000 is
expensed in Profit or Loss
Product A NEED NOT be
WRITTEN DOWN because
Product B SHALL be
its cost is LOWER than NRV
WRITTEN DOWN because
its cost is EXCEEDS than
NRV. (400,000 COST LESS
380,000 NRV)
Assuming PRODUCT B’s NRV Increases:

Cost 90,000 The increase is P40,000 (130,000 less 90,000)

Net Realizable Value 130,000 The AMOUNT OF REVERSAL that KCompany can recognize is
LIMITED to P20,000 the original amount of write down.

Inventory in Statement of Financial Position amounts to PhP 110,000

(90,000 cost plus 20,000 reversal)

- Raw Materials inventory is not written down below cost IF the finished goods in which
they will be incorporated are expected to be sold at or above cost. If this is not the case,
the raw materials are written down to their NRV.
- The best evidence of NRV for raw materials is replacement cost.

CASE 2 K Company’s Inventories:

RAW MATERIALS FINISHED GOODS

Cost 80,000.00 120,000.00
Replacement Cost / NRV 60,000.00 140,000.00

VALUE OF INVENTORIES IN STATEMENT OF FINANCIAL POSITION

ANSWER: PHP 200,000 TOTAL COST (80,000 PLUS 120,000)

The RAW MATERIALS NEED NOT be written down to replacement cost because the NRV of
finished goods exceeds the cost.

FOR CLASS BSA 1N/ CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS / MA’AM KS
 DHVSU BSA 1N/ CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS/ KS

EXPENSE RECOGNITION OF INVENTORIES

- The carrying amount of an inventory that is sold is charged as expense in the period in
which the related revenue is recognized.
- The write-down of inventories to NRV and all losses of inventories are recognized as
expense in the period the write-down or loss occurs.
- The amount of any reversal of any write-down of inventories, arising from an increase in
net realizable value shall be recognized as a reduction in the amount of inventories
recognized as an expense in the period in which the reversal occurs.

CAPITALIZED AS COST OF CONSTRUCTED ASSET

- Inventories that are used in the construction of another asset is not expensed but rather
capitalized as cost of the constructed asset. Example: Inventories used in constructing a
building. The cost will form part of the building cost and will be included in the
depreciation.

FOR DISCLOSURES:
1. Accounting policies adopted in measuring inventories, including the cost formula used;
2. Total carrying amount of inventories and the carrying amount in classifications appropriate to
the entity;
3. Carrying amount of inventories carried at fair value less costs to sell;
4. Amount of inventories recognized as an expense during the period;
5. Amount of any write-down of inventories recognized as an expense in the period;
6. Amount of any reversal of write-down that is recognized as a reduction in the amount of
inventories recognized as expense in the period;
7. Circumstances or events that led to the reversal of a write-down of inventories; and
8. Carrying amount of inventories pledged as security for liabilities.

FOR CLASS BSA 1N/ CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS / MA’AM KS
 DHVSU BSA 1N/ CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS/ KS

INVENTORIES:

1. Land or any other assets can be classified as part of inventories if the entity is engaged in
buying and selling of this kind of property such as real estate business.
2. Work-in-Process refers to the products that are yet to be completed and transferred to the
entity’s warehouse. Although not yet finished, they will already be part of the entity’s
inventory items.
3. All finished goods that are already available for sale will form part of inventories.
4. For trading businesses, inventory items will only comprise of the goods purchased or known as
merchandise inventories.
5. For manufacturing businesses, 3 types of items included in the inventory account:
a. Raw Materials
b. Work-In-Process
c. Finished Goods
6. Ownership of Goods:
*When the company has the title to the goods, regardless of their location
*If goods are still in TRANSIT, the freight terms is considered in determining the ownership of
inventories
- Whoever owns the goods during its shipment should also PAY for the Freight Charges.

FOB SHIPPING POINT

FREIGHT COLLECT – buyer made the
actual payment for the freight

• TITLE is transferred to the BUYER UPON

SHIPMENT OF GOODS
• The BUYER is responsible for the delivery charges
• Such COST will be considered as FREIGHT IN and will become part of the initial cost of the
inventory

FREIGHT PREPAID – seller made the

FOB DESTINATION actual payment for the freight

• TITLE is transferred to the BUYER ONLY UPON RECEIPT OF THE GOODS AT THE POINT OF
DESTINATION
• The SELLER is responsible for the delivery charges
• Such COST will be considered as FREIGHT OUT and will become part of OPERATING EXPENSES

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Inventories under Consignment:

Consignment- an agreement between two parties wherein the consignor is contracting consignee to
sell the goods on its behalf.

OWNERSHIP of GOODS remains with CONSIGNOR.

*Goods held on consignment – ordinarily associated with CONSIGNEE thus, inventory account will
NOT FORM PART of ITS Inventories

*Goods out on consignment – ordinarily associated with CONSIGNOR thus, inventory account will
FORM PART of ITS Inventories

INCLUDED IN THE INVENTORY:

1. Goods in transit and sold FOB Destination
2. Goods in transit and purchased FOB Shipping point
3. Goods out on consignment
4. Goods purchased under bill and hold arrangement
5. Segregated normal order goods
6. Goods purchased under installment basis
7. Goods sold with buyback arrangements
8. Goods purchased with refund offers
9. Goods owned and on hand (exclude goods held on consignment)
10. Goods in the hands of salesmen or agents
11. Goods held by customers on approval or trial

Inventory Systems:
1. Periodic Inventory Systems
- does not maintain records of inventories during the year and relies on physical count at the
end of the accounting period
- used for low prices but maintained in large quantities such as groceries, hardware
2. Perpetual Inventory Systems
-maintains a detailed record of inventories
-applicable to high value inventories such as cars, jewelry
-facilitates purchasing and production planning
-ensures adequate on-hand inventories

FOR CLASS BSA 1N/ CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS / MA’AM KS