Inventories

Inventories- are assets a. held for sale in the ordinary course of business (FG); b. In the
process of production for such sale (WIP); c. In the form of materials or supplies to be
consumed in the production process or in the rendering of services (RM and manufacturing
supplies). Ex. a. Merchandise purchased by a trading entity and held for resale; b. Land and
other property held for sale in the ordinary course of business (necessary, normal or usual
business activities of an entity); c. Finished goods, goods undergoing production, and raw
materials and supplies awaiting use in the production process by a manufacturing entity.
Inventories are recognized when they meet the definition of inventory and they qualify for
recognition as assets, such as when the entity obtains control over them. Control normally
stems from legally enforceable rights, legal title normally passes to the buyer when he takes
physical possession over the goods. However, ownership is not always necessary for control to
exist because control can arise from other rights. The transfer of control may precede, coincide
with, or comes after the transfer of physical possession. An entity considers all relevant facts
and circumstances in determining whether it has control, including the following:
1. Goods in transit- goods that the seller has already shipped but the buyer has not yet
received.
Ownership/passing of title of the goods depends on the sale term: FOB shipping
point/destination. Freight: Freight prepaid/collect; FAS (free alongside); Ex-ship-seller assumes
all expenses until the goods are unloaded from the carrier; CIF – the buyer pays the cost,
insurance and freight; CF- the buyer pays the cost and freight. The seller must deliver the
goods to the carrier and pay the cost of loading. Thus, title passes to the buyer upon delivery
of the goods to the carrier.
As a rule, the entity who owns the goods being shipped should pay for the shipping costs. No
special accounting is necessary if the term of the sales contract is either FOB shipping pt,
Freight collect and FOB destination, Freight prepaid. Special accounting arises when the term
of the sale contract is either FOB shipping point, freight prepaid or FOB destination, freight
collect.
Illustration: Goods in transit
ABC Co. purchased goods with invoice price of P100,000 on account on December 27, 2022.
The shipping cost is P1,000. The seller shipped the goods on December 31, 2022. ABC Co.
received the goods on January 2, 2023 and settled the account on January 5, 2023. Prepare the
journal entries in the books of ABC Co. under the different terms of purchase:
a. FOB shipping point, freight collect
b. FOB destination, freight collect
2. Consigned goods – consignor deliver goods to the consignee, consigned goods remain in the
consignor’s inventory. Transfers of consigned goods are recorded through memo entries.
Freight and incidental costs form part of the cost of the cosigned goods. Repair costs and other
maintenance cost are charged as expense. The consignee is entitled to a commission.
Illustration 1: Total inventory
ABC Co’s records on December 31, 2022, show the following:
Goods located at the warehouse (physical count), P3,800,000; Goods located at the sales
department (at cost), P13,600,000; Goods-in transit purchased FOB destination, P1,600,000;
Goods sold, FOB shipping point, P10,000,000 (Gross profit rate-30%); Goods in transit- FOB
shipping point, P2,100,000; Freight incurred under “freight prepaid” for the goods purchased
under FOB shipping point, P60,000; Goods held on consignment from XYZ, Inc., P1,800,000.
Requirement: Compute for the total inventory on December 31, 2022.
Illustration 2: Consigned goods
ABC Co. consigned goods, costing P100,000, to XYZ, Inc. Transportation costs is P2,000. Repair
costs for damaged goods, P500. ABC paid P1,000 to XYZ, Inc. as advance commission. How
much is the consigned goods? ____________________________
Illustration 3: Correct inventory and accounts payable
On December 31, 2022, ABC Co. has a balance of P160,000 in its inventory account determined
through physical count and a balance of P100,000 in its accounts payable account. The
balances were determined before any necessary adjustment for the following:
a. Merchandise costing P10,000 shipped FOB shipping point from a vendor on December 20,
2022, was received and recorded on January 5, 2023.
b. A package containing a product costing P50,000 was standing in the shipping area when the
physical inventory was conducted. This was not included in the inventory count because it was
marked “Hold for shipping instructions.” The sale order was dated December 17 but the
package was shipped and the customer was billed on January 3, 2023.
c. Goods in the shipping area were included in inventory because shipment was not made until
January 4, 2023. The goods, billed to the customer FOB shipping point on December 30, 2022,
had a cost of P20,000.
d. Goods shipped FOB destination on December 27, 2022, from a vendor to ABC Co. were
received on January 6, 2023. The invoice cost of P30,000 was recorded on December 31, 2022
and also included in the count as “goods in transit.”
Requirement: Determine the adjusted balances of 1) inventory and 2) accounts payable as of
December 31, 2022.
3. Inventory financing agreements – inventories may be acquired or sold under various forms
of financing agreements, which may include the following:
a. Product financing agreement- a seller sells inventory to a buyer but assumes an obligation to
repurchase it at a later date. Seller retains ownership over the inventory because this
arrangement does not result to the transfer of control over the asset.
b. Pledge of inventory- a borrower uses its inventory as collateral security for a loan. The
borrower retains ownership over the inventory because this arrangement does not result to the
transfer of control over the asset.
c. Loan of inventory- an entity borrows inventory from another entity to be replaced with the
same kind of inventory. The borrower includes the loaned goods in its inventory because this
arrangement results to transfer of control over the asset.
4. Sale with unusual right of return- the buyer does not recognize any inventory when: the
buyer assesses that no economic-benefits will be derived from the goods or the when the buyer
intends to return the goods to the seller within the time limit allowed under the sale
agreement.
5. Sale on trial-the legal title over the good does not pass to the prospective customer until he
approves it and purchase it.
6. Installment sale-the possession of the goods is transferred to the buyer but the seller retains
legal title solely to ensure the collectability of the amount due is considered as a regular sale,
hence, the goods are excluded from the seller’s inventory and included in the buyer’s inventory
at the point of sale.
7. Bill and hold sale- a seller bills a customer but retains physical possession of the goods until
it is transferred to the customer at a future date. The goods are excluded from the seller’s
inventory and included in the buyer’s inventory upon billing.
8. Lay away sale- goods are delivered only when the buyer makes the final payment in a series
of installments. The goods sold under a lay away sale are included in the seller’s inventory.