Republic of the Philippines

NORTHERN NEGROS STATE COLLEGE OF SCIENCE & TECHNOLOGY

Old Sagay, Sagay City, Negros Occidental
(034)722-4120, www.nonescost.edu.ph

INTERMEDIATE ACCOUNTING I
COURSE
(AISAE 107)

MODULE 1 (5HOURS) UNIT 2: INVENTORIES

COURSE FACILITATOR ANABELLE A. SENADOR, CPA, MBA, CTT

FB Messenger Belle Senador

CONTACT DETAILS Email Address belle.anne27a@gmail.com

Phone No. 09328706298

I. INTRODUCTION
This part of your module discusses the nature, recognition, measurement, presentation and
disclosure of inventories, as a non-financial asset in the financial statements.

II. LEARNING OUTCOMES:

At the end of this lesson, you should be able to:
1. Identify the major classes of inventory and terms related as to ownership
2. Distinguish between the two systems of accounting of inventories
3. Identify the cost component of inventories
4. Summarize the cost formulas used for valuation of inventories
5. Explain the measurement and presentation of inventories in the statement of financial position
6. Identify the necessary disclosures pertaining to inventories in the financial statements
7. Apply the concepts of accounting of inventories through problem solving

III. MOTIVATION
Write your thoughts on this quote by Taiichi Ohno, “The more inventory a company has, the less
likely they will have what they need.”
________________________________________________________________________________
_______________________________________________________________________________

Presentation
a. What are the classes of inventories?
b. How do we account for goods in transit?
c. How do we record and measure inventories?

IV. TEACHING POINTS

1.1 Inventories
 Are assets which are held for sale in the ordinary course of business (Merchandise
Inventory/Finished Goods), in the process of production for such sale (Goods in
process/Work in progress) or in the form of materials (Raw Materials) or supplies (Factory

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 or Manufacturing Supplies) to be consumed in the production process or in the rendering of
services
 Are broadly classified into two, namely inventories of a trading concern and inventories of
manufacturing concern
1.1.1 Goods includible in the inventory
 The general rule is that all goods to which the entity has title shall be included in inventory,
regardless of location.
 In other words, it is ownership that determines inventory inclusion or inventory exclusion

1.1.2 Terms related to the ownership of goods in transit

 FOB destination. It means that the ownership of the goods purchased is vested in the
buyer upon receipt thereof. Accordingly, the seller is still the owner of the goods in transit
and shall legally be responsible for freight charges and other expenses up to the point of
destination
 FOB shipping point. It means that the ownership of the goods purchased is vested in the
buyer upon the shipment thereof. Accordingly, the buyer is already the owner of the goods
in transit and shall legally be responsible for freight charges and other expenses from the
point of shipment to the point of destination

1.1.2.1 Terms related as to whom actually paid the freight charges (transportation expense)
 Freight collect. It means that the freight charge on the goods shipped is not yet paid.
Thus, the common carrier shall collect the same from the buyer. Under this, freight
charge is actually paid by the buyer
 Freight prepaid. It means that the freight charge on the goods shipped is already
paid by the seller.

2.1 Two (2) Systems of Accounting for Inventories

1. Periodic or physical system.
 It calls for the physical counting of goods on hand at the end of the accounting period to
determine quantities, which are then multiplied by the recorded unit costs to get the
inventory value.
 Under this approach, the cost of goods is computed only at the end of the period by
deducting the physical inventory from the total cost of goods available for sale
 It is generally used when the individual inventory items have small peso investment,
such as groceries, hardware and auto parts
2. Perpetual system
 It requires the keeping of stock cards that summarizes inventory inflow and outflow.
Inventory increases and decreases are reflected in the stock cards and the resulting
balance represents the inventory
 Under this approach, the cost of goods sold is computed at the time of every sale
 It is commonly used when the inventory items treated individually have large peso
investments such as jewelry and cars.
 When this is used, a physical count of the units on hand should at least be made once
a year or at frequent intervals to confirm the balances appearing on the stock cards. If
there is a difference between the balance per book and per count, an adjustment is
necessary to recognize any “inventory shortage or overage”

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 3.1 Cost of Inventories (Goods provider)
1. Cost of purchase.
 It comprise the purchase price, import duties and irrecoverable taxes, freight, handling
and other cost directly attributable to the acquisition of finished goods, materials and
services
 Trade discounts, rebates and other similar items are deducted in determining the cost
of purchase
 It shall not include foreign exchange differences which arise directly from the recent
acquisition of inventories involving a foreign currency
 When inventories are purchased with deferred settlement terms, the difference
between the purchase price for normal credit terms and the amount paid is recognized
as interest expense over the period of financing
2. Cost of Conversion
 It includes cost directly related to the units of production such as direct labor
 It also includes systematic allocation of fixed and variable production overhead that is
incurred in converting materials into finished goods
3. Other cost incurred in bringing the inventories to their present location and
condition

3.1.1 Cost not included as part of inventories (expense immediately)

 Abnormal amounts of wasted materials, labor and other production costs
 Storage cost of finished goods
 Administrative overheads that do not contribute to bringing inventories to their
present location and condition
 Distribution costs

3.2 Cost of inventories (Service provider)

 It consists primarily of the labor and other cost of personnel directly engaged in providing the
service, including supervisory personnel and attributable overhead

4.1 Inventory Cost Formula

PAS 2, expressly provides that the cost of inventories shall be determined by using either:
 First in, First out (FIFO)
 Weighted average (Periodic and Perpetual)
 Specific Identification

4.1.1 First in, First out (FIFO)

 This method assumes that the goods first purchased are first sold and consequently
the goods remaining in the inventory at the end of the period are those most recently
purchased or produced.
 In other words, The FIFO is in accordance with the ordinary merchandising procedure
that the goods are sold in the order they are purchased. The rule is first come, first sold
 It favors the statement of financial position because the inventory is stated at current
replacement cost
 The objection is that there is improper matching of cost against revenue because the
goods sold are stated at earlier or older prices resulting in understatement of cost of
sales

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 4.1.2 Periodic Weighted Average
 It means that cost of the beginning inventory plus the total cost of purchases during the
period is divided by the total units purchased plus those in the beginning inventory to
get a weighted average units cost
 Such weighted average unit cost is then multiplied by the units on hand to derive the
inventory value
 The average unit cost is computed by dividing the total cost of goods for sale by the
total number of units available for sale

4.1.3 Perpetual Weighted Average (Moving Average)

 Under this method, a new weighted average unit cost must be computed after every
purchase and purchase return
 Thus, the total cost of goods available after every purchase and purchase return is
divided by the total units available for sale at this time to get a new weighted average unit
cost
 Such new weighted average unit cost is then multiplied by the units on hand to get the
inventory cost
 This method requires the keeping of inventory stock cards in order to monitor the moving
unit cost after every purchase

4.1.4 Specific Identification

 It means that specific costs are attributed to identified items of inventory
 The cost of the inventory is determined by simply multiplying the units on hand by their
actual unit cost
 This requires records which will clearly determine the actual cost of goods on hand
 This method is appropriate for inventories that are segregated for a specific project and
inventories that are not ordinarily interchangeable
 This method is very costly to implement even with high-speed electronic computers

5.1 Measurement of Inventories

 Inventories shall be measured at the lower of cost and net realizable value (LCNRV)
 This practice is in consistent with the view that assets shall not be carried in excess of
amounts expected to be realized from their sale or use

5.1.1 Net Realizable Value

 Is the estimated selling price in the ordinary course of business less the estimated cost
of completion and the estimated cost of disposal

5.1.1.1The cost of inventories may not be recoverable under the following circumstances:
 The inventories are damaged
 The inventories have become wholly or partially obsolete
 The selling price have declined
 The estimated cost of completion of the estimated cost of disposal has increase

5.2 Determination of Net Realizable Value

 Inventories are usually written down to NRV on an item by item or individual basis
 If the cost is lower than net realizable value, the inventory is stated at cost and the
increase in value is not recognized

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  If the net realizable value is lower than cost, the inventory is measured at net
realizable value and the decrease in value is recognized as expense

5.3 Methods of accounting for inventory writedown

1. Direct method
 The inventory is recorded at the lower of cost and net realizable value
 This method is also known as “cost of goods sold” method because any loss on
inventory writedown is not accounted for separately but “buried” in the cost of goods
sold
2. Allowance method
 The inventory is recorded at cost and any loss on inventory writedown is accounted for
separately
 Under this method, the loss account “loss on inventory writedown’ is debited and a
valuation account “allowance for inventory writedown” is credited for the inventory
writedown.
 The loss on inventory writedown is included in the computation of cost of goods
 In subsequent years, this allowance account is adjusted upward or downward
depending on the difference between the cost and NRV of the inventory at year-end
 If the required allowance increases, an additional loss is recognized
 If the required allowance decreased, a gain on reversal of inventory writedown is
recorded, only to the extent of the allowance balance
 The gain on reversal of inventory writedown is also included in the computation of
cost of goods sold as a deduction

5.4 Presentation
 Inventories shall be presented as one line item in the statement of financial position but
the details of the inventories shall be disclosed in the notes to financial statements

6.1 Disclosures
 With respect to inventories, the financial statements shall disclose the following:
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 of disposal
d. The amount of inventories recognized as an expense during the period
e. The amount of any writedown of inventories recognized as an expense during the period
f. The amount of reversal of writedown that is recognized as income
g. The circumstances or events that led to reversal of a writedown of inventories
h. The carrying amount of inventories pledged as security for liabilities

V. ASSESSMENT

Test 1
Multiple Choice: Read and encircle the letter which corresponds to the correct answer

1. Inventories include all of the following assets, except

a. Held for sale in the ordinary course of business
b. In the process of production for sale

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 c. In the form of materials or supplies to be consumed in the production process or in the
rendering of services
d. Held for use in the production or supply of goods or services
2. The cost of purchase of inventory does not include
a. Purchase price
b. Import duties and irrecoverable taxes
c. Freight, handling and other cost directly attributable to the acquisition of goods
d. Trade discounts, rebates and other similar items
3. The cost of conversion of inventory include all of the following, except
a. Costs directly related to the units of production, such as direct labor
b. Systematic allocation of fixed production overhead
c. Systematic allocation of variable production overhead
d. Systematic allocation of administrative overhead
4. The inventory of a service provider is described as work in progress and include which of the
following?
a. Labor and other cost of personnel directly engaged in providing the service
b. Compensation of supervisor directly engaged in providing the service
c. Attributable overhead incurred in providing the service
d. All of these are included
5. Which of the following should be taken into account when determining the cost of inventory?
a. Storage cost of part-finished goods
b. Abnormal freight in
c. Recoverable purchase tax
d. Interest on inventory loan
6. Inventories encompass all of the following, except
a. Merchandise purchased by a retailer
b. Land and other property not held for sale
c. Finished goods produced
d. Materials and supplies awaiting use in the production process
7. Which of the following should not be reported as inventory?
a. Land acquired for resale by a real estate firm
b. Shares and bonds held for resale by a brokerage firm
c. Partially completed goods held by a manufacturing entity
d. Machinery acquired by a manufacturing entity for use in the production process
8. A consignee paid the freight cost for goods shipped from a consignor. The freight cost is to be
deducted from the consignee’s payment to the consignor when the consigned goods are sold.
Until the consignee sells the goods, the freight cost should be included in the consignee’s
a. Cost of goods sold
b. Freight out
c. Distribution cost
d. Accounts receivable
9. Which of the following describes the flow of product costs through the inventory accounts of a
manufacturer?
a. Raw materials, goods in process, factory overhead, finished goods
b. Raw materials, goods in process, finished goods
c. Raw materials, direct labor, factory overhead, finished goods\
d. Raw materials, direct labor, factory overhead
10. Which of the following inventories carried by a manufacturer is similar to the merchandise
inventory of a retailer?

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 a. Raw materials
b. Work in process
c. Finished goods
d. Supplies

Test 2
Multiple Choice: Read and encircle the letter which corresponds to the correct answer

1. Why is inventory included in the computation of net income?

a. To determine cost of goods sold
b. To determine sales revenue
c. To determined merchandise returns
d. Inventory is not included in the computation of net income
2. Which of the following is a characteristics 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
3. An entry debiting inventory and crediting cost of goods sold would be made when
a. Merchandise is sold and the periodic inventory method is used
b. Merchandise is sold and the perpetual inventory method is used
c. Merchandise is returned and the perpetual inventory method is used
d. Merchandise is returned and the periodic inventory method is used
4. A discount given to a customer for purchasing a large volume of merchandise is typically referred
to as
a. Trade discount
b. Quantity discount
c. Size discount
d. Cash discount
5. What is consigned inventory?
a. Goods that are shipped and title transfers to the consignee
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 consignor
d. Goods that have been segregated for shipment to a customer
6. Freight and other handling charges incurred in the transfer of goods from the consignor to
consignee are
a. Expense on the part of the consignor
b. Expense on the part of the consignee
c. Inventoriable by the consignor
d. Inventoriable by the consignee
7. Sales where the goods are delivered only when the buyer makes final payment are called
a. Bill and hold sales
b. Sales subject to installation or inspection
c. Consignment sales
d. Layaway sales
8. Sales in which the buyer is not yet ready to take delivery but does take title are known as
a. Barter sales
b. Bill and hold sales
c. Layaway sales

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 d. Sales with buyback
9. Inventories shall be measured at
a. Cost
b. Net realizable value
c. Lower of cost and net realizable value
d. Higher of cost and net realizable value
10. Inventories are usually written down to net realizable value
a. Item by item
b. By classification
c. By total
d. By segment
11. The amount of any writedown of inventory to net realizable value and all losses of inventory shall
be
a. Recognized as operating expense
b. Recognized as other expense
c. Recognized as component of cost of goods sold
d. Deferred until the related inventory is sold
12. Which statement is true regarding inventory writedown and reversal of writedown?
a. Reversal of inventory writedown is prohibited
b. Separate reporting of reversal of inventory writedown is required
c. An entity is required to record an inventory writedown in a separate loss account
d. All of the choices are correct
13. Which of the following inventory method reports most closely the current cost of inventory?
a. FIFO
b. Specific indentification
c. Weighted average
d. LIFO
14. In a period of falling prices, the use of which inventory cost flow method would typically result in
the highest cost of goods sold?
a. FIFO
b. LIFO
c. Weighted average
d. Specific identification
15. IFRS prohibits which of the following cost flow assumptions?
a. LIFO
b. Specific identification
c. Weighted average
d. Any of these cost flow assumptions is allowed
16. Net realizable value is
a. Current replacement cost
b. Estimated selling price
c. Expected selling price less expected cost to complete and expected cost of disposal
d. Estimated selling price less estimated cost to complete and estimated cost of disposal
17. An example of an inventory accounting policy that should be disclosed is
a. Effect of inventory profit caused by inflation
b. Classification of inventory into raw materials, work in process and finished goods
c. Identification of major suppliers
d. Method used for inventory costing

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Test 3
Problem Solving: Read carefully and answer the following requirements for each problem. Please use a
separate sheet for your solution.

Problem 1
Toronto Company provided the following data at year-end:

Items counted in the bodega

Items included in the count specifically segregated per sales contract
Items in receiving department, returned by customer, in good condition
Items ordered and in the receiving department, invoice not received
Items ordered, invoice received but goods not received. Freight is paid by seller

Required:
a. Compute the correct amount of inventory __________________

Problem 2
Canada Company is a wholesaler of car seat covers. At the beginning of the current year, the entity’s
inventory consisted of 90 car seat covers priced at 1,000 each. During the current year, the following
events occurred:
1. Purchased 800 car seat covers on account at 1,000 each
2. Returned 50 defective car seat covers to supplier and received credit
3. Paid 600 of the car seat covers purchased
4. Sold 790 car seat covers at 2,000 each
5. Received 20 car seat covers returned by a customer and gave credit. The goods were in excellent
condition
6. Received cash for 680 of the car seat covers sold
7. Physical count at year-end revealed 60 units on hand

Required:
a. Prepare journal entries, including adjustments to record the above transactions assuming the
company uses periodic system and perpetual system
b. Determine the cost of sales under each inventory system

Problem 3
Philippines Company began operations in the current year. The entity used perpetual inventory system
1. During the year, Philippines Company purchased merchandise having a gross invoice cost of
1,000,000. All purchases were made under the terms 2/10, n/30, FOB destination
2. Philippines Company paid freight charge of 50,000
3. During the year, Philippines Company paid for 80% of the merchandise within the discount period
4. The remaining 20% was paid beyond the discount period
5. Philippines Company sold 70% of the merchandise it acquired for cash of 1,200,000. The other 30%
remained in inventory a year-end

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Required:
a. Prepare journal entries to record the transactions using gross method and net method (Methods of
recording purchases on account)

Problem 4
Moonton Company began operations at the beginning of current year with 10,000 units of merchandise
with unit cost of 80. Purchases for the current year as follows:
Lot No Units Unit Cost
1 2,000 100
2 8,000 110
3 6,000 120
4 9,500 100

The physical inventory revealed 15,000 units on hand at year-end

Required: Compute inventory cost at year-end and cost of goods sold for the year following each method
listed below
a. FIFO-Periodic
b. Weighted average-periodic
c. Specific identification (assuming the inventory comes from Lot 3, 6,000 units and Lot 4, 9,000 units)

Problem 5
Boom Company provided the following purchases and sales for the month of March:

Units Unit Cost

March 1 Beginning 1,000 270
6 Purchase 3,000 250
14 Purchase 6,000 280

Required: Assuming the entity used perpetual system, compute the ending inventory and cost of sales
under:
a. FIFO
b. Moving average

Problem 6
Popo Company manufactures and sells four products, the inventories of which are priced at cost or net
realizable value whichever is lower. A normal profit of 30% is usually maintained on each product
The following information is compiled at year-end:

Normal
Original Cost to Estimated
Product selling
Cost dispose selling price
price
1 700 150 800 700
2 475 205 950 950

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Required:
a. Determine the unit value for each product applying LCNRV in measuring inventory

Problem 7
America Company provided the following inventory data at the end of first year of operations:
Cost NRV
Skis 2,200,000 2,500,000
Boots 1,700,000 1,500,000
Ski equipment 700,000 800,000
Ski apparel 400,000 500,000

Required: Prepare journal entries to adjust the ending inventory under:

a. Direct method
b. Allowance method

References
1. Course Syllabus
2. CMO no, 30, series of 2017
3. Valix, C & CA and Peralta, J (2020). Intermediate Accounting Volume 1 (2020 rev. ed.). C.M. Recto,
Manila, Philippines: GIC Enterprises & Co., Inc.

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