IAS 2, INVENTORIES

Inventories are:
a. Held for sale in the ordinary course of business
b. In the process of production for such sales
c. In the form of materials or supplies to be consumed in the production process or in the rendering of service
Cost of Inventories
 Costs of Purchase - Purchase price, import duties and other taxes, and transport, handling and other costs
directly attributable to the acquisition of finished goods, materials and services.
 Costs of Conversion - Costs directly related to the units of production such as direct labor and fixed and variable
production overhead.
 Costs of Agricultural Produce Harvested from Biological Assets Initially recognized at fair value less cost to sell
 Other Costs - Only to the extent that they are incurred in bringing the inventories to their present location and
condition.
Exclusions from Cost of Inventories
 Abnormal amounts of wasted materials, labor or other production costs
 Storage costs, unless those 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
 Selling costs
 Costs relating to sales and general administrative personnel
 Profit margins or non-attributable overheads
 Borrowing costs are recognized as finance costs

Trade and Cash Discounts

1. Gross price method - Purchase is recorded at gross amount. Purchase discount is recognized when payment is
made within the discount period.
2. Net price method - Purchase is recorded at net of cash discounts. The discount not taken is recorded in Purchase
Discount Lost, reported as Finance Cost
3. Allowance method - Purchases are recorded at net prices. Accounts payable are recorded at gross prices.
Difference is debited to allowance account

*Net price method produces the correct inventory cost.

Items to be included in inventory quantities
 Economic control over Physical possession
 Good are recorded in inventory when received by the purchases and recorded as sold by the seller when
shipped.
 All good under economic control should be included in inventory whether or not the company has physical or
legal possession of the goods.
Good in Transit
 FOB (Free on Board) Shipping Point - Legal title and economic control passes with the loading of goods at the
point of shipment. Buyer should include such goods in inventory and a corresponding liability is recognized.
Freight cost is for the account of the buyer.
 FOB Destination Point - Legal title is not transferred until the goods are delivered to the buyer’s destination.
Freight cost is for the account of the seller.
 Free Alongside (FAS) - Risk of loss shifts from the seller to the buyer at a named port alongside a vessel
designated by the buyer.
 Cost, Insurance Freight (CIF) - Seller arranges for the for the delivery of goods by sea to the port of destination.
Consigned Goods - Consignor (company delivering the goods) retains ownership, while the consignee (company
receiving the goods) attempts to sell them. If sold, consignee earns a commission and remits the net amount to the
consignor. Goods must be included in the inventory of the consignor, at cost plus handling and shipping costs incurred in
the delivery of the goods to the consignee.

Segregated Goods
 Special order goods manufactured according to customer specifications should be considered as sold when
completed, therefore excluded from seller’s inventory. Goods that are customarily manufactured and constitute
stock items of the enterprise, even if physically segregated, are considered unsold.

Conditional Sales and Installment Sales

 The substance of the transaction is that control over the goods has already passed to the buyer. Goods in the
hands of salespersons and agents, goods held by customer on approval, and goods held by other for storage,
processing or shipment, should also be shown as part of the ending inventory of the entity that has economic
control.

Goods Sold with Buyback Agreement

The customer does not obtain control of the asset (the inventory), and the transferor shall account for the transfer as a
financing arrangement and shall retain the inventory in its books.

Goods sold with refund offers

Under PFRS 15
Sales = buyer
No sales = seller
Lay Away Plans and Bill Hold Sales
1. Full payment first
2. Delivery of goods → Buyer

Cost Formulas
Inventories are to be reported at the lower of cost and net realizable value.
1. Specific Identification
 Generally:
a. High valued; low quantity
b. Cost is not interchangeable
2. First-in, First-out (FIFO) - Based on the assumption that costs should be charged against revenue in the order in
which they were incurred. Appropriate measurement of inventory is achieved, but no proper matching of cost
against revenue since earliest costs are matched to current revenues.
Period of inflation
 Lowest COGS
 Highest EI and Profit
Period of deflation
 Highest COGS
 Lowest EI and Profit

*FIFO always reports the HIGHEST ending inventory

 3. Weighted Average
a. Periodic - Simple Average
 Single per unit cost:
TGAS in Php/TGAS in units
EI in units x per unit cost = EI in Php
*masusunod ang inventory count
*Inventory shortage (normal loss)
COGS: TGAS in Php - EI in Php

Period of inflation
 Not so high COGS
 Not so low profit

Period of deflation
 Not so low COGS
 Not so high profit
b. Perpetual - Moving Average
Purchases - per unit cost will change
Sales - per unit cost remains the same
Returns (not immediate) - per unit cost will change

Inventory estimation methods

1. Gross profit method
- Major assumption: GP rate is constant over time
- Disadvantage: Uses past percentage

Based on an assumed relationship between gross profit and sales or between gross profit and cost of sales.

Calculation of inventory:
BI xx
Net Purchases xx
TGAS xx
COGS xx
Ending Inventory (EI) xx

a. Based on sales
Sales is 100%
Deduct: Sales returns
Ignore: Sales discounts and allowances
*Special discount: add sa sales
b. Based on cost
COGS is 100%
2. Retail inventory method
Often used for measuring inventories of
large
numbers or rapidly changing items.
Cost of inventory is determined by reducing
sales
value of the inventory by the appropriate
percentage
gross margin.
a. Freight-in
Addition to purchases at cost
b. Purchase discounts and allowances
Deduction from purchases at cost
c. Purchase returns
Deducted from cost and retail purchases
d. Sales returns
Deducted from retail sales
e. Sales discounts and allowances
Not deducted from retail sales
f. Departmental transfer-in (debit)
Addition to both cost and retail amounts of
purchases
g. Departmental transfer-out (credit)
Deduction from both cost and retail amount
of purchases
h. Normal losses, shortage, shrinkage
Deducted from TGAS at retail, after
computing cost ratio
i. Abnormal losses
Deducted from both cost and retail amounts
of purchases, before computing the cost
ratio
j. Discounts to employees and favored
customers
Deducted from TGAS at retail, after
computing the cost ratio (addition to sales)
Original selling prices may be modified as a
result of
some market and economic forces
● Original Retail - first selling price
● Markup - increase in the selling price over
the original retail price
● Markdown - decrease in the selling price
below the original retail price
● Markup cancellation - decrease in the SP
which does not bring new SP below the
original retail price
● Markdown cancellation - increase in the
SP
which does not bring the new SP above the
original retail price
● Net Markup - Markup less markup
cancellation
● Net Markdown - Markdown less
markdown
cancellation
*Cost - magkano nirecord sa books
*Retail - may tubo na
Steps in Retail inventory method:
1. Compute TGAS
2. Cost-to-Retail Ratio (CTR)
➢ Weighted Average
TGAS@Cost
TGAS@Retail
➢ FIFO
TGAS@Cost - BI@Cost
TGAS@Retail - BI@Retail
➢ Conventional/Consecutive/LCM
(Lower of
cost market value)
*Lowest CTR and EI
TGAS@Cost
TGAS@Retail + Net Markdown
a. Based on sales
Sales is 100%
Deduct: Sales returns
Ignore: Sales discounts and allowances
*Special discount: add to sales
b. Based on cost
COGS is 100%

2. Retail inventory method - Often used for measuring inventories of large numbers or rapidly changing items. Cost
of inventory is determined by reducing sales value of the inventory by the appropriate percentage gross margin.
a. Freight-in Addition to purchases at cost
b. Purchase discounts and allowances - Deduction from purchases at cost
c. Purchase returns - Deducted from cost and retail purchases
d. Sales returns - Deducted from retail sales
e. Sales discounts and allowances - Not deducted from retail sales
 f. Departmental transfer-in (debit)Addition to both cost and retail amounts of purchases
g. Departmental transfer-out (credit)Deduction from both cost and retail amount of purchases
h. Normal losses, shortage, shrinkage - Deducted from TGAS at retail, after computing cost ratio
i. Abnormal losses - Deducted from both cost and retail amounts of purchases, before computing the cost ratio
j. Discounts to employees and favored customers - Deducted from TGAS at retail, after computing the cost ratio
(addition to sales)

Original selling prices may be modified as a result of some market and economic forces
 Original Retail - first selling price
 Markup - increase in the selling price over the original retail price
 Markdown - decrease in the selling price below the original retail price
 Markup cancellation - decrease in the SP which does not bring new SP below the original retail price
 Markdown cancellation - increase in the SP which does not bring the new SP above the original retail price
 Net Markup - Markup less markup cancellation
 Net Markdown - Markdown less markdown cancellation

*Cost - magkano nirecord sa books

*Retail - may tubo na
Steps in Retail inventory method:
1. Compute TGAS
2. Cost-to-Retail Ratio (CTR)
 Weighted Average = TGAS@Cost/TGAS@Retail
 FIFO = TGAS@Cost - BI@Cost , TGAS@Retail - BI@Retai
 Conventional/Consecutive/LCM (Lower of cost market value)
*Lowest CTR and EI
TGAS@Cost/TGAS@Retail + Net Markdown

3. EI at Retail
TGAS @ Retail xx
Less: Net Sales xx
EI @ Retail xx
Under Net Sales:
Sales return - deduct
Sales D&A - ignore
Disc to employees - add
Disc to favored customers - add
Normal losses - add
4. EI at cost
EI @ Retail x CTR
Measurement of Inventories Subsequent to
Initial
Recognition
Inventories
● should be measured at LCNRV
● are written down to NRV on an item by
item basis
With items of inventory relating to the same
product line that
have similar purposes or end uses, produced
and marketed in
the same geographical agera, and cannot be
practicably
evaluated separately from other items in that
product line,
they are written down in group basis.
Total cost - LCNRV = Write Down
Write Down of Inventory
Amount of write down is recognized as an
expense in the
period it occurs
1. Direct Method
● EI is recorded at LCNRV
● Write down of inventory is absorbed by
COGS
● Incase of write down - will always report
higher COGS
● Incase of recovery (maximum: cost) - will
report a lower COGS
2. Allowance Method
● Ending Inventory is recorded at cost
● Write down of inventory is reported as
other
non-operating expense
● Incase of write down - will always report
lower COGS
● Incase of recovery - will report a higher
COGS
Ending balance of Allowance = EI@Cost -
LCNRV
Purchase Commitments
Purchase commitments may be subject to
revision or
cancellation before the end of the contract
period. Other PC
are non-cancellable and are not subject to
revision.
Disclosure is required for a purchase
contract subject to
revision or cancellation if:
a. A future loss is possible
b. The amount of commitment can be
reaosnably
estimated
c. The amount is material
Contract price (maximum amount you are
going to recognize
at purchases, but will always be your
payable)
*Bawal mag recognize ng gain as adjusting
entry
*Sa date of delivery, pwede na mag record
gain or loss
*Ang basis is yung previous/last MV
Effects of Inventory Errors
BI and Purchases (Expenses) - Inversely
related to profit
Ending Inventory - Directly related to profit
Disclosure Requirements
● Accounting policies adopted in measuring
inventories, including the cost formula used
● Total carrying amount of inventories and
the carrying
amount in classifications appropriate to the
entity
● Carrying amount of inventories carried at
FV - CTS
● Amount of inventories recognized as an
expense
during the period
● Amount of any writedown of inventories
recognized
as expense in the period
● Amount of any reversal of any writedown
that is
recognized as expense in the period
● Circumstances or events that led to the
reversal of a
writedown of inventories
● Carrying amount of inventories pledged as
security
for liabilities
3. EI at Retail
TGAS @ Retail xx
Less: Net Sales xx
EI @ Retail xx
Under Net Sales:
Sales return – deduct
Sales D&A – ignore
Disc to employees – add
Disc to favored customers – add
Normal losses – add
4. EI at cost
EI @ Retail x CTR
Measurement of Inventories Subsequent to Initial Recognition
Inventories
 should be measured at LCNRV
 are written down to NRV on an item-by-item basis
With items of inventory relating to the same product line that have similar purposes or end uses, produced and
marketed in the same geographical algebra, and cannot be practicably evaluated separately from other items in that
product line, they are written down in group basis.

Total cost - LCNRV = Write Down

Write Down of Inventory - Amount of write down is recognized as an expense in the period it occurs
1. Direct Method
 EI is recorded at LCNRV
 Write down of inventory is absorbed by COGS
 In case of write down - will always report higher COGS
 In case of recovery (maximum: cost) - will report a lower COGS2.
2. Allowance Method
 Ending Inventory is recorded at cost
 Write down of inventory is reported as other non-operating expense
 In case of write down - will always report lower COGS
 In case of recovery - will report a higher COGS
Ending balance of Allowance = EI@Cost – LCNRV
Purchase Commitments
- Purchase commitments may be subject to revision or cancellation before the end of the contract period.
Other PC are non-cancellable and are not subject to revision.
- Disclosure is required for a purchase contract subject to revision or cancellation if
a. A future loss is possible
b. The amount of commitment can be reasonably estimated
c. The amount is material
Contract price (maximum amount you are going to recognize at purchases, but will always be your payable)
*Bawal mag recognize ng gain as adjusting entry
*Sa date of delivery, pwede na mag record gain or loss
*Ang basis is yung previous/last MV

Effects of Inventory Errors

- BI and Purchases (Expenses) - Inversely related to profit
- Ending Inventory - Directly related to profit

Disclosure Requirements
 Accounting policies adopted in measuring inventories, including the cost formula used
 Total carrying amount of inventories and the carrying amount in classifications appropriate to the entity
 Carrying number of inventories carried at FV – CTS
 Number of inventories recognized as an expense during the period
 Amount of any write down of inventories recognized as expense in the period
 Amount of any reversal of any write down that is recognized as expense in the period
 Circumstances or events that led to the reversal of a write down of inventories
 Carrying number of inventories pledged as security for liabilities