MODULE 3

Inventory

Learning Objectives:

At the end of this module the student will be able to:

• Identify the different terminologies use in inventory

• Compute the cost of inventories based on FIFO, weighted average, specific
identification method.
• Compute and compare retail and gross profit method
• Account for biological assets after initial recognition

Pauline R. Dela Cruz, CPA

Instructor
Inventory
Inventories are assets held for sale in the ordinary course of business, in the process of
production for such sale or in the form of materials or supplies to be consumed in the production
process or in the rendering of services.
Two classes of Inventory:
1. Trading inventory- goods purchased and held for resale.
2. Inventory of manufacturing concern.
The term inventory refers to the raw materials used in production as well as the
goods produced that are available for sale. A company's inventory represents one of the
most important assets it has because the turnover of inventory represents one of the primary
sources of revenue generation and subsequent earnings for the company's shareholders.
There are three types of inventory, including raw materials, work-in-progress, and finished
goods. It is categorized as a current asset on a company's balance sheet.

Inventory is a very important asset for any company. It is defined as the array of goods used in
production or finished goods held by a company during its normal course of business. There are
three general categories of inventory, including raw materials (any supplies that are used to
produce finished goods), work-in-progress (WIP), and finished goods or those that are ready for
sale.
As noted above, inventory is classified as a current asset on a company's balance sheet, and it
serves as a buffer between manufacturing and order fulfillment. When an inventory item is sold,
its carrying cost transfers to the cost of goods sold (COGS) category on the income statement.
Inventory can be valued in many ways. These methods are the:

• First-in, first-out (FIFO) method, which says that the cost of goods sold is based on the
cost of the earliest purchased materials. The carrying cost of remaining inventory, on the
other hand, is based on the cost of the latest purchased materials
• Last-in, first-out (LIFO) method, which states that the cost of goods sold is valued using
the cost of the latest purchased materials, while the value of the remaining inventory is
based on the earliest purchased materials.
• Weighted average method, which requires valuing both inventory and the COGS based
on the average cost of all materials bought during the period.
• Specific Identification- means that specific costs are attributed to identified items of
inventory.
• Standard costs are predetermined product costs established on the basis of normal levels
of materials and supplies, labor efficiency and capacity utilization.
 • Relative sales price method- when different commodities are purchased at lump sum, the
single cost is apportioned among the commodities based on their respective sale price. This
is based on the philosophy that cost is proportionate to selling price.
Maritime Shipping terms
FAS or Free alongside- a seller who ships FAS must bear all expenses and risked involved in
delivering the goods to the dock next to or alongside the vessel on which the goods are to be
shipped.
The buyer bears the cost of loading and shipments, and title passes to the buyer when carrier takes
possession of the goods.

CIF or Cost, insurance, and freight- under this shipping contract, the buyer agrees to pay in a
lump sum the cost of the goods, insurance cost, and freight charge. The shipping contract may be
modified as CF which means that the buyer agrees to pay in lump sum the cost of the goods and
freight charge only.
The seller bears the cost of loading and shipments, and title passes to the buyer when carrier takes
possession of the goods.
Ex-ship- a seller who delivers the goods ex-ship bears all expenses and risk of loss until the goods
are unloaded at which time title and risk of loss shall pass to the buyer.

Consignment
Consignment is a method of marketing goods in which the owner called the consignor
transfers physical possession of certain goods to an agent called the consignee who sells on the
owner’s behalf.

Accounting for inventory:

1. Periodic Method -physical counting of goods on hand at the end of the accounting period
to determine quantities.
2. Perpetual Method-requires maintenance of records called stock cards that usually offer
running summary of the inventory inflow and outflow.

Trade discounts and cash discounts

Trade discounts are deductions from the list or catalog price to arrive at the invoice price
which is the amount actually charged to the buyer (not recorded).
 Cash discounts are deductions from the invoice price when payment is made within the
discount period. Recorded as purchase discount.
Purchase discount is deducted from purchases to arrive at net purchases and sales discount
is deducted from sales to arrive at net sales revenue.
Gross method- recording the purchase discount once the discount is made within the
discount period.
Net method- the recording of purchases and accounts payable is already in net account.

Subsequent measurement
PAS 2, paragraph 9, provides that “inventories shall be measured at the lower of cost and net
realizable value.
Net realizable value (NRV) is the estimated selling price in the ordinary course of business less
the estimated cost completion and the estimated cost of disposal. Inventories are usually written
down to NRV item by item or individual basis.
Accounting for inventory writedown
• Cost< NRV=no accounting problem because the inventory is stated at cost and the
increase in value is not recognized.
• Cost>NRV= the inventory is measured at net realizable value. In this case, the
problem is the proper treatment of the writedown of the inventory to net realizable
value. Accounting method for writedown may be: direct method (cost of good sold
method) and allowance method (loss method).

Estimating Inventories

Companies sometimes need to determine the value of inventory when a physical count is
impossible or impractical. For example, a company may need to know how much inventory was
destroyed in a fire. Companies using the perpetual system simply report the inventory account
balance in such situations, but companies using the periodic system must estimate the value of
inventory. Two ways of estimating inventory levels are the gross profit method and the retail
inventory method.

Gross profit method. The gross profit method estimates the value of inventory by applying the
company's historical gross profit percentage to current‐period information about net sales and the
cost of goods available for sale. Gross profit equals net sales minus the cost of goods sold.
The gross profit margin equals gross profit divided by net sales. If a company had net sales of
$4,000,000 during the previous year and the cost of goods sold during that year was $2,600,000,
then gross profit was $1,400,000 and the gross profit margin was 35%.
 Net Sales $ 4,000,000
Less: Cost of Goods Sold (2,600,000)
Gross Profit $ 1,400,000

If gross profit margin is 35%, then cost of goods sold is 65% of net sales.

Suppose that one month into the current fiscal year, the company decides to use the gross profit
margin from the previous year to estimate inventory. Net sales for the month were $500,000,
beginning inventory was $50,000, and purchases during the month totaled $300,000. First, the
company multiplies net sales for the month by the historical gross profit margin to estimate gross
profit.

Next, estimated gross profit is subtracted from net sales to estimate the cost of goods sold.

Net Sales $ 500,000

Gross Profit (175,000)
Cost of Goods Sold $ 325,000

Alternatively, cost of goods sold may be determined by multiplying net sales by 65% (100% –
gross profit margin of 35%).

Finally, the estimated cost of goods sold is subtracted from the cost of goods available for sale to
estimate the value of inventory.

Beginning Inventory $ 50,000

Purchases 300,000
Cost of Goods Available for Sale 350,000
Less: Cost of Goods Sold (325,000)
Ending Inventory $ 25,000

The gross profit method produces a reasonably accurate result as long as the historical gross
profit margin still applies to the current period. However, increasing competition, new market
conditions, and other factors may cause the historical gross profit margin to change over time.
Retail inventory method. Retail businesses track both the cost and retail sales price of
inventory. This information provides another way to estimate ending inventory. Suppose a retail
store wants to estimate the cost of ending inventory using the information shown below.

Cost Retail
Beginning Inventory $ 49,000 80,000
Purchases 209,000 350,000
Goods Available for Sale $ 258,000 430,000
Net Sales $ 400,000

The first step is to calculate the retail value of ending inventory by subtracting net sales from the
retail value of goods available for sale.

Cost Retail
Beginning Inventory $ 49,000 80,000
Purchases 209,000 350,000
Goods Available for Sale $ 258,000 430,000
Net Sales 400,000
Ending Inventory (Retail) $ 30,000

Next, the cost‐to‐retail ratio is calculated by dividing the cost of goods available for sale by the
retail value of goods available for sale.

Cost Retail
Beginning Inventory $ 49,000 80,000
Purchases 209,000 350,000
Goods Available for Sale $ 258,000 430,000
Net Sales 400,000
Ending Inventory (Retail) $ 30,000
Cost to Retail Ratio ($ 258,000 + $ 430,000 = 60%)

Then, the estimated cost of ending inventory is found by multiplying the retail value of ending
inventory by the cost‐to‐retail ratio.

Cost Retail
Beginning Inventory $ 49,000 80,000
Purchases 209,000 350,000
 Cost Retail
Goods Available for Sale $ 258,000 430,000
Net Sales 400,000
Ending Inventory (Retail) $ 30,000
Cost to Retail Ratio ($ 258,000 + $ 430,000 = 60%)
Ending Inventory (Cost) ($ 30,000 × 60%) $ 18,000

One limitation of the retail inventory method is that a store's cost‐to‐retail ratio may vary
significantly from one type of item to another, but the calculation simply uses an average ratio. If
the items that actually sold have a cost‐to‐retail ratio that differs significantly from the ratio used
in the calculation, the estimate will be inaccurate.

Treatment of items
Items Cost Retail Sales
Purchase discount -
Purchase Return - -
Freight-in +
Departmental transfer in + +
or debit
Departmental transfer - -
out or credit
Sales discount and sales disregard
allowance
Sales return -
Employee discount +
Normal shortage, -
shrinkage, spoilage,
breakage
Abnormal shortage, - -
shrinkage, spoilage,
breakage
Items related to retail method
1. Initial markup
2. Original retail
3. Additional markup
4. Mark up cancellation
5. Net additional markup or net markup
6. Mark down
7. Mark down cancellation
8. Net markdown
9. Maintained markup (Markon)
Biological Assets
Agriculture means farming or the process of producing crops and raising livestock. PAS 41
prescribes the accounting and disclosures for agricultural and related activity.
PAS 41 applies to the following when they relate to agricultural activity:
a. Biological assets, except bearer plants;
b. Agricultural produce at the point of harvest; and
c. Unconditional government grants related to a biological asset measured at its fair value
less cost to sell
Biological assets
- Only living animal or plant
Biological assets can be either:
a. Consumable biological assets – those that are harvested as agricultural produce or sold as
biological assets
b. Bearer biological assets-those that are held to bear produce. Only the produce is harvested
while the bearer biological asset remain. Bearer plants are classified as PPE.
Bearer plant is a living plant that:
a. Is used in the production or supply of agricultural produce
b. Is expected to bear produce for more than one period
c. Has a remote likehood of being sold as agricultural produce, except for incidental scrap
sales.
Agricultural produce
- The harvested produce of the entity’s biological assets.
- Harvest is the detachment of produce from biological asset or the cessation of biological
asset’s life processes.
Common features of agricultural activity
a. Capability to change
b. Management of change
c. Measurement of change
Biological Transformation
Assets changes through:
a. Growth
b. Procreation
c. Degeneration
Measurement
Biological assets
• Biological assets are initial measured at fair value less cost to sale.
• If can’t measured reliably: initially measured at cost and subsequently measured at cost
and accumulated impairment losses. Once the fair value becomes reliably measurable,
the biological asset is measured at its fair value less costs to sell.
• The gain or loss arising from initial measurement and subsequent changes in fair value
less costs to sell are recognized in profit or loss.
Illustrations:
I. INVENTORY
PROBLEM 1
Brandy Company took a physical inventory ar the end of the year and determined that
P2,600,000 of goods were on hand. In Addition, the entity determined that P2,600,000 of goods
were on hand. In addition, the entity determined that P2,600,000 of goods purchased in transit
shipped FOB shipping point were actually received two days after the physical count and that the
entity had P300,000 of goods out of consignment.
What should be reported as inventory at the year-end?
Goods on hand 2,600,000.00
Goods purchased in transit 200,000.00
Goods on consignment 300,000.00
Total Inventory 3,100,000.00

PROBLEM 2
Baritone Company counted and reported the ending inventory on December 31, 2022 at
P2,000,000.
• P150,000 in goods located in the entity’s warehouse that are on consignment from
another entity.
• P200,000 in goods that were sold by the entity and shipped on December 30 and were in
transit on December 31, 2022.
The goods were received by the customer on January 2, 2023. Terms were FOB
destination.
• P300,000 in goods that were purchased by the entity and shipped on December 30 and
were in transit on December 31, 2022.

The goods were received by the entity on January 2, 2023. Terms were FOB shipping
point.

• P400,000 in goods were sold by the entity and shipped on December 30 and were in
transit on December 31, 2022.

The goods were received by the customer on January 2, 2023. Terms were FOB shipping
point.
What is the correct amount of inventory on December 31, 2023?
Reported inventory 2,000,000.00
Goods sold in transit, FOB destination 200,000.00
Goods purchased in transit, FOB shipping point 300,000.00
Correct amount of inventory 2,500,000.00

PROBLEM 3
During the month of January, Metro Company which used perpetual inventory system recorded
the following information pertaining to inventory:
Unit Unit on
Units Total Cost
Cost Hand
Balance on 1/1 10,000 100 1,000,000.00 10,000.00
Purchased on 1/7 6,000 300 1,800,000.00 16,000.00
Sold on 1/20 9,000 7,000.00
Purchased on 1/25 4,000 500 2,000,000.00 11,000.00

1. Under the moving average method, what amount should Metro Report
as inventory on January 31?

Balance on 1/1 10,000 100 1,000,000.00

Purchased on 1/7 6,000 300 1,800,000.00
Balance on 1/17 16,000 175.00 2,800,000.00
Sold on 1/20 9,000 175 1,575,000.00
Balance on 1/20 7,000 1,225,000.00
Purchased on 1/25 4,000 500 2,000,000.00
Balance on 1/25 11,000 293.18 3,225,000.00

2. Under FIFO method, what amount should Metro report as inventory on

January 31?
Units
Units Total Cost
Cost
January 1, 2022 1,000 100 100,000.00
January 7, 2022 6,000 300 1,800,000.00
January 25, 2022 4,000 500 2,000,000.00
Total FIFO 11,000 3,900,000.00
 3. Assuming that the company use periodic inventory system, what amount should
metro report on January 31?
Balance on 1/1 10,000 100 1,000,000.00
Purchased on 1/7 6,000 300 1,800,000.00
Purchased on 1/25 4,000 500 2,000,000.00
20,000 240.00 4,800,000.00

Sold on 1/20 9,000 240.00 2,160,000.00

Ending Inventory under

11,000 240 2,640,000.00
periodic inventory system

PROBLEM 4
Casa company purchased a tract of land for P12,000,000. The entity incurred additional cost of
P3,000,000 during the remainder of the year preparing the land for sale. The tract of land was
subdivided into residential lots.
Lot Class No. of lots Sales price per lot
A 100 240,000.00
B 100 160,000.00
C 200 100,000.00

Using the relative sales value method, what amount of cost should be
allocated to Class A lots?

Lot Class Sales price per lot No. of lots Sales price Fraction Allocated Cost

A 240,000.00 100 24,000,000.00 40.00% 6,000,000.00

B 160,000.00 100 16,000,000.00 26.67% 4,000,000.00

C 100,000.00 200 20,000,000.00 33.33% 5,000,000.00

Total 60,000,000.00 15,000,000.00

Winter company provided the following inventory data at year-end:
Cost NRV
Skis 2,200,000.00 2,500,000.00
Boots 1,700,000.00 1,500,000.00
Ski equipment 700,000.00 800,000.00
Ski apparel 400,000.00 500,000.00
Total 5,000,000.00 5,300,000.00
 What should be reported as inventory at year-end?
Cost NRV LCNRV
Skis 2,200,000.00 2,500,000.00 2,200,000.00
Boots 1,700,000.00 1,500,000.00 1,500,000.00
Ski equipment 700,000.00 800,000.00 700,000.00
Ski apparel 400,000.00 500,000.00 400,000.00
Total 5,000,000.00 5,300,000.00 4,800,000.00
.
Fireworks Company has an explosion in a plant that destroyed most of
the inventory.

The records showed the following information during the current year:
Beginning inventory 400,000.00
Purchases 4,800,000.00
Sales 6,200,000.00
Gross Profit percentage 25%

The entity can sell some of the damaged inventory for P50,000. The
insurance company will reimburse the entity for 70% of the loss.

What amount should be reported as loss from explosion?

Beginning inventory 400,000.00

Purchases 4,800,000.00
Goods available for sale (GAS) 5,200,000.00
Cost of goods sold (4,650,000.00)
Ending inventory 550,000.00
Realizable value of damaged inventory (50,000.00)
Total loss from explosion 500,000.00
Reimbursement from insurance (350,000.00)
Loss from explosion 150,000.00

PROBLEM 5
Diane Company used the average cost retai inventory method and showed the following information
for the current year:

Cost Retail
Beginning Inventory 560,000.00 1,400,000.00
Sales 10,000,000.00
Purchases 4,960,000.00 10,320,000.00
Freight in 150,000.00
Mark-up 1,000,000.00
Markup cancellation 120,000.00
Markdown 500,000.00
Markdown cancellation 100,000.00
Estimated normal shrinkage is 2.5% of
sales

What is the estimated cost of ending

inventory?

Cost Retail
Beginning inventory 560,000.00 1,400,000.00
Purchases 4,960,000.00 10,320,000.00
Freight in 150,000.00
Mark up 1,000,000.00
Mark up cancelation (120,000.00)
Cost
Available for sale-conservative 5,670,000.00 12,600,000.00 ratio(conservative)=
Mark down (500,000.00) 45.00%
Mark down cancellation 100,000.00 Cost ratio(average)=
Available for sale-average 5,670,000.00 12,200,000.00 46.48%

Sales (10,000,000.00)
Shrinkage (250,000.00)
Ending Inventory 1,950,000.00

Conservative cost 877,500.00

Average cost 906,270.49 *Silent
 II. BIOLOGICAL ASSETS

Honey Company has a herd of 10 2-year old animals on January 1, 2022. One animal aged 2.5
years was purchased on July 1, 2022 for P108, and one animal was born on July 1,2022. No
animals were sold or disposed of during the year. The fair value less cost of disposal per unit as
follows:

2-year old animal on January 1

2.5 year old animal on July 1
New born animal on July 1
2 year old animal on Dec 31
2.5 year old animal on Dec 31
Newborn animal on Dec 31
3 year old animal on December 31

1. What is the fair value of the biological assets on December 31?

Fair value of 3 year old animal on December 31 1,320.00
Fair value of 0.5 year old animal on December 31 80.00
Total fair value 1,400.00

2. What amount of gain from change in fair value of biological assets should be
recognized in the current year?
Fair value of 10 animals on January 1 1,000.00
Acquisition cost of one animal on July 1 108.00
Total Carrying amount of biological assets-Dec 31 1,108.00

FV on December 31 1,400.00
Carrying amount 1,108.00
Gain from change in Fair value 2,508.00
WORKSHEETS
Problem 1: The following pertain to Ang Dami Company:
Goods out on consignment at another company’s store 820,000
Goods sold on installment basis 110,000
Goods purchased FOB Shipping Point that are in transit as of December 31 130,000
Goods sold to another company for which our company has signed an agreement 190,000
to repurchase at a set price that covers all cost related to inventory
Goods sold where large returns are predictable 250,000
Goods sold FOB Shipping point that are in transit as of December 31 140,000
Freight Charges on goods purchased 50,000
Advertising Expense 30,000
Office Supplies 10,000
Factory Supplies 5,000
Goods held on consignment from another company 450,000
Goods sold to customer which are being hold for the customer to call at 200,000
customer’s convenience
Trade discount already deducted from invoices of goods purchased 100,000
Import duties 20,000
Commission paid to agents for arranging imports 10,000
Advance payment made by the entity to a supplier for the goods to be 150,000
manufactured at entity’s specifications
Abnormal amount of wasted materials 20,000

Administrative Overhead 11,000

Selling Cost 20,000

VAT on goods purchased(the company is a non-vat taxpayer) 30,000
Storage cost before the raw materials purchased put into production 15,000
Inventory pledged as a security for a loan 100,000
Inventory borrows from another entity to be replaced with the same kind of 30,000
inventory
Inventory purchased with a right of return 15,000
Inventory purchased with trial arrangement 50,000
Inventory purchased under a bill and hold arrangement 45,000
Inventory purchased under lay away plan 30,000
How much should be reported as inventory in the financial statements?
Problem 2: On June 1, 2022, Happy Company sold merchandise with a list price of 4,000,000 to
a customer. The entity allowed trade discounts of 15%, and 10%. Credit terms were 2/10, n/30
and the sale was made FOB shipping point. The entity prepaid 100,000 of delivery cost for the
customer as an accommodation.
1. Compute the total amount of purchases to be included on the buyer’s inventory in the
determination of cost of goods available for sale under gross method and net method,
respectively.
2. What is the full amount received by the Happy company if payment was made on June
11, 2022?

Problem 3: Joy Company provided the following information:

Unit
Units Total Cost
Cost
1-Jan Beg Balance 18,000 150 2,700,000
5 Purchase 15,000 180 2,700,000
15 Sale 16,000 0
16 Sale Return 1,000 0
25 Purchase 4,500 200 900,000
26 Purchase Return 500 200 100,000

Compute the ending inventory under the following:

1. FIFO
2. Average Method-Perpetual
3. Average Method-Periodic

Problem 4: Kaya pa Company reported the following information for 2022:

Inventory, January 1 5,000,000
Purchases 26,000,000
Freight In 2,000,000
Purchase Return and allowances 3,500,000
Purchase discount 1,500,000
Sales 40,000,000
Sales Returns 3,000,000
Sales Discounts 1,000,000
A fire in the company’s warehouse occur before the year-end inventory count. A physical
inventory count taken on December 31, 2022 after the fire, resulted in an ending inventory of
2,000,000. On December 31, 2016, unsold goods out on consignment with selling price of
1,000,000 are in the hands of consignee. Included in the purchases are the inventories in transit
amounting to 100,000 which the company purchased on a FOB Shipping point arrangement.
Determine the fire loss on December 31 2016 assuming the:
1. Gross Profit was 40% based on sales
 2. Gross Profit was 60% based on cost
Problem 5:Easy lang to Company used the retail inventory method to approximate the ending
inventory. The following information is available for the current year:
Cost Retail
Beginning Inventory 650,000 1,500,000
Purchases 9,300,000 14,700,000
Freight in 200,000
Purchase Returns 300,000 500,000
Purchase Allowances 150,000
Departments transfer in 200,000 400,000
Net markups 300,000
Net markdowns 1,000,000
Sales 9,600,000
Sales Return 100,000
Sales Discount 100,000
Employee Discounts 500,000
Estimated Normal Losses 1,000,000
Abnormal Spoilage 4,800 8,000
Determine the following cost of ending inventory under the following approach:
1. Conservative Approach
2. Average Cost Approach
3. FIFO Approach

References:

• Valix, C., Peralta, J. & Valix, C., (2020). Inventories, Inventory Cost Flow, Lower of Cost and
Net Realizable Value, Gross Profit Method, Retail Inventory, in Intermediate Accounting
Volume 1 (pp. 271-401). Manila, Philippines: GIC Enterprises & Co., Inc.
• Millan, Z. (2019). Inventories and Inventories estimation in Intermediate Accounting IA
(pp.378-479). Baguio City, Philippines: Nation’s Foremost CPA Review Inc. (NCPAR)
• Valix, C., Peralta, J. & Valix, C., (2015). Inventories, Inventory Cost Flow, Lower of Cost and
Net Realizable Value, Gross Profit Method, Retail Inventory, Biological Assets in Financial
Accounting Volume 1 (pp. 477-662). Manila, Philippines: GIC Enterprises & Co., Inc.
• Valix, C., Peralta, J. & Valix, C., (2015). Biological Assets in Financial Accounting Volume 1
(pp.596-607). Manila, Philippines: GIC Enterprises & Co., Inc.
• https://www.investopedia.com/terms/i/inventory.asp
• https://www.cliffsnotes.com/study-guides/accounting/accounting-principles-
i/inventory/estimating-inventories
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Prepared by:

Pauline R. Dela Cruz