Chapter 10: Inventories

Asis, John Christian Layug, Carl Aaron

Berou, Angelica Serrano, Ivan Nathaniel
Hernandez, Angelica
All Rights reserved to: valix et. al. 2022 in their book: intermediate accounting 1
 inventories

PAS 2, paragraph 6, defines inventories as "assets which are 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".

Inventories encompass goods purchased and held for resale, for

example Land and other property held
Merchandise purchased by
for resale by a subdivision
a retailer and held for entity and real estate
resale developer.
 Classes of Inventory

Inventories of a trading Inventories of a

entity manufacturing entity
 Inventories of a trading
entity

A trading entity is one that buys The term "merchandise inventory"

and sells goods in the same form is generally applied to goods held
purchased. by a trading entity.
 Inventories of a
manufacturing entity

The terms "finished goods", "goods

A manufacturing entity is one that
in process," "raw materials", and
buys goods which are converted
"factory or manufacturing
into another form before they are
supplies" refer to inventories of a
made available for sale.
manufacturing entity.
 Inventories of a
manufacturing entity

• Raw Materials are goods that are to be

• Finished Goods are the completed
products which are ready for sale.
• Goods in process or Work in Process
are partially completed products which
require further process or work before
they can be sold.
used in the production process. Broadly,
raw materials cover all materials used in
the manufacturing operations. However,
frequently raw materials are restricted to
materials that will be physically
incorporated in the production of other
goods and which can be traced directly to
the end product of the production process.
 Inventories of a
manufacturing entity

• Factory or Manufacturing Supplies are

similar to raw materials but their
relationship to the end product is
indirect. These supplies may be
referred to as indirect materials.
 Goods includible in the
Inventories

As a rule, all goods to which the entity has title shall be

included in the inventory, regardless of location.

The phrase “passing of title” is a legal language which

means “the point of time at which ownership changes.”
 Legal Test
Is the entity the owner of the goods to be
inventoried?
• If the answer is in the affirmative, the
goods shall be included in the
inventory.
• If the answer is in the negative, the
goods shall be excluded from the
inventory
Applying the legal test, the following are
included in inventory:
a) Goods owned and on hand
b) Goods in transit and sold FOB
destination
c) Goods in transit and purchased FOB
shipping point
d) Goods out on consignment to consignee
e) Goods in the hands of salesmen or
agents
f) Goods held by customers on approval or
on trial
 Exception to the Legal
Test
Installment contracts may provide for
retention of title by the seller until the
selling price is fully collected.
Following the legal test, the goods sold
on installment basis are still in the
property of the seller and therefore
normally includible in his inventory.
However, in such cases, it is an accepted
accounting procedure to record the
installment sale as a regular sale on the part
of the seller and as a regular purchase on the
part of the buyer.
Thus, the goods sold on installment are
included in the inventory of the buyer and
excluded from that of the seller, the legal
test to the contrary notwithstanding.
 Exception to the Legal
Test

This is a clear example of economic

substance prevailing over legal form.
 Consigned Goods

A consignment
is a method of
marketing goods in
A consigned goods Freight and other
which the owner
shall be included in handling charges om
called the consignor
the consignor’s goods out on
transfers physical
inventory and consignment are part
possession of certain
excluded from the of the Cost of Goods
goods to an agent
consignee’s inventory. consigned.
called consignee who
sells them on the
owner’s behalf
 Statement Presentation

For example, the note

The inventories shall
shall disclose the
be presented as one
composition of the
line item in the
inventories of a
Inventories are statement of financial
manufacturing concern
generally classified as position, but the details
as finished goods,
current assets of the inventories shall
goods in process, raw
be disclosed in the
materials and
notes to financial
manufacturing
statements.
supplies.
Who is the owner
of Goods in
Transit?
Who is the owner of Goods in Transit?
FOB Shipping FOB
Question
Point Destination
Who pays the
Buyer Seller
freight expenses?
Who owns the
Goods during Buyer Seller
Transit?
 Freight Terms
Freight collect Freight Prepaid
Who pays the
Buyer Seller
freight?

FOB Shipping Paid by: Buyer Paid by: Seller

Point Owned by: Buyer Owned by: Buyer
Paid by: Buyer Paid by: Seller
FOB Destination
Owned by: Seller Owned By: Seller
 Maritime Shipping terms
Shipping Term Party Obligation
Ships the goods and bear all expenses and
risks in transporting goods to the dock next
Seller
FAS to or alongside the vessel on which the
(Free Along Side) goods are to be shipped.
Bears the cost of loading and shipment.
Buyer
Owns the goods once in transit
Payment in lump sum the cost, insurance,
Buyer
CIF and freight charge.
(Cost, Insurance, If buyer will only pay cost, and freight
and Freight) Seller charges only, the seller must pay for the
cost of loading.
 Maritime Shipping terms

Shipping Term Party Obligation

Bears all expenses and risks until the
Seller
goods are unloaded.
Ex - Ship
Bears all responsibility as soon as the ship
Buyer
arrives at the port.

The term Ex – Ship / Delivered Ex – Ship has expired in 2011. It were

replaced by Delivered at Terminal and Delivered at Place.
(International Chamber of Commerce, 2011)
 Accounting for Inventories

Periodic System Perpetual System

 Periodic System

Physical
Periodic System Cost of Goods Sold
Inventories
calls for the
physical counting It is computed at the
Quantities are end of the reporting
of goods on hand at
multiplied by period by deducting
the end of the of
corresponding unit ending inventory to
the accounting
cost to get the the total goods
period to determine
ending inventory available for sale
the quantities.
value
 Perpetual System

When the perpetual

This requires the The perpetual inventory
system is used, a
maintenance of records procedure is commonly used
physical count of the
called stock cards that where the inventory items
units on hand should at
usually offer a running treated individually represent
least happen once a year
summary of the a relatively large peso
to confirm the balances
inventory inflow and investment such as jewelry
appearing on the stock
outflow. and cars
cards.
 Purchase of merchandise on account, P 300,000.
Periodic Perpetual
Purchases 300,000 Merchandise Inventory 300,000
Accounts Payable 300,000 Accounts Payable 300,000

Payment of freight charges, P 20,000

Periodic Perpetual
Freight In 20,000 Merchandise Inventory 20,000
Cash 20,000 Cash 20,000
 Return of merchandise purchased to supplier, P 30,000
Periodic Perpetual
Accounts Payable 30,000 Accounts Payable 30,000
Purchase Return 30,000 Merchandise Inventory 30,000

Sale of merchandise on account, P 400,000, at 40% gross profit. The

cost of merchandise sold is 60% or P 240,000
Periodic Perpetual
Accounts Receivable 400,000 Accounts Receivable 400,000
Sales 400,000 Sales 400,000

Cost of Goods Sold 240,000

Merchandise Inventory 240,000
 Return of merchandise sold from customer, P 25,000.
Periodic Perpetual
Sales Return 25,000 Sales Return 25,000
Accounts Receivable 25,000 Accounts Receivable 25,000

Merchandise Inventory 25,000

Cost of Goods Sold 25,000

Adjustment of ending inventory, P 65,000

Periodic Perpetual
Merchandise Inventory, end 65,000 The balance of the merchandise inventory account
Income Summary 65,000 represents the ending inventory.
 Inventory shortage or
overage

If at the end of the accounting period, a physical count indicates a different

amount, an adjustment is necessary to recognize any inventory shortage or
overage

Adjusting Entry:

Inventory Shortage XX,XXX

Merchandise Inventory XX,XXX
To record shortage on inventory
 Inventory shortage or
overage

The inventory shortage is usually closed to cost of goods sold, because this
is often result of normal shrinkage and breakage in inventory.

However, abnormal and material shortage shall be separately classified and

presented as other expenses.
Trade discounts and cash discounts
Trade discounts are deductions from the list
or catalog price in order to arrive at the
invoice price which is the amount actually
charged to the buyer.
Trade discounts are not recorded
Cash discounts are deductions from the
invoice price when payment is made within
the discount period. The purpose of cash
discounts is to encourage prompt payment.
Cash discounts are recorded as purchase
discount by the buyer and sales discount by
the seller
 COMPUTATION

Illustration: Trade discount computation

500,000 x 20% = 100,000
400,000 x 10% = 40,000
140,000
The list price of a List Price 500,000
merchandise Trade discount - 140,000
purchased is P Invoice Price 360,000
500,000 less 20% and
10%, with credit terms Invoice Price 360,000
Cash discount (340,000 x 5%) - 18,000
of 5 / 10, n/30. Payment within discount period 342,000
 ANOTHER COMPUTATION

Illustration: x
500,000
80%
90%
The list price of a Invoice Price 360,000
merchandise purchased is P
500,000 less 20% and 10%, Invoice Price 360,000
with credit terms of 5 / 10, Cash discount (340,000 x 5%) - 18,000
n/30. Payment within discount period 342,000
 Purchases 360,000
Accounts Payable 360,000

Journal Payment within discount period Payment beyond discount period

entry to Accounts Payable 360,000 Accounts Payable 360,000

record the Cash
Purchase discount
342,000
18,000
Cash 360,000

purchase
 Methods of recording purchases

Gross Method Net Method

• Purchases and Accounts Payable
are recorded at gross amount of
invoice.
• Violates the matching principle
but practically used.
• Purchases and Accounts Payable
are recorded at net amount of
invoice.
• Theoretically correct
 Gross Method Net Method
Purchases on Account, P 200,000, 2 / 10, n / 30. Purchases on Account, P 200,000, 2 / 10, n / 30.

Purchases 200,000 Purchases 196,000

Accounts Payable 200,000 Accounts Payable 196,000

Assume payment is within the discount period. Assume payment is within the discount period.

Accounts payable 200,000 Accounts Payable 196,000

Cash 196,000 Cash 196,000
Purchase discount 4,000

Assume payment is beyond the discount period. Assume payment is beyond the discount period.

Accounts Payable 200,000 Accounts Payable 196,000

Cash 200,000 Purchase discount Lost 4,000
Cash 200,000
Purchase discount lost is recorded to other expense
 Net Method

Assume it is the end of accounting period, no payment is made, and the discount period has
expired.

Purchase discount lost 4,000

Accounts Payable 4,000
 The cost of Inventories shall
comprise of the following:

• Cost of Purchase
Cost of • Cost of Conversion
Inventories • Directly Attributable Cost
Cost of Purchase
The cost of purchase Trade discounts, rebates, Foreign Exchange
comprises of the following: and other similar items are differences are not included
• Purchase price deducted in determining the in the cost of purchase
• Import duty cost of purchases.
• Irrecoverable tax
• Freight
• Handling and other cost
directly attributable to
the acquisition.
 Cost of Conversion
The cost of Conversion Fixed Production Variable production
includes the following: overhead is the indirect cost overhead is the indirect cost
• Direct labor of production that remains of production that varies
• Fixed production overhead relatively constant regardless directly with the volume of
• Variable production of the volume. production.
overhead
Example: Depreciation of Example: indirect labor &
machineries and factory indirect materials.
building.
 • Directly Attributable Cost is the cost incurred in bringing
the inventory to the present location and condition.
Directly • For example, it may be appropriate to include the cost of
designing product for specific customers in the cost of

Attributabl inventories.
• Abnormal amount of wasted materials storage cost,
administrative overhead, and distribution or selling cost are
e Cost recognized as expense when incurred.
• However, storage cost for goods in process, or part-finished
goods should be included in cost of inventory
 Cost of inventory of a service
provider
The cost of inventory of a service provider comprises primarily of:
1. Labor and other cost of personnel directly engaged in providing service,
including supervisory channel.
2. Directly attributable Overhead

Labor and other cost relating to sales and administrative personnel are
recognized as expenses when incurred.
Thank You!