INVENTORIES

Leonel Brandon Acosta, CPA

INVENTORIES
Inventories are assets that are:
a. Held for sale in the ordinary course of business (finished
goods)
b. In the process of production for such sale (work in
process)
c. In the form of materials or supplies to be consumed in
the production process or in the rendering of services
(raw materials and manufacturing supplies)
INVENTORIES
Examples of inventories are:
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.
c. Finished goods, goods undergoing production, and raw
materials and supplies awaiting use in the production
process by a manufacturing entity.
RECOGNITION
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.
RECOGNITION
An entity considers all relevant facts and circumstances in
determining whether it has control, including the following:
a. Goods in transit
b. Consigned goods
c. Inventory financing agreements
d. Sale with unusual right of return
e. Sale on trial or sale on approval
f. Installment sale
g. Bill and hold sale
h. Lay away sale
Goods in transit
Goods that the seller has already shipped but the buyer has
not yet received.

Goods in transit may form part of the buyer’s or the seller’s

inventories depending on the sale term, such as:
1. FOB shipping point
2. FOB destination
FOB shipping point
Ownership is transferred to the buyer upon shipment;
hence, buyer’s inventory. The buyer records the purchase
(and accounts payable) on shipment date.
FOB destination
Ownership is transferred to the buyer only when the buyer
receives the goods; hence, the goods in transit still form
part of the seller’s inventories. The buyer records the
purchase (and accounts payable) only when he receives
the shipment.
Freight
As a rule, the entity who owns the goods being shipped
should pay for the shipping costs. But sale contracts
may also contain terms for shipping costs indicated by any
of the following:
a. Freight prepaid – The seller pays the freight in advance
before shipment.
b. Freight collect – Freight is not yet paid upon the
shipment and collects shipping costs from the buyer
upon delivery.
c. FAS (free alongside) – The seller assumes all expenses
in delivering the goods to the dock alongside the carrier.
Freight
d. Ex-ship – The seller assumes all expenses until the
goods are unloaded from the carrier.
e. CIF (cost, insurance, freight) – buyer pays
f. CF (cost, freight) – buyer pays
Freight
• FOB shipping point, freight collect
• FOB destination, freight prepaid
• FOB shipping point, freight prepaid
• FOB destination, freight collect

Illustration 1:
ABC Co. purchased goods with invoice price of 1,000 on
account on Dec. 27, 20x1. The related shipping costs
amounted to 10. The seller shipped goods on Jan. 2, 20x2
and settled the account on Jan. 5, 20x2.
Consigned goods
Under a consignment agreement, an entity (called the
‘consignor’) delivers goods to another party (called the
‘consignee’) who undertakes to sell the goods to end
customers on behalf of the consignor.

The consignor retains control over the consigned goods

until they are sold to end customers, and such remain in the
consignor’s inventory.
Consigned goods
• Freight and other incidental costs of transferring
consigned goods to the consignee form part of the cost of
the consigned goods.
• Repair costs for damages during shipment and storage
and other maintenance costs are charged as expense bu
the consignor.
• Commissions on sales are accounted for as expense by
the consignor.
Inventory financing agreements
a. Product financing agreement – a seller sells inventory to
a buyer but assumes an obligation to repurchase it at a
later date. The seller retains ownership over the
inventory.
b. Pledge of inventory – a borrower uses its inventory as
collateral security for a loan. The borrower retains
ownership over the inventory.
c. Loan of inventory – an entity borrows inventory from an
entity to be replaced with the same kind of inventory. The
borrower includes the loaned goods in its inventory.
Sale with unusual right of return
The buyer normally recognizes goods purchased under a
sale with right of return at the time of sale. Unless:
a. The buyer assesses that no economic benefits will be
derived from the goods, such as when they are defective
or unsalable; or
b. The buyer intends to return the goods to the seller within
the time limit allowed under the sale agreement.
Sale with unusual right of return
Sale on trial
Under a “sale on trial” (or “sale on approval”), a seller allows
a prospective customer to use a good for a given period of
time before deciding to purchase or not.

Under this type of arrangement, the legal title over the good
does not pass to the prospective customer until he
approves inventory during the trial period.
Sale on trial
Installment sale
An installment sale where the possession of the goods is
transferred to the buyer, but the seller retains legal title
solely to protect the collectability of the amount due is
considered as a regular sale.

Therefore, the goods are excluded from the seller’s

inventory and included in the buyer’s inventory at the
point of sale.
Installment sale
Bill and hold arrangement
A bill-and-hold arrangement is a contract of sale under
which 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.
Lay away sale
Lay away sale is a type of sale in which 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 until the goods are delivered to the
buyer when he makes the final installment payment.
ACCOUNTING FOR INVENTORIES
Inventories are accounted for either through:
1. Perpetual Inventory System
2. Periodic Inventory System
PERPETUAL INVENTORY SYSTEM
Under this, the “Inventory” account is updated each time
a purchase or sale is made. Thus, the “Inventory” account
shows a continuing or running balance of the goods on
hand. Physical count is performed only as an internal
control to determine the accuracy of the balance per
records.

All increases and decreases in inventory, such as

purchases, freight-in, purchase returns, purchase discounts,
cost of goods sold, and sales return are recorded in the
“Inventory” account.
PERPETUAL INVENTORY SYSTEM
This system is commonly used for inventories that are
specifically identifiable and are relatively high valued.
PERIODIC INVENTORY SYSTEM
Under this, the “Inventory” account is updated only when
a physical count is performed. Thus, the amounts of
inventory and cost of goods sold are determined only
periodically.

Under this system, the entity does not maintain records that
show the running balances of inventory on hand and cost of
goods sold as at any given point of time. To determine this
information, a physical count must be performed
periodically.
PERIODIC INVENTORY SYSTEM
The quantity is then multiplied by the unit cost to get the
balance of the “Inventory” account. This amount is then
used to compute for the “Cost of goods sold,” which is the
residual amount in the formula below:
PERIODIC INVENTORY SYSTEM
Net Purchases Computation
COST FORMULAS
1. Specific Identification – It is a method of tracking
inventory items by assigning a specific costs associated
to it from the point of purchase to the point of sale.
2. FIFO Method – Termed as “First-in, First-Out” method.
This method implies that the ending inventory comprises
the later purchases/production made by the company.
3. Weighted Average – Cost of sales and ending inventory
are determined based on the weighted average cost of
beginning inventory and all inventories purchased or
produced during the period.
4. Moving Average – Average is re-calculated as each
additional purchase is made.
5. LIFO Method – Termed as “Last-in, Last-Out” method.
CONVERSION COSTS
Conversion costs refer to direct labor and manufacturing
overhead that are necessary in converting raw materials
into finished goods.
Examples: Factory overhead, factory burden, production
overhead and manufacturing support costs.

Prime costs on the other hand, refer to the sum of direct

materials and direct labor costs.
INVENTORY VALUATION
Inventories are 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 costs of
completion and the estimated costs necessary to make the
sale.” (PAS 2.6)
WRITE-DOWN OF INVENTORY
Inventory is written down if its cost exceeds NRV.

The excess of cost over NRV represents the amount of

write-down, which is recognized as expense, usually as
cost of goods sold.