HAND-OUT NO.

6: INVENTORY – GENERAL CONCEPTS

Brian Christian S. Villaluz, CPA
FINANCIAL ACCOUNTING AND REPORTING
HAND-OUT NO. 6: Inventory – General Concepts

INTRODUCTION
Inventories are assets:
a. Held for sale in the ordinary course of business;
b. In the process of production for such sale; or
c. In the form of materials or supplies to be consumed in the production process in the rendering of services.

OWNERSHIP OVER INVENTORIES

Legal title normally passes when possession over the goods is transferred. However, there are cases where the transfer
of control or ownership does not coincide with the transfer of physical possession. Regardless of location, an entity
shall report in its financial statements all inventories over which it holds legal title to or has obtained control of the
economic benefits.

Proper consideration should be given to the following:

1. Goods in transit
2. Consigned goods
3. Inventory financing agreements
4. Sale on trial or approval
5. Installment sale
6. Bill and hold sale
7. Lay away sale

Problem 1: (Goods in Transit)

Buyer Company purchased goods with invoice price of P100,000 on account on December 31, 2018. The shipping costs
amounted to P10,000. The seller company shipped the goods on the same date. Buyer Company received the goods on
January 5, 2019.

Required: Prepare the required journal entries in the books of Buyer Company and Seller Company on December 31, 2018
under each of the following FOB Terms:
(a) FOB Shipping point
(b) FOB Destination
(c) FOB Shipping point, freight collect
(d) FOB Shipping point, freight prepaid
(e) FOB Destination, freight prepaid
(f) FOB Destination, freight collect

CONSIGNMENT
A consignment involves a consignor transferring goods to a consignee who acts as agent of the consignor in selling the
goods. Freight and other incidental costs of transferring consigned goods to the consignee form part of the cost of the
consigned goods

INVENTORY FINANCING AGREEMENTS

1. Product financing agreement – a seller sells inventory to a buyer but assumes an obligation to repurchase it
at a later date. This arrangement does not result to the transfer of control over the asset.
2. Pledge of inventory – a borrower uses its inventory as collateral security for a loan. This arrangement does not
result to the transfer of control over the asset.
3. Loan of inventory – an entity borrows inventory from another entity to be replaced with the same kind of
inventory. This arrangement results to transfer of control over the asset.

SALE ON TRIAL
Under a sale on trial arrangement, a seller allows a prospective customer to use a good for a given period of time. The
good is considered sold if it is not returned within a reasonable period of time after the trial period has lapsed.

INSTALLMENT SALE
An installment sale where the possession 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 a regular sale.
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BILL AND HOLD ARRANGEMENT
A bill and hold arrangement is a contract 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, provided:
a. The reason for the bill and hold arrangement is substantive (e.g., the customer has requested for the
arrangement);
b. The goods are identified separately as belonging to the customer;
c. The goods are available for immediate transfer to the customer; and
d. The seller cannot use the goods or sell them to another customer.

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.

Problem 2: (Recognition of inventory)

The records of Blast Co. show the following:

Goods sold on an installment basis to Blur Co., title to the goods is retained by 750,000
Blast until full payment is made. The goods is in the possession of Blur.

Goods sold to Pure Co., for which Blast has signed an agreement to repurchase 680,000
the goods sold at a set price that covers all costs related to the inventory.

Goods received from Furry Co. for which an agreement was signed requiring Blast 580,000
to replace such goods in the near future

1. How much is included as part of Blast Co.’s inventory?

Problem 3: (Bill-and-Hold; Lay away sale)

The following are among the transactions of Pansit Co. during the year:
 Purchased goods costing P10,000 from Palabok Co. billing was received although delivery was delayed per request
of Pansit. The goods purchased were segregated and ready for delivery on demand.
 Purchased goods costing P25,000 from Lomi Corp. on a lay away sale agreement. The goods were not yet delivered
until after Pansit makes the final payment on the purchase price.

1. How much of the goods purchased above will be included in Pansit’s year-end inventory?

ACCOUNTING FOR INVENTORIES

Inventories are accounted for either through:
(a) Periodic inventory system, or
(b) Perpetual inventory system

Periodic inventory system

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. A physical count of inventories is required to determine the year-end inventories.

Perpetual inventory system

Records called “stock cards” are maintained under this system, from which the quantities and balances of goods on hand
and goods sold can be determined at any given point of time without the need of performing a physical count of
inventories. Physical count is performed only as an internal control to determine the accuracy of the balance per records.

Problem 4: (Periodic vs. Perpetual) [WITH ANSWERS]

The following transactions occurred during the year:
 Purchased goods worth P10,000 on account under credit terms of 20%, 10%, 2/10. n/30.
 Paid shipping costs of P1,000 on the purchases above.
 Returned damaged goods worth P2,000 to the supplier.
 Sold goods costing P5,000 for P20,000 on account.

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 A customer returned goods with sale price of P800 and cost of P200.

Required: Prepare the journal entries to record the foregoing under the:
(a) Periodic inventory system
(b) Perpetual inventory system
PERIODIC PERPETUAL
Purch 10,000.00 Invty. 10,000.00
AP 10,000.00 AP 10,000.00

F. In 1,000.00 Invty. 1,000.00

Cash 1,000.00 Cash 1,000.00

AP 2,000.00 AP 2,000.00
PRA 2,000.00 Invty. 2,000.00

AR 20,000.00 AR 20,000.00
Sales 20,000.00 S 20,000.00

CGS 5,000.00
MI 5,000.00

SRA 800.00 SRA 800.00

AR 800.00 AR 800.00

MI 200.00
CGS 200.00

ACCOUNTING FOR DISCOUNTS

There are two types of discounts:
1. Trade discounts
2. Cash discounts

Trade discounts are given to encourage orders in large quantities. Trade discounts do not form part of inventory. They
are deducted from the list price in order to determine the invoice price. Trade discounts are not recorded in the books
of either the buyer or seller.

Cash discounts are given to encourage prompt payment. They are deducted from the invoice price to determine the
amount of net payment required within the discount period.

Accounting for Cash Discounts

The two accounting methods for cash discounts are:
1. Gross method
2. Net method

Under the gross method, the cost of inventory and accounts payable are recorded gross of cash discounts. Purchase
discounts are recorded only when actually taken.

Under the net method, the cost of inventory and accounts payable are initially recorded net of cash discounts, regardless
of whether such discounts are taken or not. Purchase discounts not taken are recorded under the purchase discounts
lost account included as part of other expense or finance cost.

Theoretically, the net method should be used because it supports the concept of conservativism. However, the gross
method is more commonly used because of cost-benefit considerations and convenience.

Problem 5: (Accounting for Discounts; Periodic vs. Perpetual) [WITH ANSWERS]

An entity purchased inventory with a list price of P10,000 on account under credit terms of 20%, 10%, 2/10, 1/15, n/45.

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1. Prepare the journal entries to record the foregoing using the gross method under periodic inventory system
assuming:
(a) The account was settled on Day 10.
(b) The account was settled on Day 15.
(c) The account was settled on Day 45.
2. Prepare the journal entries to record the foregoing using the gross method under perpetual inventory system
assuming:
(a) The account was settled on Day 10.
(b) The account was settled on Day 15.
(c) The account was settled on Day 45.
3. Prepare the journal entries to record the foregoing using the net method under periodic inventory system assuming:
(a) The account was settled on Day 10.
(b) The account was settled on Day 15.
(c) The account was settled on Day 45.
4. Prepare the journal entries to record the foregoing using the net method under perpetual inventory system
assuming:
(a) The account was settled on Day 10.
(b) The account was settled on Day 15.
(c) The account was settled on Day 45.

GROSS METHOD
PERIODIC PERPETUAL
Upon Purch. P 7,200.00 Invty. 7,200.00
AP 7,200.00 AP 7,200.00

Case A AP 7,200.00 AP 7,200.00

PD (7,200 x 2%) 144.00 Invty. 144.00
Cash (7,200 x 98%) 7,056.00 Cash 7,056.00

Case B AP 7,200.00 AP 7,200.00

PD (7,200 x 1%) 72.00 Invty. 72.00
Cash (7,200 x 99%) 7,128.00 Cash 7,128.00

Case C AP 7,200.00 AP 7,200.00

Cash 7,200.00 Cash 7,200.00

NET METHOD
PERIODIC PERPETUAL
Upon Purch. P (7,200 x 98%) 7,056.00 Invty. 7,056.00
AP 7,056.00 AP 7,056.00

Case A AP 7,056.00 AP 7,056.00

Cash 7,056.00 Cash 7,056.00

Case B AP 7,056.00 AP 7,056.00

PDL (7,200 x 1%) 72.00 PDL 72.00
Cash 7,128.00 Cash 7,128.00

Case C AP 7,056.00 AP 7,056.00

PDL (7,200 x 2%) 144.00 PDL 144.00
Cash 7,200.00 Cash 7,200.00
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Problem 6:
SS Company regularly buys goods from a supplier and is allowed trade discounts of 20% and 10% from the list price. SS
made a purchase during the year and received an invoice with a list price of P600,000, a freight charge of P15,000 and
payment terms of 2/10, n/30.

What is the cost of the purchase?

A. 432,000 B. 447,000
C. 438,360 D. 435,000

Problem 7:
On June 1, 2018, RR Company sold merchandise with a list price of P5,000,000 to BFV Company on account. RR allowed
trade discounts of 30% and 20%.

On June 11, 2018, the customer paid in full.

Credit terms were 2/10, n/30 and the sale was made FOB shipping point. RR prepaid P200,000 of delivery costs for BFV
as an accommodation.

1. What amount of should be reported as sales revenue?

A. 5,000,000 B. 2,800,000
C. 3,500,000 D. 2,500,000

2. What amount was received by RR from BFV as remittance in full?

A. 2,744,000 B. 2,940,000
C. 2,944,000 D. 3,140,000

Problem 8:
On April 1, 2018, MM Company recorded purchases of inventory of P800,000 and P1,000,000 under credit terms of 2/15,
net 30.

The payment due on the P800,000 purchase was remitted on April 16. The payment due on the P1,000,000 purchase was
remitted on May 1.

Under the net method and gross method, these purchases should be included at what respective amounts in the
determination of cost of goods available for sale?

Net method Gross method

A. 1,784,000 1,764,000
B. 1,764,000 1,800,000
C. 1,764,000 1,784,000
D. 1,800,000 1,764,000

MEASUREMENT OF INVENTORIES
The cost of inventories comprises the following:
1. Purchase cost – this includes the purchase price (net of trade discounts and other rebates), import duties, non-
refundable or non-recoverable purchase taxes, and transport, handling and other costs directly attributable to the
acquisition of the inventory.
2. Conversion costs – these refer to the costs necessary in converting raw materials into finished goods.
Conversion costs include direct labor and production overhead costs.
3. Other costs necessary in bringing the inventories to their present location and condition.

The following are excluded from the cost of inventories and are expensed in the period in which they are incurred:
1. Abnormal amounts of wasted materials, labor or other production costs;
2. Selling costs, e.g., advertising and promotion costs and delivery expense or freight out;
3. Administrative overheads that do not contribute to bringing inventories to their present location and condition;
and

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Brian Christian S. Villaluz, CPA
4. Storage costs, unless those costs are necessary in the production process before a further production stage. For
example, warehousing costs and other costs of storing inventories before they are sold are expensed in the
period they are incurred. However, the storage cost of wine during fermentation is a necessary cost that can be
capitalized as cost of inventory by a wine producer. Also, the storage costs of partly finished goods may be
capitalized as cost of inventory, but the storage costs of completed goods are expensed.

Problem 9: (Initial measurement of inventory)

Chan Co. imported goods from France and incurred the following costs:

Purchase price P200,000

Import duties 20,000
Value added tax 26,000
Transportation and handling costs 10,000
Commission to broker 4,000

1. How much is the cost of purchase of the imported goods if the entity is a VAT payer?
2. How much is the cost of purchase of the imported goods if the entity is not a VAT payer?

Problem 10:
OO Company has incurred the following costs during the current year:

Cost of purchases based on vendors’ invoices P 5,000,000

Trade discounts on purchases already deducted from vendors’ invoices 500,000
Import duties 400,000
Freight and insurance on purchases 1,000,000
Other handling costs relating to imports 100,000
Salaries of employees in the accounting department 600,000
Brokerage commission paid to agents for arranging imports 200,000
Sales commission paid to sales agents 300,000
After-sales warranty costs 250,000

What is the total cost of purchases?

A. 5,700,000 B. 6,100,000
C. 6,700,000 D. 6,500,000

Problem 11:
Sweets Industries commenced operations during the year as large importer and exporter of sweet products. The imports
were all from one country overseas. The company reported the following data:

Purchases during the year P 12,000,000

Shipping costs from overseas 1,500,000
Shipping costs to export customers 1,000,000
Inventory at year-end (excluding applicable shipping costs, if any) 3,000,000

What amount of shipping costs should be included in the year-end inventory valuation?
A. 250,000 B. 625,000
C. 375,000 D. -0-

OTHER CONSIDERATIONS
1. Borrowing Costs
Borrowing cost or interest expense forms part of the cost of inventory only if it is incurred on borrowings taken to finance
the acquisition or production of inventory that meets the definition of a qualifying asset. A qualifying asset is an asset that
necessarily takes a substantial period of time to get ready for its intended use or sale. All other interests are charged as
expenses.

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Brian Christian S. Villaluz, CPA
2. Deferred settlement terms
When payment for purchases is deferred and the arrangement effectively contains a financing element, the difference
between the purchase price for normal credit terms and the amount paid is recognized as interest expense over the
period of the financing.

3. Inventories purchased in lump sum

The cost of different inventories having different values purchased on a lump sum basis is allocated to such inventories
using their relative sales price.

Problem 12: (Lump Sum acquisition)

A real estate developer acquired a tract of land for P3,000,000. The land was developed and subdivided into residential lots
at an additional cost of P600,000. Although the subdivided lots are relatively equal in sizes, they were offered at different
sales prices due to differences in terrain and locations. Information on the subdivided lots is shown below:

Lot group: No. of lots: Price per lot:

A 4 P400,000
B 10 200,000
C 15 160,000

1. Compute for the allocated costs of the groups of lots.

2. Compute for the unit cost per lot group.

Problem 13:
VV Company provided the following data:

Items counted in the bodega P 4,000,000

Items included in the count specifically segregated per sale contract 100,000
Items in the receiving department, returned by customer in good condition 50,000
Items ordered and in the receiving department 400,000
Items ordered, invoice received but goods not received. Freight is on account of seller 300,000
Items shipped today, invoice mailed, FOB shipping point 250,000
Items shipped today, invoice mailed, FOB destination 150,000
Items currently being used for window display 200,000
Items on counter for sale 800,000
Items in receiving department, refused because of damage 180,000
Items included in count, damaged and unsalable 50,000
Items in the shipping department 250,000

What is the correct amount of inventory?

A. 5,700,000 B. 6,000,000
C. 5,800,000 D. 5,150,000

Problem 14:
AA Company included the following items in inventory:

Materials P 1,400,000
Advance for materials ordered 200,000
Goods in process 650,000
Unexpired insurance on inventory 60,000
Advertising catalogs and shipping cartons 150,000
Finished goods in factory 2,000,000
Finished goods in company-owned retail store, including 50% profit on cost 750,000
Finished goods in hands of consignees including 40% profit on sales 400,000
Finished goods in transit to customers, shipped FOB destination at cost 250,000
Finished goods out on approval, at cost 100,000
Unsalable finished goods, at cost 50,000
Office supplies 40,000
Materials in transit, shipped FOB shipping point, including freight of P30,000 360,000
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Brian Christian S. Villaluz, CPA
Goods held on consignment, at sales price (cost, P150,000) 200,000

What is the correct amount of merchandise inventory?

A. 5,375,000 B. 5,500,000
C. 5,540,000 D. 5,250,000

Problem 15:
AA Company reported inventory on December 31, 2018 at P6,000,000 based on a physical count of goods priced at cost
and before any necessary year-end adjustments relating to the following:

 Included in the physical count were goods billed to a customer FOB shipping point on December 30, 2018. These
goods had a cost of P125,000 and were picked up by the carrier on January 2, 2019.
 Goods shipped FOB shipping point on December 28, 2018 from a vendor to AA were received and recorded on
January 2, 2019. The invoice cost was P300,000.

What amount should be reported as inventory on December 31, 2018?

A. 5,875,000 B. 6,000,000
C. 6,175,000 D. 6,300,000

Problem 16:
Katindig Company conducted a physical count on December 31, 2020 which revealed inventory with a cost of P4,410,000.

The following items were not included in the physical count:

Merchandise held by Katindig on consignment P 610,000

Merchandise shipped by Katindig FOB destination to a customer on

December 31, 2020 and was received by the customer on January 5, 2021 380,000

Merchandise shipped by Katindig FOB shipping point to a customer on

December 31, 2020 and was received by the customer on January 5, 2021 460,000

Merchandise shipped by a vendor FOB destination on December 31, 2020

was received by Katindig on Janauary 5, 2021 830,000

Merchandise purchased FOB shipping point was shipped by the supplier on

December 31, 2020 and received by Katindig on January 5, 2021 510,000

What is the correct amount of inventory on December 31, 2020?

A. 5,300,000 B. 4,690,000
C. 3,800,000 D. 4,920,000

Problem 17:
Cardo Company reported accounts payable on December 31, 2019 at P4,500,000 before any necessary year-end
adjustments relating to the following transactions:
 On December 27, 2019, Cardo wrote and recorded checks to creditors totaling P2,000,000 causing an overdraft of
P500,000 in Cardo’s bank account on December 31, 2019. The checks were mailed on January 5, 2020.
 On December 28, 2019, Cardo purchased and received goods for P750,000, terms 2/10, n/30. Cardo records
purchases and accounts payable at net amount. The invoice was recorded and paid January 3, 2020.
 Goods shipped FOB destination on December 24, 2019 from a vendor to Cardo were received January 8, 2020.
The invoice cost was P325,000.

On December 31, 2019, what amount should be reported as accounts payable?

A. 7,575,000 B. 7,250,000
C. 7,235,000 D. 7,553,500

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Problem 18: (Answer: D)
Marco Company’s usual sales terms are net 60 days, FOB shipping point. Sales, net of returns and allowances, totaled
P9,200,000 for the year ended December 31, 2018, before year-end adjustments.
 On December 28, 2018, Marco authorized a customer to return, for full credit, goods shipped and billed at P200,000
on December 15, 2018. The returned goods were received by Marco on January 2, 2019, and a P200,000 credit
memo was issued and recorded on the same date.
 Goods with an invoice amount of P300,000 were billed and recorded on January 3, 2019. The goods were shipped
on December 30, 2018.
 Goods with an invoice amount of P400,000 were billed and recorded on December 30, 2018. The goods were
shipped on January 2, 2019.
 On January 5, 2019, a customer notified Marco that goods billed and shipped on December 21, 2019 were lost in
transit. The invoice amount was P500,000.

What is the correct amount of net sales for 2018?

A. 9,300,000 B. 9,100,000
C. 8,400,000 D. 8,900,000

FINANCIAL ACCOUNTING THEORIES

1. Which is incorrect? Inventories are assets
A. Held for sale in the ordinary course of business.
B. In the process of production for sale.
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. When accounting for inventories

A. The form of the sales contract is more important than its substance.
B. The agreement between the seller and the buyer shall be considered in determining the timing of transfer of
ownership over the goods.
C. The sales contract is ignored since ownership over inventories is transferred only upon receipt of delivery by
the buyer.
D. A journal entry is made only upon receipt of the delivery by the purchaser.

3. Who should properly shoulder the freight of the goods shipped?

A. The buyer
B. The seller
C. The shipper
D. The entity who owns the goods

4. Which of the following is incorrect regarding the accounting for consigned goods?
A. Consigned goods are properly included in the inventory of the consignor and not the consignee.
B. Freight incurred by the consignor in delivering the consigned goods to the consignee forms part of the cost of
the inventories.
C. The consignee records goods received from the consignor through journal entries.
D. The consignor should not recognize revenue until the consigned goods are sold by the consignee to third
parties.

5. A merchandising entity utilizes an automated accounting system in which the entity inputs the serial number of each
item of inventory in the system. This enables the entity to track the movement of each inventory. Which inventory
system is most likely to be used by the said entity?
A. Periodic system
B. Perpetual system
C. Advanced accounting system
D. Either A or B

6. Under this inventory system, a physical count is necessary before profit is determined.
A. Periodic system
B. Perpetual system
C. SME inventory system
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Brian Christian S. Villaluz, CPA
D. Under no such system

7. Under this inventory system, a physical count is necessary only for internal control purposes
A. Periodic system
B. Perpetual system
C. Large multinational entity system
D. Under no such system

8. At each reporting period, inventories are measured at

A. Cost
B. Net realizable value
C. Lower of cost and net realizable value
D. Fair value less cost to sell

9. The purchase cost of inventories includes all of the following, except

A. Purchase price
B. Import duties and non-refundable taxes.
C. Freight cost incurred in bringing the inventory to its intended location
D. VAT paid by a VAT-registered entity.

10. Under the gross method of recording purchases

A. Cash discounts are initially ignored and are recorded only when taken.
B. Cash discounts are deducted from the cost of inventory on initial recognition.
C. Cash discounts lost are debited to “purchase discounts lost” account
D. A and C

END OF HANDOUT

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