Inventories are 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 rendering of services.

Measurement of Inventory
Initial Measurement = Cost*
Subsequent Measurement = Lower of Cost or Net Realizable Value**
Note: **Net Realizable Value (NRV) is the estimated selling price in the ordinary course of business less estimated cost of completion and
the estimated cost necessary to make the sale.

Measurement of Cost*

Purchase Conversion
 Purchase price  Direct materials
 Import duties  Direct Labor
 Irrevocable Taxes  Fixed and variable production overhead
 Freight  Abnormal amounts of waste and spoilage
 Handling  Storage costs
 Other Cost Directly attributable to the  Administrative Overheads
purchase  Selling Costs
Deduct
- Trade Discounts
- Rebates
- Other Similar Items
Note: When purchased with deferred settlement terms, the
difference between the purchase price for normal
credit terms and the amount paid is recognized as
interest expense over the period of financing.

Freight on Board (Fob) Terms

a. FOB destination – ownership of goods purchased is transferred only upon the receipt of goods by the buyer at
the point of destination. The seller shall be responsible for the freight charges and other charges up to the point
of destination.
b. FOB shipping point – ownership is transferred upon shipment of the goods. The buyer shall be responsible for
the freight charges and other charges up to the point of destination.
c. Freight collect – freight charge is paid by the buyer.
d. Freight prepaid – freight charge is paid by the seller.

Maritime Shipping Terms

a. Free alongside (FAS) – seller must bear the risk 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 shipment and thus,
title passes to the buyer when the carrier takes possession of the goods.
b. Cost, insurance and freight (CIS) – buyer agrees to pay in a lump sum the cost of the goods, insurance cost and
freight charges. The seller must pay for the cost of loading. Thus, title and risk of loss shall pass to the buyer upon
delivery of the goods to the carrier.
c. Ex-ship (super FOB destination) - seller bears all expenses and risk of loss until the goods are unloaded at which
time and risk of loss shall pass to the buyer.
Consigned Goods
Consignment –method of marketing of goods in which the owner called the consignor transfers physical possession of
certain goods to an agent called the consignee who sells them on the owner’s behalf.
Rule: Consigned goods shall be included in the consignor’s inventory and excluded from the consignee’s inventory.
Freight and other charges on goods out on consignment are part of the cost of goods consigned.

Trade Discounts and Cash Discounts

Trade discounts
 deductions from the list catalog price in order to arrive at the invoice price which is the amount actually
charged to the buyer
 to encourage trading or increase sale.
Cash discounts
 deductions from the invoice price when payment is made within the discount period  to encourage prompt
payment.

Illustrative Problems:

1. Sterling Company is preparing its 2021 year-end financial statements. Prior to any adjustments, inventory is
valued at P7,600,000. The following information has been found relating to certain inventory transactions.
Identify the correct inventory in 2021.

 Goods valued at P1,000,000 are on consignment with a customer. These goods are not included in the year-end
inventory.  part of the inventory of consignor; consignor here is Sterling Company
 Goods costing P250,000 were received from a vendor on January 5, 2022. The related invoice was received and
recorded on January 12, 2014. The goods were shipped on December 31, 2021, terms FOB shipping point.
FOB Shipping point  ownership will transfer to the buyer upon shipment
 Part of the inventory; Sterling Company bought the goods that were shipped on December 31, 2021. Hence,
ownership was already transferred to Sterling Company during the time it was shipped.
 Goods costing P850,000 were shipped on December 31, 2021, and were delivered to the customer on January 2,
2022. The terms of the invoice was FOB shipping point. The goods were included in ending inventory for 2021
even though the sale was recorded 2021.
 this should not be included in the inventory because it was shipped to the customer on December 31, 2021.
Ownership was already transferred.
 since these were included in the ending inventory based on the last sentence, the amount should be deducted
from the inventory.
 A P350,000 shipment of goods to a customer on December 31, 2021, terms FOB destination, was not included in
the year-end inventory. The goods cost P260, 000 and were delivered to the customer on January 8, 2022. The
sale was properly recorded in 2022.
 this should be included in the inventory because it was FOB destination. Ownership will transfer when the
goods are received by the customer, that is on January 8, 2022. Recorded at cost.
 An invoice for goods costing P350,000 was received and recorded as a purchase on December 31, 2021. The
related goods, shipped FOB destination, were received on January 2, 2022, and thus were not included in the
physical inventory.
 this is correct; this should not be included because it is FOB destination and goods were received on Jan. 2,
2022. Ownership of the goods bought was transferred to Sterling Company on Jan. 2, 2022.
 Goods valued at P650,000 are on consignment from a vendor. The goods are not included in the year-end
inventory.
 Consigned goods should be included in the consignor’s books. In this case, Sterling company is the consignee,
hence, it is proper that this should not be included in the year-end inventory.
  A P1,050,000 shipment of goods to a customer on December 30, 2021, terms FOB destination, was recorded as a
sale in 2021, the goods, costing P840,000 and delivered to the customer on January 6, 2022, were not included
in 2021 ending inventory.
 In FOB destination, ownership is transferred when the goods are delivered; that is January 6, 2022. Hence, as
of December 31, 2021, the owner of the goods is still Sterling Company. This should be included in the
inventory at cost.

Solution:
Inventory, end – unadjusted 7,600,000
Consigned goods to agent 1,000,000
Goods in Transit (goods purchased)-FOB Shipping point 250,000
Goods in Transit (sold FOB shipping point) (850,000)
Goods in Transit (sold FOB destination) 260,000
Consigned goods from vendor 840,000
Inventory, end – adjusted 9, 100, 000

Periodic System and Perpetual System

Periodic System – calls for the physical counting of goods on hand at the end of the accounting period to determine
quantities. This procedure is generally used when the individual inventory items turn over rapidly and have small
peso investment such that it may prove impractical or inconvenient to record inventory inflow and outflow, such as
groceries, hardware and auto parts.
Perpetual System – requires the maintenance of records called stock cards that usually offer a running summary of the
inventory inflow and outflow. This procedure is commonly used where the inventory items treated individually
represent a relatively large peso investment. This is designed for control purposes.

Inventory Costing Methods

First in, First out (FIFO) Method
 Goods first purchased are first sold
 Inventory is stated at current replacement cost.
 In the period of inflation, FIFO method would result to the highest net income. I
 In a period of deflation or declining prices, FIFO method would result to the lowest net income.
Note: Under FIFO-periodic and FIFO-perpetual, the inventory costs are the same.

Weighted Average – Periodic

 The cost of beginning inventory plus the total costs of purchases during the period is divided by the total number of
units purchased plus those in the beginning inventory to get the weighted average unit cost. Such weighted average
unit cost is then multiplied by the units on hand to derive the inventory value.

Weighted Average – Perpetual (moving average method)

 A new weighted average unit cost must be computed every after purchase. Such weighted average unit cost is then
multiplied by the units on hand to get the inventory cost.
Specific Identification
 The cost of inventory is determined by simply multiplying the units on hand by their actual unit cost.
 Appropriate for inventories that are segregated for a specific project and inventories that are not ordinarily
interchangeable.
Illustrative Problem:

Assume the following data:

Date Transaction Units Unit Cost Total Cost
Jan-01 Beginning balance 5,000 200 1,000,000
10 Purchase 5,000 250 1,250,000
15 Sale -7,000
16 Sales return 1,000
30 Purchase 16,000 150 2,400,000
31 Purchase return -2,000 150 - 300,000
Ending Balance 18,000

Compute the Jan 31 Inventory.

Solution:

FIFO (Periodic or Perpetual)

Date Units Goods purchased (sold) Returns Unit Cost Ending Units Cost
Jan-01 5,000 -5,000 200 - -
10 5,000 -2,000 1,000 250 4,000 1,000,000
16 16,000 -2,000 150 14,000 2,100,000
Ending Inventory 18,000 3,100,000

Weighted Average – Periodic

Date Transactions Units Unit Cost Total Cost
a b a*b
Jan-01 Beg. Balance 5,000 200 1,000,000
10 Purchase 5,000 250 1,250,000
30 Purchase 16,000 150 2,400,000
31 Purchase return -2,000 150 -300,000
24,000 4,350,000
Weighted average unit cost (4,350,000/24,000) 181.25
Cost of ending inventory (18,000 * 181.25 3,262,500

Moving Average Method

Date Transaction Units Unit Cost Total Cost
Jan-01 Beg. Balance 5,000 200 1,000,000
10 Purchase 5,000 250 1,250,000
Balance 10,000 225 2,250,000
15 Sale -7,000 225 -1,575,000
Balance 3,000 225 675,000
16 Sales Return 1,000 225 225,000
Balance 4,000 225 900,000
30 Purchase 16,000 150 2,400,000
Balance 20,000 165 3,300,000
31 Purchase return -2,000 150 -300,000
Balance 18,000 167 3,000,000
Average cost = Total Cost / Total Units; this is computed every time
the number of units move.
Inventory Pro-forma Computation:

Inventory, beg xx
Purchases xx
Goods available for sale xx
- Cost of Goods Sold xx
Inventory, end xx

SUBSEQUENT MEASUREMENT: Lower of Cost or Net Realizable Value (NRV)

NRV – estimated selling price in the ordinary course of business less the estimated cost of completion and the estimated
cost of disposal.
General rule: Assets shall not be carried in excess of amounts expected to be realized from their sale or use.
Inventory cost may not be recoverable under the following circumstances:
a. Inventories are damaged.
b. Inventories have become wholly or partially obsolete.
c. Selling prices have declined.
d. Estimated cost of completion or the estimated cost of disposal has increased.
Accounting for Inventory Write-down
Direct Method Allowance Method
 Loss on inventory write-down is not Loss on inventory write-down is accounted
accounted for separately but buried in the for separately and credited to “allowance
cost of goods sold. for inventory write-down”
 The loss on inventory write down and gain
on reversal is included in the computation
of COGS.
Note: Gain on reversal of inventory write-down is
limited only to the extent of the allowance balance.

Illustrative Problem:
Inventory, January 1:
Cost 5,000,000
NRV 4,500,000
Net Purchases 20,000,000
Inventory, December 31:
Cost 6,000,000
NRV 5,900,000
Solutions:
Direct Method – cost of goods sold
Inventory, January 1 4,500,000
Net Purchases 20,000,000
Goods available for sale 24,500,000
Inventory, December 31 5,900,000
Cost of goods sold 18,600,000
Allowance Method – cost of goods sold
Inventory, January 1 at cost 5,000,000
Net Purchases 20,000,000
Goods Available for Sale 25,000,000
Inventory, December 31 at cost 6,000,000
COGS before reversal of writedown 19,000,000
*Gain on reversal of inventory writedown (400,000)
COGS after reversal of writedown 18,600,000
 *Required allowance – December 31 (6, 000, 000 – 5, 900, 000) 100, 000
Required allowance – January 1 (5, 000, 000 – 4, 500, 000) 500, 000
Reversal of inventory writedown – decrease in allowance (400, 000)

Relative Sale Price Method

When different commodities are purchased at a lump sum, the single cost is apportioned among the commodities based
on their respective sale price.

Purchase Commitments
Purchase commitments are obligations of the entity to acquire certain goods sometime in the future at a fixed price and
fixed quantity.

 market price = gain on purchase commitment

market price = loss on purchase commitment

Agricultural, Forest and Mineral Products

 measured at net realizable value at certain stages of production(PAS 2, par 4)
 This occurs when agricultural crops have been harvested or mineral products have been harvested and a sale is
assured under a forward contract or a government guarantee, or when a homogenous market exists and there is a
negligible risk of failure to sell.

Commodities of Broker-Traders
 measured at fair value less cost to sell.
Note: Broker-traders are those who buy and sell commodities for others or on their own account for the purpose of selling them in the near
future and generating a profit from fluctuations in price or broker-traders’ margin.

Inventory Estimation Reasons:

 inventory is destroyed by fire and other catastrophe, or theft
 to prove the correctness or reasonableness of physical count
 for interim financial statements

Gross Profit Method Retail Inventory Method

This method is based on the assumption that the rate of gross This method is generally employed by department stores,
profit remains approximately the same from period supermarkets and other retail concerns where there is a
to period and therefore the ratio of cost of goods sold to net wide variety of goods because keeping track of unit cost at all
sales is relatively constant from period to period. times is difficult.
1. Gross profit rate “based on sales” 1. Conservative Cost Approach (conventional or lower
2. Gross profit rate “based on cost” of average cost or market approach)
 Include mark-up, exclude mark-down
Note: Sales Allowances and Sales Discounts are ignored in computing 2. Average Cost Approach
the net sales for purposes of using gross profit rate method in
computing COGS.
 Mark-up and mark-down are included
3. FIFO Approach 4. LIFO Approach
Note: PAS 2 requires either the FIFO or Average Cost Approach

Cost ratio = Goods available for sale at cost

Goods available for sale at selling price
Terminologies:
Initial Mark-up - Original mark-up on the cost of goods
Original Retail - Sales price at which the goods are first offered for sale
Additional mark-up - Increase in sales price above the original sales price
Mark-up Cancelation - Decrease in sales price that does not decrease the sales price below the original sales price
Net additional mark-up or net mark-up - Mark-up minus mark-up cancelation
Markdown - Decrease in sales price below the original sales price
Markdown Cancelation - Increase in sales price that does not increase the sales price above the original sales price
Net Markdown - Markdown minus markdown cancelation
Maintained Mark-up or mark-on - Difference between cost and sales price after adjustment for all the above items

Treatment of other items:

Purchase Discount – deducted from purchases at cost only
Purchase Return – deducted from purchases at cost and at retail
Purchase Allowance – deducted from purchases at cost only
Freight in – addition to purchases at cost only
Departmental transfer in or debit – addition to purchases at cost and at retail
Departmental transfer out or credit – deduction from purchases at cost and at retail
Sales discount and sale allowance – disregarded, meaning, not deducted from sales
Sales return – deducted from sales. If the account is “sales return and allowances”, the same should be deducted from
sales.
Employee discounts – added to sales.
Normal shortage, shrinkage, spoilage and breakage – this are deducted from goods available for sale at retail.
Abnormal shortage, shrinkage, spoilage and breakage – this are deducted from goods available for sale both at cost and
at retail so as not to distort the cost ratio. Any abnormal amount is recorded separately as loss.