INVENTORIES

GOODS INCLUDIBLE IN THE INVENTORY

v All goods to which the entity has title, regardless of location

v Passing of Title - the point of time at which ownership

changes.
 LEGAL TEST
ü Goods owned on hand
ü Goods in transit and sold FOB destination
* Seller shall be responsible for freight charges and other expenses up
to the point of destination.
ü Goods in transit and purchased FOB shipping point
* Buyer shall legally be responsible for freight charges and other
expenses from the point of shipment to the point of destination.
ü Goods out on consignment
ü Goods in the hands of salesmen or agents
ü 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.
• It is an accepted accounting procedure to record the
installment sale as a regular sale involving deferred income on
the part of the seller and as a regular purchase on the part of
the buyer.
 FREIGHT TERMS
• “FOB destination” and “FOB shipping point” determine
ownership of the goods in transit and the party who should
pay the freight charge and other expenses.
• “Freight Collect” and “Freight Prepaid” determine the party
who actually paid the freight charge.
 STATEMENT PRESENTATION
• Inventories are generally classified as current assets as a single
line item.
• Details of the inventories shall be disclosed in the notes to
financial statements.
ACCOUNTING FOR INVENTORIES
ü Periodic System

ü Perpetual System
INVENTORY SHORTAGE OR OVERAGE
ü The inventory shortage is usually closed to cost of goods sold
because this is often the result of normal shrinkage and
breakage in inventory.

ü Abnormal and material shortage shall be separately classified

and presented as other expense.
 TRADE DISCOUNTS
AND CASH DISCOUNTS
• Trade discounts are not recorded
• Cash discounts are recorded as purchase discount by the
buyer and sales discount by the seller.
 COST OF INVENTORIES
• COST OF PURCHASE
- shall not include foreign exchange differences
- the difference between the purchase price for normal credit
terms and the amount paid on deferred settlement terms is
recognized as interest expense
• COST OF CONVERSION (labor and overhead)
• OTHER COST INCURRED IN BRINGING THE
INVENTORIES TO THEIR LOCATION AND
CONDITION
 COSTS EXCLUDED
FROM THE COST OF INVENTORIES
• Abnormal amounts of wasted materials, labor and other
production costs.
• Storage costs, unless these costs are necessary in the
production process prior to a further production stage.
* Related to Goods in process - capitalized
* Related to finished goods - expensed
• Administrative overheads that are irrelevant to inventories
• Distribution or selling costs
INVENTORY COST FLOW (PAS 2, par 25)
• First In, First Out

• Weighted average

• The standard does not permit anymore the use of the last in,
first out (LIFO) as an alternative formula in measuring cost of
inventories.
 LOWER OF COST
AND NET REALIZABLE VALUE
• PAS 2 par 9
Ø Inventories shall be measured at the lower of cost an net
realizable value (LCNRV)
• Net Realizable Value (NRV)
Ø Estimated selling price in the ordinary course of business less
the estimated cost of completion and the estimated cost of
disposal.
 IRRECOVERABLE
COST OF INVENTORIES
a. Damaged Inventories
b. Wholly or partially obsolete inventories
c. Inventories with declined selling prices
d. Inventories with estimated cost of completion or estimated
cost of disposal that increased
v Assets shall not be carried in excess of amounts expected to
be realized from their sale or use.
 MEASUREMENT OF INVENTORY
AT LCNRV
• Inventories are usually written down to net realizable value on an
item by item or individual basis.
• Inventories are not appropriate to be written down based on
classification.
• If the cost is lower than net realizable value, the inventory is stated
at cost and the increase in value is not recognized.
• If the net realizable value is lower than cost, the inventory is
measured at net realizable value and the decrease in value is
recognized as expense.
 METHODS OF ACCOUNTING
FOR INVENTORY WRITEDOWN
DIRECT METHOD
Ø “cost of goods sold” method
Ø any loss on inventory write down is not accounted for separately
but buried in the COGS.
 METHODS OF ACCOUNTING
FOR INVENTORY WRITEDOWN
ALLOWANCE METHOD
Ø inventory is recorded at cost and any loss on inventory write down
is accounted for separately.
Ø “loss method”
Ø Entry: (Dr. Loss on Inventory Write down/Cr. Allowance for
Inventory Write down)
Ø Loss on Inventory Write down is included in the computation of
COGS.
Ø Gain of reversal entry is limited only to the allowance balance,
which is a deduction from COGS.
 MEASUREMENT OF AGRICULTURAL,
MINERAL AND FOREST PRODUCTS
Ø measured at net realizable value at certain stages of production
provided that:
a. there is a forward contract or a government guarantee.
b. a homogeneous market exists and there is a negligible risk of failure
to sell.
MEASUREMENT OF COMMODITIES
OF BROKER TRADERS
• Measured at Fair Value less cost of disposal.
• Inventories are principally acquired with the purpose of selling
them in the near future and generating a profit from fluctuations in
price or broker- traders’ margin.
REASONS FOR ESTIMATING INVENTORY
1. Determination of inventory loss due to fire and other catastrophe or
theft of merchandise.

2. Proof of the reasonable accuracy of a physical count. (Gross Profit

Test)

3. Preparation of interim statements. (statements of less than one year)

 GROSS PROFIT METHOD
§ Ending Inventory = Goods Available for Sale - Cost of sales
§ Cost of sales - determined through the use of the Gross Profit
Rate which is assumed to be relatively constant from period to
period
 GROSS PROFIT METHOD
§ COST OF SALES
Ø Net Sales x Cost Ratio (used when Gross Profit Rate is based on
sales)
Ø Net Sales/ Sales Ratio (used when Gross Profit Rate is based on
cost)
 GROSS PROFIT METHOD
§ SALES ALLOWANCE AND SALES DISCOUNT
Ø ignored and not deducted from sales.
Ø these items decrease the amount of sales but do not affect the
physical volume of goods sold

§ SALES RETURN
Ø actual addition to goods on hand
 RETAIL METHOD
Ø Selling Price or Retail Price is tagged to each item and therefore, the ending
inventory is stated at selling price.
• COMPUTATION
Ø Goods available for sale at selling price - net sales = Ending Inventory at
Selling Price
Ø Ending Inventory at Selling Price x Cost Ratio = Inventory at Cost
• COST RATIO
Ø Goods available for sale at Cost/ Goods available for sale at Selling Price
 REQUIRED INFORMATION
§ Beginning Inventory valued at Cost and at Retail Price
§ Purchases during the period at Cost and at Retail Price
§ Adjustments to the original retail price
§ Other adjustments such as departmental transfer, breakage,
shrinkage, theft, damaged goods and employee discount
 RETAIL INVENTORY METHOD
§ CONSERVATIVE/CONVENTIONAL APPROACH
Ø Cost Ratio is determined by including markups and excluding
markdowns in computing the goods available for sale at retail.
§ AVERAGE COST APPROACH
Ø Markups and markdowns are both included in the computation of
the cost ratio
§ FIFO APPROACH
Ø A cost ratio is computed for the current year
Ø Only the current purchases are considered together with markups
and markdowns
Ø Beginning inventory is excluded in the computation
 SOURCE
Peralta, J.F., Valix, C.A.M., Valix, C.T. 2019. Intermediate
Accounting Volume 1. GIC Enterprises & Co., Inc.
Sampaloc, Manila.
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