PAS 2 INVENTORIES

MODULE 4

Learning Objectives:

 Prescribe the accounting treatment for inventories.

 Provide guidance for determining the cost of inventories.
 Provide guidance on the cost formulas that are used to assign cost of inventories.
 Provide guidance for subsequently recognizing expense, including any write-down to
net realizable value.

ICE BREAKER:
TWO TRUTHS AND A LIE (ACCOUNTING TRIVIAS)
The goal of the game is to guess which statements are true and which one is a lie.
a. Double-entry bookkeeping was first developed by a Filipino. LIE (Italian)
b. Luca Pacioli is the Father of Accounting and Bookkeeping. TRUTH
c. Saint Matthew worked as a tax collector for the Romans before becoming one of
Christ's 12 apostles. TRUTH

a. Bubble gum was invented by an accountant. TRUTH

b. Excel sheets were used in the ancient accounting. LIE (Clay tablets)
c. The FBI employs over 2,000 accountants. TRUTH

a. International Accounting Day does not exist. LIE (Does)

b. The first CPA exam was issued in New York way back in 1896. TRUTH
c. Income Tax was Used to finance a War. TRUTH

a. Vicente Fabella was the first Filipino CPA. TRUTH

b. Accountants spend approximately 1,700 hours hand-counting ballots for the
Oscars. TRUTH
c. By preparing ledgers, financial positions cannot be known easily. LIE (Can)

a. Accountants must be good in math. LIE

b. Assets = Liabilities + Owner’s Equity TRUTH
c. Accountants are happy. TRUTH

Time Duration: 5 minutes

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Inventories
Inventories include assets held for sale in the ordinary course of business, assets
in the production process for such sale in the ordinary course of business, or in the form
materials or supplies to be consumed in the production process.
Inventories encompass goods purchased and held for resale. It also
encompasses finished goods produced, goods in process, and materials and
supplies awaiting use in the production process.
Ordinary course of business – normal activities or operations of an entity.
Classes of Inventories
Inventories are classified into two, namely:
a. Inventories of a trading concern
b. Inventories of manufacturing concern
The term merchandise inventory is generally applied to goods held by a
trading concern.
A manufacturing concern is one that buys goods which are converted into
another form before they are available for sale. The terms raw materials, work-in-
process, and finished goods refer to inventories of a manufacturing concern.

 Raw materials are goods that are to be used in the production process. Raw
materials become part of a finished product and can be conveniently and
economically traced to a specific product.
 Work-in-process are partially completed products which require further
process or work before they can be sold.
 Finished goods are completed products which are ready for sale.
Measurement of Inventories
PAS 2 provides that inventories shall be measured at the lower of cost and net
realizable value. The measurement of inventory at the lower of cost and net realizable
value is also known as LCNRV.

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Cost of Inventories
1. Purchase cost
a. Purchase price
b. Import duties and irrecoverable taxes
c. Freight, handling and other costs directly attributable is the acquisition of
finished goods, materials, and services,
d. Trade discounts, rebates, and other similar items are deducted in
determining the cost of purchase.
2. Conversion cost
a. Direct labor
b. Production overhead (manufacturing or factory overhead)
3. Other costs incurred in bringing the inventories to their present location and
condition is included in the cost of inventories.
The following are excluded from the cost of inventories:
a. Abnormal amounts of wasted materials, labor and other product costs.
b. Storage costs (there are storage costs that are not excluded such as
work-in-process as it is capitalized as cost of inventory but finished goods
are expensed).
c. Administrative overheads unrelated to the production.
d. Selling costs
Illustration:
ABC Co. acquires inventories and incurs the following costs:
Purchase price, gross of trade discount
364,000
Trade discount
72,800
Non-refundable purchase tax, not included in the purchase price above
18,200
Freight-in (Transportation costs)
54,600
Commission to broker
7,280
Advertisement costs
36,400

Required: How much is the cost of the inventories purchased?

Solution:
Purchase price, gross of trade discount
364,000
Trade discount
(72,800)

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 Non-refundable purchase tax, not included in the purchase price above
18,200
Freight-in (Transportation costs)
54,600
Commission to broker
7,280
Total cost of inventories
371,280

The administrative costs are selling costs, which are expensed when incurred.

Cost Formulas
Cost formulas are used to determine different types of costs and to measure these costs
individually.
1. Specific Identification – shall be used for inventories that are not ordinarily
interchangeable (used for specific inventories that are unique).
2. First-In, First-Out (FIFO) – cost of sales is based on the cost of inventories that
were purchased first, while ending inventory represents the cost of the latest
purchase.
3. Weighted Average – cost of sales and ending inventory are based on the
average cost of beginning inventory and all inventories purchased during the
period.

 For inventory items that are not interchangeable, specific costs are attributed to
the specific individual items of inventory.
 For inventory items that are interchangeable, PAS 2 allows the FIFO or
Weighted Average cost formulas.
 The same cost formula should be used for all inventories with similar
characteristics as to their nature and use to the entity. For groups of inventories
that have different characteristics, different cost formulas may be justified.
The Last-In, First-Out (LIFO) cost formula, which had been allowed prior to the
2003 revision of IAS 2, is no longer permitted to use in PAS 2.
Net Realizable Value
Net realizable value or NRV is the estimated selling price in the ordinary course of
business, less the estimated costs of completion and estimated costs necessary to make
the sale.
NET REALIZABLE VALUE VS FAIR VALUE

Net Realizable Value Fair Value

 Refers to the amount that an entity  Refers to the price at which an orderly
expects to realize from the sale of transaction to sell the same inventory in
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 inventory. the principal market.
 Entity-specific value  Not entity-specific value

Inventories are usually written down to net realizable value on an item-by-item basis.
Accounting for Inventory Write-down
 If the cost is lower than the net realizable value, there is no accounting
problem because the inventory is stated at cost and the increase in value is not
recognized.
 If the net realizable value is lower than the cost, the inventory is measured at
the net realizable value.

Illustration:
Information on ABC Co.’s December 31, 2023 inventory is show below:
Product A Product B
Cost 100,000 200,000
Estimated selling price 140,000 220,000
Estimated costs to sell 20,000 30,000

Required: Compute for the valuation of Products A and B in ABC Co.’s statement of
financial position.
Solution:

Product A Product B
Cost 100,000 200,000
Estimated selling price 140,000 220,000
Estimated costs to sell (20,000) (30,000)
Net Realizable Value 120,000 190,000

LCNRV:
Lower of cost 100,000
190,000
Amount of write-down -
10,000
Recognition as an Expense
 Any write-down to NRV should be recognized as an expense in the period in
which the write-down occurs.

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  Any reversal should be recognized in the income statement in the period in
which the reversal occurs.
“The amount of any reversal of any write-down of inventories, arising from an increase in
net realizable value, shall be recognized as a reduction in the amount of inventories
recognized as an expense in the period in which the reversal occurs.” (PAS 2.34)

Time Duration: 30 minutes

Diclosures:

 Accounting policies adopted in measuring inventories, including the cost formulas

used;
 Carrying amount, generally classified as merchandise, supplies, materials, work-in-
progress, and finished goods. The classifications depend on what is appropriate for
the entity;
 Carrying amount of any inventories carried at fair value less costs to sell;
 Amount of inventories recognized as an expense during the period;
 Amount of any write-down of inventories recognized as an expense in the period;
 Amount of any reversal of a write-down to NRV and the circumstances that led to
such reversal; and
 Carrying amount of inventories pledged as security for liabilities. (PAS 2.36)

Summary:

 Inventories include assets held for sale in the ordinary course of business, assets in
the production process for such sale in the ordinary course of business, or in the
form materials or supplies to be consumed in the production process;
 PAS 2 provides that inventories shall be measured at the lower of cost and net
realizable value. The measurement of inventory at the lower of cost and net
realizable value is also known as LCNRV;
 Trade discounts, rebates, and other similar items are deducted in determining the
costs of purchase.

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 The following are excluded from the cost of inventory: abnormal costs, storage
costs, administrative costs, and selling costs.
 The cost formulas permitted under PAS 2 are: specific identification, first-in,
first-out, and weighted average.
 Specific identification shall be used for inventories which are not ordinarily
interchangeable.
 Net realizable value 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.
 Inventories are usually written-down to NRV on an item-by-item basis.
 Raw materials inventory is not written-down below cost if the finished goods in which
they will be incorporated are expected to be sold at or above cost.
 Reversals of inventory write-downs shall not exceed the amount of original write-
down.

END-OF-CHAPTER QUIZ:
I. TRUE or FALSE.
1. Inventory is not written down if its cost does not exceed the net realizable
value. TRUE
2. Reversals of inventory write-downs may exceed the amount of write-downs
previously recognized. FALSE
3. Trade discounts are deducted from the cost of inventories. TRUE
4. Freight-out is included in the cost of inventories. FALSE
5. Storage costs of part-finished goods may be included in the cost of inventory,
but not storage costs of finished goods. TRUE

II. MULTIPLE CHOICE.

6. Used to determine different types of costs and to measure these costs
individually.
a. Specific Identification
b. First-in, First-Out
c. Weighted Average
d. Cost Formulas
7. Inventories that pertain to materials and supplies that are consumed in the
production process of a manufacturing entity is
a. Finished goods inventory
b. Merchandise inventory
c. Work-in-process inventory
d. Raw materials inventory
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 8. The measurement of inventories should include all of the following costs,
except:
a. Costs of purchase net of trade discounts received
b. Costs of conversion
c. Storage costs
d. Other costs incurred in bringing the inventories to their present
location
9. In PAS 2, which of the following is not allowed to use as a cost measurement
formula?
a. Last-in, Last-out
b. First-in, Last-out
c. Last-out, First-in
d. Last-in, First-out
10. Statement 1 - Inventories are required to be stated at the higher of cost and
net realizable value (NRV).
Statement 2 - Net Realizable Value is the estimated selling price in the
ordinary course of business, added the estimated cost of completion and
estimated costs necessary to make the sale.
a. Statement 1 is true, Statement 2 is false
b. Statement 1 is false, Statement 2 is true
c. Both statements are true
d. Both statements are false

III. ENUMERATION.
11-12: Two Classifications of Inventories
 trading concern
 manufacturing concern
13-15: Give the Three Cost Formulas in PAS 2
 specific identification
 fifo
 weighted average
16-18: Give the Costs that are Expensed when Incurred
 abnormal amounts
 storage costs
 administrative overhead
 selling costs

IV. IDENTIFICATION.
19-20: Inventories are measured at the _____________ and _______________.
(lower of cost, net realizable value)

Time Duration: 10 minutes