PAS 2 – INVENTORIES

LEARNING OBJECTIVES:
 To understand the meaning of inventories and the
items to be included in inventory cost.
 Know the measurement of inventory in the
Statement of Financial Position.
 Apply the lower of cost and net realizable value
basis of measurement.
DEFINITION OF INVENTORIES
 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 the rendering of services.

 CLASSIFICATION AND PRESENTATION OF INVENTORIES IN FINANCIAL STATEMENTS

 Inventories are generally classified as current assets
 Inventories shall be presented as one line item in the statement of financial position but the
details of the inventories shall be disclosed in the notes to financial statements.
CLASSIFICATIONS OF INVENTORIES
1. Inventories of a trading concern – is the one that buys and sells goods in the same
form purchased. The term “merchandise inventory” is generally applied to goods held
by a trading concern.
2. Inventories of a manufacturing concern – is the one that buys goods which are altered
or converted into another form before they are made available for sale.
Inventories of a manufacturing entity are generally categorized as follows:
a. Finished Goods – assets held for sale in the ordinary course of business
b. Goods in process – assets in the process of production for such sale
c. Raw Materials – assets in the form of materials to be consumed in the production process
d. Factory or Manufacturing Supplies – assets in the form of supplies to be consumed in the
production process
This applies to all inventories except:
e. Work in process arising under construction contracts, including directly related service
contracts
f. Financial instruments
g. Biological assets related to agricultural activity and agricultural produce at the point of
harvest
MEASUREMENT OF INVENTORY
 Inventories are initially recorded at cost.
 Inventories are subsequently valued at the lower of cost or net realizable value.
 This shall not apply to the following:
1. Biological assets related to agricultural activity and agricultural produce specifies that
an entity shall measure agricultural produce harvested from biological assets at its fair
value less costs to sell at the point of harvest.
2. Broker-dealers buy or sell commodities for others on their own account. A commodity
broker-dealers has inventories that are acquired principally for the purpose of selling in
the near future and generating a profit from fluctuations in the price or broker-dealer’s
margin. To reflect the economic substance of such transactions, commodity broker-
traders frequently measure their inventories at fair value less costs to sell.
COST OF INVENTORIES
 The cost of inventory shall consist of the following:
1. Cost of Purchase
2. Cost of Conversion
3. Other costs incurred in bringing the inventory to its present location and condition
COST OF PURCHASE
 The costs of purchase of inventories comprise the:
1. Purchase price
2. Import duties and taxes
3. Freight
4. Handling
5. And other costs attributable to the acquisition of finished goods, materials and,
services.
 The following shall be deducted in determining the cost of purchase:
1. Trade discounts
2. Rebates
3. Other similar items
 When inventories are 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.
COST OF PURCHASE
ABC, a VAT registered, imported goods from a foreign supplier and incurred the following costs:
Purchase price P 100,000
Import duties 10,000
Value added tax 13,000
Transportation and handling 5,000
Commission to broker 2,000

How much is the cost of the imported goods?

 COST OF PURCHASE
 Trade Discounts – also known as volume or quantity discounts. These are reductions in
the list price or catalog price in order to get the invoice price or the amount actually
charged to the buyer.
 Cash Discounts –Reduction from the invoice price allowed only when payment is made
within the discount period. Cash discounts are called purchase discount on the part of
the buyer and sales discount on the part of the seller.

 METHODS OF RECORDING PURCHASES

1. Gross Method – Purchases are recorded at gross amount of the invoice. Cash
discounts are recorded in purchase discount account at the time of payment, and this
balance is deducted from purchases when measuring cost of goods sold.
2. Net Method – The purchases are recorded at net amount.
COST OF PURCHASE
An entity purchase inventory with a list price of P 10,000 on account.
Terms: 20, 10, 2/10, n/30

1. How much is the cost of net purchase?

2. Prepare necessary journal entries
COST OF PURCHASE
 FOB destination – means that the ownership of the goods purchased is vested in the
buyer upon receipt thereof. Accordingly, the seller is still the owner of the goods in
transit and shall legally be responsible for freight charges and other expenses up to the
point of destination.
 FOB shipping point - means that the ownership of the goods purchased is vested in
the buyer upon shipment thereof. Accordingly, the buyer is already the owner of the
goods in transit and shall legally be responsible for freight charges and other expenses
from the point of shipment to the point of destination.
 Freight collect – means that the freight charge on the goods shipped is not yet paid.
The common carrier shall collect the same from the buyer. Thus, under this, the freight
charge is actually paid by the buyer.
 Freight prepaid - means that the freight charge on the goods shipped is already paid
by the seller.
CONSIGNED GOODS

 Consignment – is a method of marketing goods in which the owner known as the

consignor transfer physical possessions of certain goods to an agent known as the
consignee who sells the goods on the owner’s behalf.
 Goods on consignment should be included in the consignor’s inventory and excluded
from the consignee’s inventory. Freight and other handling charges are part of the cost
of the inventory of consigned goods.
CONSIGNED GOODS
ABC Co. provided you the following information for the purpose of determining the amount
of its inventory as of December 31, 2021

Goods located at the warehouse P 3,800,000

Goods at the store (at cost) 14,000,000
Goods-in-transit purchased FOB Destination 1,500,000
Goods-in-transit purchased FOB Shipping point 2,200,000
Freight (FOB Shipping point, freight prepaid) 60,000
Goods held on consignment from XYZ 1,400,000
Goods on consignment 700,000

How much is the total inventory?

COST OF CONVERSION
 Are the costs involved in converting the direct material into the product such as direct
labor. It also includes a systematic allocation of fixed and variable production overhead
that is incurred in converting materials into finished goods.
 Fixed production overheads are those indirect costs of production that remain
relatively constant regardless of the volume of production, such as depreciation and
maintenance of factory buildings and equipment, and the cost of factory management
and administration.
 Variable production overheads are those indirect costs of production that vary
directly, or nearly directly, with the volume of production.
 ALLOCATION OF PRODUCTION OVERHEAD
 An entity shall allocate fixed production overheads to the costs of conversion on the
basis of the normal capacity of the production facilities. Normal capacity is the
production expected to be achieved on average over a number of periods or seasons
under normal circumstances.
 The actual level of production may be used if it approximates normal capacity. The
amount of fixed overhead allocated to each unit of production is not increased as a
consequence of low production or idle plant.
 Unallocated overheads are recognized as an expense in the period in which they are
incurred.
 Variable production overhead is allocated to each unit of production on the basis of
the actual use of the production facilities.
JOINT PRODUCTS
 A production process may result in more than one product being produced
simultaneously. When costs of raw materials or conversion of each product are not
separately identifiable, an entity shall allocate them between the products on a
rational or consistent basis.
 Most by-products are immaterial. When this is the case, the entity shall measure them
at selling price less costs to complete and sell and deduct this amount from the cost of
the main product.

COSTS NOT INCLUDED IN COST OF INVENTORY

1. Abnormal amounts of wasted materials, labor and other production costs.
2. Storage costs
3. Administrative overheads
4. Selling costs
COST OF INVENTORY OF A SERVICE PROVIDER
 It consists primarily of the labor and other costs of personnel directly engaged in
providing the service, including supervisory personnel and attributable overheads. The
inventory of a service provider may simply be described as work in progress.
 Labor and other costs relating to sales and general administrative personnel are not
included but are recognized as expenses in the period in which they incurred.

COST OF INVENTORIES SHALL BE DETERMINED BY USING:

 First-in, First out method (FIFO) – assumes that the items of inventory that were
purchased or produced first are sold first, and consequently the items remaining in
inventory at the end of the period are those most recently purchased or produced.
 Weighted average – the cost of each item is determined from the weighted average of
the cost of similar items at the beginning of a period and the cost of similar items
purchased or produced during the period.
 The cost of inventories that are not ordinarily interchangeable and inventories that are
segregated for specific projects shall be determined by using specific identification
method.
SYSTEMS OF ACCOUNTING FOR INVENTORIES AND COST OF GOODS SOLD

 Periodic or physical system – this calls for the physical counting of goods on hand at
the end of the accounting period. The quantities are then multiplied by the recorded
unit costs to get the inventory value. Under this approach, the cost of goods sold is
computed only at the end of the period by deducting the physical inventory from the
total cost of goods available for sale.
 Perpetual system – this requires the keeping of stock cards that summarize inventory
inflow and outflow. Under this approach, the cost of goods sold is computed at the
time interval of every sale.
 SYSTEMS OF ACCOUNTING FOR INVENTORIES AND COST OF GOODS SOLD

ABC Co. a wholesaler has the following information for the month of Aug
Date Transaction Units Unit cost Total
Aug 1 Beginning 2,000 36 P 72,000
7 Purchase 3,000 37.2 111,600
12 Sales 4,200
13 Sales return 600
21 Purchase 4,800 38 182,400
22 Sales 3,800
29 Purchase 1,900 38.60 73,340
30 Purchase return 300 38.60 (11,580)
INVENTORY WRITEDOWN
 PAS 2 requires that “ïnventories shall be measured at cost or net realizable value
whichever is lower.
 Net realizable value is the estimated selling price in the ordinary course of business
less the estimated cost of completion and estimated cost necessary to make the sale.
 The practice of writing inventories down below cost to the net realizable value is
consistent with the view that assets should not be carried in excess of amounts
expected to be realized from their sale or use.

METHODS OF ACCOUNTING FOR INVENTORY WRITEDOWN

 Direct Method – the inventory is recorded at the lower of cost or net realizable value.
Any loss on the inventory writedown is not accounted for separately but buried in the
Cost of Goods Sold.
 Allowance Method – the inventory is recorded at cost and any loss on inventory
writedown is accounted for separately.
DISCLOSURE OF INVENTORIES IN FS
 The accounting policies adopted in measuring inventories, including the cost formula
used.
 The total carrying amount of inventories and the carrying amount in classifications
appropriate to the entity
 The amount of inventories recognized as an expense during the period
 Impairment losses recognized or reversed in profit or loss in accordance with Section
27 Impairment of Assets
 The total carrying amount of inventories pledged as security for liabilities
END OF PRESENTATION