PHINMA University of

Pangasinan and
PHINMA Upang College of
Urdaneta
INVENTORIES (PART 1)

LEARNING OBJECTIVES:
1. Recall
2. Accounting for inventories
3. Cost formula
○ Perpetual vs Periodic Inventory System
○ Shortages/Overages
○ Inventory error under periodic inventory
○ Accounting for cash discounts
○ Conversion Cost ( Allocation of Production Overhead)
○ Absorption vs Variable Costing
○ Standard Costing
○ Joint By-Products
○ Borrowing Cost, Cost of agricultural produced from biological asset
○ Deferred Settlement, Cost of inventories purchased in lump-sum
RECALL

Inventories are assets

● Held for sale in the ordinary course of business
● In the process of production for such sale
● In the form of materials or supplies to be consumed
in the production process or in rendering of service
Related standard: PAS 2
RECOGNITION

● Inventories are recognized when:

○ Meet the definition of inventory
○ Asset recognition criteria
○ Control
SUMMARY
Type of Arrangement Included in the inventory of

FOB Shipping Point Buyer

FOB Destination Seller

Consigned goods Consignor

Product Financing & Pledge Borrower

Sale with unusual right of return Buyer, except when unsalable

Sale on trial ( Or Approval) Seller

Installment Sale Buyer

Bill and hold Buyer

Lay away sale Seller

Financial statement presentation

● Single line item “ Inventories”

● Current Assets
● Breakdown is disclosed in the notes to FS
Accounting for Inventories

● Major objectives of inventory accounting

○ Proper determination of periodic income ( Matching Concept)
○ Proper representation of inventories recognized as assets
Periodic vs Perpetual Inventory System

Transactions Perpetual Periodic

Purchased of Inventories Inventory Purchases

Cash/AP Cash/AP
Payment of freight-in Inventory Freight-in
Cash Cash
Return of Damaged AP AP
Inventories to suppliers Inventory Purchased Returns
Sale of Inventories Cash/AR Cash/AR
Sales Sales

COGS
Inventory
Return of Inventories from Sales Returns Sales Returns
Customers AR AR

Inventory
COGS
Perpetual vs Periodic

Perpetual Periodic

Physical count is performed only to Physical count is necessary to

check the accuracy of ledger determine the balances of inventory
balances on hand and COGS
Does not require the use of any Use a formula to determine COGS
formula to determine COGS
BI
Add: Net Purchases
Add: Freight In
TGAS
Less: EI
COGS
Shortage/Overages, Inventory errors

Shortage/Overage ( Perpetual) Inventory error ( Periodic)

Per count ≠ Balance per Record Beginning Inventory & Purchases: Profit = Inverse

Shortage: Ending Inventory: Profit= Direct

Inventory Shortage or Overage Beginning Inventory & Purchases: COGS = Direct

Inventory
Ending Inventory: COGS= Inverse
Overage Contra- Purchases Account = reverse of the effect
of the purchases account
Inventory
Inventory Shortage or Overage Adjunct- Purchases Account= the same as the
effect of purchases
 MEASUREMENT
● Inventories are measured at lower of cost and net realizable value ( LCNRV)
Included Not Included

Purchase Cost Refundable or recoverable taxes ( VAT)

• Purchase Price ( Net of trade
discounts and other rebates), Abnormal costs
• Import Duties
• Non-refundable purchase taxes Selling Costs
• Directly Attributable Cost to
acquisition
Conversion Cost Administrative Cost
• Direct Labor
• Manufacturing Overhead
• Other Necessary Cost Storage Cost of FG
Example: Storage Cost of WIP goods
Accounting for Cash Discounts

Transaction Gross Method Net Method

Purchase of inventory Purchases Purchases

AP AP
Payment within discount period AP AP
Purchase Discounts Cash
Cash
Payment beyond discount period AP AP
Cash Purchase disc. Loss
Cash
ILLUSTRATION

● An entity purchases inventory with a list price of

10,000 on account under credit terms 20%,10%,
2/10,n/30
● How much is the invoice price?
● How much is the amount of purchases to be
recognized on the date of purchase using gross and
net method?
● Prepare the journal entries
 SOLUTION
Transaction Gross Method Net Method

Purchase of inventory Purchases 7,200 Purchases 7,056

AP 7,200 AP 7,056

Payment within discount period AP 7,200 AP 7,056

Purchase Discounts 144 Cash 7,056
Cash 7,056

Payment beyond discount period AP 7,200 AP 7,056

Cash 7,00 Purchase disc. Loss 144
Cash 7,200

List price 10,000 List price 10,000

x80% x 90% x 80% x 90%
Invoice price 7,200 Invoice price 7,200
Less: Cash Discount 144
Invoice Price Net CD 7,056
Conversion Cost

● Direct Labor and Manufacturing Overhead ( Production Overhead)

that are necessary in converting raw materials into finished goods.
● Sub-classification
○ Variable production overhead – vary directly with the volume of production -
indirect materials and indirect labor
Production > VOH >
ALLOCATION: allocated to each unit of production based on actual use of
production facilities
○ Fixed Production overhead – indirect production overhead that remains
constant regardless of volume of production- depreciation of factory
equipment, cost of factory management and administration
ALLOCATION: Allocated to the costs of conversion based on the normal capacity
of production facilities.
Absorption vs Variable Costing

Absorption Costing ( Full Costing) Variable Costing ( Direct Costing)

Includes both variable and fixed Includes only variable overhead in

overhead in the cost of inventories the cost of inventories
PAS 2 requires the use of Use for internal reporting purposes
absorption costing
Joint By-product

● Production process may result in more than one product

being produced simultaneously
● Production= Main Product and By-product
● Conversion cost of each product not separately
identifiable
○ Allocated on rational and consistent basis
■ Relative sale value
● By-product with immaterial value ( common)
■ Net realizable Value
( Deducted from the cost of the Main Product)
Standard Costing

● Budgeted inventory unit costs established to motivated

optimal productivity and efficiency
● Designed to alert management when actual cost of
production differs significantly from target or standard
cost
● It is allowed under PAS 2 for convenience provided the
results approximate cost
Borrowing Cost, Cost of agricultural produced
from biological asset

Borrowing Cost Agricultural produced from biological

asset

It is incurred to finance the After the point of harvest it is

acquisition or production of a presented under “ Inventories”
qualifying asset - inventory
Deferred Settlement, Cost of inventories purchased in
lump-sum
Cost of inventories purchased in Cost of inventories purchased in
Deferred Settlement ( With lump-sum
Financing Component)

Cash Price equivalent of the Inventories with different values

inventories = Present Value acquired in lump-sum basis

Purchase Price ( Normal Credit Cost of each type of inventory is

terms) computed base on their relative
Less: Amount Paid sales price
Interest Expense over the period of
financing
Deferred Payment

● On January 1, 20x1 ABC Co. acquired goods for sale in the ordinary course of
business for 100,000 including 5,000 refundable purchase taxes. The supplier usually
sells goods on 30 days’ interest-free credit. However, as a special promotion, the
purchase agreement for these goods provided for payment to be made in full on Dec
31, 20x1. In acquiring the goods, transport charges of 2,000 were paid on January 1,
20x1. An appropriate discount rate is 10% per year.
● What is the initial cost of the inventories?
Total Purchase price 100,000
Less: refundable purchase taxes 5,000
Purchase Price Net of RPT 95,000
Multiply by: PV of 1 @10%, n=1 0.90909
CPE of inventory purchased 86,364
Add: Freight-In 2,000
Initial cost of inventories 88,364
Purchased in Lump-sum

● ABC acquired a tract of land for 1,000,000. The land was developed and subdivided
into residential lots at an additional cost of 200,000. Although the subdivided lots are
relatively equal in sizes, they were offered at different sales prices due to differences
in terrain. Information on the sub-divided lots is shown.

Lots Group No. of Lots Price per Lot

A 4 400,000

B 10 200,000

C 15 160,000

1. Compute for the allocated costs of the group lots

2. Compute the cost per lot
SOLUTION
Lots No. of Lots Price per Lot Total Price per Allocation Allocated Cost Cost per Lot
Grou group lot ( Fraction)
p
A 4 400,000 1,600,000 1.6/6 320,000 80,000

B 10 200,000 2,000,000 2/6 400,000 40,000

C 15 160,000 2,400,000 2.4/6 480,000 32,000

6,000,000 1,200,00
COST Formula
● Major objectives of inventory accounting
1. Proper determination of periodic income ( Matching Concept)
2. Proper representation of inventories recognized as assets

The major objective no. 1 can be obtained thru proper determination of cost
by selecting an appropriate cost formula

1. Specific Identification
2. First-in, First-Out
3. Weighted Average ( Periodic , Perpetual/Moving Average)
ILLUSTRATION
● BTS Company sells blankets for 30 pesos each. The following was taken
from inventory records during July.
Date Transactions Units Cost/unit

July 3 Purchase 500 15

July 10 Sale 300
July 17 Purchase 1,000 17
July 20 Sale 600

July 23 Sale 300

July 30 Purchase 1,000 20

Determine the cost of sales and cost of ending inventory using

1. FIFO ( Periodic) 2. FIFO ( Perpetual) 3. Weighted Average 4. Moving Average
SOLUTION

Requirements FIFO ( Periodic) FIFO( Perpetual) Weighted Moving

Average Average
Cost of Sales 19,400 19,400 21,360 19,500

Ending 25,100 25,100 23,140 25,000

Inventory
Note:

● In a period of rising prices the first-in-first-out (FIFO) inventory valuation method makes
the assumption that the oldest and lowest priced inventory purchases are sold first. This
results in a higher amount of gross profit than last-in-first-out (LIFO).

● The FIFO method tends to result in higher gross profit and net income when the costs of
inventory items are rising, as the lower costs are matched with the higher revenues.

● In a time of rising inflation, the profits for a company will be shown increased under FIFO
method as compared to weighted average method, because the goods will be sold on
higher prices but the cost of goods deducted will likely be the earliest and cheapest. In a
time of decreasing inflation, the profit margins for a company will be higher under
weighted average method as compared to FIFO method because the cost of goods sold
will be an average figure under weighted average method which will be lower if costs are
recorded under FIFO method.
NET REALIZABLE VALUE

● Estimated selling price in the ordinary course of business less estimated cost of
completion and the estimated cost necessary to make the sale

Estimated Selling Price

Less: Cost to complete
Less: Cost to sell
NRV
● Note that Inventories are measured at LCNRV which is in line with the basic
accounting concept that an asset shall not be carried at an amount that exceeds its
recoverable amount.
● If Cost exceeds its NRV inventory write down is recognized. The excess represents the
amount of write down which is recognized as expense ( usually COGS). Material write
down is charged as loss.
● Previous write down is reversed if the NRV subsequently increased but should not
exceed the previous write down.
EXERCISE

● Answer Problem 2 ( Chapter 7) MCQ

QUESTION AND ANSWER
THANK YOU FOR LISTENING
PHINMA University of
Pangasinan and
PHINMA Upang College of
Urdaneta