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COLLEGE OF BUSINESS AND ACCOUNTANCY
Topic: PAS 2 – Inventories
Learning Outcomes:
• To understand the meaning of inventories.
• To identify the items included in inventory cost.
• To identify the cost formulas required by IFRS.
• To know the measurement of inventory in the statement of financial position
• To apply the lower of cost and net realizable value basis of measurement. Thank.
• State the accounting for inventory write-down and the reversal thereof.
Biblical Values Integration
Psalm 23:1-6
A Psalm of David. The Lord is my shepherd; I shall not want. He makes me lie down in green pastures. He leads
me beside still waters. He restores my soul. He leads me in paths of righteousness for his name's sake. Even
though I walk through the valley of the shadow of death, I will fear no evil, for you are with me; your rod and
your staff, they comfort me. You prepare a table before me in the presence of my enemies; you anoint my head
with oil; my cup overflows.
Introduction:
PAS 2 prescribes the accounting treatment for inventories. PAS 2 recognizes that a primary issue in the
accounting for inventories is the determination of cost to be recognized as asset and carried forward until it
isexpensed. Accordingly, PAS2 provides guidance in the determination of cost of inventories, including the
use of cost formulas, and their subsequent measurement and recognition as expense.
Body:
Inventories are assets 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.
Classes of inventories
1. Trading Concern
● A trading concern is 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. Manufacturing Concern
● A manufacturing concern is one that buys goods which are altered or converted into another
form before they are made available for sale.
● The inventories of a manufacturing concern are:
a. Finished goods
b. Goods in process
c. Raw materials
d. Factory or manufacturing supplies
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Example of Inventories
1. Merchandise purchased by a retailer and held for resale
2. Land and other property held for resale by a subdivision entity and real estate developer.
3. Finished goods produced, goods in process and materials and supplies awaiting use in the production
process.
RECOGNITION
Inventories are recognized when they meet the definition of inventory and they qualify for recognition as
assets, such as when control (legal title) is obtained by the buyer from the seller.
MEASUREMENT
Inventories are measured at the lower of cost and net realizable value.
● The Cost of inventories comprises all costs of purchase, costs of conversion and other costs incurred
in bringing the inventories to their present location and condition.
● Net realizable value (NRV) 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.
Cost of Inventories
1. Cost of Purchase/ Purchase Cost
Includes Purchase Price, Import Duties and Irrecoverable Taxes, Freight, Handling,
and other Directly Attributable Cost
Doesn’t Include Trade discounts, Rebates and other similar items
2. Costs of Conversion
Includes Direct Labor, Manufacturing Overhead
Doesn’t Include Trade discounts, Rebates and other similar items
3. Other costs necessary in bringing the inventories to their present location and condition.
The following are excluded from the cost of inventories and are expensed in the period in which
they are incurred:
a. Abnormal amounts of wasted materials, labor or other production costs.
b. Selling costs, e.g., advertising and promotion costs and delivery expense or freight out.
c. Administrative overheads that do not contribute to bringing inventories to their present
location and condition; and
d. Storage costs unless those costs are necessary in the production stage.
● Storage costs of partly finished or partly completed goods are capitalized as cost of
inventory, e.g., storage cost of wine during fermentation.
● Storage costs of finished or completed goods are expensed,
e.g., warehousing costs of completed inventories.
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Cost of inventories of a service provider
The cost of inventories of a service provider consists primarily of the labor and other costs of personnel
directly engaged in providing the service, including supervisory personnel and attributable overhead.
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.
ILLUSTRATION NO. 1
Entity A acquires inventories and incurs the following costs:
Purchase price, gross of trade discount 100,000
Trade discount 20,000
Non-refundable purchase tax, not included in the purchase price above 5,000
Freight-in (Transportation costs) 15,000
Commission to broker 2,000
Advertisement costs 10,000
Requirement: How much is the cost of the inventories purchased? 102,000
Cost Formulas
1. Specific Identification
● Specific identification means that specific costs are attributed to identified items of inventory.
● The cost of the inventory is determined by simply multiplying theunitson handby the actual unit
cost.
● PAS 2, paragraph 23, provides that this method is appropriate for inventories that are segregated
for a specific project and inventories that are not ordinarily interchangeable.
2. First-in, First-out (FIFO)
● Under this formula, it is assumed that inventories that were purchased or produced first are sold
first, and therefore unsold inventories at the end of the period are those most recently purchased
or produced.
● Accordingly, cost of sales represents costs from earlier purchases while the cost of ending
inventory represents costs from the most recent purchases.
3. Weighted Average
● Under this formula, cost of sales and ending inventory are determined based on the weighted
average cost of beginning inventory and all inventories purchased or produced during the period.
The average may be calculated on a periodic basis or as each additional purchase is made,
depending upon the circumstances of the entity.
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● The cost formulas refer to "cost flow assumptions," meaning they pertain to the flow of costs
(i.e., from inventory to cost of sales) and not necessarily to the actual physical flow of inventories.
Thus, the FIFO or Weighted Average can be used regardless of which item of inventory is
physically sold first.
Net Realizable Value (NRV)
Net realizable value or NRV is the estimated selling price in the ordinary course of business less the estimated
cost of completion and the estimated cost of disposal.
The cost of inventories may not be recoverable under the following circumstances:
a. The inventories are damaged.
b. The inventories have become wholly or partially obsolete.
c. The selling prices have declined.
d. The estimated cost of completion or the estimated cost of disposal has increased.
WRITE-DOWN OF INVENTORY
Inventories are usually written down to net realizable value on an item-by-item basis.
If the cost of an inventory exceeds its NRV, the inventory is written down to NRV, the lower amount. The
excess of cost over NRV represents the amount of write-down.
REVERSAL OF WRITE-DOWNS
The amount of reversal to be recognized should not exceed the amount of the original
write-down previously recognized.
FINANCIAL STATEMENT PRESENTATION
All inventories are aggregated and presented on the statement of financial position under a single
line item captioned "Inventories." The breakdown (i.e., finished goods, work in process, and raw materials
and manufacturing supplies) is disclosed in the notes. Inventories are classified as current assets.
DISCLOSURES
a. Accounting policies adopted in measuring inventories, including the cost formula used;
b. Total carrying amount of inventories and the carrying amount in classifications appropriate to the
entity;
c. Carrying amount of inventories carried at fair value less costs to sell;
d. Amount of inventories recognized as an expense during the period;
e. Amount of any write-down of inventories recognized as an expense in the period;
f. Amount of any reversal of write-down that is recognized as a reduction in the amount of inventories
recognized as expense in the period;
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g. Circumstances or events that led to the reversal of a writedown of inventories; and
h. Carrying amount of inventories pledged as security for liabilities. (PAS 2.36)
APPLICATION (Problem 3: For Classroom Discussion)
Cost Formulas
Information on Entity’s A inventory of Product A is as follows:
Units Unit cost Total cost
Balance at January 1 3,000 19.55 58,650
Purchases
Jan. 6 10,200 21.50 219,300
Jan. 26 2,250 20.60 46,350
Sales
Jan. 7 2,700
Jan. 31 7,200
Requirements:
1. How much are the ending inventory and cost of sales under the FIFO cost formula?
2. How much are the ending inventory and cost of sales under the Weighted Average cost formula?
“Periodic Basis”
3. How much are the ending inventory and cost of sales under the Weighted Average cost formula?
“Moving average”
Solution:
Requirement No. 1
Ending inventory, in units = (3,000 + 2,250 + 10,200 – 2,700 – 7,200) = 5,550
Units Unit cost Total cost
Ending inventory in units 5,550
Allocation to latest
purchases:
Jan. 26 2,250 20.60 46,350
Jan. 6 (balance) 3,300 21.50 70,950
Ending inventory in pesos 117,300
TGAS (58,650 + 219,300 + 46,350) 324,300
Less: Ending inventory in pesos (117,300)
COGS 207,000
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Requirement No. 2
TGAS in pesos
Weighted ave. unit cost =
TGAS in units
(58,650 + 219,300 + 46,350) = 324,300
Weighted ave. unit cost =
(3,000 + 10,200 + 2,250) = 15,450
Weighted ave. unit cost = 20.99
Ending inventory in units 5,550
Multiply by: Wtd. Ave. Cost 20.99
Ending inventory in pesos 116,495
TGAS in pesos 324,300
Less: Ending inventory in pesos (116,495)
COGS 207,805
Units Unit Cost Total Cost
Balance at January 1, 2002 3,000 19.55 58,650
January 6, 2002 10,200 21.5 219,300
TGAS 13,200 21.06 277,950
January 7, 2002 (2,700) 21.06 (56,862)
January 26, 2002 2,250 20.6 46,350
TGAS 12,750 20.98 267,438
January 31, 2002 (7,200) 20.98 (151,056)
Ending inventory 5,550 116,382
COGS = (56,862 + 151,056) = 207,918
Lower of Cost and NRV
Information on ABC Co.’s December 31,20x2 inventory of Product A is shown below:
Product A Product B Product C
Purchase price 100,000 250,000 300,000
Freight-in 12,000 30,000 36,000
Selling price 210,000 300,000 570,000
Freight-out 10,500 75,000 11,400
General Overhead Cost 6,300 9,000 17,100
How much is the valuation of ABC’s total inventory on December 31, 20x2?
Solution:
Product A Product B Product C Total
Purchase price 100,000 250,000 300,000
Freight-in 12,000 30,000 36,000
Cost 112,000 280,000 336,000
Selling price 210,000 300,000 570,000
Freight-out (10,500) (75,000) (11,400)
NRV 199,500 225,000 558,600
Lower 112,000 225,000 336,000 673,000
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SUMMARY
● Inventories include goods that are held for sale in the ordinary course of business, in the process of
production for such sale. and in the form of materials and supplies to be consumed in the production.
● Inventories are measured at the lower of cost and net realizable value (NRV).
● The cost of inventories comprises all costs of purchase, costs of conversion and other costs incurred in
bringing the inventories to their present location and condition.
● Trade discounts, rebates and other similar items are deducted in determining the costs of purchase.
● The following are excluded from the cost of inventory: Abnormal costs, Storage costs, unless necessary,
Administrative costs, and Selling costs.
● The cost formulas permitted under PAS 2 are (a) specific identification, (b) FIFO, and (c) 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 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 finished goods in which they will be
incorporated expected to be sold at or above cost. Reversals of inventory write-downs shall not exceed
of the original write-down.
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References:
Milan, Z.V. (2020). Conceptual Framework and Accounting Standards. 2020 Ed. Bandolin Enterprise.
Valix, C.A (2020). Conceptual Framework. 2020 Ed. GIC Enterprises & Co., Inc.
https://www.youtube.com/watch?v=xvaLRjGlKqI
https://www.youtube.com/watch?v=2cEAmpE0l2A
https://www.youtube.com/watch?v=9KO6iBO5mYk
