CHAPTER 10 (INVENTORIES)

Inventories – assets held for sale in the ordinary course – covers all materials used in the manufacturing
of business operations

– in the process of production for such sale – are frequently restricted to materials that will
be physically incorporated in the production of
– in the form of materials
other goods and which can be traced directly to
– supplies to be consumed in the prod. process the end product of the production process

– in the rendering of services. Factory or manufacturing supplies – are similar to raw

materials but their relationship to the end
Inventories encompasses the following: product is indirect
a. goods purchased and held for resale – may be referred as indirect materials
1. merchandise purchased by a retailer and
held for resale – it is indirect because they are not physically
2. land and other property held for resale incorporated in the products being
by a subdivision entity and real estate manufactured
developer
GOODS INCLUDIBLE IN THE INVENTORY
b. finished goods produced
c. goods in process As a rule, all goods to which the entity has title shall be
d. material and supplies awaiting use in the included in the inventory, regardless of location.
production process
Passing of title – is a legal term which means “the point
CLASSES OF INVENTORIES of time at which ownership changes”.

trading Legal test

concern
entity = owner ???
Inventories
manufacturing
concern Legal Test affirmative = INCLUDED

Trading concern – one that buys and sells goods in the negative = EXCLUDED
same form purchased

– term generally used is “merchandise a. Goods owned and on hand;

inventory” b. Good in transit and sold FOB destination;
c. Goods in transit and purchased FOB shipping
Manufacturing concern – one that buys goods which are point;
altered or converted into another form before d. Goods out on consignment;
they are made available for sale e. Goods in the hands of salesmen or agents; and
Inventories of a manufacturing concern are: f. Goods held by customers on approval or on trial.

- Finished goods (FG) Installment sales (exception to the legal test)

- Goods in process or Work in process (WIP) Following the legal test, the goods sold on
- Raw materials (M) installment basis are still the property of the
- Factory or manufacturing supplies seller and therefore includible in his inventory.
Finished goods – are completed products which are However, it is an accepted accounting procedure
ready for sale to record the installment sale as a regular sale
involving deferred income on the part of the
– have been assigned their full share of seller and as a regular purchase on the part of
manufacturing costs the buyer. Thus, the goods sold on installments
are included in the inventory of the buyer and
Goods in Process – are partially completed products
excluded from that of the seller.
which require further process or work before
they can be sold WHO IS THE OWNER OF GOODS IN TRANSIT?
Raw material – are goods that are to be used in the Goods in transit (under FOB destination)
production process
– ownership of goods purchased is only
– no work or process has been done on them as transferred when received by the buyer at the
yet by the entity inventorying them point of destination

– seller shoulders the freight and charges

Goods in transit (under FOB shipping point) ACCOUNTING FOR INVENTORIES

– ownership is transferred upon shipment of Periodic

goods System
Two Systems
– buyer shoulders the freight and charges Perpetual
System
FREIGHT TERMS

Freight collect a. periodic system

- calls for the physical counting of goods on
– freight charge on the goods shipped is not yet
hand at the end of the accounting period to
paid
determine quantities.
– freight charge is actually paid by the buyer - gives actual or physical inventories
- generally used when the individual inventory
Freight prepaid
items have small peso investment
– freight charge on the goods shipped is already b. perpetual system
paid by the seller - requires the maintenance of records called
“stock cards” that usually offer a running
FOB … = ownership of the goods & party who’s supposed
summary of the inventory inflow and
to pay the expenses from point of shipment outflow.
Freight … = party who actually paid the freight charge but - gives book or perpetual inventories
not the party supposed to legally pay - commonly used where the inventory items
treated individually represent or relatively
CONSIGNED GOODS large peso investment
Consignment - stock cards are kept to reflect and control
both units and costs
– marketing goods where owner transfers - a physical count of the units on hand should
physical possession of goods to an agent (not at least be made once a year to confirm the
ownership, only possession) balances appearing on the stock cards
– consignor: owner

– consignee: agent who sells the goods on the INVENTORY SHORTAGE OR OVERAGE
consignor's behalf If at the end of the accounting period, a physical count
indicates a different amount, an adjustment is necessary
Inventory Consignor Consignee
to recognize any inventory shortage or overage
CONSIGNED GOODS Included Excluded After adjustment, if the physical count is…

– Freight and other handling charges on goods Lesser = inventory shortage

out on consignment are part of the cost of goods Greater = inventory overage
consigned.
TRADE DISCOUNTS AND CASH DISCOUNTS
– only memorandum entry
Trade discounts
– accounting entry will only be recorded when
goods are sold by consignee – are deductions from the list or catalog price in
order to arrive at the invoice price which is the
Cost on Sale formula: amount actually charged to the buyer. Trade
Inv beg. + purchases + freight - purchase returns - discounts are not recorded.
purchase discount – inv end Cash discounts
STATEMENT PRESENTATION – are deductions from the invoice price when
- Inventories are generally classified as current assets payment is made within the discount period. Cash
discounts are recorded as purchase discount by the
- shall be presented as one-line-item in the statement of buyer and sales discount by the seller.
financial position but the details or composition of the
inventories shall be disclosed in the notes to financial Purchase discounts
statements. – are deducted from the purchases and sales
discount are deducted from sales to arrive at net
sales revenue.
METHODS OF RECORDING PURCHASES Normal capacity

1. Gross method – purchases and accounts payable are – is the production expected to be achieved on
recoded at gross. average

2. Net method – purchases and accounts payable are The amount of FOH allocated to each unit of production
recorded at net. is not increased as consequence of low production.

COST OF INVENTORIES Unallocated Fixed Overhead - recognized as expense

ALLOCATION OF VARIABLE PRODUCTION OVERHEAD

Cost of Purchase
VPO is allocated to each unit of production on the basis
Cost of Cost of Conversion of the actual use of the production facilities
Inventories

Other Costs

Cost of Purchase OTHER COSTS

- usually merchandising business Other costs is included in the cost of inventories only to
- raw materials purchased the extent that it is incurred in bringing the inventories to
- comprises of purchase price, import duties their present location and condition
and irrecoverable taxes, freight, handling,
and other costs directly attributable The following costs are excluded from the costs of
- trade discounts and other similar items are inventories and are recognized as expense:
deducted to get the cost of purchase a. Abnormal amounts of wasted materials, labor,
- shall not include foreign exchange and other costs
differences (only applicable if there are b. Storage costs, unless necessary
imported goods) - Goods in process = capitalized
- recognize as interest expense when - Finished goods = expensed
inventories are purchase with deferral terms c. Administrative overheads that do not
Cost of Conversion contribute to bringing inventories to their
present location
- only manufacturing business d. Distribution or selling costs
- includes cost directly related to the units of
production such as direct labor COST OF INVENTORIES OF A SERVICE PROVIDER
- also includes systematic allocation of fixed - Consists primarily of the labor and other
and variable production overhead incurred costs of personnel directly engaged in
in converting materials into FG providing the service, including supervisory
- Fixed production overhead (FPO) and personnel and attributable overhead
variable production overhead (VPO) are - Labor and other costs relating to sales and
indirect costs of production general administrative personnel are not
ALLOCATION OF FIXED PRODUCTION OVERHEAD included but recognized as expense

Allocation of FPO to the cost of conversion is based on

the normal capacity of the production facilities
CHAPTER 11 (INVENTORY COST FLOW)

NOTA BENE

First in, First out Note well that under FIFO-periodic and FIFO-perpetual,
the inventory costs are the same. In both cases, January
(FIFO)
Cost 31 inventory is P152,000
Formulas
Weighted Avergae The cost of goods sold is determined from the stock card
as follows:

The standard does not permit anymore the use of the Last
in, First out (LIFO) as alternative formula in cost of
inventories.

FIRST IN, FIRST OUT (FIFO)

– The FIFO assumes that “the goods first

purchased are first sold” and consequently the
goods remaining in the inventory at the end of
the period are those most recently purchased or
produced

– “first come, first sold”

– goods are sold in the order they are purchased

– inventory is expressed in terms of recent or

new prices

– cost of goods sold is representative of earlier or

old prices

– Accordingly, in a period of inflation or rising

prices, the FIFO method would result to the
highest net income. However, in a period of
deflation or declining prices, the FIFO method WEIGHTED AVERAGE - PERIODIC
would result to the lowest net income
Beg inv cost xxx
– inflation = highest net income Add: Total Cost of purchases xxx
– deflation = lowest net income Total xxx
Divide: Total Units purchased + Beg
inv units xxx

WEIGHTED AVERAGE UNIT COST XXX

OR

Total cost of GAS xxx

Divide: Total units of GAS xxx

WEIGHTED AVERAGE UNIT COST XXX

Weighted Average Unit Cost xxx

Units on hand xxx

INVENTORY COST XXX

– deflation = highest net income

WEIGHTED AVERAGE – PERPETUAL

Weighted Average Method (moving average method)

Note: Under LIFO-periodic, the January 31 inventory is
– PAS 2 provides that the weighted average may P140,000 and under LIFO-perpetual, the January 31
be calculated on a periodic basis or as its original inventory is P150,000
shipment is received depending upon the
SPECIFIC IDENTIFICATION
circumstances of the entity.
Specific identification
– Under this method, a new weighted average
unit cost must be computed after every purchase – specific costs are attributed to identified items
and purchase return. of inventory
– The total cost of goods available after every – cost of inventory is determined by multiplying
purchase and purchase return is divided by total units on hand by their actual unit cost
units available for sale at this time to get a new
weighted average unit cost. – requires records which will clearly determine
the actual costs of goods on hand
– Such new weighted average unit cost is then
multiplied by the units in hand to get the – PAS 2 provides that this method is
inventory cost. appropriate for inventories that are segregated
for a specific project and inventories that are
– This method requires the keeping of inventory not ordinarily interchangeable.
stock card in order to monitor the “moving” unit
cost every after purchase. STANDARD COSTS

Standard costs

– are predetermined product costs established

on the basis of normal levels of materials and
supplies, labor, efficiency and capacity
utilization

– it is predetermined

– once determined, it is applied to all inventory

LAST IN, FIRST OUT (FIFO) movements

Last in, First out (LIFO) – PAS 2 states that the standard cost method
may be used for convenience if the results
– “the goods last purchased are first sold” approximate cost.
– the goods remaining in the inventory at the end RELATIVE SALES PRICE METHOD
of the period are those first purchased or
produced Relative sales price method

– inventory is expressed in terms of earlier or old – when different commodities are purchased at
prices a lump sum, the single cost is apportioned
among the commodities based on their
– cost of goods sold is representative of recent or respective sales price
new prices.
– this is based on the philosophy that cost is
– inflation = lowest net income proportionate to selling price