Discussion Notes

Inventories Test of Ownership

❖ PAS 2
➢ Held for sale Consignment
➢ Work in progress - contract between two parties, wherein one
➢ Finished Goods party allows another to sell goods on his
➢ Raw Materials behalf.
❖ Service ❖ Consignor - true owner of the goods
❖ Merchandise ❖ Consignee - an extension of the consignor
❖ Manufacturing
Inventory for testing
- The owner of the goods is still the seller
Periodic Perpetual
- No transfer of ownership
- counting of - counting of
inventories is inventories everyday Examples of consignee:
scheduled - Convenience Stores (7-eleven)
- not voluminous
- voluminous
Goods in Transit
- expensive items (ex.:
- cheaper items cars, jewelries) ❖ FOB Shipping point - when given to the
courier, buyer owns the goods
- monthly, - no record of ending ❖ FOB Destination - when the goods are
semi-annually, annually inventory because you delivered, that is the only time the
already have a ownership is transferred.
complete record

Ending Inventory: Ending Inventory: Freight

Based on estimation - based on sufficient ❖ Freight collect - buyer actually paid; FOB
(inventory count) record shipping point
- every change in ❖ Freight prepaid - seller actually paid; FOB
inventory is recorded destination
When you receive When you receive
goods: goods: *please refer to the example and the table on the
next page
Dr. Purchases Dr. Merchandise
Inventory Assignment Margin / Mark-up

When you sold goods: When you sold goods:

Based on Sales Based on Cost
Dr. A/R Dr. COGS
Cr. Sales Cr. MI 100% Sales 100% Cost

Sales - 100% Sales - 120%

Beginning Inventory xx Cost - 80% Cost - 100%
Freight In xx
Purchases xx Mark-up 20% Mark-up 20%
Ending Inventory xx
 ❖ Materials and supplies awaiting use in the
Example: B purchased goods for 100,000. Freight production process
Amounted to 20,000 Classes of Inventories:
❖ Inventories of a trading concern
FOB - shipping point, FOB - shipping point,
Freight Collect Freight Prepaid - one that buys and sells goods in the
same form purchased
Buyer Seller Buyer Seller - The term “merchandise inventory”
generally applies to goods held by a
Purchases A/R Purchases A/R
A/P Sales A/P Sales trading concern
❖ Inventories of manufacturing concern
Freight in No entry No entry A/R - one that buys goods which are
Cash Cash altered or converted into another
A/P Cash A/P Cash form before they are made available
Cash A/R Freight A/R for sale
Cash - Inventories of a manufacturing
concern:
FOB - destination, FOB - destination,
Freight Prepaid Freight Collect → finished goods (FG)
→ goods in process (GIP)
Buyer Seller Buyer Seller → raw materials (RM)
→ factory or manufacturing supplies
Purchases A/R Purchases A/R
A/P Sales A/P Sales Definitions:
● Finished goods
No entry Freight-out A/P No entry - completed products which are ready
Cash Cash for sale
A/P Cash
Cash Cash Freight - have been assigned their full share
A/R A/R of manufacturing costs

● Goods in process/work in process

Notes from Book: (Valix) - partially completed products which
require further process or work
Inventories before they can be sold
- Assets held for sale in the ordinary course
of business, in the process of production for ● Raw materials
such sale or in the form of materials or - Goods that are to be used in the
supplies to be consumed in the production production process
process or in the rendering of services - No work has been done on them as
yet by the entity inventorying them
Inventories encompass goods purchased and - All materials used in the
held for resale, for example: manufacturing operations
a. Merchandise purchased by a retailer and - Frequently raw materials are
held for resale restricted to materials that will be
b. Land and other property held for resale by a physically incorporated in the
subdivision entity and real estate developer production of other goods and which
can be traced directly to the end
Inventories also encompass: product of the production process
❖ Finished goods (FG)
❖ Goods in process (GIP) ● Factory/Manufacturing Supplies
 - Similar to raw materials but their Thus, the goods sold on installment are included in
relationship to the product is indirect the inventory of the buyer and excluded from that of
- May be referred to as indirect the seller, the legal test to the contrary
materials because they are not notwithstanding.
physically incorporated in the
products being manufactured This is a clear example of economic substance
- part of the manufacturing overhead prevailing over legal form.

Goods includible in the Inventory Ownership of Goods in Transit

- All goods to which the entity has title shall
be included in the inventory, regardless of Terminology: FOB - free on board
location
- “passing of title” is a legal language which ❖ FOB destination
means “the point of time at which ownership ➢ Ownership of goods purchased is
changes” only transferred upon receipt of the
goods by the buyer at the point of
Legal test destination
Is the entity the owner of the goods to be ➢ Goods in transit are still the property
inventoried? of the seller
❖ If yes, the goods shall be included in the ➢ The seller shall be legally
inventory responsible for freight charges and
❖ If no, the goods shall be excluded from the other expenses up to the point of
inventory destination
❖ FOB shipping point
a. goods owned and on hand ➢ Ownership is transferred upon
b. goods in transit and sold FOB destination shipment of the goods and therefore,
c. goods in transit and purchased FOB the goods in transit are the property
shipping point of the buyer
d. goods out on consignment to consignee ➢ The buyer shall be legally
e. goods in the hands of the salesmen or responsible for freight charges and
agents other expenses up to the point of
f. goods held by customers on approval or on destination
trial
Freight Terms:
Exception to the legal test: ❖ Freight Collect
Installment contracts may provide for retention of ➢ The freight charge on the goods
title by the seller until the selling price is fully shipped is not yet paid. The common
collected carrier shall collect the same from
the buyer. Thus, the freight charge is
Following the legal test, the goods sold on actually paid by the buyer if the term
installment basis are still the property of the seller is freight collect
and therefore normally includible in his inventory ❖ Freight Prepaid
➢ The freight charge on the goods
However, in such a case, it is an accepted shipped is already paid by the seller
accounting procedure to record the installment sale
as a regular purchase on the part of the buyer.
Maritime Shipping Terms ➢ Freight and other handling charges
❖ FAS or free alongside on goods out on consignment are
➢ A seller who ships FAS must bear all part of the cost of goods consigned
expenses and risk involved in ➢ When these are sold, a report is
delivering the goods to the dock next made to the consignor together with
to or alongside the vessel on which a cash remittance for the amount of
the goods are to be shipped sales minus commission and other
➢ The buyer bears the cost of loading expenses chargeable to the
and shipment and thus title passes consignor.
to the buyer when the carrier takes
possession of the goods Statement Presentation
➢ same as FOB shipping point - Inventories are generally classified as
❖ CIF or Cost, insurance and freight current assets
➢ The buyer agrees to pay in a lump - Shall be presented as one line item in the
sum the cost of the goods, insurance statement of financial position but the
cost, and freight charge details of the inventories shall be disclosed
➢ The shipping contract may be in the notes to fs.
modified as CF which means that
the buyer agrees to pay in lump sum Accounting for Inventories
the cost of the goods and freight - There are 2 systems in accounting for
charge only inventories:
➢ same as FOB shipping point
❖ Periodic System
*In either case, the seller must pay for the cost of ➢ Physical counting of goods on hand
loading. Thus, title and risk of loss shall pass to the at the end of the accounting period
buyer upon delivery of the goods to the carrier. to determine the quantities. The
quantities are then multiplied by the
❖ Ex-ship corresponding unit costs to get the
➢ A seller who delivers the goods inventory value for balance sheet
ex-ship bears all expenses and risk purposes. This approach gives
of loss until the goods are unloaded actual or physical inventories.
at which time title and risk of loss ➢ Generally used when the individual
shall pass to the buyer. inventory items have small peso
➢ same as FOB destination investment, such as groceries,
hardware and auto parts.
Consigned Goods ❖ Perpetual System
❖ Consignment ➢ Requires the maintenance of
➢ A method of marketing goods in records called stock cards that
which the owner called the usually offer running summary of the
consignor transfers physical inventory inflow and outflow
possession of certain goods to an ➢ Inventory increases and decreases
agent called the consignee who sells are reflected in the stock cards and
them on the owner’s behalf the resulting balance represents the
❖ Consigned goods inventory. This approach gives
➢ Shall be included in the consignor’s books or perpetual inventories.
inventory and excluded from the ➢ Commonly used where inventory
consignee’s inventory items treated individually represent a
 relatively large peso investment 3. Return of merch purchases to supplier, 30k
such as jewelry and cars. A/P 30k
➢ In an ideal perpetual system, the MI 30k
stock cards are kept to reflect and
control both units and costs. 4. Sale of merch on acc., 400k at 40% gross profit.
➢ When used, a physical count of the The cost of the merchandise sold is 60% or 240k
units on hand should at least be A/R 400k
made once a year to confirm the Sales 400k
balances appearing on the stock
cards. COGS 240k
MI 240k
Illustration - Periodic System
1. Purchase of merchandise on account, 300k *under the perpetual system, the cost of
Purchases 300k merchandise sold is immediately recorded because
A/P 300k this is clearly determined from the stock card

2. Payment of freight on the purchase, 20k 5. Return of merchandise sold from customer, 25k.
Freight in 20k The cost of the merchandise returned is 60% or
Cash 20k 15k
Sales return 25k
3. Return of merch purchases to supplier, 30k A/R 25k
A/P 30k
Purchases return 30k MI 15k
COGS 15k
4. Sale of merch on acc., 400k at 40% gross profit
A/R 400k 6. Adjustment of ending inventory, 65k
Sales 400k - As a rule, the ending MI is not adjusted. The
balance of the MR account represents the
5. Return of merch sold from customer, 25k ending inventory.
Sales return 25k
A/R 25k Inventory Shortage or Overage
In the illustration, the merchandise inventory
6. Adjustment of ending inventory, 65k account has a debt balance of 65k
MI, ending inventory 65k
Income summary 65k If at the end of the accounting period, physical
count indicates a different amount, an adjustment is
necessary to recognize any inventory shortage or
Illustration - Perpetual System overage.
1. Purchase of merchandise on account, 300k
Merchandise Inv. 300k Adjusting entries: (ex. 55k)
A/P 300k
Inventory Shortage 10k
2. Payment of freight on the purchase, 20k Merchandise Inventory 10k
MI 20k
Cash 20k *shortage is usually closed to COGS (often a result
of normal shrinkage and breakage inventory),
however, abnormal and materials shortage shall be
separately classified and presented as other Illustration - Net Method
expense. 1. Purchases on account, 200k, 2/10, n/30
Purchases 196k
Trade Discounts A/P 196k
- deductions from the list price In order to 2. *payment is paid within discount period
arrive at the invoice price which is the A/P 196k
amount usually charged to the buyer Cash 196k
- not recorded 3. *payment is paid beyond discount period
- to encourage trading increased sales A/P 196k
Purchase disc.lost 4k
Cash Discounts Cash 200k
- deduction from the invoice price when 4. Assume it is the end of accounting period,
payment is made within the discount period no payment is made and the discount
- to encourage prompt payment period has expired
- recorded as purchase discount (buyer) or Purchase disc. lost 4k
sales discount (seller) A/P 4k

Purchases xx Notes:
Purchase discount (xx) ● In practice, most entities record purchase at
Net Purchases xx gross invoice amount
● the gross method violates the matching
Sales xx principle
Sales discount (xx) ● gross method does not allocate discounts
Net Sales xx taken between goods sold and goods on
hand
Methods of Recording Purchases: ● however, it is supported on practical
1. Gross Method grounds
- purchases and accounts payable are ● more convenient
recorded at gross amount of invoice
2. Net Method Cost Inventories
- purchases and accounts payable are a. cost of purchase
recorded at net amount of the b. cost of conversion
invoice c. directly attributable cost incurred bringing
the inventories to their present location and
Illustration - Gross Method condition
1. Purchases on account, 200k, 2/10, n/30
Purchases 200k Cost of purchase
A/P 200k - comprises the purchase price import duties
2. *payment is paid within discount period and irrecoverable taxes, freight handling
A/P 200k and other costs directly attributable to the
Cash 196k acquisition of finished goods, materials and
Purchase disc. 4k services.
3. *payment is paid beyond discount period - trade discounts, rabates and other similar
A/P 200k items are deducted in determining cost of
Cash 200k purchases
- shall not include foreign exchange
differences which arise directly from the
 recent acquisition of inventories involving a b. directly attributable overhead
foreign currency
- when inventories are purchased with labor and other costs relating to sales and general
deferred settlement terms, the difference administrative personnel are not included but are
between the purchase price for normal recognized as expenses in the period incurred.
credit terms and the amount paid is
recognized as interest expense over the
period of financing Cost Formulas
PAS 2, paragraph 23, expressly provides that the
Cost of Conversion cost of inventories shall be determined by sing
- includes cost directly related to the units of either:
production such as direct labor. a. First in, First out (FIFO)
- includes a systematic allocation of fixed and b. Weighted Average
variable production overhead that is
incurred in converting materials into finished The standard does not permit anymore the use of
goods the last in, first out (LIFO) as an alternative formula
- fixed production overhead: the indirect cost in measuring cost of inventories
of production that remains relatively
constant regardless of the volume of First In, First Out (FIFO)
production (e.g. depreciation and - assumes that the goods first purchased are
maintenance of factory first sold and consequently the goods
- variable production overhead: the indirect remaining in the inventory at the end of the
cost of production that varies directly with period are those most recently purchased or
the volume of production. (e.g. indirect produced.
labor and indirect materials) - in accordance with the ordinary
merchandising procedure hat the goods are
Directly Attributable Cost sold in the order they are purchased
- cost of inventories incurred in bringing the - the inventory is thus expressed in terms of
inventories to their present location and recent or new prices while the cost of goods
condition sold is representative of earlier or old prices
a. Abnormal amounts of wasted materials, - favors the statement of financial position
labor and other production costs
b. Storage costs, unless necessary in the Illustration - FIFO
production process prior to a further
production stage. Thus, storage costs on Date Units Unit Total Sales
goods in process are capitalized but storage Cost cost (in
units)
costs finished goods are expensed
c. Administrative overheads that do not Jan. 1 Beg.Ba 800 200 160k
l.
contribute to bringing inventories to their
present location and condition 8 Sale 500
d. Distribution or selling costs
18 Purc. 700 210 147k

Cost of inventories of a service provider 22 Sale 800

- consists primarily of the following:
31 Purch. 500 220 110k
a. Labor and other costs of personnel directly
engaged in providing the service, including The ending inventory is 700 units
supervisory personnel
FIFO - Periodic Note:
Units Unit Cost Total Cost Under FIFO-periodic and FIFO-perpetual, the
inventory costs are the same.
Fr. 1/18 200 210 42,000
purch.
Weighted Average - Periodic
Fr. 1/31 500 220 110,000 - the cost of the beginning inventory plus the
purch.
total cost of purchases during the periods is
700 152,000 divided by the total units purchased plus
those in the beginning inventory to get a
weighted average unit cost
Cost of Goods Sold
- weighted average it cost is then multiplied
by the units on hand derive the inventory
Inventory - Jan. 1 160,000 value
Purchases (147k+110k) +257,000 - in other words the average unit cost is
computed by dividing the total cost of goods
Goods available for sale (TGAS) 417,000 available for sale by the total number of
units available for sale for the period
Inventory - January 31 (152,000)

Cost of Goods Sold 265,000

Date Units Unit Cost Total Cost

FIFO - Perpetual Jan. 1 800 200 160,000

*this requires preparation of stock cards
Jan. 18 700 210 147,000

Purchases Jan. 31 500 220 110,000

Date Units Unit Cost Total Cost TGAS 2,000 417,000

Jan. 1 Weighted average unit cost (417k/2k) = 208.5

Jan. 8 Inventory Cost (700 x 208.5) = 145,950

Jan. 18 700 210 147,000 Cost of Goods Sold

Jan. 22 Inventory - January 1 160,000

Jan. 31 500 220 110,000 Purchases 257,000
Goods available for sale 417,000
Inventory - January 31 (145,950)
Sales
Cost of goods sold 271,050
Date Units Unit Cost Total Cost

Jan. 1

Jan. 8 500 200 100,000

Jan. 18

Jan. 22 300 200 60,000

Jan. 31 500 210 105,000