INVENTORIES
NATURE OF INVENTORIES
As described in IAS 2, Paragraph 6, Inventories are
assets of an enterprise, which are
Held for sale in the ordinary course of business
In the process of production for such sales; or
In the form of materials or supplies to be consumed in
the production process or in the rendering services
GUESS THE WORDS
CLASSIFICATION
Trading Entity
One that buys and sells goods in the same
purchased.
Merchandise Inventory - generally applied to goods
held by trading entity.
Manufacturing Entity
One that buys goods which are altered or
converted into another form before they are made
available for sale
Finished Goods
Goods in Process
Raw materials and factory/ Manufacturing Supplies
COST OF INVENTORIES
The cost of inventories shall compromise all cost
of purchase, cost of conversion and other costs
incurred in bringing the inventories to their
present location and condition.
COST OF PURCHASE
The cost purchase of inventories includes the
purchase price, import duties and other taxes,
and transport, handling and other costs directly
attributable to the acquisition of finished goods,
materials and services.
COST OF CONVERSION
It includes costs directly related to the units of
production, such as direct labor.
They also include a systematic allocation of fixed
and variable production overheads.
Fixed
Indirect costs that remain relatively constant
regardless of the production.
Variable
Indirect costs of production that may vary
directly or nearly directly with the volume of
production.
COST OF INVENTORIES OF A
SERVICE PROVIDER
Consist primarily of the labor and other costs of
personnel directly engaged in providing the
service
COST OF AGRICULTURAL PRODUCE
HARVESTED FROM BIOLOGICAL ASSET
measured on initial recognition at their fair value
less cost to sell at the point of harvest
OTHER COSTS
Are included in the cost of inventories only to the extent that
they are incurred in bringing the inventories to their present
location.
EXCLUSIONS FROM COST OF INVENTORIES
Abnormal amounts of wasted materials, labor, or other
production costs
Storage costs, unless those costs are necessary in the
production process before a further production stage.
Administrative overheads that do not contribute to
bringing inventories to their present location and
condition.
Selling costs b(IAS 2, Inventories, paragraph 16)
Labor and other costs relating to sales and general
administrative personnel
Financing element involved in purchases under deferred
payment arrangement (IAS 2, inventories, paragraph 18)
GUESS THE WORDS
ITEMS TO BE INCLUDED IN
INVENTORY QUANTITIES
Goods in Transit
FOB destination
Legal title is not transferred until the goods
are delivered to the buyer’s destination
FOB shipping point
Legal title to the goods passes with the
loading of goods at the point of shipment
TERMS OF
SHIPMENT DISPOSITION
Seller Buyer
FOB shipping Exclude Include
point
FOR destination Include Exclude
Freight Collect
Freight charge on the goods shipped is not yet paid.
The common carrier shall collect the same from the
buyer.
Freight Prepaid
Means that the freight charge on the goods shipped is
already paid by the seller
FAS/ Free Alongside
The seller must bear all expenses and risk involved in
delivering the goods up to the dock next or alongside
the vessel.
CIF or Cost, Insurance, and Freight
The buyer agrees to pay in lump sum for the cost of
the goods, insurance cost and freight charge.
EX-ship
The seller bears all expenses and risk of loss until the
goods are unloaded.
Consigned Goods
A consignment is a method of marketing goods
in which the owner transfers physical
possession of goods to the agent.
The goods must be included in the inventory of
the consignor, at the cost plus the handling
and shipping cost incurred in the delivery of
the goods to the consignee.
Segregate Goods
Special goods manufactured according to the
customer specifications, should be considered
sold when completed.
Conditional Sales and Installment Sales
The control over the goods has already passed
to the buyer. The seller anticipates completion
of contract and ultimate passing of the title.
Goods Sold with Buyback Agreement
The owner of the goods sells the inventory to
another party and agrees to repurchase the
goods at a specified price.
Goods Sold with Refund Offers
Buyers are given the right to rescind the
purchase of goods for a reason specified in the
sales contract.
PERIODIC SYSTEM
Also known as Physical System
A company does not maintain continuous record
of the physical quantities or costs on inventory
on hand.
Physical inventory is taken at the end of the
period
Computation of Cost of Good Sold:
Merchandise Inventory, Beginning xx
Add net cost of purchases xx
Cost of goods available for sale xx
Less Merchandise Inventory, End xx
Cost of Goods Sold xx
Computation of Net Cost:
Purchases xx
Add Freight in xx
Less Purchase Discount, xx
Returns, and Allowances
Net Cost xx
Pro-Forma Entries to record transactions using periodic
inventory system:
Transaction Pro Forma Entries
Purchase of goods Purchases XX
Accounts Payable/Cash XX
Purchase returns Accounts Payable/ Cash XX
Purchase Returns XX
Sales of Goods Accounts Receivable/Cash XX
Sales XX
Sales Returns Sales Returns XX
Accounts Receivable/Cash XX
Year-end entry to set up Merchandise Inventory, end XX
ending inventory Income Summary XX
Year-end entry to close Income Summary XX
beginning inventory Merchandise Inventory, end XX
PERPETUAL SYSTEM
A company maintains a continuous record of the
movement or the items in its inventory
This system is essential when management wants to
maintain effective planning and control over inventory
No adjusting entry is needed to set up ending inventory.
Physical count is made at least once a year to confirm the
inventory balance per books
Variation between the physical count and ledger may
result from errors in recording, shrinkage, waste,
breakage, theft and other causes.
Pro-forma entries:
Transaction Pro Forma Entries
Purchase of goods Merchandise Inventory XX
Accounts Payable/Cash XX
Purchase returns Accounts Payable/ Cash XX
Merchandise Inventory XX
Sales of Goods Accounts Receivable/Cash XX
Sales XX
Cost of Sales XX
Merchandise Inventory XX
Sales Returns Sales Returns XX
Accounts Receivable/Cash XX
Merchandise Inventory XX
Cost of Sales XX
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PRINCIPLE CONCERNING
MEASUREMENT OF INVENTORY
Paragraph 9 provides that inventories shall be measured at
lower of cost and net realizable value or LCNRV
Paragraph 25 provides that the cost of inventories shall be
determined by using either the FIFO method/ weighted
average method.
PAS 2 prohibits the use of LIFO costing
Paragraph 3 provides that 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.
SPECIFIC IDENTIFICATION METHOD
The cost of inventories that are not ordinarily
interchangeable and inventories that are segregated for
specific projects
The cost of inventory can be determined by multiplying
the units on hand by their actual units.
FIRST IN FIRST OUT
Assumes that “the goods first purchased are first sold”
The rule is “First come, First sold”
Favors the statement of financial position.
The inventory is thus expressed in terms of recent or new
prices while cost of goods sold is representative of earlier
or old prices
LAST IN FIRST OUT
“Goods last purchased are first sold “
The inventory is thus expressed in terms of earlier or old
prices while cost of goods sold is representative of recent
or new prices
WEIGHTED AVERAGE
This method considers goods to be undistinguishable and
are, therefore, valued at an average of the costs incurred.
MOVING AVERAGE CAPITAL (PERPETUAL)
This method requires a computation of new unit cost
after each purchase an subsequent issues are priced at
the latest average unit.
WEIGHTED AVERAGE METHOD (PERIODIC)
Under the weighted average formula, the cost of each item is
determined from the weighted average cost of similar items at the
beginning of a period and the cost of similar items purchased or
produced during the period.
EXAMPLE:
Transaction Units Unit Cost
1. Inventory 2000 50
2. Purchases 18000 52
3. Sales (@130 7000
per unit)
4. Purchases 6000 55
5. Sales (@ 135 16000
per unit)
6. Purchases 3000 60
Specific Identification Method
Cost of ending inventory
From no. 1 2000 x 50 100,000
From No. 4 1000 x 55 55,000
From No. 6 3000 x 60 180,000
Total cost of ending inventory 335,000
Cost of goods sold
No. 3 sales 7000 x 52 364,000
No. 5 sales 11000 x 52 572,000
5000 x 55 275,000
Total cost of goods sold 1,211,000
Gross Profit
Sales 7000 x 130 910,000
16000 x 135 2,160,000
Less Cost of goods sold 1,211,000
Total cost of of goods sold 1,859,000
First in First Out
Cost of ending inventory
Most recent cost 3000 x 60 180,000
Next most recent cost 3000 x 55 165,000
Total cost of ending inventory 345,000
Cost of goods sold
Cost of goods available for sale 2000 x 50
18000 x 52
6000 x 55
3000 x 60 1,546,000
Less cost of ending inventory 345,000
Total cost of goods sold 1,201,000
Gross Profit
Sales 3,070,000
Less Cost of goods sold 1,201,000
Total cost of of goods sold 1,869,000
Weighted Average Method (Periodic)
Cost of ending inventory
Total cost of goods available for sale 1,546,000 53.31
Total units available for sale 29,000 (average
cost per
unit)
Multiply units on hand 6000
Total cost of ending inventory 319,860
Cost of goods sold
Cost of goods available for sale 1,564,000
Less cost of ending inventory 319,860
Total cost of goods sold 1,226,140
Gross Profit
Sales 3,070,000
Less Cost of goods sold 1,226,140
Total cost of of goods sold 1,843,860
Moving Average Method (Perpetual)
Transactio Received Issued Balance
n
1 2,000@50 = 100,000
2 18,000@52 = 936,000 20,000@51.80 =
1,036,000
3 7,000@51.80 = 362,600 13,000@51.80 =
673,400
4 6,000@55 = 330,000 19,000@52.81 =
1,003,400
5 16,000@52.81 = 3,000@52.81 =
844,960 158,400
6 3,000 @ 60 = 180,000 6,000@56.41 =
338,440
Cost of ending inventory = 338,440
Cost of Goods Sold = 362,600 + 844,960 = 1,207,560
Gross Profit = 3,070,000 - 1,207,560 = 1,862,440
GUESS THE WORDS
PURCHASE COMMITMENTS
Obligations of an entity to acquire certain goods sometime
in the future at a fixed price and at a fixed quantity.
Purchase Commitments may be subject to revision or
cancellation before the and of contract period.
If there is a decline in purchase price after a
noncancelable purchase commitment has been made, a
loss is recorded in the period of the pricedecline
If the market price rises by the time the entity makes the
purchase, a gain on purchase commitment would be
recorded.
However, the amount of gain is limited to the recorded in
the previous period for same purchase commitment.
Illustration:
Assume that on October 1,2012. ABC entered into a non-
cancelable commitment to purchase six months after date,
100,000 units of an inventory item at 10 each. On
December 31, 2012, the average purchase price of an
inventory item is 9.00 per unit.
Entries:
Loss on Purchase Commitments 100,000
Estimated Liability on Purchase Commitments 100,000
