Inventories

IAS 2 | Assets which are 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.

OBJECTIVE
O IAS 2 Inventories prescribes the

accounting treatment for inventories.

O The standard provides guidance on

the determination of cost and its

subsequent recognition as an
expense, including any write-down to
net realisable value.

SCOPE
O IAS 2 applies to all inventories, except:
O work in progress arising under construction contracts

including directly related service contracts refer IAS

11 Construction Contracts
O financial instruments refer IAS 32 Financial

Instruments: Presentation and IAS 39 Financial

Instruments: Recognition and Measurement
O biological assets related to agricultural activities and

agricultural produce at the point of harvest refer IAS

41 Agriculture

Kinds of Inventories
O In merchandising,
Goods purchased and held for resale

O In manufacturing,
Raw Materials and supplies
Goods in process
Finished goods

O In service provider,
The cost of service for which related revenue is not
yet recognized (labor and other cost of personnel directly
engaged in providing the service)

Goods includible in the

inventory
O As a rule, all goods to which the

entity has title shall be included in

the inventory regardless of location.
O Passing of title legal language

which means the point of time at

which ownership changes

Legal Test
Is the entity the owner of the goods
to be inventoried?

Who is the owner of

goods in transit?

Free on Board (FOB)

O FOB destination goods purchased

is transferred only upon receipt.

O FOB shipping point ownership is

transferred upon shipment.

Who is the owner of

consigned goods?

Consignment
OA

method of marketing goods in

which the owner called consignor
transfer
physical
possession
if
certain goods to an agent called the
consignee who sells them on the
owners behalf.

Exception to the legal

test
O Installment Contracts

- retention of the title by the seller

until selling price is fully collected.
However, it is an accepted accounting
principle to record installment sale as
regular sale involving deferred income
on the part of the seller.

Activity
Identify which inventories are included:
Goods
point
Goods
Goods
Goods
Goods
Goods
Goods

in transit and purchased FOB shipping

in transit and sold FOB shipping point
on consignment
in the hand of an agent
held by consignment
held by customers on approval
held by customers on trial

Recognition and
measurement
O IAS 2 requires inventories to be

measured at the lower of cost and

net realisable value on an item by
item basis.

Expense recognition
O Upon the sale of inventories, the carrying amount of

those inventories is to be recognised as an expense

in the statement of comprehensive income in the
period in which the related revenue is recognised.
O If

net realisable value falls below the cost of

inventories the write-down is expensed in the
statement of comprehensive income in the period in
which the write-down occurs. An increase in net
realisable value that reverses a previous write-down
is to be recognised as a reduction in the amount of
inventories recognised as an expense in the period
the reversal occurs.

Accounting for
inventories
O Periodic

system calls for the

physical counting of goods on hand
at the end of the accounting period.

O Perpetual

system requires the

maintenance of records called stock
cards that usually offer running
summary of the inventory inflow and
outflow.

Purchase of Merchandise on
account
Periodic System
Purchases
Accounts Payable

Perpetual System

Merchandise Inventory
Accounts Payable

Payment of freight on purchase

Periodic System
Freight In
Cash

Perpetual System

Merchandise Inventory
Cash

Return of merchandise
purchased
Periodic System
Accounts Payable
Purchase Return

Perpetual System

Accounts Payable
Merchandise Inventory

Sale of merchandise on account

Periodic System
Accounts receivable
Sales

Perpetual System

Accounts Receivable
Sales
Cost of Goods Sold
Merchandise Inventory

Return of merchandise sold

Periodic System
Sales
Accounts receivable

Perpetual System

Sales
Accounts Receivable

Merchandise Inventory
Cost of Goods Sold

Sale of merchandise on account

Periodic System
Merchandise Inventoryend
Income Summary

Perpetual System

No entry.

Measurement of
inventory
O Lower of Cost or Net Realizable Value

(LCNRV)
O Either First In or First Out (FIFO) or

weighted average method

O Specific Identification Method

Cost of inventory
The cost of inventories is the aggregation of the:
costs of purchase net of trade discounts and rebates
(e.g. purchase price, import duties, transportation and handling costs)

the costs of conversion into finished products

(e.g. labor and production overhead costs)

other costs in bringing the inventories to their

present location and condition excluding the cost of

abnormal wastage, storage, administration and
selling.

Cost of purchase
O Comprises the purchase price, import duties

and irrecoverable taxes, freight, handling and

other costs directly attributable to the
acquisition.
O Trade discounts, rebates and other similar

items are
purchase.
O Shall

not
differences.

deducted

include

from

the

foreign

cost

of

exchange

Discounts
TRADE DISCOUNT

O Deductions

CASH DISCOUNT

from O Deductions from

the list or catalog
invoice price
price in order to
when payment is
arrive
at
the
made within the
invoice
price
discount period.
which is actually
charged to the
buyer.

The list price of a merchandise

purchased is P500,000 less 20% and
10%, with credit terms of 5/10, n/30.
List Price
500,000
First trade discount (20% of 500,000) (
100,000)
400,000
Second trade discount (10% of 400,000)(
40,000)
Invoice Price
360,000
Cash discount (5% of 360,000)
18,000
Payment within the discount period

Methods of recording
purchases
GROSS METHOD

O Purchases and

accounts payable
are recorded at
gross.

NET METHOD

O Purchases and

accounts payable
are recorded at
net.

Purchase of merchandise on
account
GROSS METHOD
Purchases
360,000
Accounts Payable 360,000

NET METHOD
Purchases
342,000
Accounts Payable 342,000

Assume payment is made

beyond the discount period
GROSS METHOD
Accounts Payable 360,000
Cash
360,000

NET METHOD
Accounts Payable
342,000
Purchase Discount Loss
18,000
Cash
360,000
The purchase discount loss
account is classified as other
expense.

Assume payment is made within

the discount period
GROSS METHOD
Accounts Payable 360,000
Cash
342,000
Purchase discount
18,000

NET METHOD
Accounts Payable 342,000
Cash
342,000

Assume it is the end of accounting period,

no payment is made and the discount has
expired.
GROSS METHOD
No entry.

NET METHOD
Purchase Discount Loss
Accounts Payable

18,000
18,000

Cost of conversion
O Cost directly related to the units of

production such as direct labor.

O Includes a systematic allocation of

fixed
and
overhead.

variable

production

Fixed production
overhead

O Indirect

Variable
production
overhead

cost of O Indirect cost of

production
that
production
that
remains relatively
varies
directly
constant
with the volume
regardless of the
of production.
volume
of
production.

Other cost
Cost of inventories only to the extent that it is
incurred in bringing the inventories to their
present location and condition.
Exclude the following from cost of inventory
and recognize as expense:
O Abnormal amounts of wasted materials, labor

and other production costs

O Storage cost, unless necessary for production
O Administrative overheads
O Distribution or selling costs

Net realizable value

O Estimated selling price in the ordinary course

of business less the estimated cost of

completion and the estimated cost necessary
to make the sale.
O The cost may not be recoverable,

- If inventories are damaged, wholly or

partially obsolete or if their selling prices have
declined.
- If the estimated cost of completion or the
estimated cost to sell has increased.

O The practice of writing inventories

down below cost to net realizable

value is consistent with that assets
shall not be carried in excess of
amounts expected to be realized
from their sale or use.
O Inventories are usually written down

to net realizable value on an item or

individual basis.
O But if not appropriate, based on a
classification.

LCNRV
If cost < NRV

O Inventory is

stated at cost.
Increase in value
is not recognized.

If cost > NRV

O Inventory is

measured at net
realizable value.
Write-down
inventory to net
realizable value.

Accounting for inventory writedown

Direct Method

O Inventory

Allowance Method

is O Inventory
is
recorded
at
recorded at cost
LCNRV. Any loss
and any loss on
on
inventory
inventory writewrite-down is not
down
is
accounted
for
accounted
for
separately
but
separately.
buried in the
cost
of
goods
sold.

As of December 31, 2014, Cost = P800,000

and NRV = P785,000

Direct Method
Inventory, 12/31/14 785,000
Income
summary
785,000

Allowance Method
Inventory, 12/31/14 800,000
Income summary 800,000
Loss on inventory 15,000
Allowance for
inventory
write-down
15,000

As of December 31, 2015, Cost = P1,000,000

and NRV = P990,000

Direct Method
Inventory, 12/31/15 990,000
Income
summary
990,000

Allowance Method
Allowance for
Inventory write-down 5,000
Gain on reversal of
inventory
write-down
5,000

Methods
of valuation
First In, First Out
(FIFO)
O Goods first purchased

are first sold.

O The inventory is thus

expressed in terms of
recent or new prices
and COGS are in terms
of old or earlier prices.

Weighted Average

O Coat of beginning

inventory plus
cost of purchases
divided by the
total number of
units.

Weighted average
method
Periodic

O Average unit cost

=
Total cost of COGS
Total no. of COGS

Perpetual

O Periodic basis,

upon purchase of
new inventory.

Apply AVCO method of inventory

valuation on the following information,
first in periodic inventory system and
then in perpetual inventory system to
determine the value of inventory on
hand on Mar 31 and cost of goods sold
during March.

Specific identification
O Specific

costs are attributed

identified items of inventory.

to

O Inventories that are segregated for a

specific project and inventories that

are not ordinarily interchangeable.

Biological Assets

IAS 41: AGRICULTURE

Applied to account for the following
when they relate to agricultural
activity:
O Biological assets
O Agricultural produce (@ point of

harvest)
O Government grant related to biological
assets

Definition of terms

BIOLOGICAL ASSETS
living animals and living plants

AGRICULTURAL PRODUCE
harvested product of an entitys
biological assets

HARVEST
detachment of
produce from a
biological asset
or cessation of a
biological
assets life
processes

Biological
Asset

Product
Agricultural
after
harvest
Produce

Sheep
Diary cattle
Bushes
Vines
Fruit trees

Yarn
Wool
Cheese
Milk
Tea
Leaf
Wine
Grapes
Fruit
Picked fruitcocktail

Agricultural activity
(Agriculture)
This is the management by an entity
of the biological transformation and
harvest of biological assets for sale or
for
conversion
into
agricultural
produce or into additional biological
assets.

Examples of agricultural
activity

Features of agricultural
activity
O CAPABILITY TO CHANGE biological

transformation
O MANAGEMENT OF CHANGE enhancing

or at least stabilizing conditions

necessary for the process to take place
O MEASUREMENT OF CHANGE measured

and monitored as a routine management

function

Biological
Transformation
Comprises the process of growth, degeneration,
production and procreation that cause qualitative or
quantitative changes in a biological asset.
Results from:
Asset changes

Growth
Degeneration
Procreation

Production

Recognition
O Entity controls the asset as a result

of past event
O Flow of probable future economic

benefits associated with the asset

O Fair value or cost can be measured

reliably

Measurement
O Initial recognition and at the end of

reporting period
At fair value less cost to sell
(Agricultural produce @ FV costs at the point of harvest)
Cost to sell incremental costs directly attributable to the
disposal of an asset, excluding finance costs and income
taxes

Determination of Fair
Value
O Quoted price in an active market
O Most recent market transaction price
O Market price for similar assets
O Sector benchmark
O Present value of expected net cash

flow from the asset

Gain or Loss
O On initial recognition,

Biological Assets
O Loss, when Cost to Sell is greater than

FV
O Gain, on precreation
Agricultural produce
O Depends on the result of harvesting