INVENTORY

ALCANTARA
ALORIA

Inventories
According to PAS 2, paragraph 6

Assets which are held for sale in the ordinary course of business, in the
process of production for such sale in the form of materials or supplies to be
consumed in the production process or in the rendering of services.

Current Asset

Classes of inventories

Trading entity
- is one that buys and sells goods in the same form

purchased.

- Merchandise inventory or inventory

Manufacturing entity
- is one that buys goods which are altered or converted into another form
before they are made available for sale.
- Raw materials, Work in process & Finished goods

Cost of Inventories

The cost of inventories should comprise all costs of purchase, costs of conversion and other
costs incurred in bringing the inventories to their present location and condition.

The cost of purchase of inventories comprise 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.

Trade discounts, rebates and other similar items are deducted in determining the cost of
purchase.

The cost of conversion of inventories include costs directly related to the units of production.

The cost of inventories of a service provider consists primarily of the labor and other costs of
personnel directly engaged in providing the service.

Two methods of recording purchases

Gross method
-Purchases are recorded at the gross amount of the invoice.
-Cash discounts taken are recorded in a purchases discount account at the time of
payment.

Net method
-The purchase are recorded at net amount, meaningn the cost of purchases is measured
net of cash discounts allowable whether or nottaken.

FOB(Free On Board)

It is an term that indicates when the ownership of Merchandise/Goods is

transfer from the seller to the buyer.

FOB Shipping Point

FOB Destination

Transportation Cost

FOB
Destination

FOB
Sipping point

Buyer of the Merchandise/

Goods Pays the transportation
cost.
The cost is added in
merchandise inventory.

Seller of the Merchandise/

Goods pays the transportation
cost.

The cost is recorded as a

Delivery Expense/Cost
separately.

Consignment

Is a method of marketing goods in which the owner known as the consignor

transfers physical possession of certain goods to an agent known as the
consignee who sells the goods on the owners behalf

Goods on consignment shall be included in the consignors inventory and

excluded from the consignees inventory

Freight and other handling charges are part of the cost of the inventory of
consigned goods.

Inventory
Inventory
Accounting
Accounting
Method
Method

Perpetual
Method

Periodic/
Physical
Method

Perpetual System:
All Transaction including Costs of merchandise are recorded immediately as
they occur. Record is up-to- date all the time.

Periodic System:
No effort is made to keep records up-to-date neither inventory nor Cost of
goods sold and are only updated at the end of interim period.

Perpetual inventory system

The following example contains several journal entries used to account
for transactions in a perpetual inventory system:

Purchase of Merchandise:
Purchase of inventory is recorded at cost.
To record a purchase of $5,000 of 5 items that are stored in inventory
each item has cost $1,000.

Perpetual inventory system

Sales of Merchandise:
Sold 3 items $1200 each, for $3,600. for which the cost is 3,000.

Gross Profit: 3600 3000 = $600

Let Expenses are $200. Then,
Net Income = 600 200 = $400

If inventory is purchased and sold on account, Then entries will be:

Purchase of Inventory: (On Account)
Account Title

Debit

Inventory

Credit

$5000
A/C Payable

$5000

Selling of Inventory: (On Account)

Debit
A/C Receivables

Inventory Record:

$3600
Revenue

$3600
Debit

Cost of Goods Sold

Credit

Credit

$3000
$3000

Inventory

Payment of A/C Payables to Suppliers:

Debit
A/C Payables

Credit

$5000
Cash

$5000

Collection of Accounts Receivable from Customers:

Debit
Cash

Credit

$3600
A/C Receivable

$3600

Periodic Inventory System:

Example

The inventory on hand at the end of 2011 cost $20000.

During 2012, purchases of merchandise for resale of customers totaled

$100000

Inventory on hand at the end of 2012 cost $15000.

Recording Purchases of Merchandises:

Suppose from total purchases of $100,000 the first purchase
was of $10,000 so purchase entry will be:

Debit
Purchases
Cash

Credit

10000
10000

Computing the cost of goods sold:

Inventory(beginning of the year 2012) $20000
Add : Purchases....................100000
Cost of goods available for sale..$120000
Less : Inventory (end of the year 2012).15000
Cost of goods sold.$105000

Disclosure Requirements

Accounting policies adopted in measuring inventories, including the cost method used;

The total carrying amount of inventories and the carrying amount in classification appropriate to the
enterprise

The total carrying amount of inventories carried at fair value less cost to sell;

The amount of inventories recognized as an expense during the period;

The amount of any write down of inventories recognized as an expense in the period;

The amount of any reversal of any write down that is recognized as income in the period and the
circumstances or events that led to the reversal of a write down;

The circumstances or events that led to the reversal of a write down of inventories; and

The carrying amount of inventories pledged as security for liabilities.

INVENTORY VALUATION

MEASUREMENT OF INVENTORY

Shall be measured at LCNRV

Cost of Inventories:

All costs of purchase

Cost of conversion

Other costs incurred in bringing the inventories to their present location and
condition

The objective in accounting for

inventories is the proper
determination of COGS

DETERMINING COST OF INVENTORIES

FIFO

WEIGHTED AVERAGE/ MOVING AVERAGE METHOD

SPECIFIC IDENTIFICATION METHOD

LIFO

FIFO METHOD

GOODS ARE SOLD IN THE ORDER THEY ARE

PURCHASED

FIFO METHOD
INVENTORY = RECENT OR NEW PRICES
COGS = EARLIER OR OLD PRICES
unde
r

However... It violates the matching principle

Inflation = highest net income
Deflation = lowest net income

state

men
t

WEIGHTED AVERAGE METHOD (WAM)

Average unit cost = TCGAS total units

available for sale

MOVING AVERAGE METHOD (MAM)

Average unit cost = TGAS after every
purchase and purchase return total
units available for sale

SPECIFIC IDENTIFICATION

Appropriate for inventories that are segregated for a specific project and
inventories that are not ordinarily interchangeable.

Specific costs are attributed to identified items of inventory

Cost of inventory = units on hand x actual unit cost

NET REALIZABLE VALUE (NRV)

The estimated selling price in the ordinary course of business less the
estimated cost of completion and the estimated cost of disposal.

Why LCNRV?
assets shall not be carried in excess of amounts expected to be
realized from their sale or use.

ACCOUNTING FOR INVENTORY WRITEDOWN

Cost is lower than NRV

The increase in value is not

recognized

Cost is greater than NRV

The proper treatment of the

writedown of the inventory to net
realizable value

DIRECT METHOD
ALLOWANCE METHOD

DIRECT METHOD

The inventory is recorded at the lower of cost or NRV

Also known as the Cost of goods sold method because

any loss on inventory writedown is not accounted for
separately but buried in the cost of goods sold.
NRV is lower than cost

increase COGS

ALLOWANCE METHOD

The inventory is recorded at cost and any loss on inventory writedown is

accounted for separately.

If the required allowance increases, an additional loss is recognized

If the required allowance decreases, a gain on reversal of inventory writedown is
recorded; provided that the gain is only to the extent of the allowance balance.

Preferable method because the effects of writedown and reversal of writedown

can be clearly identified.

OTHER INVENTORY ISSUE: PURCHASE

COMMITMENTS

Are obligations of the entity to acquire certain goods sometime in the

future at a fixed price and fixed quantity

A decline in purchase price after a purchase commitment has been

made, a loss is recorded in the period of the price decline (noncancelable)

Loss on purchase commitments

Estimated liability for purchase commitment

xxx
xxx

INVENTORY ESTIMATION
METHODS: GROSS
PROFIT METHOD

Use of estimate in inventory valuation

Insurance purposes (fire, theft)

To prove the reasonableness of the

physical count done
Interim financial statements are
prepared

Use of approximate value of inventory when it

is not possible/inconvenient to take a
physical count

GROSS PROFIT METHOD

The rate of gross profit remains approximately the same from period to period and therefore the ratio of
cost of goods sold to net sales is relatively constant from period to period.
GAS

xxx

Less: Cost of sales

xxx

Ending inventory

xxx

Net sales * cost ratio

- based on sales

Net sales sales ratio

- based on cost

INVENTORY ESTIMATION
METHODS: RETAIL
INVENTORY METHOD

 Uses

both the retail value and cost of items for sale to

calculate a cost to retail ratio.

Ending
Ending
Inventory
Inventory
at Retail
Retail
at

Ending
Ending
Inventory
Inventory
at Cost
Cost
at
Must know . . .

Sales for the period.

Beginning inventory at retail and cost.
Net purchases at retail and cost.

Problem
Webb, Inc. uses the retail method to estimate inventory at the end of each month. For
the month of May the controller gathers the following information:

Cost
Retail
Beg. Inventory $ 27,000 $ 45,000
Net Purchases 180,000 300,000
Lets estimate inventory at May 31.
Net Sales
n/a
310,000

Solution
Inventory, May 1
Net purchases for May
Goods available for sale

Cost
$ 27,000
180,000
207,000

Retail
$
45,000
300,000
345,000

Inventory, May 1
Net purchases for May
Goods available for sale
Cost ratio (207,000 345,000)
60%

Cost
$ 27,000
180,000
207,000

Retail
$
45,000
300,000
345,000

Inventory, May 1
Net purchases for May
Goods available for sale
Cost ratio (207,000 345,000)
60%
Sales for May
Ending inventory at retail

Cost
$ 27,000
180,000
207,000

Retail
$
45,000
300,000
345,000

310,000
35,000

Inventory, May 1
Net purchases for May
Goods available for sale
Cost ratio (207,000 345,000)
60%
Sales for May
Ending inventory at retail
Cost ratio
Ending inventory at cost

Cost
$ 27,000
180,000
207,000

Retail
$
45,000
300,000
345,000

$
$ 21,000

310,000
35,000
60%