Inventories (PAS 2)

Topic Outline
1. Definition of inventories
2. Recognition
3. Initial measurement
4. Subsequent measurement

Definition of Inventories
- According to PAS 2, inventories are asset:
a. Held for sale in the ordinary course of business
b. In the process of production for such sale
c. In the form of materials or supplies to be consumed in the production process or in
rendering of services
Classes of inventories vary in accordance with entity’s nature of business
1. Merchandise business – Merchandise Inventories
2. Manufacturing business – Finished Goods Inventories; Work in process inventories; Raw
materials inventories and factory supplies
3. Service business – work in progress inventories (generally materials and supplies in the
rendering of services – e.g. long term constructions)
Recognition
What shall be included in inventory? – All goods to which the entity has title shall be included in
inventory, regardless of location
General rule: The one who has possession has legal title
Exceptions:
1. Goods in transit
Shipping term: Point of transfer
a. FOB Shipping point – Shipping point (libre ni seller ang shipping point) – owner is
buyer
b. FOB Destination – Buyers Location (libre ni seller until destination) – owner is seller
c. Free alongside (FAS) – upon delivering the goods up to the dock next to or alongside
the vessel on which goods are to be shipped (transfer of ownership alongside the
vessel)
d. Cost, insurance, freight (CIF) – upon loading of the goods to the vessel
e. Ex-ship – when the goods are unloaded at the other side (at the buyer’s port)

2. Consigned goods
The owner of consigned goods is the CONSIGNOR (the shipper)

Inventoriable costs
a. Freight cost and other handling costs of goods out on consignment
Non-inventoriable costs
a. Freight costs if the consigned goods are returned to the consignor (if full capacity na
si consignee and can no longer accommodate)
b. The original freight costs of returned consigned goods
c. Storage cost and other reimbursable costs charged to consignor
d. Freight cost to final customer
 3. Inventory financing agreements Owner
a. Sale with repurchase agreement Seller
b. Pledge inventories Pledgor or borrower
c. Loan of inventory Borrower
4. Sale or return Buyer
5. Sale on trial or approval Seller
6. Installment sale Buyer
7. Bill and hold sale Buyer
8. Lay-away sale Seller
9. Special order sale Buyer upon completion
Measurement
1. Initial measurement – according to PAS 2: COST
Elements of cost:
a. Cost of purchase
1. Purchase price
Means of acquisition Purchase price
a. Regular price Invoice price
b. Deferred settlement Cash price equivalent
c. Lump sum purchase Allocated purchase price

2. Import duties
3. Irrevocable taxes
Note: VAT, being recoverable is generally not capitalized as cost of inventories
UNLESS the entity is NON-VAT REGISTERED.
4. Freight and handling costs
5. Insurance while inventories are in transit
6. Broker’s commission

b. Cost of conversion (material to finished goods)

1. Direct Labor
2. Factory Overhead Allocation basis

i. Variable FOH Actual capacity

ii. Fixed FOH Normal capacity
Note: Unallocated fixed FOH are expensed and not capitalized
Exclusion from costs
1. Abnormal losses capitalized if normal losses
2. Administrative expenses traceable
3. Storage costs of finished goods Related to RM or WIP
4. Selling costs NA – always expense

c. Other necessary costs in bringing inventories to their present location and condition
 2. Lower of costs or NRV
Cost Formulas
1. Specific identification
2. FIFO – assumed that items of inventory which purchase first are sold first and ending
are represented by the most recent purchases
Solution Guide:
Ending inventory – (inventory, end quantity x cost of latest purchase)
COGS – (inventory sold in quantity x cost of oldest purchases)
3. Average method
 Periodic system – Weighted average method
 Perpetual system – moving average method
Exercise:
The following information is available regarding the inventory movements of THAI CORP. for
the month of September:
At the beginning of the month, the company has 2000 units with a cost of P36.00 per unit.

Purchases Sales
Date Units Unit cost Date Units Price
9/3 3,000 37.20 9/6 4,200 45
9/15 4,800 38 9/7 (600) 45
9/20 1,900 38.60 9/16 3,800 50
9/23 (300) 38.60
Requirements:
Compute for the ending inventory, costs of goods sold, gross profit under the following cost
formulas:
a. FIFO
b. Average method – periodic
c. Average method – perpetual
Solution: FIFO

In units In total
Beginning 2,000 P72,000
Inventory
Net 9,400 355,760
purchases
TGAS 11,400 427,760
Ending (4,000)
Inventory
COGS 7,400

Ending Inventory:
(1,600 units x P38.60) + (2,400 units x P38) P152,960
COGS:
(2,000 units x 36) + (3,000 units x 37.2) + (2,400 x 38) P274,800
Sales (3600 x 45) + (3,800 x 50) P352,000
COGS (274,800)
Gross Profit 77,200
 Weighted Average Method (Average – Periodic)
 Ending Inventory – (Inventory, end quantity x weighted average unit cost)
 COGS – (Inventory sold in quantity x weighted average unit cost)
Note: weighted average cost is recomputed once every year and computed as TGAS
in total divided by TGAS in units
WAM – Weighted average unit cost (P427,760 / 11,400 units) P37.52
Cost of ending inventory (4,000 units x P37.52) P150,080
Cost of goods sold (7,400 units x P37.52) P277,648
Note: difference due to rounding off
Sales 352,000
COGS (277,648)
GP 74,352

Weighted Average Method (Average – perpetual)

 Ending inventory – (inventory, end quantity x latest moving average unit cost)
 COGS – (inventory sold in quantity x latest moving average unit cost)
Units Unit cost Total
Invy, beginning 2,000 36.00 72,000
Purchases 3,000 37.20 111,600
Balance 5,000 36.72 183,600
Sales (4,200) 36.72 (154,224)
Balance 800 36.72 29,376
Sales return 600 36.72 22,032
Balance 1,400 36.72 51,408
Purchases 4,800 38 182,400
Balance 6,200 37.71 233,808
Sales (3,800) 37.71 (143,298)
Balance 2400 37.71 90,510
Purchases 1900 38.60 73,340
Balance 4,300 38.10 163,850
Purchase return (300) 38.60 11,580
Ending Invy 4,000 38.07 152,270

COGS – 154,224 + 143,298 – 22,032 275,490

Sales 352,000
COGS (275,490)
GP 76,510

Measurement:
Concept of NRV – measuring inventories at lower of cost or NRV is in line with the basic accounting
concept that an asset shall not be carried at an amount in excess of amounts it is expected to be realized
(recoverable amount)

So if:
Cost > NRV = There is inventory write down
Cost < NRV = There is reversal of inventory write down if there is a previous inventory write down

How to Compute NRV?

A. Finished goods/Merchandise Inventories: ESP – ECTS
B. Work in process inventories: ESP – ECTSell – ECTComplete
C. Raw materials and Factory Supplies: Current Replacement Cost

Determination of LCNRV – is applied only on an item by item basis. This is applied to all types of
inventories except for raw materials and factory supplies.
These items of inventories are tested for possible write down only if the related finished goods are to be
writedown.
 Inventory Estimation: Gross Profit and Retail Inventory

Inventory Estimation: Purpose

- Inventory reporting purposes
- Internal reports
- Missing Inventory
- Inventory loss (due to catastrophes)

Methods: Inventory Estimation

1. Gross Profit Method
2. Retail Inventory Method

Gross Profit Method

Beginning Inventory XX
Add: Net Purchases XX
TGAS XX
Less: Ending Inventory (xx) - this is our focus
COGS XX

TGAS = COGS + INVENTORY, END

Ending Inventory = TGAS – COGS

Beginning Inventory xx
Add: Gross Purchases xx
Freight in xx
Less: Purchase discount (xx)
Purchase allowance (xx)
Purchase returns (xx) xx
TGAS XX

Net Sales xx - For purposes of Gross Profit Method

Less: COGS (XX)
Gross Profit xx

Gross Sales xx
Less: Sales returns (xx) There is physical movement of inventory;
Net Sales xx Sales discounts no movement of inventory
But for purposes of reducing payment

Note: if the given problem is Net Sales, add back the sales discounts and sales allowances

Net Sales xx
Add: Sales discounts xx
Sales allowances xx
Net sales before discount and allowances xx

Gross Profit rate:

1. Based on sales (GP/Net Sales) - if the problem is silent
2. Based on Cost (GP/COGS)

COGS:
1. Net Sales x (1-GPR based on sales)
2. Net Sales / (1+GPR based on cost)

Shortage or Overage
Estimated > Actual: Shortage
Estimated<Actual: Overage
Loss on Catastrophe
Estimated Inventory xx
Less: NRV of damaged goods (xx)
Costs of undamaged goods (can be sold) (xx)
Cost of goods in transit (xx)
(not included in the estimated inventory because its in transit)
Inventory Loss xx

1. FOB SP: Buyers --------- costs

2. FOB Destination: Seller ----------costs ** inventory is in transit but transfer of ownership only
upon arrival at buyers location, hence, part of inventory if not yet arrived.

FOB Destination :Seller ---- stated at Selling Price (because you are the seller) --- get the cost
ratio through this formula (Cost ratio = (1-GPR based on sales)

Illustration:

Oscar Company would like to estimate its ending inventory balance using gross profit method because
there was a tip received indicating that some of its warehouse employees are involved in inventory
misappropriation schemes. For the current period, the company reported the following balances:

Beginning Inventory P1,008,000

Purchases 6,384,000
Purchase discounts 89,600
Purchase allowances 56,000
Purchase returns 280,000
Sales 7,392,000
Sales discounts 134,400
Sales returns 392,000
Sales allowances 112,000

Physical count showed inventory of P1,064,000

Assumption 1: Determine the estimated amount of stolen inventory, if any, assuming that the company
consistently applies 25% gross profit based on cost.
Assumption 2: Determine the estimated amount of stolen inventory, if any, assuming that the company
consistently applies 18% gross profit based on sales.

Solution: Based on Cost

Ending Inventory = TGAS – COGS

Beginning Inventory P1,008,000

Purchases 6,384,000
Purchase discounts (89,600)
Purchase allowances (56,000)
Purchase returns (280,000)
TGAS 6,966,400

Sales 7,392,000
Sales returns (392,000)
Net Sales 7,000,000
Divided by: 1.25%
COGS 5,600,000

Ending Inventory = TGAS – COGS

6,966,400 – 5,600,000 = 1,366,400 * estimated
Actual Inventory = 1,064,000
Inventory loss = 302,400
Solution: Based on Sales
Sales 7,392,000
Sales returns (392,000)
Net Sales 7,000,000
multiply by: 82% (1-18%)
COGS 5,740,000

Ending Inventory = TGAS – COGS

6,966,400 – 5,740,000 = 1,226,400 * estimated
Actual Inventory = 1,064,000
Inventory loss = 162,400

RETAIL INVENTORY METHOD

Ending Inventory at retail= TGAS at retail – Net Sales

Ending Inventory at retail x cost ratio = ending inventory @ cost

Cost Retail
Beg. Invy xx xx
Purchases xx xx

Freight in xx - we do not sell freight but goods 😊

Purchase returns (xx) (xx)
Purchase discounts (xx) - no physical flow of goods
and allowances
Dept. transfer in xx xx transferred to you
Dept. transfer out (xx) (xx) you transferred outside
Abnormal loss (xx) (xx)
*Net mark ups xx
**Net mark down (xx)
TGAS XX XX

*Net mark ups = mark up less mark up cancellation

** Net markdown = marks down less mark down cancellation

Gross Sales xx
Add: Normal loss at retail xx malulubog sa COGS eventually
Employee discount xx
Less: Sales returns (xx)
Net Sales xx

Note: if net sales is given (trick) add back those NL,ED,SDA

Net Sales xx
Add: Normal loss xx
Employee discount xx
Sales discount & allow xx
Net sales xx

TGAS at Retail xx
Less: Net Sales (xx)
Ending Inventory at retail xx
Multiply by Cost ratio %
Ending Inventory at Cost xx

Cost Ratio:
1. Average Cost Ratio = TGAS @ cost / TGAS @retail (if problem is silent)
2. LCNRV cost ratio = TGAS @cost / (TGAS @ retail + Net MarkDowns)
3. FIFO cost ratio = TGAS @ cost less beginning inventory @ cost / TGAS @ retailo less Beg.
Inventory @ retail