​ ​ ​ ​ ​ ​ ​ ​ ​ INVENTORY PART 2

​ ​ Lecture

INVENTORY PART 2 (PAS 2)

In accounting (PAS 2), inventory is often the largest current asset on a merchandising or
manufacturing company’s balance sheet, and Cost of Goods Sold (COGS) is usually the largest
expense on the income statement. Because inventory directly impacts both net income (it affects
Income Statement) and total assets (it affects Balance Sheet), international standards provide strict
rules on how we track, value, and report it.

A. Inventory Valuation Methods (Cost Formulas & Cost Flow Assumptions)

When a company buys identical inventory items at different prices over time, it faces an accounting
challenge: When an item is sold, which specific cost do we transfer from Inventory on the
Balance Sheet to Cost of Goods Sold on the Income Statement?

To solve this, PAS 2 allows specific cost formulas depending on the nature of the goods.

1. Specific Identification
You track the actual, physical cost of each specific individual item from the moment it is bought until
the moment it is sold.
●​ When Required: PAS 2 mandates this method for goods and services that are not ordinarily
interchangeable, and for goods or services produced and segregated for specific projects.
●​ Corporate Reality: Think of a high-end art gallery, a luxury car dealership selling customized
Ferraris, or a real estate developer building bespoke villas. It would be absurd to average the
cost of a painting by Juan Luna with a contemporary print; each item has a unique cost and
identification number.

2. First-In, First-Out (FIFO)

Assumes that the oldest units purchased are the first ones sold. Consequently, the units remaining in
Ending Inventory represent the most recent purchases at the latest market prices.
●​ Corporate Reality: This mimics the physical flow of perishable goods. In a supermarket like
SM Supermarket, dairy workers stock new milk cartons at the back of the shelf so customers
grab the oldest cartons from the front.
●​ The Golden Rule: Whether a company uses the Periodic System or the Perpetual System,
FIFO will always yield the exact same Ending Inventory and Cost of Goods Sold
amounts.

3. Weighted Average
Under this method, the cost of each item is determined from the weighted average of the cost of
similar items at the beginning of a period and the cost of similar items purchased or produced during
the period. The mechanics change depending on the inventory system used:
●​ Periodic System (Weighted Average): The average unit cost is calculated only once at the
very end of the accounting period.​
Weighted Average Unit Cost=Total Units Available for SaleTotal Cost of Goods Available for
Sale​
●​ Perpetual System (Moving Average): A new average unit cost is calculated after every
single purchase (or inventory return). When a sale occurs, the units are cost out using the
most recent average cost established prior to that sale.
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Why is LIFO Prohibited under PAS 2?

The Last-In, First-Out (LIFO) method assumes the newest items bought are sold first, leaving the
oldest, ancient costs in Ending Inventory. While permitted under US GAAP for tax advantages, PAS 2
explicitly prohibits using LIFO metho. Why?

1.​ Balance Sheet Distortion: In an inflationary economy where prices constantly rise, LIFO
leaves decades-old costs on the balance sheet. A company in 2026 might report inventory at
1990 prices, severely undervaluing its assets and misleading investors. PAS 2 prioritizes
balance sheet accuracy.

2.​ Artificial Profit Manipulation (LIFO Liquidation): LIFO allows corporate managers to
manipulate net income. If profits are higher than expected near year-end, managers can
deliberately buy massive amounts of expensive raw materials. Under LIFO, those expensive
late purchases are immediately dumped into the Cost of Goods Sold, slashing reported profits
and evading corporate income taxes.

3.​ Divorce from Physical Reality: Hardly any business physically sells its newest goods while
letting older stock sit in a warehouse to rot or become obsolete.

Sample Problem: FIFO vs. Weighted Average

Global Tech Merchandising sells specialty hard drives. During January 2026, the company recorded
the following inventory transactions:
Date Transaction Units Unit Cost Total Cost
Jan 1 Beginning Inventory 100 ₱1,000 ₱100,000
Jan 10 Purchase 200 ₱1,200 ₱240,000
Jan 15 Sale (at ₱2,000/unit) (220) — —
Jan 25 Purchase 150 ₱1,400 ₱210,000
Jan 30 Sale (at ₱2,200/unit) (130) — —
TOTALS Available for Sale 450 ₱550,000
(beginning inventory +
purchases less returns)
Total Units Sold: 220+130=350 units.
Physical Ending Inventory: 450−350=100 units.

A. FIFO Method (Periodic & Perpetual yield identical results)

Since 100 units remain in ending inventory, under FIFO, they must come from the latest purchase on
Jan 25:

Ending Inventory = 100 units (remaining units) × ₱1,400 (cost of the latest purchase because older
purchased were sold first) = ₱140,000

Cost of Goods Sold= Total Goods Available for Sale or TGAS − Ending Inventory
Cost of Goods Sold= ₱550,000 − ₱140,000 = ₱410,000
​ ​ ​
or

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Total Units Sold: 220 + 130 ​ =​ 350 units (Under FIFO, all older stocks were sold first)
Beginning Inventory ​ ​ =​ (100 units @ P1,000)​​ ​ = P100,000
Jan 10 Purchase​ ​ =​ (200 units @ P1,200)​​ ​ = P240,000
Jan 25 Purchase​ ​ =​ (50 units @ P1,400)​ ​ ​ = P70,000
Cost of Goods Sold​ ​ ​ ​ ​ ​ ​ ​ = P410,000​

B. Weighted Average — Periodic System

Average unit cost is calculated only once at the very end of the accounting period.​

We compute a single average rate at the end of the month:

Average Rate​ =​ ₱550,000/450 units​ ​ ​=​ ₱1,222.22 per unit
Ending Inventory​ =​ 100 units × ₱1,222.22​ =​ ₱122,222

Cost of Goods Sold​= ​ Total Goods Available for Sale or TGAS − Ending Inventory
Cost of Goods Sold=​ ₱550,000 − ₱122,222​ =​ ₱427,778

C. Moving Average — Perpetual System

New average unit cost is calculated after every single purchase (or inventory return).
We must track the shifting average unit cost dynamically after every purchase date:
●​ Jan 1 Balance: 100 units @ ₱1,000 = ₱100,000
●​ Jan 10 Purchase: Add 200 units @ ₱1,200 (₱240,000).
○​ New Total Balance: 300 units worth ₱340,000.
○​ New Moving Average Rate:​
₱340,000 / 300 units ​= ₱1,133.33 per unit

●​ Jan 15 Sale of 220 units:​

COGS for Jan 15= 220 units × ₱1,133.33 = ₱249,333
○​ Remaining Balance: 300−220 = 80 units worth of ₱340,000 − ₱249,333 = ₱90,667.

●​ Jan 25 Purchase: Add 150 units @ ₱1,400 (₱210,000).

○​ New Total Balance: 80+150 = 230 units worth ₱90,667 + ₱210,000 = ₱300,667.
○​ New Moving Average Rate:​
₱300,667 / 230 units ​= ₱1,307.25 per unit

●​ Jan 30 Sale of 130 units:​

COGS for Jan 30 = 130 units × ₱1,307.25 = ₱169,943

●​ Ending Inventory (100 units remaining):​

Ending Inventory= 100 units × ₱1,307.25 = ₱130,725
●​
●​ COGS under Moving Average = ₱249,333 + ₱169,943 = ₱419,276.

Check how changing purchase prices or inventory systems alters your Balance Sheet and Income
Statement valuations:

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Subsequent Measurement — LCNRV

Once inventory is recorded at its initial purchase or production cost, it does not simply sit on the
balance sheet at that number forever. The question to ask on why there is Subsequent
measurement for Inventory:
What happens if the inventory loses value while sitting in our warehouse?

PAS 2 states that inventories shall be measured at the Lower of Cost and Net Realizable Value
(LCNRV).

Why Adopt LCNRV? (Concept of Prudence / Conservatism)

In corporate accounting, hope is never a valid accounting strategy. The foundational accounting
concept of Prudence (or Conservatism) dictates that when faced with uncertainty, an accountant
must:
●​ Anticipate and record all probable losses immediately.
●​ Never anticipate or record unearned gains until they actually happen.

If a retailer buys inventory for ₱500,000, but due to market changes, damage, or obsolescence, they
can now only expect to realize ₱380,000 from selling it, the inventory has lost economic utility. Under
Prudence, we cannot wait until next year when the item is finally sold to recognize the loss. We must
write down the inventory asset to ₱380,000 today and charge a ₱120,000 loss against this period's
income.
●​ Corporate Reality: Imagine a consumer electronics distributor holding 1,000 units of an
iPhone model bought at cost for ₱45,000 each. Apple suddenly announces a brand-new model
at a lower price point. To clear out old stock, our distributor is forced to drop their retail selling
price to ₱38,000. Because the expected recoverable value dropped below cost, PAS 2
mandates an immediate write-down.

Net Realizable Value (NRV) vs. Fair Value

Students often confuse Net Realizable Value with Fair Value. They are fundamentally different
measurement bases in IFRS.

What is Net Realizable Value (NRV)?

NRV is the estimated selling price in the ordinary course of business, less the estimated costs of
completion and the estimated costs necessary to make the sale.

NRV = Estimated Selling Price − Estimated Costs to Complete − Estimated Cost to Sell

Key Differences at a Glance

Feature Net Realizable Value (NRV) Fair Value (IFRS 13)
Perspective Entity-Specific: Based on the specific Market-Based: Based on what general
company's sales contracts and business market participants would pay in an
strategy. orderly transaction.
Transaction Deducted: Selling expenses (commissions, Not Deducted: Represents the gross
Costs shipping, packaging) are subtracted. exit price in the principal market without
deducting transaction costs.

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Use Case in The official benchmark used to test Not used for standard inventory
PAS 2 inventory for write-downs. valuation under PAS 2 (used for
biological assets or broker-traders).

Write-Down of Finished Goods Inventory

When applying the LCNRV test, PAS 2 generally requires companies to compare cost and NRV on an
item-by-item basis (individual basis). Grouping items is only permitted if the inventory items belong
to the same product line, have similar purposes, and are produced and marketed in the same
geographical area.

Sample Problem: Item-by-Item Valuation

Apex Fashion Retailers has three distinct garment lines in their warehouse at year-end. The
accounting department gathered the following data:

Product Line Total Historical Cost Est. Selling Price Est. Selling Expenses
Line A (Formal Suits) ₱450,000 ₱580,000 ₱30,000
Line B (Casual Shirts) ₱280,000 ₱260,000 ₱20,000
Line C (Winter Coats) ₱350,000 ₱390,000 ₱50,000

Step 1: Calculate NRV for each item

●​ Line A: ₱580,000−₱30,000=₱550,000
●​ Line B: ₱260,000−₱20,000=₱240,000
●​ Line C: ₱390,000−₱50,000=₱340,000

Step 2: Compare Cost vs. NRV item-by-item

Product Historical Calculated LCNRV Valuation Write-Down Loss
Line Cost NRV (Lower amount) Required
Line A ₱450,000 ₱550,000 ₱450,000 ₱0 (Cost is lower)
Line B ₱280,000 ₱240,000 ₱240,000 (₱40,000) (NRV is lower)
Line C ₱350,000 ₱340,000 ₱340,000 (₱10,000) (NRV is lower)
TOTALS ₱1,080,000 ₱1,030,000 (₱50,000)

Step 3: Journal Entry for the Write-Down

To reflect the loss in the financial statements at year-end, the company records:
●​ Debit: Loss on Inventory Write-Down (Income Statement expense) — ₱50,000
●​ Credit: Allowance for Inventory Write-Down (Contra-asset reducing Inventory) — ₱50,000

​ ​ ​ ​ ​ ​ ​ or

(Note: In practice, some companies credit the Inventory account directly, or embed the loss directly
into the Cost of Goods Sold).
●​ Debit: Cost of Goods Sold (Income Statement expense) — ₱50,000
●​ Credit: Inventory (Balance Sheet account) — ₱50,000

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Write-Down of Raw Materials

When auditing a manufacturing company, raw materials have a unique, highly exam-tested exception
under PAS 2.

The Golden Exception Rule

Raw materials held for use in the production of inventories are NOT written down below cost if the
finished products in which they will be incorporated are expected to be sold at or above cost.
●​ Why? A company does not buy raw steel, flour, or fabric to resell them in their raw state. Their
utility comes from being processed into finished cars, bread, or clothing. Even if the global
market price of raw flour crashes, as long as the bakery can still sell its baked loaves of bread
at a profitable price that covers all costs, the raw flour has not lost its economic value to that
company.

When to write down Raw Materials?

We only write down raw materials when a decline in the price of materials indicates that the cost of
the finished product will exceed its Net Realizable Value. When this happens, raw materials are
written down to their NRV. For raw materials, Replacement Cost is generally considered the best
available measure of their NRV.

Problem:
Builders Hardware Mfg. produces steel doors. At year-end, they hold raw iron ore with a historical
cost of ₱600,000. The current market replacement cost of this raw iron ore has dropped to ₱480,000.
This iron ore will be used to manufacture 1,000 finished steel doors. The total additional cost required
to convert this iron ore into finished doors (direct labor and overhead) is ₱400,000, making the total
cost of finished goods ₱600,000+₱400,000=₱1,000,000.

Let us test two different market scenarios for the finished steel doors:

Scenario A: Finished Doors sell for ₱1,200 each (Total Selling Price = ₱1,200,000)
●​ Test the Finished Good: The expected revenue (₱1,200,000) is higher than the total
production cost (₱1,000,000). The finished product is profitable!
●​ Conclusion: DO NOT write down the raw materials. The raw iron ore remains on the
balance sheet at its historical cost of ₱600,000, completely ignoring the drop in replacement
cost.

Scenario B: Severe market recession drops door prices to ₱850 each (Total Selling Price =
₱850,000)
●​ Test the Finished Good: The expected revenue (₱850,000) is now lower than the total
production cost (₱1,000,000). The finished goods will be sold at a loss!
●​ Conclusion: Because the finished product will lose money, the raw iron ore must be written
down to its replacement cost of ₱480,000.
●​ Write-Down Computation:​
Loss = Historical Cost − Replacement Cost​
Loss = ₱600,000 − ₱480,000 = ₱120,000

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Reversal of Write-Downs
Economic conditions change. A fashion trend that died last year might suddenly revive, or global
supply shortages might drive selling prices back up.

The Reversal Rule

When the circumstances that previously caused inventory to be written down no longer exist, or when
there is clear evidence of an increase in NRV because of changed economic circumstances, the
amount of the write-down must be reversed.

The Ceiling Limit

The reversal is strictly limited to the amount of the original write-down. You can restore
inventory value back up to its original historical cost, but you can never value inventory above its
original historical cost.

Sample Problem: Write-Down Recovery

Scenario: Let us track Product Line B (Casual Shirts) from the Write-down of Finished Goods
Inventory sample problem over two years.

Apex Fashion Retailers has three distinct garment lines in their warehouse at year-end. The
accounting department gathered the following data:

Product Line Total Historical Cost Est. Selling Price Est. Selling Expenses
Line B (Casual Shirts) ₱280,000 ₱260,000 ₱20,000

Product Historical Calculated LCNRV Valuation Write-Down Loss

Line Cost NRV (Lower amount) Required
Line B ₱280,000 ₱240,000 ₱240,000 (₱40,000) (NRV is lower)

Year 1: Historical Cost = ₱280,000. NRV dropped to ₱240,000.​

We recorded a write-down loss of ₱40,000, bringing carrying value to ₱240,000.

Year 2, a viral social media campaign makes Casual Shirts extremely popular! The company
re-evaluates the remaining inventory at Year 2 end:
●​ New Estimated Selling Price: ₱330,000
●​ New Selling Expenses: ₱20,000
●​ New Calculated NRV: ₱330,000−₱20,000= ₱310,000

How much is the Reversal? Can we report the inventory at ₱310,000? No! Doing so would violate
the historical cost principle and recognize unearned profits.
●​ Maximum Permissible Valuation (Original Cost): ₱280,000
●​ Current Carrying Value (from Year 1): ₱240,000
●​ Allowable Reversal Gain: ₱280,000 − ₱240,000 = ₱40,000

Year 2 Journal Entry:

●​ Debit: Allowance for Inventory Write-Down (or Inventory) — ₱40,000
●​ Credit: Gain on Reversal of Inventory Write-Down (or deduction from COGS) — ₱40,000

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Purchase Commitments
In corporate manufacturing and retail, companies often sign binding, long-term contracts with
suppliers to buy a set quantity of raw materials at a guaranteed fixed price months in the future. This
is a Purchase Commitment.
●​ Why do companies do this? To lock in supply and protect themselves against inflation. If an
airline fears aviation fuel prices will skyrocket next year, they sign a contract today to buy 1
million liters at a fixed price of ₱40/liter.
●​ The Accounting Problem: What happens if market prices crash before the delivery date?

Onerous Contract Rule

Normally, executive contracts (where neither party has performed yet) are not recorded on the
balance sheet—we just disclose them in the notes. However, under Prudence/Conservatism and
the rules for onerous contracts (PAS 37 / PAS 2), if a purchase commitment is non-cancelable and
the market price falls below the agreed contract price, the contract has become a liability. We must
recognize the expected loss immediately in the period the price decline occurs, even though the
goods haven't even been shipped yet!

Sample Problem: Purchase Commitments

On October 1, 2026, TireMaster Inc. enters into a formally binding, non-cancelable contract to
purchase 20,000 kilos of raw rubber from a Brazilian supplier on March 1, 2027, at a fixed contract
price of ₱150 per kilo (Total Commitment = ₱3,000,000).

Let us trace the required accounting entries across year-end and delivery dates:

Step 1: Year-End Evaluation (December 31, 2026)

By December 31, 2026, a global surplus of rubber causes the open market replacement price to
plummet to ₱120 per kilo.
●​ Contract Price we are locked into: ₱150 / kilo
●​ Current Market Price: ₱120 / kilo
●​ Unavoidable Loss per kilo: ₱150−₱120= ₱30 per kilo
●​ Total Expected Loss: 20,000 kilos×₱30= ₱600,000

Dec 31, 2026 Journal Entry:

●​ Debit: Loss on Purchase Commitment (Income Statement expense) — ₱600,000
●​ Credit: Estimated Liability on Purchase Commitment (Current Liability) — ₱600,000

Step 2: Delivery Date Scenarios (March 1, 2027)

When March 1, 2027 arrives, TireMaster must pay the full ₱3,000,000 cash agreed in the contract
and receive the rubber. How we record the inventory depends on the market price on delivery day:

Scenario A: Market price stays at ₱120 per kilo

The inventory is brought onto our balance sheet at its true current market value (₱2,400,000), and our
previously estimated liability absorbs the ₱600,000 difference:
●​ Debit: Raw Materials Inventory (20,000×₱120) — ₱2,400,000
●​ Debit: Estimated Liability on Purchase Commitment — ₱600,000
●​ Credit: Cash (paying the fixed contract price) — ₱3,000,000

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Scenario B: Market price partially recovers to ₱135 per kilo by March 1

The rubber is worth more than we feared on Dec 31, but still less than our ₱150 contract price! True
inventory value today is 20,000×₱135=₱2,700,000. The actual loss is only ₱300,000. We reverse half
of our estimated liability as a recovery gain:
●​ Debit: Raw Materials Inventory (20,000×₱135) — ₱2,700,000
●​ Debit: Estimated Liability on Purchase Commitment (clearing full balance) — ₱600,000
●​ Credit: Cash — ₱3,000,000
●​ Credit: Gain on Recovery of Purchase Commitment — ₱300,000

Scenario C: Market price soars to ₱160 per kilo by March 1 (Above Contract Price)
The price has fully recovered. Our contract is no longer onerous, it's actually a bargain! We clear out
the entire estimated liability as a gain. But remember: we record the inventory at our cost of
₱150/kilo (₱3,000,000), never at the higher ₱160 market price!
●​ Debit: Raw Materials Inventory (20,000×₱150) — ₱3,000,000
●​ Debit: Estimated Liability on Purchase Commitment — ₱600,000
●​ Credit: Cash — ₱3,000,000
●​ Credit: Gain on Recovery of Purchase Commitment (capped at original ₱600k loss) —
₱600,000

(Presentation, Derecognition, and Disclosure Requirements)

Once an inventory item has been defined (D), recognized on the books (R), and valued under initial
and subsequent measurement rules (Me), the accountant must properly present it to the public (Pre),
know precisely when to remove it (De), and disclose all required secrets in the footnotes (Dis).

PRESENTATION (Pre): Where does Inventory sit in the Financial Statements?

Presentation governs how inventory is categorized and displayed on the face of the formal financial
statements. Under PAS 2 and PAS 1 (Presentation of Financial Statements), inventory impacts two
major statements:

A. On the Statement of Financial Position (Balance Sheet)

●​ Default Classification: Inventories are always presented as a CURRENT ASSET.
●​ The Operating Cycle Rule: Why is inventory always current? PAS 1 states that an asset is
current if it is expected to be realized, sold, or consumed during the entity's normal operating
cycle, even if that cycle is longer than 12 months!
●​ Corporate Reality: Consider a distillery like Emperador or a luxury winemaker aging vintage
wine in oak barrels for 3, 5, or even 10 years before selling it. Students often think, "That
takes longer than a year, so it must be a Non-Current Asset!" Wrong! Because aging is a
necessary part of their normal operating cycle, that 10-year-old wine remains classified as a
Current Asset on the balance sheet from day one until it is sold.

B. On the Statement of Comprehensive Income (Income Statement)

When inventory leaves the warehouse and is sold to a customer, its carrying value is immediately
transformed from an Asset into an Expense.
●​ Cost of Goods Sold (COGS): Recognized as an expense in the exact same period the
related sales revenue is recognized (The Matching Principle).​
Cost of Goods Sold = Beginning Inventory + Net Purchases - Ending Inventory
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●​ Write-Downs & Losses: Any write-down of inventory to Net Realizable Value (LCNRV) and all
losses of inventory (theft, spoilage, fire) must be presented as an expense in the period the
write-down or loss occurs.
●​ Reversals: If a write-down is reversed due to recovering market prices, the reversal is
presented as a deduction from Cost of Goods Sold (reducing total expenses) in the period
of recovery.

DERECOGNITION (De): Removing Inventory from the Books

Derecognition means officially erasing or removing an asset from the accounting records. You
cannot just delete an account; you must follow specific rules on why and how it left the company.

Under PAS 2, inventory is derecognized under four main corporate scenarios:

Scenario 1: Sale to a Customer
●​ The Rule: When inventories are sold and the control (risks and rewards of ownership)
transfers to the buyer, the carrying amount of the inventory is derecognized from the Balance
Sheet and recognized as Cost of Goods Sold on the Income Statement.

Scenario 2: Consumption in Self-Constructed Assets

●​ Rule: What if a company consumes its own inventory not to sell to a customer, but to build
another asset for its own use? The inventory is derecognized, but it is NOT charged to Cost
of Goods Sold or Expense. Instead, its cost is capitalized (added) into the carrying amount
of the new asset.
●​ Corporate Reality: Imagine DMCI Homes (a major construction and real estate firm). DMCI
holds millions of pesos worth of cement, steel bars, and hollow blocks in their "Inventory for
Resale." The executive board decides to take ₱5,000,000 worth of that steel and cement
inventory to build DMCI's own new corporate headquarters.
●​ The Journal Entry:
○​ Debit: Building Under Construction (Property, Plant, and Equipment — PAS 16) —
₱5,000,000
○​ Credit: Inventories (Raw Materials) — ₱5,000,000
○​ Takeaway: The inventory is derecognized, but the cost will be expensed slowly over the
next 30 or 40 years as Depreciation Expense on the building, NOT as COGS today!

Scenario 3: Abnormal Losses (Theft, Spoilage, Fire, Floods)

●​ Rule: If inventory is destroyed, stolen, or damaged beyond repair, it no longer holds any future
economic benefit. It must be derecognized immediately.
●​ Corporate Reality: A typhoon floods a warehouse of a retail clothing brand, destroying
₱1,200,000 worth of garments. The company derecognizes the inventory and records an
outright Loss on Inventory Casualty/Flood on the income statement. If they have insurance,
they record a separate receivable from the insurance company—they never offset the loss
directly against the insurance claim!

Scenario 4: Advertising or Promotional Samples

●​ Rule: When inventory is distributed for free to potential clients as marketing samples, it is
derecognized from Inventory and immediately charged to Advertising / Marketing Expense.

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DISCLOSURE REQUIREMENTS (Dis): Telling the Truth in the Footnotes

The financial statements tell the what and the how much, but the Notes to Financial Statements
(Disclosures) tell the why and the how. PAS 2 requires strict transparency so banks, investors, and
auditors understand the quality of a company's inventory.

An entity must disclose the following 7 core items in the footnotes:

Item Disclosure Requirement Why do Investors and Auditors care? (Corporate
Reality)
1 Accounting Policies & Cost The company must state if it uses FIFO, Weighted
Formulas Average, or Specific Identification. Investors need to
know this because switching formulas can artificially
inflate or deflate reported profits!
2 Total Carrying Amount & The company must break down total inventory into
Sub-classifications logical categories. For a manufacturing firm, they must
reveal the exact breakdown of Raw Materials, Work in
Process, Finished Goods, and Production Supplies.
3 Inventories carried at Fair Required if the company is an agricultural producer
Value Less Costs to Sell (PAS 41 harvest) or a commodity broker-trader whose
inventory is exempted from the standard LCNRV rule.
4 Amount Recognized as an The total cost of inventory consumed or sold during the
Expense (COGS) reporting period, which helps analysts calculate gross
profit margins and inventory turnover ratios.
5 Amount of any Write-Downs The total losses recognized during the year for
damaged, obsolete, or slow-moving inventory. A high
write-down number warns investors that management
is buying poor-quality stock or failing to predict
consumer trends.
6 Amount & Circumstances of If the company reversed a write-down and boosted its
Write-Down Reversals income, it must publicly explain the exact economic
events (e.g., "A surge in global demand for microchips")
that justified the recovery.
7 Inventories Pledged as Remember our earlier lesson on Pledge of Inventory /
Security (Collateral) Warehouse Financing? If a company uses its
inventory as collateral for a bank loan, it must disclose
the carrying amount pledged. Why? Because if the
company defaults on the loan, the bank has the legal
right to seize the warehouse! Shareholders have a right
to know if the inventory is mortgaged.

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T-Account Analysis

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