INTERMEDIATE ACCOUNTING 1
CHAPTER 8 - INVENTORIES
INVENTORIES
These are assets:
1. held for sale in the ordinary course of business (finished goods);
2. in the process of production for such sale (work in process);
3. materials or supplies to be consumed in the production process or in rendering
services (supplies).
EXAMPLES OF INVENTORIES BY NATURE OF BUSINESS
RETAILERS
Merchandise held for resale.
REAL ESTATE DEALERS / DEVELOPERS
Land and other properties held for resale
CLASSES OF INVENTORIES
Inventories are broadly classified into two:
1. INVENTORIES OF A “TRADING CONCERN”
These are goods bought and sold in the same purchased.
2. INVENTORIES OF A “MANUFACTURING CONCERN”
These are goods which are altered or converted into another form before they
are made available for sale.
The inventories of a manufacturing concern are:
a. FINISHED GOODS INVENTORIES
All goods that underwent the full process of manufacturing.
b. WORK IN PROCESS INVENTORIES
All goods that underwent the partial process of manufacturing and are
still be completed for further processing.
c. RAW MATERIALS INVENTORIES
All goods that are direct materials to be used in the manufacturing
process.
d. FACTORY OR MANUFACTURING SUPPLIES INVENTORIES
All goods that are indirect materials to be used in the manufacturing
process.
GOODS TO BE INCLUDED TO THE LINE ITEM ACCOUNT “INVENTORIES”
As a rule, all goods to which the entity has “title” shall be included in the
inventory, regardless of location.
PASSING OF TITLE
This is the legal language which means “the point in time at which ownership
changes”.
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LEGAL TEST
This is how we determine if we can include the inventories to our line item
account:
Question: Is the entity the owner of the goods regardless of location?
Answer 1: If yes, include in the inventory account.
Answer 2: If no, exclude in the inventory account.
EXCEPTION TO THE LEGAL TEST
INSTALLMENT SALE
This is a type of sale on a deferred payment basis.
Installment contracts “may provide” for retention of title by the seller until
the selling price is fully collected.
UNDER THE LEGAL TEST
The goods sold on installment basis are still the property of the seller and
therefore normally includible in the inventory account.
UNDER ACCEPTED ACCOUNTING PROCEDURES
In practice, it is acceptable to record the installment basis sale as a regular
sale on the part of the seller and as a regular purchase on the part of the
buyer.
ECONOMIC SUBSTANCE PREVAILING OVER LEGAL FORM
The goods sold on installment basis are included in the inventory of the buyer
and are excluded in the inventory of the seller.
FREIGHT TERMS AS TO WHO HAS THE OWNERSHIP OF INVENTORY DURING SHIPMENT
FREE ON BOARD (FOB) SHIPPING POINT
The owner of the inventory during the shipment is the “buyer”. The title passes
to the buyer upon shipment of the inventory.
The buyer shall be legally responsible for the freight. The buyer uses the account
title “Freight – in” to recognize the freight.
FREIGHT - IN ACCOUNT
This account shall be part of the cost of the inventory purchased.
FREE ON BOARD (FOB) DESTINATION
The owner of the inventory during the shipment is still the “seller”. The title
passes to the buyer upon receipt of such inventory.
The seller shall be legally responsible for the freight. The seller uses the
account title “Freight – out” to recognize the freight.
FREIGHT – OUT ACCOUNT
This account shall be part an “outright” expense of the seller.
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EXERCISE
On December 31, 2022, XYZ Company revealed the following account balances:
Inventory per books P 2,500,000
Accounts Payable P 800,000
Sales P 5,000,000
Accounts Receivable P 1,000,000
At the end of the year, the following transactions were to be examined:
a. Bought merchandise worth P 300,000 on account on December 16, 2022, FOB
Shipping Point, received and recorded by the company on January 2, 2023.
b. Bought merchandise worth P 200,000 on account on December 28, 2022, FOB
Shipping Point, received by the company on December 30, 2022. The company
recorded the transaction on January 3, 2023.
c. Bought merchandise worth P 150,000 on account on December 26, 2022. FOB
Destination. The merchandise was received and recorded on January 3, 2023.
d. Bought merchandise worth P 100,000 on account on December 24, 2022. FOB
Destination. The merchandise was received and recorded on January 3, 2023.
This transaction was recorded on December 24, 2022.
e. Sold merchandise on account with a sales price of P 400,000 costing P 300,000
on December 20, 2022, FOB Shipping Point. This transaction was recorded on
January 3, 2023.
f. Sold merchandise on account with a sale price of P 300,000 costing P 250,000,
FOB Destination. This transaction was recorded on December 30, 2022.
Required:
1. Compute the adjusted balances of the accounts on December 31, 2022.
2. Prepare the necessary adjusting journal entries.
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FREIGHT TERMS AS TO WHO “ACTUALLY” PAID THE FREIGHT
The term FOB Destination and Shipping Point determines the ownership of the
inventory and the party who is supposed to pay the freight.
FREIGHT COLLECT
Under this, the freight is still not yet paid. The common carrier shall collect
from the buyer the freight. Therefore, the freight charge was actually paid by
the buyer.
FREIGHT PREPAID
Under this the freight is already paid. The seller paid the freight to the common
carrier upon shipment of the inventory. Therefore, the freight charge was actually
paid by the seller.
EXERCISE:
Prepare the journal entries on the books of the seller.
1. An entity sold on account a merchandise worth P 100,000 term FOB Destination.
The customer paid freight charge of P 5,000.
Journal entry to record the sale:
Journal entry to record the collection:
2. An entity sold on account a merchandise worth P 100,000 term FOB Shipping
Point. The seller paid freight charge of P 5,000.
Journal entry to record the sale:
Journal entry to record the collection:
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MARITIME SHIPPING TERMS
FREE ALONGSIDE (FAS)
SHIPMENT OF INVENTOR FROM SELLER TO THE SHIPPING DOCK
The seller must bear all expenses and risk involved in delivering the goods to
the shipping dock. Therefore, the seller is still the owner of the inventory
during shipment from the seller’s warehouse to the shipping dock.
LOADING OF INVENTORY FROM SHIPPING DOCK TO THE SHIP
The buyer must bear the expenses of “loading” and “shipment”. Therefore, the
title passes to the buyer when the “carrier” takes possession of the goods.
COST, INSURANCE, AND FREIGHT (CIF)
Under this shipping contract, the buyer agrees to pay in a lumpsum the:
1. cost of the goods,
2. insurance cost, and
3. freight charge.
LOADING OF INVENTORY FROM SHIPPING DOCK TO THE SHIP
The seller must pay for the cost of loading. Thus, the title and risk of loss
shall pass to the buyer upon delivery of the goods to the carrier.
EX-SHIP
SHIPMENT OF INVENTOR FROM SELLER TO THE SHIPPING DOCK
The seller shall bear the expenses and risk of loss.
LOADING OF INVENTORY FROM SHIPPING DOCK TO THE SHIP
The seller shall bear the cost of loading.
UNLOADMENT OF INVENTORY FROM THE SHIP TO THE BUYER’S WAREHOUSE
When the goods are unloaded from the ship, the title and risk of loss shall pass
to the buyer. From this point, the buyer shall pay the freight.
EXERCISE 1
A seller sold merchandise worth P 300,000 term, FAS. The following costs were to
be paid by the seller and the buyer:
Freight charge from the seller’s warehouse
to the shipping dock P 5,000
Cost of Loading P 3,000
Cost of Unloading P 2,000
Freight charge after unloading to the
buyer’s warehouse P 7,000
Required: Prepare the journal entry on the books of the seller and the buyer.
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EXERCISE 2:
A seller sold merchandise worth P 300,000 term, FAS. The following costs were to
be paid by the seller and the buyer:
Total Freight Charge P 20,000
Insurance P 5,000
Cost of Loading P 15,000
Required: Prepare the journal entry on the books of the seller and the buyer.
EXERCISE 3
A seller sold merchandise worth P 300,000 term, Ex-ship. The following costs were
to be paid by the seller and the buyer:
Freight charge from the seller’s warehouse
to the shipping dock P 5,000
Cost of Loading P 3,000
Cost of Unloading P 2,000
Freight charge after unloading to the
buyer’s warehouse P 7,000
Required: Prepare the journal entry on the books of the seller and the buyer.
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CONSIGNED GOODS
CONSIGNMENT
This is a method of marketing and selling of goods in which the owner called the
consignor transfers physical possession of certain goods to an agent called
consignee who sells them on the owner’s behalf.
OWNERSHIP OF CONSIGNED GOODS
The consigned goods shall be included in the consignor’s inventory and excluded
from the consignee’s inventory.
FREIGHT AND HANDLING CHARGES INCURRED FROM THE COSIGNOR TO THE CONSIGNEE
Shall be part of the cost of goods consigned.
FREIGHT AND HANDLING CHARGES INCURRED TO RETURN THE CONSIGNED GOODS
Shall be an outright expense.
JOURNAL ENTRIES TO RECORD THE TRANSACTION RELATED TO THE CONSIGNMENT OF GOODS
TO RECORD THE SHIPMENT OF THE GOODS TO THE CONSIGNEE.
“No journal entry”. Memorandum entry is only done to record the transaction.
TO RECORD THE SALE OF THE CONSIGNEE AND REMITTANCE THEREOF
DEBIT CREDIT
Cash XX
Expenses XX
Sales XX
EXERCISE
XYZ Company shipped merchandise worth costing P 100,000. The consignee shall sell
the inventory for P 150,000 and is going to incur a P 10,000 commission and P 5,000
advertising expense.
Required:
1. Prepare the entry to record the shipment of the consigned goods.
2. Prepare the journal entry to record the sale and remittance of the consignee.
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STATEMENT PRESENTATION
The inventories shall be presented as one line item in the statement of financial
position but the details of the inventories shall be disclosed in the notes to
financial statements.
Inventories are generally classified as current assets.
ACCOUNTING FOR INVENTORIES
Two systems may be used in accounting for inventories:
1. PERIODIC SYSTEM
This system calls for the physical counting of goods on hand at the end of
the accounting period to determine the quantities.
This approach gives actual or physical inventories. This method is generally
used when the individual inventory items have small peso investment.
Stock cards are not required to be used in this system.
RELATIVE JOURNAL ENTRIES UNDER PERIODIC SYSTEM
a. Purchase of merchandise.
DEBIT CREDIT
PURCHASES XX
CASH/ACCOUNTS PAYABLE XX
b. Payment of freight.
DEBIT CREDIT
FREIGHT IN XX
CASH XX
c. Return of merchandise purchased.
DEBIT CREDIT
CASH/ACCOUNTS PAYABLE XX
PURCHASE RETURNS XX
d. Sale of merchandise.
DEBIT CREDIT
CASH/ACCOUNTS RECEIVABLE XX
SALES XX
e. Return of sold merchandise.
DEBIT CREDIT
SALES RETURNS XX
CASH/ACCOUNTS RECEIVABLE XX
f. Adjustment of ending inventory.
DEBIT CREDIT
MERCHANDISE INVENTORY – END XX
INCOME SUMMARY XX
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2. PERIODIC SYSTEM
This system calls requires the maintenance of records called stock cards that
usually offer a running summary of the inventory flow and outflow.
This approach gives book or perpetual inventories. This method is generally
used when the individual inventory items have large peso investment.
Also under this approach, a physical count of the units on hand should at
least be made once a year to confirm the balances appearing on the stock
cards.
RELATIVE JOURNAL ENTRIES UNDER PERIODIC SYSTEM
a. Purchase of merchandise.
DEBIT CREDIT
MERCHANDISE INVENTORY XX
CASH/ACCOUNTS PAYABLE XX
b. Payment of freight.
DEBIT CREDIT
MERCHANDISE INVENTORY XX
CASH XX
c. Return of merchandise purchased.
DEBIT CREDIT
CASH/ACCOUNTS PAYABLE XX
MERCHANDISE INVENTORY XX
d. Sale of merchandise.
DEBIT CREDIT
CASH/ACCOUNTS RECEIVABLE XX
SALES XX
DEBIT CREDIT
COST OF GOODS SOLD XX
MERCHANDISE INVENTORY XX
e. Return of sold merchandise.
DEBIT CREDIT
SALES RETURNS XX
CASH/ACCOUNTS RECEIVABLE XX
DEBIT CREDIT
MERCHANDISE INVENTORY XX
COST OF GOODS SOLD XX
f. Adjustment of ending inventory.
As a rule, the ending merchandise inventory is not adjusted. The balance
of the merchandise inventory account represents the ending inventory.
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T-ACCOUNT COMPOSITION OF MERCHANDISE INVENTORY ACCOUNT
FORMAL T-ACCOUNT:
MERCHANDISE INVENTORY
Beg. Balance XX Cost of Sales XX
Purchases XX Purchase Returns XX
Sales Ret. – good con. XX Purchase Discounts XX
End. Balance XX
MERCHANDISE INVENTORY ACCOUNT NORMAL BALANCE
This account has a normal balance of “debit balance”.
T-ACCOUNT FOR PROBLEM SOLVING PURPOSES:
MERCHANDISE INVENTORY
Beg. Balance XX End. Bal. XX
Purchases XX Cost of Sales XX
Sales Ret. – good con. XX Purchase Returns XX
Purchase Discounts XX
XX XX
EXERCISE
Summer Company is a wholesaler of car seatcovers. At the beginning of the current
year, the entity’s inventory consisted of 90 car seatcovers priced at P 1,000 each.
During the current year, the following events occurred:
1. Purchased 800 car seatcovers on account at P 1,000 each.
2. Returned 50 defective car seatcovers to supplier and received credit.
3. Paid 600 of the car seatcovers purchased.
4. Sold 790 car seatcovers at P 2,000 each.
5. Received 20 car seatcovers returned by a customer and gave credit. The goods
were in excellent condition.
6. Received cash for 680 of the car seatcovers sold.
7. Physical count at year-end revealed 60 units on hand.
Required:
1. Prepare the journal entries, including adjustments to record the above
transactions assuming the company uses periodic system and perpetual system.
2. Determine the cost of sales under each inventory system.
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INVENTORY SHORTAGE OR OVERAGE
This happens when the physical count of the inventory and the record per book does
not match, an adjustment is necessary to recognize the difference.
INVENTORY SHORTAGE
This happens when the physical count is less than the record per book.
DEBIT CREDIT
INVENTORY SHORTAGE XX
MERCHANDISE INVENTORY XX
INVENTORY OVERAGE
This happens when the physical count is more than the record per book.
DEBIT CREDIT
INVENTORY SHORTAGE XX
MERCHANDISE INVENTORY XX
REGULAR TREATMENT
This is usually closed to the cost of goods sold. This may have resulted from
“normal shrinkage and breakage” in inventory
OTHER TREATMENT
“Abnormal shrinkage, breakage, and material shortage” shall be separately
classified and presented as “other expense”.
TYPES OF DISCOUNTS
TRADE DISCOUNTS
These discounts are deductions from list or catalog price in order to arrive at
the invoice price. The purpose of this discount is to encourage trading or
increase sales.
Trade discounts are not recorded.
EXERCISE
On January 5, 2022, XYZ Company bought merchandise with a list price of P 500,000
less 20%, 15%, 10%.
Required:
1. Compute the invoice price.
2. Prepare the journal entry to record the above transaction.
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CASH DISCOUNTS
These are deductions from the invoice price when payment is made within the
discount period. The purpose of cash discount is to encourage prompt payment.
CASH DISCOUNTS ON THE BOOKS OF THE BUYER
This is recorded as “Purchase Discounts”
CASH DISCOUNTS ON THE BOOKS OF THE SELLER
This is recorded as “Sales Discounts”
EXERCISE
On January 5, 2022, XYZ Company bought on account merchandise with an invoice
price of P500,000 terms 3/10, n/30.
Required:
1. Prepare the journal entry to record the above transaction.
2. If the company paid within the discount period, compute the amount payable.
3. Prepare the journal entry to record item no. 2.
4. If the company paid beyond the discount period, compute the amount payable.
5. Prepare the journal entry to record item no. 4.
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METHODS OF RECORDING PURCHASES
1. GROSS METHOD
Purchases and accounts payable are recorded at gross.
PROBLEM
ABC Company bought an inventory with a list price of P 2,000,000 less 10% and
20%, with credit terms of 5/10, n/30.
Required:
1. Compute the invoice price.
2. Prepare the various journal entries below:
a. Purchases on account.
DEBIT CREDIT
b. Assume payment was made within the discount period.
DEBIT CREDIT
c. Assume payment was made beyond the discount period.
DEBIT CREDIT
2. NET METHOD
Purchases and accounts payable are recorded at net.
PROBLEM
ABC Company bought an inventory with a list price of P 2,000,000 less 10% and
20%, with credit terms of 5/10, n/30.
Required:
1. Compute the invoice price.
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2. Prepare the various journal entries below:
a. Purchases on account.
DEBIT CREDIT
b. Assume payment was made within the discount period.
DEBIT CREDIT
c. Assume payment was made beyond the discount period.
DEBIT CREDIT
d. Assume that it is the end of accounting period, no payment was made
and the discount period has expired.
DEBIT CREDIT
CAPITALIZABLE COSTS FOR INVENTORY
The cost of purchase shall comprise of:
1. Purchase price;
2. Import duties;
3. Irrecoverable taxes;
4. Freight;
5. Handling and other direct attributable costs.
COSTS THAT ARE EXPENSED AS INCURRED
The following costs shall be recognized as expense in the period these were
incurred:
1. Abnormal amounts of wasted materials, labor and overhead.
2. Storage costs, unless these costs are necessary in the “production process”
prior to further production stage.
Storage costs for “goods in process” are capitalized.
Storage costs for “finished goods” are expenses as incurred.
3. Administrative Overheads.
4. Distribution and Selling Costs.
~end~
~nothing follows~
Source:
Intermediate Accounting Volume 1, Valix, Peralta, Valix
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