FINANCIAL ACCOUNTING AND REPORTING

INVENTORIES (PAS 2)
Inventories  CIF (cost, insurance, and freight)
- Held for sale in the ordinary course of business ~ Buyer pays in lump sum the cost of the
(finished goods); goods and the insurance and freight
- In the process of production for such sale cost.
(work-in process);  CF (cost and freight)
- In the form of materials or supplies to be ~ Buyers pays in lump sum the cost of the
consumed in the production process or in the goods and the freight cost.
rendering of services (raw materials).  As a rule, the entity who owns the goods being
- RECOGNITION: Meets the definition of shipped should pay for the shipping cost.
inventory and qualify for recognition as assets,  Special accounting arises when the terms of the
such as when control over them. sale contract is either:
- PRESENTATION: Statement of Financial o FOB Shipping Point, Freight Prepaid 
Position under a single line item captioned buyer already owns the goods but the
“Inventories”; Classified as current asset seller already paid the shipping cost.
- MEASUREMENT: Lower of Cost and Net o FOB Destination, Freight Collect 
Realizable Value seller already owns the goods being
shipped but the carrier will be
GOODS IN TRANSIT collecting the shipping cost from the
Goods in Transit buyer.
- Goods that the seller has already shipped but
the buyer has not yet received. CONSIGNED GOODS
o FOB Shipping Point  Consignment
~ Ownership is transferred to ~ Arrangement wherein a consignor
the buyer upon shipment. delivers good to consignee who
~ Form part of buyer’s undertakes to sell the goods to end
inventories. customer on behalf of the consignor.
o FOB Destination  Consignor retains control over the consigned
~ Ownership is transferred to goods until they are sold to end customers.
the buyer when buyer  Consigned goods remains in the consignor’s
receives the goods. inventory.
~ Form part of seller’s  Transfer of consigned goods between consignor
inventories. and consignee are usually recorded through
memo entries.
FREIGHT  Freight and other incidental cost of transferring
 Freight Prepaid consigned goods to the consignee form part of
~ Seller pays the freight in advance the cost of the consigned goods.
before shipment.  Repair cost for damages during shipment and
 Freight Collect storage and other maintenance cost are
~ Freight is not yet paid upon shipment. charged as expense.
~ Carrier collects shipping cost from the  Consignee is entitled to a commission on the
buyer upon delivery. sale he makes.
 FAS (Free Alongside)  Expense  consignor
~ Seller assumes all expenses in  Income  consignee
delivering the goods to the dock next to
the carrier on which the goods are to be INVENTORY FINANCING AGREEMENT
shipped.  Product Financing Agreement
~ Buyer assumes loading and shipping ~ Seller sells inventory to a buyer but
costs. assumes an obligation to repurchase it
~ Title passes upon shipment to the to a later date.
carrier. ~ Does not result to transfer of control
 Ex-ship over the asset.
~ The seller assumes all expenses until ~ Seller retains ownership over the
the goods are unloaded from the inventory.
carrier, at which time title passes to the  Pledge of Inventory
buyer.
 FINANCIAL ACCOUNTING AND REPORTING
~ Borrower uses its inventory as a a. Reason for the bill-and-hold
collateral security for a loan. arrangement is substantive;
~ Does not result to a transfer of control b. Goods are identified separately
over the asset. as belonging to the customer;
~ Borrower retains ownership over the c. Goods are available for
inventory. immediate transfer to the
≈ Warehouse Financing customer; and
~ Third party holds the d. Seller cannot use the goods or
inventory and acts as a sell them to another customer.
creditor’s agent.
 Loan of Inventory LAY AWAY SALE
~ Entity borrows inventory from another  Lay Away Sale
entity to be replaced with the same kind ~ Type of sale which goods are delivered
of inventory. only when the buyer makes final
~ This result to a transfer of control over payment in a series of installment.
the asset. ~ Goods are included in the seller’s
~ Borrower includes the loaned goods in inventory until the goods are delivered
its inventory. to the buyer when he makes the final
installment payment.
SALE WITH UNUSUAL RIGHT OF RETURN
 Buyer normally recognizes goods purchased ACCOUNTING FOR INVENTORIES
under a sale with right of return at the time of  Inventories are accounted for either through:
sale, unless the goods purchased does not a. Perpetual Inventory System
qualify for recognition as asset. b. Periodic Inventory System
 Perpetual Inventory System
SALE ON TRIAL ~ Updated each time a purchase or sale is
 Sale on Trial made.
~ Seller allows a prospective customer to ~ Records called “stock cards” and “stock
use a good for a given period of time. ledger cards” are maintained under this
~ Legal title over the goods does not pass system, from which quantities and
to the prospective customer until he balances of goods on hand and goods
approves it and purchased it. sold can be determined at any given
~ Goods remains at the seller’s inventory point of time without the need of
during the trial period. performing a physical count of
inventories.
INSTALLMENT SALE ~ Physical count is performed only as an
 Installment Sale internal control to determine the
~ Possession of goods is transferred to accuracy of the balance per records.
the buyer but the seller retains legal ~ Commonly used for inventories that are
title solely to protect the collectability of specifically identifiable and are
the amount due is considered as a relatively high-valued.
regular sale.  Periodic Inventory System
~ Goods are excluded from the seller’s ~ Updated only when physical count is
inventory but included in the buyer’s performed.
inventory at the point of sale. ~ Entity does not maintain records that
shows the running balance if inventory
on hand and cost of goods sold as at
BILL AND HOLD ARRANGEMENT
any given point of time.
 Bill-and-Hold Arrangement
~ Format in Computing COGS:
~ Seller bills a customer but retains
Beginning Inventory xx
physical possession of the goods until it
Add: Net Purchase xx
is transferred to the customer at a
Total Goods Available for
future date. Sale xx
~ Goods are excluded from the seller’s Less: Ending Inventory
inventory and included in the buyer’s (Physic. Count) (xx)
inventory upon billing, provided: COST OF GOOD SOLD xx
 FINANCIAL ACCOUNTING AND REPORTING
~ Format in Computing Net Purchase: their present location and condition;
Purchases xx and
Add: Freight-in xx d. Storage cost; unless it is necessary in
Less: Purchase Return (xx) the production process before a further
Less: Purchase Discount (xx) production stage
NET PURCHASE xx
 Inventory shortage is charged to cost of good DISCOUNTS
sold if it is considered normal spoilage.  Trade Discounts
 If abnormal spoilage  charged to loss ~ Encourage orders in large quantities.
 INVENTORY ERRORS: ~ Deducted from the list price when
o Ending Inventory: Profit  Direct determining the invoice price.
o Ending Inventory: COGS  Inverse ~ Not recorded in the books of either the
o Beg. Inventory & Purchases: Profit  buyer or the seller.
Inverse  Cash Discounts
o Beg. Inventory & Purchases: COGS  ~ Given to encourage prompt payments.
Direct ~ Deducted from the invoice price when
o Contra-purchase Account is misstated determining the amount of net payment
 reverse of the effect of purchase required within the discount period.
account ~ Reflected in the books of the buyer and
o Adjunct-purchase Account is misstated seller.
 same as the effect of purchase  Accounting for Cash Discount:
account o Gross Method
~ Cost of inventory and accounts
COST payable are recorded gross of
 Purchase Cost cash discount.
~ Includes: o Net Method
a. Purchase price (net of trade ~ Cost of inventory and accounts
discount and other rebates) payable are initially recorded
b. Import duties net of cash discount, whether
c. Non-refundable or non- taken or not.
recoverable purchase taxes  Cash discount not taken reflect penalties added
d. Transport, handling and other to an established price to encourage prompt
cost directly attributable to the payments.
acquisition of inventory
~ Excludes: CONVERSION COST
a. Refundable or recoverable  Conversion Cost
taxes ~ Direct labor and manufacturing
~ Trade discount, rebates and other overhead that are necessary in
similar items are deducted in converting raw materials into finished
determining purchase cost. goods.
 Conversion Cost  Manufacturing Overhead
~ Cost necessary in converting raw ~ Cost that are not directly traceable to
materials into finished goods. the finished goods but are necessary in
~ Includes direct labor and production producing those goods.
overhead cost. ~ Sub-classified into:
 Other cost necessary in bringing the a. Variable Production Overhead
inventories to their present location and b. Fixed Production Overhead
condition.  Variable Production Overhead
 The following are excluded from the cost of ~ Indirect costs of production that vary
inventories and are expensed in the period in directly with the volume of production.
which they are incurred: ~ Allocated to each unit of production
a. Abnormal amount of wasted materials, based on the actual use of the
labor or other production costs; production facilities.
b. Selling costs;  Fixed Production Overhead
c. Administrative overhead that do not
contribute to bringing inventories to
 FINANCIAL ACCOUNTING AND REPORTING
~ Indirect cost of production that remains DEFERRED SETTLEMENT TERMS
relatively constant regardless of the  The difference between the purchase price for
volume of production. normal credit terms and the amount paid is
~ Allocated to the cost of conversion recognized as interest expense over the
based on the normal capacity of the period of the financing.
production facilities.
~ Actual Level of Production may be
COST FORMULAS
used if it approximates normal capacity.
 Specific Identification
~ Amount of fixed overhead is allocated
~ Used for inventories that are not
to each unit of production is not
ordinarily interchangeable and
increased as a consequence of low
segregated for specific projects.
production or idle plant.
~ Specific cost are attributed to identify
~ Unallocated overhead are recognized
items of inventory.
as expense in the period in which they
~ Cost of Sales  represents the actual
are incurred.
cost of specific item sold
~ Ending inventory  actual cost of
ABSORPTION AND VARIABLE COSTING
specific item on hand
 Absorption Costing ~ Not practicable when inventories
~ Costing method in which both the fixed consist large number of items that are
and variable production overhead are ordinarily interchangeable.
included in the cost of inventories.  First-In, First-Out (FIFO)
 Variable Costing ~ Assumes that inventories that were
~ Costing method in which only variable purchased or produced first are sold
production overhead is included in the fist, and therefore unsold inventories at
cost of inventories. the end of the period are those most
 PAS 2 requires the use of absorption costing. recently purchased or produced.
 Variable costing is used only for internal ~ Cost of Sales  cost from earlier
reporting purposes. purchases
~ Ending Inventory  cost from most
JOINT AND BY-PRODUCTS recent purchase
 Conversion cost of each product are not  Weighted Average
separately identifiable  allocated between the ~ Cost of Sales and Ending Inventory are
products on a rational and consistent basis determined based on the weighted
 Most by-products, by their nature, are average cost of beginning inventory and
immaterial. They are often measured at net all inventories purchased or produced
realizable value and this value is deducted during the period.
from the cost of the main product. TGAS in Pesos
~
TGAS in Units
STANDARD COST SYSTEM
NET REALIZABLE VALUE
 Standard Cost
~ Budgeted inventory unit cost  Net Realizable Value
established to motivate optimal ~ Estimated selling price in the ordinary
productivity and efficiency. course of business less the estimated
 Standard Cost System cost of completion and the estimated
~ Designed to alert management when cost necessary to make the sale.
the actual costs of production differ ~ Net amount that an entity expects to
significantly from target or standard realize from the sale of inventory in the
cost. ordinary course of business.

BORROWING COST WRITE-DOWN OF INVENTORY

 It form part only of the cost of inventory only if  Inventory is written down if cost exceeds NRV.
it is incurred on the borrowing taken to  The excess of cost is recognize as expense,
finance the acquisition or production of usually as COGS.
inventory that meets the definition of  Raw materials inventory is not written down
qualifying asset. below cost if the finished goods in which they
 FINANCIAL ACCOUNTING AND REPORTING
will be incorporated are expected to be sold at a. Based on Sales  GP / Net
or above cost. Sales
 A previous write-down is reversed if the NRV b. Based on COGS  GP / COGS
subsequently increase. However, the amount of
reversal shall not exceed the previous write- RETAIL METHOD
down.  The retail method is used in retail industry for
measuring large quantities of inventories with
PURCHASE COMMITMENTS rapidly changing items and with similar margins
 Purchase Commitment and for which it is impracticable to use other
~ Agreement with an unrelated party, costing method.
binding on both parties and usually  Cost ratio is computed directly without regard
legally enforceable, that: to the gross profit rate.
a. Specifies all significant terms,  Net mark-up and net mark-down are
including the price and timing of considered.
the transactions, and  Applied using either:
b. Includes a disincentives for a. Average Cost Method
non-performance that is  TGAS at Cost divided TGAS at
sufficiently large to make Sales Price  cost ratio
performance highly probable.  Cost ratio x Net Sales  COGS
 End Inventory @ Retail x Cost
INVENTORY ESTIMATION Ratio  End Inventory @ Cost
 Inventory estimation is made only for interim  TGAS @ Sales Price
reporting. → (+) Net Markup
 It may be estimated using: → (-) Net Mark-down
a. Gross Profit Method  PAS 2 requires that cost ratio to
b. Retail Method be used in estimating inventory
under retail method should be
GROSS PROFIT METHOD marked down below its
original retail price.
 In this method, gross profit is assumed to be
b. FIFO Cost Method
relatively constant from period to period.
 Gross Profit Rate
~ Used to determine the cost ratio which
in turn is used to estimate the inventory
and the cost of good sold.
~ Can be expressed as a percentage:

T-ACCOUNTS FOR INVENTORIES

A. Inventories
Inventory
Beg. xx
Net Purchase xx xx Cost of Good Sold
Freight-in xx
xx End.
B. Accounts of a Manufacturing Entity
Accounts Payable Raw Materials
xx Beg. Beg. xx
Net
Net Purchase xx
xx Purchase
Payment to Freight-in xx Raw
Suppliers xx materials
xx issued to
production
End. xx xx End.
FINANCIAL ACCOUNTING AND REPORTING
Work-in Process Finished Goods
Beg. xx Beg. xx
xx COGM COGM xx xx COGS
Raw
materials xx
issued to
production

Direct
Labor xx

Production
Overhead xx
xx End. xx End.

Total Total
Goods put Goods
into xx xx Available xx xx
Process for Sale