INTERMEDIATE ACCOUNTING I

INVENTORY
Inventories
Objectives:
To define inventories.
To identify the major classes of inventory.
To account for inventory transactions using periodic and perpetual inventory
system.
To know the gross method and net method of recording purchases.
To identify the items included in inventory cost.
Inventories
Inventories are assets held for sale in the ordinary course of business, in the process
of production for such sale or in the form of materials or supplies to be consumed in
the production process or in the rendering of services.
Inventories encompass goods purchased and held for resale, for example:
a. Merchandise purchased by a retailer and held for resale.
b. Land and other property held for resale by a subdivision entity and real estate
developer.
They also encompass finished goods produced, goods in process and materials and
supplies awaiting use in the production process.
Classes of Inventories
1. Inventories of a trading concern
 one that buys and sells goods in the same form purchased
“Merchandise Inventory” is the term generally applied to goods held by a trading
concern.
2. Inventories of manufacturing concern
 one that buys goods which are altered or converted into another form before they
are made available for sale
Finished goods, goods in process, raw materials and factory or manufacturing
supplies
Inventories are generally classified as current assets. It 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 of a Manufacturing Concern
1. Finished Goods
completed products which are ready for sale
have been assigned their full share of manufacturing costs
2. Goods in Process (Work in Process)
partially completed products which require further process or work before they can be sold
3. Raw Materials
goods that are to be used in the production process
4. Factory or Manufacturing Supplies
 similar to raw materials but their relationship to the end product is indirect
may be referred to as “Indirect Materials” because they are not physically incorporated in
the products being manufactured
these supplies find their way into the product cost as part of the manufacturing overhead
Goods Includible in the Inventory
RULE: all goods to which the entity has title shall be included in the inventory, regardless
of the location.
”PASSING OF TITLE” – a phrase that is a legal language which means “the point of time at
which ownership changes”.
Legal Test:
Is the entity the owner of the goods to be inventoried?
If the answer is:
 affirmative, the goods shall be included in the inventory.
negative, the goods shall be excluded in the inventory.
Goods Includible in the Inventory
Applying the legal test, the following items are includible in inventory:
a. Goods owned and on hand
b. Goods in transit and sold FOB destination
c. Goods in transit and purchased FOB shipping point
d. Goods out on consignment
e. Goods in the hands of salesman or agents
f. Goods held by customers on approval or on trial
Who is the owner of goods in transit?
FOB – free on board
1. FOB destination
ownership of goods purchased is transferred only upon receipt of goods by the buyer at the point
of destination
thus, the goods in transit are still the property of the seller
 accordingly, the seller shall legally be responsible for freight charges and other expenses up to
the point of destination
2. FOB shipping point
 ownership is transferred upon shipment of the goods
 therefore, the goods in transit are the property of the buyer
accordingly, the buyer shall legally be responsible for freight charges and other expenses from
the point of shipment to the point of destination
Freight Terms
1. Freight collect
 freight charge on the goods shipped is not yet paid
common carrier shall collect the same from the buyer
 thus, the freight charge is actually paid by the buyer
2. Freight prepaid
 freight charge on the goods shipped is already paid by the seller
Freight Terms
Maritime Shipping Terms
1. FAS or Free alongside
A seller who ships FAS must bear all expenses and risks involved in delivering the goods to the
dock next to or alongside the vessel on which the goods are to be shipped.
The buyer bears the cost of loading and shipment and thus, title passes to the buyer when the
carrier takes possession of the goods.
2. CIF or Cost, insurance and freight
The buyer agrees to pay in a lump sum the cost of the goods, insurance and freight charge.
The shipping contract may be modified as CF which means that the buyer agrees to pay in lump
sum the cost of the goods and freight charge only.
The seller must pay for the cost of loading. Thus, title and risk of loss shall pass to the buyer upon
delivery of the goods to the carrier.
3. Ex-ship
A seller who delivers the goods ex-ship bears all expenses and risk of loss until the goods are
unloaded at which time title and risk of loss shall pass to the buyer.
Consigned Goods
A consignment is a method of marketing goods in which the owner called the consignor transfers
physical possession of certain goods to an agent called the consignee who sells them on the owner’s
behalf.
Consigned goods shall be included in the consignor’s inventory and excluded from the consignee’s
inventory.
Freight and other handling charges on goods out of consignment are part of the cost of goods
consigned.
When consigned goods are sold by the consignee, a report is made to the consignor together with
a cash remittance for the amount of sales minus commission and other expenses chargeable to the
consignor.
Exception to the Legal Test
Installment contracts may provide for retention of title by the seller until the selling price is fully
collected.
Following the legal test, the goods sold on installment basis are still the property of the seller and
therefore normally includible in his inventory.
However, in such a case, it is an accepted accounting procedure to record the installment sale as a
regular sale on the part of the seller and as a regular purchase on the part of the buyer.
Thus, the goods sold on installment are included in the inventory of the buyer and excluded from
that of the seller, the legal test to the contrary notwithstanding.
This is a clear example of economic substance prevailing over legal form.
Accounting for Inventories
1. Periodic System
 calls for the physical counting of goods on hand at the end of the accounting period to
determine quantities
The quantities are then multiplied by the corresponding unit costs to get the inventory value
for balance sheet purposes.
This approach gives actual or physical inventories.
This procedure is generally used when the individual inventory items have small peso
investment.
Accounting for Inventories
2. Perpetual System
requires the maintenance of records called stock cards that usually offer a running summary
of the inventory inflow and outflow
Inventory increases and decreases are reflected in the stock cards and the resulting balance
represents the inventory.
This approach gives book or perpetual inventories.
This procedure is commonly used where the inventory items treated individually represent a
relatively large peso investment
When used, 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.
Illustration
Inventory Shortage or Overage
If at the end of the accounting period, a physical count indicates a different amount, an
adjustment is necessary to recognize any inventory shortage of overage.
The inventory shortage is usually closed to cost of goods sold because this is often the result
of normal shrinkage and breakage in inventory.
However, abnormal and material shortage shall be separately classified and presented as
other expense.
Trade Discounts and Cash Discounts
1. Trade discounts
 deductions from the list or catalog price in order to arrive at the invoice price which is the amount
actually charged to the buyer
thus, not recorded
its purpose is to encourage trading or increase sales
also suggest to the buyer the price at which the goods may be resold

2. Cash discounts
deductions from the invoice price when payment is made within the discount period
 its purpose is to encourage prompt payment
recorded as purchase discount by the buyer and sales discount by the seller
 Purchase discount is deducted from the purchases to arrive at net purchases.
 Sales discount is deducted from sales to arrive at net sales revenue.
Methods of Recording Purchases
1. Gross method
 purchases and accounts payable are recorded at gross
in practice, most entities record purchases at gross invoice amount
technically, this violates the matching principle because discounts are recorded only when taken or when
cash is paid rather than when purchases that give rise to the discounts are made
this procedure does not allocate discounts taken between goods sold and goods on hand
 despite theoretical shortcomings, this is supported on practical grounds
 more convenient than the net method from a bookkeeping standpoint
if applied consistently over time, it usually produces no material errors in the financial statements
2. Net method
purchases and accounts payable are recorded at net
cost measured represents the cash equivalent price on the date of payment and therefore the theoretically
correct historical cost
Cost of Inventories
1. Cost of Purchase
comprises the purchase price, import duties and irrecoverable taxes, freight, handling and other
costs directly attributable to the acquisition of finished goods, materials and services
trade discounts, rebates and other similar items are deducted
shall not include foreign exchange differences which arise directly from the recent acquisition of
inventories involving a foreign currency
 when inventories are purchased with deferred settlement terms, the difference between the
purchase price for normal credit terms and the amount paid is recognized as interest expense over
the period of financing
Cost of Inventories
2. Cost of Conversion
includes cost directly related to the units of production such as direct labor
also includes a systematic allocation of fixed and variable production overhead that is
incurred in converting materials into finished goods.

a. Fixed production overhead – the indirect cost of production that remains relatively
constant regardless of the volume of production.
EXAMPLES: depreciation and maintenance of factory building and equipment, and
administration.
b. Variable production overhead – the indirect cost of production that varies directly with the
volume of production.
EXAMPLES: indirect labor and indirect materials.
Cost of Inventories
Other Costs
Included in the cost of inventories only to the extent that it is incurred in bringing the
inventories to their present location and condition
 For example, it may be appropriate to include the cost of designing product for specific
customers in the cost of inventories.
However, the following costs are excluded from the cost of inventories and recognized as
expenses in the period when incurred:
a. Abnormal amounts of wasted materials, labor and other production costs.
b. Storage costs, unless these costs are necessary in the production process prior to a further
production stage. Thus, storage costs on goods in process are capitalized but storage costs on
finished goods are expensed.
c. Administrative overheads that do not contribute to bringing inventories to their present location
and condition.
d. Distribution or selling costs
Cost of Inventory of a Service Provider
Consists primarily of the:
a. Labor and other costs of personnel directly engaged in providing the service, including
supervisory personnel
b. Directly attributable overhead

Labor and other costs relating to sales and general administrative personnel are not included
but are recognized as expenses in the period in which they are incurred.
Reference
Valix, C.T, Peralta, J.F.,Valix, CA M. (2022). Intermediate Accounting 2022
Edition. Philippines: GIC Enterprises & Co., Inc.