INVENTORIES

ACA 326/AMA 326

 Inventories are assets that are:
a. Held for sale in the ordinary course of
business (Finished Goods);
b. In the process of production for such
sale (Work In Process); or
Inventories
c. In the form of materials or supplies to
be consumed in the production process
or in the rendering of services (Raw
materials and manufacturing supplies).
 ▪ Inventories are recognized when they
meet the definition of inventory and they
qualify for recognition as assets, such as
when legal title is obtained by the buyer
from the seller.
▪ Legal title normally passes when
Recognition possession over of the goods is
transferred.
▪ However, there may be cases where the
transfer of control (ownership) does not
coincide with the transfer of physical
possession.
 ▪ FOB Shipping Point - ownership over the
goods is transferred upon shipment.
Therefore, the goods in transit form part
of the buyer’s inventories.

Goods in transit ▪ FOB Destination - ownership over the

goods is transferred only when the goods
are received by the buyer. Therefore, the
goods in transit still form part of the
seller’s inventories.
 ▪ Consigned goods are included in the
consignor’s inventory.
▪ The consignee records the consigned
goods received through memo entry only.
▪ Freight and other incidental costs of
Consigned transferring consigned goods to the
goods consignee form part of the cost of the
consigned goods. Repair costs for
damages during shipment and storage
and other maintenance costs are charged
as expense.
 ▪ Ownership is normally not transferred when
inventories are used as collateral security for a loan.
Inventory held or Therefore, the inventory remains in the borrower’s
sold under (pledgor’s) inventory.

financing
agreements
 A seller is not precluded from transferring ownership
over an inventory sold in an installment sale where
possession is transferred to the customer but the seller
retains legal title solely to protect the collectability of the
Retention of amount of consideration.
legal title under
installment sale In such case, the inventory is excluded from the seller’s
inventory and included in the buyer’s inventory.
 ▪ A bill-and-hold arrangement is a contract (of sale) under
which the seller bills the buyer for goods sold but the
seller retains physical possession until the goods are
transferred to the buyer at a future date.
▪ The goods sold under a bill and hold sale are excluded
from the seller’s inventory and included in the buyer’s
inventory at the time of sale when title passes to the
buyer and he accepts billing, provided:

Bill & hold a. the reason for the bill-and-hold arrangement must
be substantive (for example, the buyer has
arrangement requested the arrangement);
b. the product must be identified separately as
belonging to the buyer;
c. the product currently must be ready for physical
transfer to the buyer; and
d. the seller does not have the ability to use the
goods or to direct them to another customer.
 ▪ Lay away sale is a type of sale in which goods are
delivered only when the buyer makes the final payment
in a series of installments. This is different from a
regular installment sale wherein goods are delivered to
the buyer at the time of sale.

▪ The goods sold under a lay away sale are included in

Lay away sale the seller’s inventory until the goods are delivered to
the buyer. Delivery is made after the final installment
payment is paid. However, when significant payments
have already been made, the goods may be included in
the buyer’s inventory, provided delivery is probable.
 ▪ All items that meet the definition of
inventory are presented on the statement
Financial of financial position as one line item
under the caption “Inventories.” The
statement breakdown (as finished goods, WIP and
presentation Raw materials) is disclosed in the notes.
 1. Perpetual inventory system – All transactions
involving the acquisition, purchase returns,
incurrence of freight-in, sales and sales returns are
recorded in the “Inventory” account (real account)
and the “Cost of sales” account, as appropriate.
Inventory 2. Periodic inventory system – Uses the “Purchases,”
systems “Purchase returns,” and “Freight-in” accounts
(nominal accounts). Cost of sales is determined only
after a physical count is performed.
 ▪ Under the periodic inventory system, cost of sales is
determined using the following formula:

Beg. Inventory xx
Inventory Add: Net purchases xx
systems - Total goods available for sale xx
Less: End. Inventory (Physical count) (xx)
continuation Cost of sales xx
 ▪ Ending inventory : Profit ------ Direct relationship

Inventory errors
➢ If ending inventory is overstated, Profit is also
under the overstated.
periodic system
 ▪ Inventories are measured at the lower of cost and net
realizable value (NRV).

▪ The cost of inventories comprises all costs of purchase,

costs of conversion and other costs incurred in
Measurement bringing the inventories to their present location and
condition.
▪ Net realizable value (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.
 1. Abnormal amounts of wasted materials, labor or
other production costs.
2. Selling costs, for example, advertising and promotion
costs and delivery expense or freight out.
Costs that are 3. Administrative overheads that do not contribute to
EXPENSED bringing inventories to their present location and
condition.
when incurred 4. Storage costs, unless those costs are necessary in the
production process before a further production stage.
Recording the ▪ Trade discounts and Cash discounts
acquisition of ▪ Gross method vs. Net method
inventory
 ▪ The cost of different inventories
Cost of inventories having different values purchased
purchased in lump on a lump sum basis is allocated to
sum such inventories using their
relative sales prices.
 1. Specific identification - is used for inventories that
are not ordinarily interchangeable (i.e., inventories
that are unique). Cost of sales is the cost of the
specific inventory that was sold.
2. FIFO – cost of sales is based on the cost of
Cost Formulas inventories that were purchased first. Consequently,
ending inventory represents the cost of the latest
purchases.

3. Weighted Average Cost – cost of sales is based on

the average cost of all inventories purchased during
the period.
➢ Wtd. Ave. Cost = (TGAS in pesos ÷ TGAS in units)
 ▪ Inventories are usually written down to
net realizable value on an item by item
basis.

Write down of ▪ If the cost of an inventory exceeds its NRV,

inventories the inventory is written down to NRV, the
lower amount. The excess of cost over
NRV represents the amount of write-
down.
 ▪ The amount of reversal to be
recognized should not exceed the
Reversal of amount of the original write-down
write-downs previously recognized.
 Accounts payable Inventory
xx beg. beg. xx
The Inventory T- Payments xx xx Net purchases Net purchases xx xx COGS
account end. xx xx end.
 1. Gross profit method
a. GPR based on sales
b. GPR based on cost
Inventory
estimation 2. Retail method
a. Average cost method
b. FIFO cost method
GROSS PROFIT
METHOD ➢ Gross profit rate based on sales is computed by
dividing gross profit by the net sales.
➢ Gross profit rate based on cost is computed by
dividing gross profit by the cost of goods sold.
 ▪ GPR based on sales
Example: GPR based on sales is 25%.

Cost ratio = (100% - 25%) = 75%

COST RATIO ▪ GPR based on cost

Example: GPR based on cost is 25%.

Cost ratio = (100% ÷ 125%) = 80%

 RETAIL METHOD

▪ The cost ratio is computed directly

without regard to the gross profit rate,
unlike in gross profit method.
COST RATIO ▪ Net mark-ups and net mark-downs are
considered.
 ▪ Net markups (markups less markup cancellations) are net
DEFINITION OFtheTERMS
increases above original retail price, which are generally
caused by changes in supply and demand.
▪ Markup refers to increase above the original retail price.
▪ Original retail price refers to the selling price at which the
goods are first offered for sale.

Important ▪ Markup cancellation refers to decrease in selling price that

does not reduce the selling price below the original retail
Terms price.
▪ Net markdowns (markdowns less markdown cancellations) are
net decreases below the original retail price.
▪ Mark-down refers to the decrease below the original retail
price.
▪ Markdown cancellation refers to increase in selling price that
does not raise the selling price above the original retail price.
 APPLICATIONS OF THE RETAIL METHOD

1. Average cost method

2. FIFO cost method

THANK
YOU!!!