MODULE 4 INVENTORY

LEARNING OBJECTIVES:
1. Identify major classifications of inventory.
2. Distinguish between perpetual and periodic inventory systems.
3. Understand the items to include as inventory cost.
4. Describe and apply the lower-of-cost-or-net realizable value rule.
5. Explain when companies use the relative sales value method to value inventories.
6. Determine ending inventory by applying the gross profit method.
7. Determine ending inventory by applying the retail inventory method.
8. Explain how to report and analyze inventory.

OVERVIEW
PAS 2 Inventories contains the requirements on how to account for most types of inventory. The
standard requires inventories to be measured at the lower of cost and net realizable value
(NRV) and outlines acceptable methods of determining cost, including specific identification (in
some cases), first-in first-out (FIFO) and weighted average cost.

 
Acquiring new knowledge
Asynchronous - links to more information: www.farhatlectures.com
A synchronous discussion for this lesson will be scheduled on AUGUST 25, 2020 (Tuesday
7:30 – 8:30 AM)

Inventories are:
• items held for sale, or
• goods to be used in the production of goods to be sold.

INITIAL VALUATION
Costs – includes cash acquisition price and costs directly connected with bringing the
goods to the buyer’s place of business and converting such goods to a salable condition.

Classification
Four accounts
• Raw materials
• Work in process
• Finished goods
• Mfg. supplies

ACCOUNTING FOR INVENTORIES

Perpetual System
1. Purchases of merchandise are debited to Inventory.
2. Freight-in is debited to Inventory. Purchase returns and allowances and purchase
discounts are credited to Inventory.
3. Cost of goods sold is debited and Inventory is credited for each sale.
4. Subsidiary records show quantity and cost of each type of inventory on hand.

The perpetual inventory system provides a continuous record of Inventory and

Cost of Goods Sold.
Periodic System
1. Purchases of merchandise are debited to Purchases.
2. Ending Inventory determined by physical count.
3. Calculation of Cost of Goods Sold:
Beginning inventory XX
Purchases, net XX
Goods available for sale XX
Ending inventory XX
Cost of goods sold XX

Inventory Control
All companies need periodic verification of the inventory records by actual count, weight, or
measurement, with the counts compared with the detailed inventory records.
Companies should take the physical inventory near the end of their fiscal year, to properly report
inventory quantities in their annual accounting reports.

Valuation requires determining

• The physical goods (goods on hand, goods in transit, consigned goods, special sales
agreements).
• The costs to include (product costs).
• The cost flow assumption (specific Identification, average cost, FIFO, retail, etc.).

Goods Included in Inventory

A company should record purchases when it obtains legal title to the goods.
Subsequent Valuation of Inventory

Net Realizable Value

Estimated selling price in the normal course of business less estimated costs to complete and
estimated costs to make a sale.

Use of an Allowance
Instead of crediting the Inventory account for net realizable value adjustments, companies
generally use an allowance account.

Loss due to decline to NRV xx

Allowance to reduce inventory to NRV xx

Recovery of Inventory Loss

• Amount of write-down is reversed.
• Reversal limited to amount of original write-down.

Assume the net realizable value increases. Entity makes the following entry, using the loss
method.
Allowance to reduce inventory to NRV xx
Recovery of inventory loss xx

Inventory Estimates

Gross Profit Method

(1) Provides an estimate of ending inventory.
(2) Uses past percentages in calculation.
(3) A blanket gross profit rate may not be representative.
(4) Normally unacceptable for financial reporting purposes. IFRS requires a physical
inventory as additional verification.

Retail Inventory Method

A method used by retailers, to value inventory without a physical count, by converting retail
prices to cost.

Requires retailers to keep:

(1) Total cost and retail value of goods purchased.
(2) Total cost and retail value of the goods available for sale.
(3) Sales for the period.

Special Items
• Freight costs
• Purchase returns
• Purchase discounts and allowances
• Transfers-in
• Normal spoilage
• Abnormal shortages
• Employee discounts
Examples of retail inventory method

Purchase commitments
A firm Purchase commitment is “an agreement with an unrelated party, binding on both parties
and usually legally enforceable, that
a. Specifies all significant terms, including the price and timing of the transactions, and
b. Includes a disincentive for non-performance that is sufficiently large to make
performance highly probable.” (PFRS 5. Appendix)

A contracting party under a firm purchase commitment cannot cancel the contract without
suffering penalty. Thus, the buyer has to accept future delivery even if the goods promised to
be purchased become impaired. In such a case the buyer recognizes loss on purchase
commitment.
When prices subsequently increase, the buyer recognizes gain on purchase commitment,
however the gain should not exceed the loss previously recognized.

Analysis of Inventories
Common ratios used in the management and evaluation of inventory levels are inventory
turnover and average days to sell the inventory.

Inventory Turnover Ratio

Measures the number of times on average a company sells the inventory during the period.

Illustration: In its 2020 annual report Tate & Lyle reported a beginning inventory of 562 million,
an ending inventory of 538 million, and cost of goods sold of 2,019 million for the year.

Average Days to Sell Inventory

Measure represents the average number of days’ sales for which a company has inventory on
hand.

Average Days to Sell

365 days / 3.67 times = every 99.5 days

Disclosures:
Accounting standards require disclosure of:
(1) Accounting policies adopted in measuring inventories, including the cost formula used
(weighted-average, FIFO).
(2) Total carrying amount of inventories and the carrying amount in classifications
(merchandise, production supplies, raw materials, work in progress, and finished goods).
(3) Carrying amount of inventories carried at fair value less costs to sell.
(4) Amount of inventories recognized as an expense during the period.
(5) Amount of any write-down of inventories recognized as an expense in the period and the
amount of any reversal of write-downs recognized as a reduction of expense in the
period.
(6) Circumstances or events that led to the reversal of a write-down of inventories.
(7) Carrying amount of inventories pledged as security for liabilities, if any.
 MODULE 4 Post-test
PRACTICAL ACCOUNTING 1 – REVIEW
INVENTORY

PROF. U.C. VALLADOLID

Multiple Choice
Identify the choice that best completes the statement or answers the question.
All answers shall be submitted on or before AUGUST 28, 2020 (Friday)

1. Mamshie Company included the following items in inventory:

Materials 1,400,000
Advance for materials ordered 200,000 other receivables
Goods in process 650,000
Unexpired insurance on inventory 60,000
Advertising catalogs and shipping cartons 150,000
Finished goods in factory 2,000,000
Finished goods in entity-owned retail store,
Including 50% profit on cost 750,000 (750/150%)500k
Finished goods in hands of consignees
including 40% profit on sales240k included 400,000 (400x60%)
Finished goods out on approval at cost 250,000
Unsalable finished goods, at cost 100,000
Office supplies 40,000
Materials in transit, shipped FOB shipping point
Excluding freight of P30,000included 360k 330,000
Goods held on consignment, at sales price cost P150,000 200,000

What is the correct amount of inventory?

a. 5,375,000 b. 5,500,000 c. 5,540,000 d. 5,250,000

2. Papa Koo Company provided the following data:

Items counted in the bodega 4,000,000
Items included in the count specifically segregated
per sale contract 100,000
Items in receiving department, returned by customer,
in good condition 50,000
Items ordered and in the receiving department 400,000
Items ordered, invoice received but goods not
received. Freight is on account of seller 300,000
Items shipped today, invoice mailed, FOB shipping point 250,000
Items shipped today, invoice mailed, FOB destination 150,000
Items currently being used for window display 200,000
Items on counter for sale 800,000
Items on receiving department, refused because of damage 180,000
Items included in count, damaged and unsalable 50,000
Items in the shipping department 250,000

What is the correct amount of inventory?

a. 5,700,000 b. 6,000,000 c. 5,800,000 d. 5,150,000
3. In connection with your audit of the Angel Manufacturing Company, you reviewed its inventory as of December 31,
2019 and found the following items:

(a) A packing case containing a product costing 100,000 was standing in the shipping room when the physical
inventory was taken. It was not included in the inventory because it was marked “Hold for shipping instructions.” The
customer’s order was dated December 18, but the case was shipped and the customer billed on January 10, 2020.

(b) Merchandise costing 600,000 was received on December 28, 2019, and the invoice was recorded. The invoice
was in the hands of the purchasing agent; it was marked “On consignment”.

(c) Merchandise received on January 6, 2020, costing 700,000 was entered in purchase register on January 7. The
invoice showed shipment was made FOB shipping point on December 31, 2019. Because it was not on hand during
the inventory count, it was not included.

(d) A special machine costing 200,000, fabricated to order for a particular customer, was finished in the shipping
room on December 30. The customer was billed for 300,000 on that date and the machine was excluded from
inventory although it was shipped January 4, 2020.

(e) Merchandise costing 200,000 was received on January 6, 2020, and the related purchase invoice was recorded
January 5. The invoice showed the shipment was made on December 29, 2019, FOB destination.

(f) Merchandise costing 150,000 was sold on an installment basis on December 15. The customer took possession
of the goods on that date. The merchandise was included in inventory because Angel still holds legal title. Historical
experience suggests that full payment on installment sale is received approximately 99% of the time.

(g) Goods costing 500,000 were sold and delivered on December 20. The goods were included in the inventory
because the sale was accompanied by a purchase agreement requiring Angel to buy back the inventory in February
2020.

Based on the above and the result of your audit, how much of these items should be included in the inventory
balance at December 31, 2019?
a. 1,300,000 b. 800,000 c. 1,650,000 d. 1,050,000

4. Massive Company provided the following information for the current year:
Units Unit cost Total cost
January 1 Inventory on hand 200 1,500 300,000
April 3 Purchase 300 1,750 525,000
October 1 Purchase 500 2,000 1,000,000
The entity sold 400 units on June 25 and 400 on December 10. What is the weighted average cost of the inventory at
year-end?
a. 350,000 b. 400,000 c. 730,000 d. 365,000

5. Adrian Company has two products in the inventory.

Product X Product Y
Selling price 1,500,000 2,000,000
Materials and conversion costs 1,000,000 1,200,000
General administration costs 200,000 300,000
Estimated selling costs 400,000 500,000
 At the year-end, the manufacture of items of inventory has been completed but no selling costs have yet been
incurred.

What is the measurement of Product X and Product Y?

a. 1,000,000 and 1,200,000
b. 1,100,000 and 1,500,000
c. 1,500,000 and 2,000,000
d. 500,000 and 800,000

6. The Starla Corporation applies the lower of cost or net realizable value (NRV) inventory. Data regarding the items in
work-in-process inventory are shown below:
Shorts Pants
Historical cost P56,640 P90,000
Selling Price 108,800 108,000
Estimated cost to complete 14,400 20,400
Replacement Cost 50,400 95,400
Normal profit margin as percentage of selling price 25% 10%

Under the lower cost or NRV rule, the pants should be valued at?
a. 67,800 b. 90,000 c. 87,600 d. 95,400

7. On November 15, 2021, Angel Company entered into a commitment to purchase 10,000 pillows on February 15,
2022 at a price of 310 per piece. On December 31, 2021, the market price of pillow is 270 per piece. On February 15,
2022, the price of pillow is P300 per piece. What is the gain on purchase commitment to be recognized on February
15, 2022?
a. 400,000 b. 100,000 c. 300,000 d. 0

8. Balloon Company’s accounting records indicated the following information for 2020:
Inventory, January 1 700,000
Purchases 3,000,000
Sales 3,500,000

A physical inventory taken on December 31, 2020 resulted in an ending inventory of 700,000. The gross profit on
sales has remained constant at 25% in recent years. The entity suspects some inventory may have been taken by a
new employee.

On December 31, 2020, what is the estimate cost of missing inventory?

a. 300,000 b. 375,000 c. 700,000 d. 0

9. On September 30, a tsunami destroyed a retail location of Waliyha Clothing including the entire inventory on hand at
the location. The inventory on hand as of October 31 totaled 480,000. From October 31 until the time of the
hurricane, the company made purchases of 53,000 and had sales of 458,000. Assuming the rate of gross profit to
selling price is 70%, what is the approximate value of the inventory that was destroyed?
a. 137,933 b. 181,500 c. 205,000 d. 395,600

10. You obtained the following information in connection with your audit of Ajing Corporation:
Cost Retail
Beginning inventory P1,987,200 P2,760,000
 Sales 7,812,000
Purchases 4,688,640 6,512,000
Freight in 94,560
Mark ups 720,000
Mark up cancellations 120,000
Markdown 240,000
Markdown cancellations 40,000
Ajing Corp. uses the retail inventory method in estimating the values of its inventories.
Based on the above and the result of your audit, answer the following:

1. The cost ratio to be used considering the provisions of PAS 2 is

a. 68.58% b. 69.20% c. 70.00% d. 75.78%

2. The estimated ending inventory at retail is

a. 2,300,000 b. 2,060,000 c. 1,940,000 d. 1,860,000

3. The estimated ending inventory at cost is

a. 1,412,786 b. 1,275,588 c. 1,302,000 d. 1,287,120

4. The estimated cost of goods sold is

a. 5,468,400 b. 5,494,812 c. 5,357,614 d. 4,685,117

11. Joseph Factory started operations in 2021.  Joseph manufactures bath towels.  60% of the production are “Class A”
which sell for P500 per dozen and 40% are “Class B” which sell for P250 per dozen.  During 2021, 6,000 dozens
were produced at an average cost of P360 per dozen.  The inventory at the end of the year was as follows:

220 dozens “Class A” @ P360 P  79,200

300 dozens “Class B” @ P360   108,000
P187,200

Using the relative sales value method, which management considers as a more equitable basis of cost distribution,
answer the following:

1.   How much of the total cost should be allocated to “Class A”?
a. 1,296,000                                    b. 1,620,000     c. 1,284,324 d. 925,714

2.   How much of the total cost should be allocated to “Class B”?
a. 540,000                                       b. 875,676     c. 864,000 d. 1,234,286

3.   How much is the value of inventory as of December 31, 2021?

a. 187,200                                       b. 187,946           c. 117,000 d. 166,500

4.   How much is the cost of sales for the year 2021?
a. 1,972,800                                    b. 1,993,500                         c. 2,043,000 d. 1,972,054

5.   How much is the gross profit for the year 2021?
a. 242,200                                       b. 406,500                                   c. 221,500 d. 242,946

12. Rice Lake Corp. produces milk on its farms. The entity produces 20% of the community's milk that is consumed.
Farmville Incorporated owns 5 farms and had a stock of 4,200 cows and 2,100 heifers.
 The farms produce 1,600,000 kilograms of milk a year and the average inventory held is 30,000 kilograms of milk.
However, on December 31, 2021 the entity is currently holding 100,000 kilograms of milk in powder. On December
31, 2021, the biological assets are:

Purchased before January 1, 2021. ( 3 years old ) 4,200 cows

Purchased on January 1, 2021. ( 2 years old) 600 heifers
Purchased on July 1, 2021. (1.5 years old) 1,500 heifers

No animals were born or sold during the current year. The unit fair value less cost of disposal is as follows:

January 1, 2021:
1-year old. 3,000
2-year old. 4,000
July 1, 2021:
1-year old. 3,000
December 31, 2021:
1-year old. 3,200
2-year old. 4,500
1.5-year old. 7,200
3-year old. 10,000

The entity has had problems during the year. Contaminated milk was sold to customers. As a result, milk
consumption has gone down.

The entity's business is spread over different parts of the country. The only region affected by the contamination was
Quezon. However, the cattle in this area were unaffected by the contamination and were healthy. The entity feels
that it cannot measure the fair value of the cows in the region because of the problems created by the contamination.
There are 1,200 cows and 400 heifers in the Quezon farm and all these animals had been purchased on January 1,
2021.

1. What is the fair value of biological assets on January 1, 2021?

a. 18,600,000 b. 19,200,000 c. 16,800,000 d. 14,400,000

2. What is the fair value of biological assets purchased on July 1, 2021?

a. 4,500,000 b. 6,000,000 c. 7,500,000 d. 6,750,000

3. What is the fair value of biological assets on December 31, 2021?

a. 29,100,000 b. 31,500,000 c. 30,450,000 d. 23,700,000

4. What is the increase in fair value of biological assets due to price change on December 31, 2021?
a. 6,000,000 b. 10,500,000 c. 9,900,000 d. 12,300,000

5. What is the increase in fair value of biological assets due to physical change?
a. 2,520,000 b. 3,480,000 c. 6,000,000 d. 2,880,000

13. A fire destroyed Jerome Company's inventor on October 31. On January 1, the inventory had a cost of 3,500,000.
During the period January 2 to October 31, the entity had net purchases of 8,500,000 and net sales of 17,000,000.
Undamaged inventory at the date of fire had a cost of 170,000. The mark up on cost is 66 2/3%. What was the cost
of inventory destroyed by fire?
a. 1,630,000 b. 1,970,000 c. 1,550,000 d. 5,170,000
14. Kasama Company conducted a physical count on December 31, 2020 which revealed total cost of 5,000,000.

However, the following items were excluded from the count:

• Goods costing 100,000 shipped by a vendor FOB shipping point on December 29, 2020 and received by
Kasama Company on January 12, 2021.
• Goods in process costing 550,000 held by an outside processor for further processing.
• Goods sold to a customer which is being held for the customer to call for at the customer's convenience with
a cost of 400,000.
• A packing case containing a product costing 150,000 was standing in the shipping room when the physical
inventory was taken. It was not included in the inventory because it was marked "hold for shipping
instructions".

What is the correct inventory on December 31, 2020?

a. 6,200,000 b. 5,800,000 c. 5,650,000 d. 5,000,000

15. In year 2021, a division experienced fire in which it destroyed all of inventory except for P55,000 of inventory
measured at cost. Additional Data available are below:

2020 2021 (to date of fire)

Sales P850,000 P510,000
Purchases 560,000 305,000
Cost of goods sold 425,000
Ending inventory 95,000

What is the approximate inventory lost to the fire?

a. 55,000 b. 90,000 c. 145,000 d. 400,000

16. A retailer imported goods at a cost of P 260,000, including P 40,000 non-refundable import duties and P 20,000
refundable purchase taxes. The risks and rewards of ownership of the time imported goods were transferred to the
retailer upon collection of the goods from the harbor warehouse. The retailer was required to pay for the goods upon
collection. The retailer incurred P 10,000 to transport the goods to its retail outlet and a further P 4,000 in delivering
the goods to its customer. Further selling costs of P 6,000 were incurred in selling the goods.

What amount should the inventory be valued?

a. 240,000 b. 250,000 c. 260,000 d. 270,000

17. The ff. audited balances pertain to Wen Company

Accts. Payable:
Jan.1, 2020 286, 924
Dec.31, 2020 737, 824
Inventory balance:
Jan. 1, 2020 815, 386
Dec.31, 2020 488, 874
Cost of goods sold-2020 1, 859, 082

How much was paid by Wen Company to its supplier in 2020?

a. 1, 081, 670 b. 1, 065, 900 c. 1, 071, 678 d. 1, 097, 000
18. On October 1, 2020, Fabulous Company entered into a 6-month, P5,200,000 purchase commitment for a supply of a
special product on March 31, 2021, On December 31, 2020, the market value of this material had fallen to
P5,000,000. O March 31, 2021, the market value of the purchase commitment is P4,900,000. What is the loss on
purchase commitment that should be recognized on March 31, 2021?
a. 200,000 b. 100,000 c. 300,000 d. 0

19. A fire destroyed the New Jersey Company’s warehouse causing damage to its inventories stored in the warehouse.
The company uses average retail inventory method in inventory estimation. In connection with this, the company’s
accountant gathered the following information relating its inventories:
Cost Retail Price
Inventory, Beginning 190,000 300,000
Purchase Price 2,900,000 4,000,000
Purchase Discount 50,000 100,000
Purchase Allowance 90,000 150,000
Purchase returns 60,000 120,000
Freight In 20,000 30,000
Net Mark-up   60,000
Net Mark Down   80,000
Departmental Transfer – in (Debit) 386,800 430,000
Departmental Transfer – Out (Credit) 400,000 550,000
Abnormal Wastages 80,000 120,000
Normal Wastages 100,000 120,000
Employee Discounts 6,000 9,500
Sales Discount 5,000 8,200
Sales Allowances 21,000 32,150
Sales Returns 5,000 6,780

The company’s policy is to record sales adjustments directly to sales account. The sales account showed ending
balance of P2,908,000 on the date of fire. Physical inventory conducted after the fire disclosed usable damaged
goods which the company estimates can be sold at P100,000. Also, it is estimated that the company will incur
P4,000 to sell the goods. The original cost of this goods amounted to P50,000.

How much should the company recognize as loss on inventory fire?

a. 550,000 b. 842,150 c. 386,800 d. 556,348

20. A herd of ten 2 yr-old animals was held at January 1, 2021. One animal aged (2.5 years old) was purchased on July
1, 2021 for P10,800 and one animal was born on July 1, 2021. Two 3-yr old animals were sold at 12/31/2021 for
P13,500 each, the company incurring P1,500 sale of each.

Per unit fair vale less cost of disposal were as follows:

1/1/2021
2-yr old animal P 10,000
7/1/2021
New born animal 7,000
2.5-yr old animal 10,800
12/31/2021
New born animal 7,200
0.5-yr old animal 8,000
3-yr old animal 10,500
2.5 yr old animal 11,100
 3-yr old animal 12,000

1. Compute for the change in fair value less cost to sell of the biological asset due to price change and physical
change respectively.
a. 5,000; 27,300 b. 5,500; 23,700
c. 5,500; 27300 d. 5,000; 23700

2. Which of the following entries in 2021 is false regarding the record for the transactions in the biological assets?
a. 7/31/2021 debit entry to Biological Assets 10,800
b. 12/31/2021 credit entry to Increase in FV less CTS due to Physical Change 16,700
c. 12/31/2021 credit entry to Increase in FV less CTS due to Physical Change 23,700
d. 12/31/2021 debit entry to Cash 24,000

3. The balance of Biological Assets account at December 31, 2021 is

a. 116,000 b. 126,000 c. 136,000 d. 146,000