College of Accounting Education

3nd Floor, Dr. Florencio T. Facundo Hall, Business

& Engineering Bldg., Matina, Davao City
Phone No.: (082)305-0640 Local 137

(PAS 2) INVENTORIES
Definition: September 29, 2021
These are assets-
a. held for sale in the ordinary course of business,
b. in the process of production for such sale, or
c. in the form of materials or supplies to be consumed in the production process or rendering services
- one-line item account

Composition:
a. Trading companies
v Merchandise inventory (goods purchased for resale)
b. Manufacturing companies
v Finished goods (ready for sale to customers)
v Work in process ( in the process of production for subsequent sale)
v Raw materials (in the form of materials and supplies to be consumed in the production process)
v Factory supplies
c. Service companies
v Office supplies
v “Work in progress”
Measurement:
Initial:-Historical Cost
1.a Cost of purchase – purchase price, import duties and taxes, freight, handling and other direct acquisition costs
(minus trade discounts, rebates and other similar items).
1.b Cost of conversion – direct labor and overhead (variable and fixed) incurred in conversion.
1.c Other costs incurred in bringing the inventories to their present location and condition
- installation cost, testing cost, borrowing cost etc.,
Cost of Inventories NOT included:
v Abnormal waste
v Storage costs
v Administrative overheads unrelated to production
v Foreign exchange differences arising directly on the recent acquisition of inventories invoiced in a foreign
currency
v Interest cost when inventories are purchased with deferred settlement terms.

Practice:
Summer Company received quotations from two entities for an item of merchandise as follows:
Company X: List price P500,000 less 20-10-10, FOB shipping point,2/10,n/30.
Company Y: List price P500,000 less 35, FOB shipping point,2/10,n/30.

Accounting Systems for Inventories:

a. Periodic
ü An inventory system in which only revenue is recorded each time a sale occurs
ü Inventory balance is based by a periodic physical inventory.
b. Perpetual
ü Provides a continuous summary of goods on hand
ü Entries for revenue, cost of goods sold, and reduction of inventory are recorded for each sales
transaction.
Practice:
CA Company is a wholesaler of IPAD original covers. On January 1, 2021, CA’s inventory consisted of 90 covers priced at
P1,000 each. During the current year, the following events occurred:
1. Purchased 800 IPAD covers on account at a P1,000 each.

2. Returned 50 defective IPAD covers to supplier and received credit.

3. Paid 600 of the IPAD covers purchased.

4. Sold 790 IPAD covers at P2,000 each.

Competency Appraisal Page 1st Semester SY2021-2022

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 College of Accounting Education
3nd Floor, Dr. Florencio T. Facundo Hall, Business
& Engineering Bldg., Matina, Davao City
Phone No.: (082)305-0640 Local 137

5. Received 20 IPAD covers returned by a customer and gave credit. The goods were in excellent condition.

6. Received cash for 680 of the IPAD covers sold.

7. Physical count at year-end revealed 60 units on hand.

Required:
a. Prepare journal entries, including adjustments to record the above transactions assuming Prerev uses periodic
system and perpetual system.
b. Determine the cost of sales under each inventory system.

Classification:
As a current Asset – for those Unsold/Unused/Remaining Goods or Items
As part of Cost of Sales – for those Sold/Used/Expired Goods or Items

Considerations:
1. Merchandise in transit –
a. FOB SP
b. FAS or free alongside
Buyer is the owner of goods in transit and thus responsible for freight
charges and other expenses up to the point of destination.
A seller who ships FAS must bear all expenses and risk 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.
c. CIF or Cost, insurance The buyer agrees to pay in a lump sum the cost of the goods, insurance cost
and freight and freight charge.

d. Ex-ship
e. FOB Destination
2. Goods on consignment
-Goods out on consignment
-goods held on consignment
*Freight – out to consigned
goods
3. Sales on approval
4. product-financing “park sale”
5. Segregated goods
6. installment sale
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.
A seller 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.
Seller is the owner of goods in transit and thus responsible for freight
charges and other expenses up to the point of destination.
The consignor is the owner of the goods while the consignee is the agent or
representative of the consignor only.
Seller until payment is received for items kept by the buyer.
No entry for the date of sale, Seller retains ownership.
“sales with repurchase agreement.”
(special order) buyer; excluded from inventory of seller
Buyer owns the goods.

Competency Appraisal Page 1st Semester SY2021-2022

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mgsombilon
 College of Accounting Education
3nd Floor, Dr. Florencio T. Facundo Hall, Business
& Engineering Bldg., Matina, Davao City
Phone No.: (082)305-0640 Local 137

• Autumn Company reported P5,000,000 of inventory on December 31, 2020, based on physical count.
Additional information is as follows:
a. Excluded from the physical count were goods billed to a customer, FOB shipping point, on December 31, 2020.
The goods had a cost of P200,000 and had been billed at P350,000. The shipment is ready for pick-up by the
delivery contractor on January 5, 2021.
b. Goods were in transit from a vendor. The invoice cost was P300,000 and goods were shipped FOB shipping
point on December 31, 2020.
c. Work in process costing P400,000 was sent to an outside processor for finishing on December 31, 2020.
d. Goods out on consignment with sales price of P1,000,000 and markup of 25% on cost. Shipping costs amounted
to P50,000.
e. An invoice for P100,000, FOB shipping point, was received on December 15. The receiving report indicates that
the goods were received on December 18 but across the face of the report is the notation “merchandise not
of the same quality as ordered – returned for credit, December 19”. The merchandise was included in
inventory.
f. A special article of P80,000, fabricated to order for a customer, was finished and in the shipping room on
December 31, 2020. The customer was billed on that date and the article was included from the inventory
although it was shipped on January 4, 2021.
The correct amount of inventory on December 31, 2020 should be __________6

,750,000million

• The inventory on hand at December 31, 2020 for SM Prime Holdings, Inc. valued at a cost of P947,800. The
following items were not included in this inventory amount:
a. Purchased goods, in transit, shipped FOB destination invoice price P32,000 which include freight charges of
P1,600.
b. Goods held on consignment by SM Prime Holdings, Inc. at a sales price of P28,000, including sales commission of
20% of the sales price.
c. Goods sold to Universal Robina Corporation, under the terms FOB destination, invoiced for P18,500 which
includes P1,000 freight charges to deliver the goods. Goods are in transit.
d. Purchased goods in transit, terms FOB shipping point, invoice price P48,000, freight cost, P3,000.
e. Goods out on consignment to Metro Pacific Investments Corporation, sales price P36,400, shipping cost of
P2,000.
f. An invoice for goods costing P150,000 was received and recorded as a purchase on December 31, 2020. The
related goods, shipped FAS, were in transit on December 31, 2020 and received on January 4, 2021, and were not
included in the year-end inventory figure.
g. Supplier’s invoice for P180,000 worth of merchandise dated December 28, 2020 was received through the mail on
December 31, 2020 although the goods were in transit on December 31, 2020 and arrived only on January 4,
2021. Shipment term is CIF. This item was not included in the December 31, 2020 inventory by the entity.
Assuming that the company’s selling price is 140% of inventory cost, What is the correct amount of inventory at
December 31, 2020?

Competency Appraisal Page 1st Semester SY2021-2022

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mgsombilon
 College of Accounting Education
3nd Floor, Dr. Florencio T. Facundo Hall, Business
& Engineering Bldg., Matina, Davao City
Phone No.: (082)305-0640 Local 137

Subsequent:
• Lower of COST or NET REALIZABLE VALUE* – Item by item
*NRV=ESP-ECTC-ECTS”
• “PAS 2 expressly provides that the cost of inventories shall be determined by using either:

Inventory COST formulas

1. FIFO (First-In, First-Out)
• first goods purchased are the first goods sold
• the accountant computes the COS and ending inventory as if the first items purchased are the first to be sold,
leaving the most recently purchased items in inventory.
• best approximates the current replacement value of ending inventory.
• Rising prices, matches oldest low-cost inventory with rising sales prices, thus expanding the gross profit margin.
• Declining prices, oldest high-cost inventory is matched with declining sales prices, thus narrowing the gross profit
margin.
• Inventories are reported on the statement of financial position at or near current costs.

• Average(Weighted Average/ Moving Average)

• Assigns the same average cost to each unit.
• COS should be charged at an average cost.
• Can be supported as realistic and as paralleling the physical flow of goods, particularly where there is intermingling
of identical inventory units.
• Differs from other methods in that no assumption is made about the sale of specific units.
• Rather, all sales are assumed to be of the “average” unit at the average cost per unit.

• Specific Identification
• Required for inventories that are not ordinary interchangeable and goods or services produced and segregated
for specific projects.
• The original cost of each item is identified, resulting in actual costs being accumulated for the specific items on
hand and sold.
• Consistent with the physical flow of goods
• Though theoretically attractive and useful when each inventory item is unique and has a high cost, it is frequently
not economically feasible.
• It is subject to manipulation and it is the least common method observed in practice.
• Can produce any variety of results depending on which particular units are selected for shipment.

Practice:
*Sunspot Company is a wholesaler of scented candles. The activity for item number 1234 during June is presented
below:
Date Transaction Units Cost
June 01 Inventory balance 16,000 P 140
04 Purchases 4,000 150
12 Sales 15,000
19 Purchases 20,000 160
20 Purchase return 1,000 160
22 Sales 8,000
24 Sales return 4,000
29 Purchases 30,000 150
How much is the ending inventory of item 1234 at June 30 using FIFO periodic, perpetual, weighted average and
moving average?

Competency Appraisal Page 1st Semester SY2021-2022

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mgsombilon
 College of Accounting Education
3nd Floor, Dr. Florencio T. Facundo Hall, Business
& Engineering Bldg., Matina, Davao City
Phone No.: (082)305-0640 Local 137

Competency Appraisal Page 1st Semester SY2021-2022

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mgsombilon
 College of Accounting Education
3nd Floor, Dr. Florencio T. Facundo Hall, Business
& Engineering Bldg., Matina, Davao City
Phone No.: (082)305-0640 Local 137

*Angela Company has two products in its inventory which have costs and selling prices per unit as follows:
Product A Product B
Selling price 200 300
Materials and conversion costs 150 180
General administrative costs 30 80
Selling costs 60 70
At the year end, the manufacturer of items of inventory has been completed but no selling costs have yet been
incurred. Product A and B shall be measured at 140 and 180, respectively.

Accounting for inventory Writedown:

1. Direct method – inventory is recorded at LC or NRV;”Cost of goods sold method”; loss not accounted separately
2. Allowance method- inventory is recorded at cost and any loss on inventory writedown is accounted for separately.

Purchase Commitments
- Obligations of the entity to acquire certain goods (noncancelable) sometime in the future at a fixed price and fixed
quantity.
- If there is a decline in purchase price after a purchase commitment has been made, a loss is recorded in the period
of the price decline.

Competency Appraisal Page 1st Semester SY2021-2022

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mgsombilon
 College of Accounting Education
3nd Floor, Dr. Florencio T. Facundo Hall, Business
& Engineering Bldg., Matina, Davao City
Phone No.: (082)305-0640 Local 137

INVENTORY ESTIMATION
Importance:
1) Impossible to take physical count – ex. Force majeure (earthquake, flood..)
Act of man (thief)
2) Possible to take physical count - prove correctness/reasonableness

Methods:
1) Gross profit – assumed that gross profit ratio is consistent from period to period.
Practice: (1)
The following information appears in Oliva Company’s records for the year ended December 31, 2020:
Inventory, 1/1 650,000
Purchases 2,300,000
Purchase returns 80,000
Freight in 60,000
Sales 3,400,000
Sales discounts 20,000
Sales returns 30,000

On December 31,2020, a physical inventory revealed that the ending inventory was only P420,000. The gross profit
on sales has remained constant at 30 percent in recent years. Oliva Company suspects that some inventory may
have been pilfered by one of the entity’s employees. On December 31,2020, what is the estimated cost of missing
inventory?

(2)
Sheep Company began operations on January 1,2020. The following information is available for the year ended
December 31,2020:
Total merchandise purchase 7,000,000
Merchandise inventory @ 12/31 1,400,000
Collections from customers 4,000,000
All merchandise is marked to sell at 40% above cost. All sales are credit sales and all receivables are collectible.
What is the balance of accounts receivable on December 31,2020?

Competency Appraisal Page 1st Semester SY2021-2022

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mgsombilon
 College of Accounting Education
3nd Floor, Dr. Florencio T. Facundo Hall, Business
& Engineering Bldg., Matina, Davao City
Phone No.: (082)305-0640 Local 137

(3) On December 31,2020, a typhoon damaged Sunstar Company’s warehouse. The entire company and many
accounting records stored in the warehouse were destroyed. Although the inventory was not insured, a portion
could be sold for scrap. Using microfilmed records, the following data were gathered.

Inventory, 1/1, P500,000; Purchases, P2,200,00; Cash sales, P273,600; Collection of AR (including the amount of
recovery), P2,520,000; AR, 1/1, P210,000; Accounts written off, P9,600; Recovery of accounts written off, P3,600;
Allowance for DA-1/1,P10,500; AR, 12/31/2020 (net of required allowance), P342,000; Sales returns, P36,000;
Sales discounts, P14,400; Purchase returns, P60,000; Purchase discounts, P12,000; Freight-in, P21,600; Salvage
value-Inventory, P60,000; Gross profit percentage on sales, 32%. The company consistently measures doubtful
accounts in percent of AR. The value of inventory loss is _______.

2) Retail inventory - generally employed by department stores, supermarkets & other retails concerns where there is
wide variety of goods.
- Selling price or retail price is tagged to each item.

Treatment of special items:

Accounts Cost Retail
1.) Purchase discount/allowance -
2.) Purchase returns - -
3.) Freight – in +
4.) Departmental transfer – in /Debit + +
5.) Departmental transfer – out/Credit - -

6.) Employee discount + sales

7.) Sales returns - sales
8.) Normal shortage, shrinkage,
Spoilage & breakage + sales
9.) Abnormal shortage, shrinkage, Spoilage &
breakage - -
10.) Sales discount/allowance Ignore

Competency Appraisal Page 1st Semester SY2021-2022

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mgsombilon
 College of Accounting Education
3nd Floor, Dr. Florencio T. Facundo Hall, Business
& Engineering Bldg., Matina, Davao City
Phone No.: (082)305-0640 Local 137

Practice: 1
Charlene Company uses the average cost retail method to estimate its inventory. Data relating to the inventory at
December 31, 2020 are: Cost Retail
Inventory, January 1 1,000,000 1,500,000
Purchases 5,300,000 7,000,000
Net markup 800,000
Net markdown 300,000
Sales 6,000,000
Estimated normal shoplifting losses 200,000
Estimated normal shrinkage is 5% of sales
The estimated cost of goods sold and merchandise inventory end for 2020 should be

Competency Appraisal Page 1st Semester SY2021-2022

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mgsombilon
 College of Accounting Education
3nd Floor, Dr. Florencio T. Facundo Hall, Business
& Engineering Bldg., Matina, Davao City
Phone No.: (082)305-0640 Local 137

Practice: 2
Pauline Company uses the retail inventory method to approximate its ending inventory. The following information is
available for the current year:
Cost Retail
Beginning inventory 650,000 1,200,000
Purchases 9,000,000 14,700,000
Freight in 200,000
Purchase returns 300,000 500,000
Purchase allowances 150,000
Departmental transfer in 200,000 300,000
Net markups 300,000
Net markdowns 1,000,000
Sales 11,500,000
Sales discounts 100,000
Employee discounts 500,000
1.What should be reported as the estimated cost of ending inventory using the lower of average cost or market?
2.What should be reported as estimated cost of ending inventory using the average cost approach of applying retail
method?

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