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PAS 2, PAS 7, and PAS 8

PAS 2: INVENTORIES
Philippine Accounting Standard 2 (PAS 2) or IAS 2 Inventories provides guidance for determining the cost of
inventories and the subsequent recognition of the cost as an expense, including any write-down to net realizable
value.

Definition
Inventories are assets:
o held for sale in the ordinary course of business;
o in the process of production for such sale; or
o in the form of materials or supplies to be consumed in the production process or rendering of services.

The classification of inventories usually varies depending on the type of business the firm is involved with. For
a merchandising type of business, its inventory usually comes from its purchases. This account is usually termed
as merchandise inventory which is the sole item of inventory appearing in the financial statement.

A manufacturing type of business produces goods to sell to merchandising forms. It usually has three (3)
inventory accounts:
o Raw materials inventory – Goods and materials on hand not yet placed into production.
o Work in process inventory – The cost of the unfinished product or goods still under the production
process. The cost of these units also comprises the direct labor cost applied and the manufacturing
overhead cost.
o Finished goods inventory - This includes completed but unsold units on hand.

Goods Included in Inventory

1. Goods in Transit – Often, companies purchase merchandise that remains in transit at the end of the fiscal
period. Proper accounting of these goods depends on who has the control over the goods. The passage of
title rule is applicable in this situation (Kieso, 2016).

The following are the shipping terms essential in identifying the legal title over the goods (Kieso, 2016):
o FOB shipping point – The title passes to the buyer the moment the seller delivers the goods to the
common carrier, who acts as an agent for the buyer.
o FOB destination – The title passes to the buyer only when it receives the goods from the common
carrier.
o Free alongside (FAS) – The risk of loss is transferred from the seller to the buyer at a named port
alongside a vessel designated by the buyer (Robles & Empleo, 2016).
o Cost, insurance, and freight (CIF) – Under this shipping contract, the buyer agrees to pay all the cost
of goods, insurance cost, and freight. The risk of loss is transferred to the buyer upon delivery of goods
to the carrier (Valix, 2017).
Freight Terms
o Freight collect – This means that the carrier will collect the cost of transporting the goods to the buyer.
o Freight prepaid – This means that the seller already pays the freight cost on the goods shipped.
2. Consigned goods – These are goods under consignment arrangement. For example, under this
arrangement, a company (the consignor) ships various art merchandise to another company (the
consignee), who acts as an agent in selling the consigned goods. These goods remain the property of the
consignor.
3. Segregated goods – These are specially ordered or manufactured goods based on the customer’s
preference. These goods, once completed, shall be considered sold and excluded from the inventory of
the seller.
4. Conditional sale and installment sale – The title has already passed to the buyer.

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5. Goods sold with buyback agreement – The goods are still part of the inventory of the seller.
6. Goods sold with refund offers – If returns are predictable, goods are excluded from the inventories of
the seller. If not, retained as part of the inventory.

Cost of Inventories
Inventories shall be measured at the lower of cost and net realizable value. The cost of inventories shall
comprise all costs of purchase, costs of conversion, and other costs incurred in bringing the inventories to
their present location and condition.
o Costs of purchase – These include purchase price, import duties and other taxes (other than those
subsequently recoverable by the entity from the taxing authorities), and transport, handling and other
costs directly attributable to the acquisition of finished goods, materials, and services. Trade discounts,
rebates, and other similar items are deducted in determining the costs of purchase.
o Costs of conversion - These are directly related to the units of production, such as direct labor. Also,
these include a systematic allocation of fixed and variable production overheads that are incurred in
converting materials into finished goods. Fixed production overheads are those indirect costs of
production that remain relatively constant regardless of the volume of production, such as depreciation
and maintenance of factory buildings and equipment, right-of-use assets used in the production
process, and the cost of factory management and administration. Variable production overheads are
those indirect costs of production that vary directly, or nearly directly, with the volume of production,
such as indirect materials and indirect labor.
o Other costs – These are costs included in the cost of inventories only to the extent that they are
incurred in bringing the inventories to their present location and condition.

Examples of costs excluded from the cost of inventories and recognized as expenses in the period in which
they are incurred are:
o abnormal amounts of wasted materials, labor or other production costs;
o storage costs, unless those costs are necessary in the production process before a further production
stage;
o administrative overheads that do not contribute to bringing inventories to their present location and
condition; and
o selling costs.

Cost Formulas
The cost of inventories that are not ordinarily interchangeable and goods or services produces and segregated
for specific projects shall be assigned by using specific identification of their individual costs.
o Specific identification – This means that specific costs are attributed to identified items of inventory.
This is the appropriate treatment for items that are segregated for a specific project, regardless of whether
they have been bought or produced. However, specific identification of costs is inappropriate when there
are large numbers of items of inventory that are ordinarily interchangeable. In such circumstances, the
method of selecting those items that remain in inventories could be used to obtain predetermined effects
on profit or loss.

When the goods are ordinarily interchangeable, then IAS 2 permits using either of the following cost formulas:
o First in, first out (FIFO) – This cost formula assumes that the items of inventory purchased or produced
first are sold first, and, consequently, the items remaining in inventory at the end of the period are those
most recently purchased or produced.
o Weighted average – This is a cost formula in which each item is determined from the weighted average
of the cost of similar items at the beginning of a period and the cost of similar items purchased or
produced during the period. The average may be calculated on a periodic basis, or as each additional
shipment is received, depending upon the circumstances of the entity.

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Measurement of Inventory at Lower of Cost and Net Realizable Value (LCNRV)

Net realizable value 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. This refers to the net amount that an entity
expects to realize from the sale of inventory in the ordinary course of business.

The cost of inventories may not be recoverable if those inventories are damaged, if they have become wholly
or partially obsolete, or if their selling prices have declined. The cost of inventories may also not be recoverable
if the estimated costs of completion or the estimated costs to be incurred to make the sale have increased. The
practice of writing inventories down below cost to net realizable value is consistent with the view that assets
should not be carried in excess of amounts expected to be realized from their sale or use.

Inventories are usually written down to net realizable value item by item. In some circumstances, however, it
may be appropriate to group similar or related items. This may be the case with items of inventory relating to
the same product line that have similar purposes or end uses, are produced and marketed in the same
geographical area, and cannot be practicably evaluated separately from other items in that product line. It is not
appropriate to write inventories down on the basis of a classification of inventory (e.g., finished goods or all the
inventories in a particular operating segment).

A new assessment is made of net realizable value in each subsequent period. When the circumstances that
previously caused inventories to be written down below cost no longer exist or when there is clear evidence of
an increase in net realizable value because of changed economic circumstances, the amount of the write-down
is reversed (i.e., the reversal is limited to the amount of the original write-down), so that the new carrying amount
is the lower of the cost and the revised net realizable value. This occurs, for example, when an item of inventory
that is carried at net realizable value, because its selling price has declined, is still on hand in a subsequent
period and its selling price has increased.

PAS 7: STATEMENT OF CASH FLOWS

Philippine Accounting Standards 7 (PAS 7) or Statement of Cash Flow (IAS 7) is the standard that provides
guidance in preparing the statement of cash flows.
o Statement of cash flows – This is the financial statement that provides information to users with a basis
to assess the ability of the entity to generate cash and cash equivalents and the needs of the entity to
utilize those cash flows. The economic decisions that are taken by users require an evaluation of the
ability of an entity to generate cash and cash equivalents and the timing and certainty of their generation.

Cash and Cash Equivalents

o Cash - It comprises cash on hand and demand deposits.
o Cash equivalents – These are short-term, highly liquid investments that are readily convertible to known
amounts of cash and which are subject to an insignificant risk of changes in value.
Cash equivalents are held to meet short-term cash commitments rather than for investment or other purposes.
For an investment to qualify as a cash equivalent, it must be readily convertible to a known amount of cash and
be subject to an insignificant risk of changes in value. Therefore, an investment normally qualifies as a cash
equivalent only when it has a short maturity of, say, three (3) months or less from the date of acquisition.

Cash flows exclude movements between items that constitute cash or cash equivalents because these
components are part of the cash management of an entity rather than of its operating, investing, and financing
activities. Cash management includes the investment of excess cash in cash equivalents.

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Different Activities in the Statement of Cash Flows
The statement of cash flows shall report cash flows during the period classified by operating, investing, and
financing activities.
Operating Activities
Definition These are principal revenue-
producing activities of the
entity. Therefore, cash flows
from operating activities
generally result from the
transactions and other events
that enter into the
determination of profit or loss.
Example o cash receipts from the
sale of goods and the
rendering of services
o cash receipts from
royalties, fees,
commissions, and other
revenues
o cash payments to
suppliers for goods and
services
o cash payments to and on
behalf of employees
o cash receipts and cash
payments of an insurance
entity for premiums and
claims, annuities, and
other policy benefits
o cash payments or refunds
of income taxes unless
they can be specifically
identified with financing
and investing activities
o cash receipts and
payments from contracts
held for dealing or trading
purposes
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Investing Activities Financing Activities
These are activities in which These are activities
expenditures have been made for where the company gets
resources intended to generate its funds, such as
future income and cash flows. Only investment of providers
expenditures that result in a of capital to the entity.
recognized asset in the statement
of financial position are eligible for
classification as investing
activities.
o cash payments to acquire o cash proceeds from
property, plant and equipment, issuing shares or
intangibles, and other long-term other equity
assets instruments
o cash receipts from sales of o cash payments to
property, plant and equipment, owners to acquire or
intangibles and other long-term redeem the entity’s
assets shares
o cash payments to acquire o cash proceeds from
equity or debt instruments of issuing debentures,
other entities and interests in loans, notes, bonds,
joint ventures (other than mortgages, and other
payments for those instruments short- or long-term
considered to be cash borrowings
equivalents or those held for o cash repayments of
dealing or trading purposes) amounts borrowed
o cash receipts from sales of o cash payments by a
equity or debt instruments of lessee for the
other entities and interests in reduction of the
joint ventures (other than outstanding liability
receipts for those instruments relating to a lease
considered to be cash
equivalents and those held for
dealing or trading purposes)
o cash advances and loans made
to other parties (other than
advances and loans made by a
financial institution)
o cash receipts from the
repayment of advances and
loans made to other parties
(other than advances and loans
of a financial institution)
o cash payments for futures
contracts, forward contracts,
option contracts, and swap
contracts except when the
contracts are held for dealing or
trading purposes, or the
payments are classified as
financing activities
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o cash receipts from futures

contracts, forward contracts, option
contracts, and swap contracts
except when the contracts are
held for dealing or trading
purposes, or the receipts are
classified as financing activities

Reporting
An entity shall report cash flows from operating activities using either:
o the direct method, whereby major classes of gross cash receipts and gross cash payments are
disclosed; or
o the indirect method, whereby profit or loss is adjusted for the effects of transactions of a non-cash nature,
any deferrals or accruals of past or future operating cash receipts or payments, and items of income or
expense associated with investing or financing cash flows.

PAS 8: ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES, AND ERRORS

Definition
o Accounting policies – These are the specific principles, bases, conventions, rules, and practices
applied by an entity in preparing and presenting financial statements.
o Change in accounting estimate – This is an adjustment of the carrying amount of an asset or a liability,
or the amount of the periodic consumption of an asset, that results from the assessment of the present
status of, and expected future benefits and obligations associated with, assets and liabilities. Changes
in accounting estimates result from new information or new developments and, accordingly, are not
corrections of errors.
o Prior period errors – These are omissions from, and misstatements in, the entity’s financial statements
for one (1) or more prior periods arising from a failure to use, or misuse of, reliable information that:
o was available when financial statements for those periods were authorized for issue; and
o could reasonably be expected to have been obtained and taken into account in the preparation
and presentation of those financial statements.
o Retrospective application - This is applying a new accounting policy to transactions, other events, and
conditions as if that policy had always been applied.
o Retrospective restatement - This is correcting the recognition, measurement, and disclosure of the
amounts of elements of financial statements as if a prior period error had never occurred.
o Prospective application of a change in accounting policy and of recognizing the effect of a change in an
accounting estimate, respectively, are:
o applying the new accounting policy to transactions, other events and conditions occurring after
the date as at which the policy is changed; and
o recognizing the effect of the change in the accounting estimate in the current and future periods
affected by the change.

Application
When a PFRS specifically applies to a transaction, other event, or condition, the accounting policy or policies
applied to that item shall be determined by applying the PFRS. In the absence of a PFRS that specifically applies
to a transaction, other event, or condition, the management shall use its judgment in developing and applying
an accounting policy that results in information that is:
a. relevant to the economic decision-making needs of users; and
b. reliable, in that the financial statements:
i. represent faithfully the financial position, financial performance, and cash flows of the entity;
ii. reflect the economic substance of transactions, other events and conditions, and not merely the
legal form;

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iii. are neutral, i.e., free from bias;

iv. are prudent; and
v. are complete in all material respects.

An entity shall select and apply its accounting policies consistently for similar transactions, other events, and
conditions, unless a PFRS specifically requires or permits categorization of items for which different policies
may be appropriate. If a PFRS requires or permits such categorization, an appropriate accounting policy shall
be selected and applied consistently to each category.

Changes in Accounting Policies

An entity shall change an accounting policy only if the change:
a. is required by a PFRS; or
b. results in the financial statements providing reliable and more relevant information about the effects of
transactions, other events or conditions on the entity’s financial position, financial performance, or cash
flows.

An entity shall account for a change in accounting policy resulting from the initial application of a PFRS in
accordance with the specific transitional provisions, if any, in that PFRS. When an entity changes an accounting
policy upon initial application of a PFRS that does not include specific transitional provisions applying to that
change, or changes an accounting policy voluntarily, it shall apply the change retrospectively.

When a change in accounting policy is applied retrospectively, the entity shall adjust the opening balance of
each affected component of equity for the earliest prior period presented and the other comparative amounts
disclosed for each prior period presented as if the new accounting policy had always been applied.

When retrospective application is required, change in accounting policy shall be applied retrospectively except
to the extent that it is impracticable to determine either the period-specific effects or the cumulative effect of the
change.

When it is impracticable to determine the period-specific effects of changing an accounting policy on

comparative information for one (1) or more prior periods presented, the entity shall apply the new accounting
policy to the carrying amounts of assets and liabilities as at the beginning of the earliest period for which
retrospective application is practicable, which may be the current period, and shall make a corresponding
adjustment to the opening balance of each affected component of equity for that period.

When it is impracticable to determine the cumulative effect, at the beginning of the current period, of applying a
new accounting policy to all prior periods, the entity shall adjust the comparative information to apply the new
accounting policy prospectively from the earliest date practicable.

References
International Financial Reporting Standards Foundation. (2003). IAS 2 inventories. Retrieved on November 20,
2018, from https://www.ifrs.org/issued-standards/list-of-standards/ias-2-inventories
International Financial Reporting Standards Foundation. (2003). IAS 8 accounting policies, changes in
accounting estimates and errors. Retrieved on November 20, 2018, from https://www.ifrs.org/issued-
standards/list-of-standards/ias-8-accounting-policies-changes-in-accounting-estimates-and-errors
International Financial Reporting Standards Foundation. (2016). IAS 7 statement of cash flows. Retrieved on
November 20, 2018, from https://www.ifrs.org/issued-standards/list-of-standards/ias-7-statement-of-
cash-flows

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