DON HONORIO VENTURA STATE UNIVERSITY

COLLEGE OF BUSINESS STUDIES

Bacolor, Pampanga

CHAPTER 7- INVENTORIES

LEARNING OBJECTIVES:

At the end of this chapter, the student should be able to:

1. To understand the meaning of Inventories

2. To identify the major classes of inventories

3. To account for inventory transactions using periodic and perpetual inventory system

4. To know the gross method and net method of recording purchases

5. To identify the items included in Inventory Cost

Definition of Inventories is as follows:

“Inventories are assets which are 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 service.”

Inventories encompasses goods purchased and are held for resale including for example,
merchandise purchased by a retailer and held for resale, or land and other property held for resale
by subdivision company and real estate developer. It also encompass finished goods produced,
goods in process and materials and supplies awaiting use in the production process.

In case of service provider, inventories include the cost of the service for which the entity has not
yet recognized the related revenue. The cost of the service consists primarily of the labor and the
other cost of personnel directly engaged in providing the service, including supervisory personnel
and the attributable overhead.

CLASSES of INVENTORY

Inventories are broadly classified into two, namely inventories of a trading concern and inventories
of manufacturing concern.

Trading concern is one that buys and sells goods in the same form purchased. The term
“merchandise inventory” is generally applied to goods held by trading concern.

Manufacturing concern is one that buys goods which are altered or converted into another form
before they are made available for sale. The terms “finished goods”, “goods in process”, “raw

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 DON HONORIO VENTURA STATE UNIVERSITY
COLLEGE OF BUSINESS STUDIES
Bacolor, Pampanga

materials”, and “factory of manufacturing supplies” refer to inventories of manufacturing concern.

➢ Finished goods are completed products which are ready for sale.
➢ Goods in process or work in process are partially completed products which require further
process or work before they can be sold.
➢ Raw materials are goods that are to be used in the production process. No work or process
has been done on them as yet by the company inventorying them.
➢ Factory of manufacturing supplies are similar to raw materials but their relationship to the
end-product is indirect. These supplies may be referred to as indirect materials.

GOOD INCLUDIBLE IN INVENTORY

As a rule, all goods to which the company has title should be included in the inventory, regardless of
the location. Where title has already passed from the seller to the buyer, the goods form part of the
inventory of the latter.

The phrase “passing of title” is a legal language which means “the point in time at which the
ownership changes.

Therefore, the legal test is as follows: Is the company the owner of the goods to be inventoried? If
the answer is in the affirmative, the goods should be included in the inventory. If the answer is in
the negative, the goods should be included 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 salesmen or agents
f. Goods held by customers on approval or on trial

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 the installment basis are still 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 involving deferred income on the part of the seller and as a regular purchase on the
part of the buyer. Thus, the good 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.

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COLLEGE OF BUSINESS STUDIES
Bacolor, Pampanga

WHO IS THE OWNER OF THE GOODS IN TRANSIT

This will depend on the terms, whether FOB destination or FOB shipping point. FOB means Free on
Board.

Under the FOB shipping point, ownership of the goods is transferred upon shipment of the goods
and therefore, the goods in transit are the property of the buyer. It means that the title of the
ownership passes to the buyer as soon as seller as deliver the goods to the buyer.
.
Under the FOB destination, ownership of the goods purchased is transferred upon receipt of the
goods by the buyer at the point of the destination. Therefore, the seller is liable for the freight and is
still considered the owner of goods until it reaches the buyer.

The accountant should carefully analyze the invoice terms of the goods that are in transit at the end
of the accounting period to determine who has legal title.

Accordingly, adjustments are in order if errors are committed in recording purchases and sales.

The term Freight Collect means that the freight charge on the goods shipped is not yet paid. The
common carrier shall collect the same from the buyer. Thus, under this, the freight charge is
actually paid by the buyer.

The term freight prepaid means that the freight charge on the good shipped is already paid by the
seller.

CONSIGNED GOODS

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 in the owner’s
behalf.

Consigned goods should be included in the consignor’s inventory and excluded from the
consignee’s inventory.

Freight and other handling charges on the goods out on consignment are part of the cost of goods
consigned.

Consigned goods are recorded by the consignor by means of memorandum entry.

STATEMENT PRESENTATION

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COLLEGE OF BUSINESS STUDIES
Bacolor, Pampanga

Inventories are generally classified as Current Assets

The inventories shall be presented as one line item in the statement of financial position but the
details of inventories shall be disclosed in the motes to financial statements.

ACCOUNTING FOR INVENTORIES

The two accounting systems offered for accounting inventories are:

The periodic system which calls for the physical counting of the 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 the balance sheet purposes. This approach gives actual or
physical inventories.

On the other hand, the perpetual system requires the maintenance of records called stock cards
that usually

Trade Discounts and Cash Discounts

Trade discounts are deductions from the list or catalog price in order to arrive at the invoice price
which is the amount actually charged to the buyer.

Cash discounts are the deductions from the invoice price when payment is made within the
discount period.

Comparing Periodic and Perpetual Inventory System:

Periodic Perpetual

1. Upon Purchase of Goods Purchases Merchandise Inventory

Cash or Accounts Payable Cash or Accounts

Payable

2. Upon paying Freight ( borne Freight In Merchandise Inventory

by buyer)
Cash or Accounts Payable Cash or Accounts Payable

3. Upon Purchase Returns and Cash or Accounts Payable Cash ot Accounts Payable
Allowances
Purchase Returns and Merchandise Inventory
Allowances

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COLLEGE OF BUSINESS STUDIES
Bacolor, Pampanga

4. Upon Purchase Discount Cash or Accounts Payable Cash or Accounts Payable

Purchase Discount Merchandise Inventory

5. Upon Sales Cash or Accounts Receivable Cash or Accounts Receivable

Sales Sales

Cost of Goods Sold

Merchandise Inventory

6. Upon Sales Returns Sales Returns and Allowances Sales Returns and Allowances

Cash or Accounts Cash or Accounts

Receivable Receivable

7. Upon Sales Discounts Cash Cash

Sales Discounts Sales Discounts

Accounts Receivable Accounts Receivable

8. Upon paying Freight (borne Freight Out Freight Out

by Seller)
Cash Cash

MEASUREMENT of INVENTORY

The following are principles concerning measurement of inventory:

• Inventories shall be measured at the lower of cost or net realizable value.

• The cost of inventories shall be determined by using either the FIFO method or weighted
average method.

The cost of inventories that are not ordinarily interchangeable and the inventories that are
segregated for specific projects shall be determined by using specific identification method

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COLLEGE OF BUSINESS STUDIES
Bacolor, Pampanga

Cost of Inventories

The cost of inventories shall comprise:

➢ Cost of Purchase
➢ Cost of Conversion
➢ Other cost incurred in bringing the inventories to their present location

a. Cost of purchase -Comprises the purchase price, import duties and 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 in determining the cost of purchase.

b. Cost of Conversion - Includes cost directly related to the units of production such as direct labor.
It also includes a systematic allocation of fixed and variable production overhead that is incurred
in converting materials into finished goods.

c. Other cost - Other Cost is included in the cost of inventories only to the extent that it is incurred
in bringing the inventories to their present location and condition

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COLLEGE OF BUSINESS STUDIES
Bacolor, Pampanga

Methods of recording purchases

1. Gross Method- purchases and accounts payable are recorded at gross

2. Net Method- Purchases and accounts payable are recorded at net

Transactions Gross Method Net Method

1. Purchases on account P Purchases P 200,000 Purchases P 196,000

200,000, 2/10, n/30
Accounts Payable P 200,000 Accounts Payable P 196,000

2. Assume payment is made Accounts Payable 200,000 Accounts Payable P 196,000

within the discount period
Cash Cash P 196,000
196,000

Purchase Disc. 4,000

2. Assume payment is Accounts Payable 200,000 Accounts Payable 196,000

made beyond the
discount period Cash Purchase Disc. Lost 4,000
200,000
Cash 200,000

Note: Purchase Discount Lost is classified as other expense.

REFERENCES:

Millan, Zeus Vernon. (2022). Intermediate Accounting 1A. Baguio City: Bandolin Enterprise

Valix Conrado T & Valix Christian Aris M. (2022). Intermediate Accounting. Manila: GIC
Enterprises & Co. Inc.

CPAR, RESA, ICARE Review Materials in Intermediate Accounting or Financial Accounting

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 DON HONORIO VENTURA STATE UNIVERSITY
COLLEGE OF BUSINESS STUDIES
Bacolor, Pampanga

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