INTERMEDIATE ACCOUNTING 1

CHAPTER 10 – LOWER OF COST AND NET REALIZABLE VALUE

INVENTORY VALUATION
Under PAS 2, paragraph 9, provides that inventories shall be measured at the lower
of cost and net realizable value (LCNRV).

NET REALIZABLE VALUE

The NRV is computed as follows:

Selling Price XX
Less:
Estimated Cost of Completion (XX)
Estimated Cost of Disposal (XX)
Net Realizable Value XX

WRITING DOWN OF INVENTORIES

This is consistent with the view that assets shall not be carried in excess of
amounts expected to be realized from their sale or use.

INSTANCES THAT THE COST OF INVENTORIES MAY NOT BE FULLY RECOVERABLE

The following circumstances may indicate that inventories may not be fully
recoverable:
1. Inventories were damaged.
2. Inventories were wholly or partially damaged.
3. Selling Prices have declined.
4. Estimated cost of completion or the estimated cost of disposal has increased.

DETERMINATION OF NET REALIZABLE VALUE

Inventories are usually written down to NRV on an “item by item or individual
basis”.

WRITE DOWN OF MATERIALS HELD FOR USE IN PRODUCTION

NOT TO BE WRITTEN DOWN BELOW COST
If the finished goods are expected to be sold at or above cost.

TO BE WRITTEN DOWN BELOW COST

If the cost of the finished goods are expected to be sold below NRV or below
cost.

METHODS OF ACCOUNTING FOR THE INVENTORY WRITEDOWN

DIRECT METHOD
This method is also known as “cost of goods sold method” because any loss on
inventory writedown or gain on reversal of inventory writedown is not accounted
for separately but “buried” in the cost of goods sold.

ALLOWANCE METHOD
The inventory is recorded at “cost” and any loss on inventory writedown is
accounted for separately.

This method is also known as “loss method”. Any loss is debited to an account
“loss on inventory writedown” and “allowance for inventory writedown” is credited.

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 JOURNAL ENTRY TO RECOGNIZE INVENTORY WRITEDOWN
DEBIT CREDIT
LOSS ON INVENTORY WRITEDOWN XX
ALLOWANCE FOR INVENTORY WRITEDOWN XX

REQUIRED ALLOWANCE INCREASES

Additional loss is recognized.

REQUIRED ALLOWANCE DECREASES

A gain on reversal of inventory writedown is recorded.
DEBIT CREDIT
ALLOWANCE FOR INVENTORY WRITEDOWN XX
GAIN ON REVERSAL INVENTORY WRITEDOWN XX

The gain is only limited to the extent of the allowance balance.

PAS 2 REQUIREMENT
Under paragraph 36, it requires disclosure of the amount of any inventory writedown
and the amount of any reversal of inventory writedown.

Preferably, the allowance method is used in order that the effects of writedown
and reversal of writedown can be clearly identified.

Under paragraph 34, it provides that the amount of any reversal of any writedown
of inventory arising from an increase in net realizable value shall be recognized
as a reduction in the amount of inventory recognized as an expense (cost of goods
sold) in the period in which the reversal occurs.

EXERCISE

ABC Company disclosed the following information related to its inventory for 2022
and 2023.

2022 2023
Cost of Sales P 10,000,000 P 11,000,000

Inventory COST NRV

December 31, 2022 P 8,000,000 P 7,850,000
December 31, 2023 P 8,500,000 P 8,400,000

Required:

1. How much shall the ending inventory of 2022 be recorded?

2. Prepare the necessary journal entry in 2022 under the DIRECT METHOD.

3. Prepare the necessary journal entry in 2022 under the ALLOWANCE METHOD.

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 4. Compute the adjusted cost of sales in 2022.

5. Compute the required allowance for inventory writedown in 2023.

6. Compute the increase or decrease of the required allowance for inventory

writedown in 2023.

7. Prepare the necessary journal entry in 2023 under the DIRECT METHOD.

8. Prepare the necessary journal entry in 2023 under the ALLOWANCE METHOD.

EXERCISE

DEF Company provided the following information related to its inventory in 2022:

Inventory – January 1:
Cost P 2,500,000
Net Realizable Value P 2,250,000

Net Purchases P 10,000,000

Inventory – December 31:

Cos P 3,000,000
Net Realizable Value P 2,650,000

Required:

1. Under the direct method, compute the cost of goods sold.

2. Under the Allowance method, compute the increase or decrease of the required
allowance for inventory writedown.

3. Under the Allowance Method, compute the adjusted cost of goods sold.

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 EXERCISE

DEF Company provided the following information for inventory valuation purposes on
December 31, 2022.
CATEGORY 1 COST NRV
A P 300,000 P 280,000
B P 500,000 P 550,000
C P 400,000 P 430,000
TOTAL P 1,200,000 P 1,260,000

CATEGORY 2 COST NRV

D P 700,000 P 680,000
E P 250,000 P 270,000
F P 300,000 P 320,000
TOTAL P 1,250,000 P 1,270,000

Required:

1. Compute the LCNRV by item or individual.

2. Compute the LCNRV by category.

3. Compute the LCNRV by total.

4. Compute the inventory writedown.

5. Under the Direct Method, prepare the necessary journal entry.

6. Under the Allowance Method, prepare the necessary journal entry.

7. If in 2023, the company had net purchases of P 5,000,000 and had an ending
inventory with total cost of P 2,300,000 and NRV of P 2,280,000. Under the
direct method:

a. Compute the Cost of Goods Sold.

b. Prepare the necessary journal entry in 2023.

8. If in 2023, the company had net purchases of P 5,000,000 and had an ending
inventory with total cost of P 2,300,000 and NRV of P 2,280,000. Under the
Allowance Method:

a. Compute the Cost of Goods Sold.

b. Prepare the necessary journal entry in 2023.

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PURCHASE COMMITMENTS
These are obligations of the entity to acquire certain goods sometime in the future
at a “fixed price” and “fixed quantity”.

The purchase contract has been already made for future delivery of goods fixed in
price and in quantity.

If at the end of the reporting period, the purchase price falls below the agreed
price, the difference is accounted for as a loss.

The purchase commitment must be noncancelable in order that a loss can be

recognized.

JOURNAL ENTRY TO RECOGNIZE THE LOSS

DEBIT CREDIT
Loss on Purchase Commitment XX
Estimated Liability for Purchase Commitment

EXERCISE

On December 1, 2022, XYZ Company entered into a noncancelable purchase commitment

to buy inventory from ABC Company and is scheduled to be executed on January 10,
2023. The contract price was at P 500,000. On December 31, 2022, the replacement
cost was at P 450,000. On January 10, 2021, the replacement cost furtherly declined
to P 420,000.

Required:

1. Compute the loss on purchase commitment to be recognized in 2022.

2. Prepare the journal entry to recognize the loss in 2022.

3. Compute the loss on purchase commitment to be recognized in 2023.

4. Prepare the necessary journal entry on January 10, 2023.

Source:
Intermediate Accounting Volume 1, Valix, Peralta, Valix

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