INVENTORIES

PAS 2
Inventories 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 in the
rendering of services.
Cost of Inventories
> Costs of purchase
> Costs of conversion
> Other costs incurred in bringing the
inventories to their present location and
condition.
Costs of Purchase
> The costs of purchase of inventories comprise
the purchase price, import duties and other
non recoverable taxes 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.
Costs of Conversion
> Direct labor
> Variable production overhead is allocated
to each unit using the actual use of
production facilities.
> Fix production overhead allocated using
the normal operating capacity of production
facilities.
Other Costs

> Other costs are included in the cost of

inventories only to the extent that they are
incurred in bringing the inventories to their
present location and condition. For example, it
may be appropriate to include non-production
overheads or the costs of designing products
for specific customers in the cost of
inventories.
Inventory cost should exclude:
1. Abnormal waste of wasted materials,
labor and other production costs

2. Storage costs, unless necessary in the

production process prior to a further
production stage. Thus, the storage cost
on goods in process are capitalized but
storage cost on finished goods are
expensed.
Inventory cost should exclude:

3. Administrative overheads unrelated to

production

4.Selling or distribution costs

Cost Formulas

PAS 2, paragraph 25, expressly provides that the cost of

inventories shall be determined by using either:
a. First in, First Out
b. Weighted Average

The standard does not permit anymore the use of the last in, first
out (LIFO) as an alternative formula in measuring cost of
inventories.
Specific Identification

➢ Means that specific costs are attributed to

identified items of inventory.
➢ The cost of inventory is determined by simply
multiplying the units on hand by the actual
unit cost.
➢ PAS 2, paragraph 9, provides that this
method is appropriate for inventories that are
segregated for a specific project and
inventories that are not ordinarily
interchangeable.
FIFO

➢ The rule is first come, first sold.

> The inventory is expressed in terms of

recent or new prices while the COGS is
representative of earlier or old prices.
Weighted Average

> The cost of beginning inventory plus the

total cost of purchases during the period is
divided by the total units purchased plus those
in the beginning inventory to get a weighted
average unit cost. The weighted average unit
cost is then multiplied by the units on hand to
derive the inventory value.
> The inventory approximates current value if
there is a rapid turnover of inventory.
LIFO

> The rue is last purchased, first sold.

> The inventory is expressed in terms of
earlier or old prices while the COGS is
representative of recent or new prices.
Measurement of Inventories
> Inventories are required to be stated at the
lower of cost and net realizable value
(LCNRV). Inventories are usually written down
to net realizable value item by item. (Par. 9,
PAS 2)
> In some circumstances, however, it may be
appropriate to group similar or related items.
NRV

> Net realizable value is the estimated selling

price in the ordinary course of business less
the selling cost (completion and disposal).
> Inventories are usually written down to NRV
on individual basis.
> Inventories are usually written down to NRV
using allowance method.
The cost of the inventories may not be recoverable
under the following circumstances:

1.The inventories are damaged

2.The inventories have become wholly or partially
obsolete.
3.The selling prices have been declined.
4.The estimated cost of completion or the estimated cost
of disposal has increased.
Accounting for Inventory Writedown

If the cost is lower than the net realizable value, there is no

accounting problem because the inventory is stated at cost and
the increase in value is not recognized.

If the net realizable value is lower that cost, the inventory is

measured at net realizable value.

In this case the, the problem is the proper treatment of the

writedown of the inventory to net realizable value.

The writedown of inventory to net realizable value is accounted

for using the allowance method.
Allowance Method

> The inventory is recorded at cost and any

loss on inventory writedown is accounted for
separately.
> AKA loss method because a loss account is
debited, and a valuation account is credited:
Dr. Loss on inventory writedown xxx
Cr. Allowance for inventory writedown xxx
➢ Subsequently, this allowance/valuation
account is adjusted up or down depending on
the difference between cost and NRV of the
inventory at year-end.
➢ If the required allowance increases, an
additional loss is recognized
➢ If the required allowance decreases, a gain
on reversal of inventory writedown is
recorded
References:

Valix, C., Peralta, J., Valix, C.A. (2020). Intermediate Accounting

Volume 3. Manila City, Phils. GIC Enterprises & Co., Inc.

Valix, C., Peralta, J., Valix, C.A. (2020). Conceptual Framework and
Accounting Standards. Manila City, Phils. GIC Enterprises & Co.,
Inc.
Which goods do we include in our
inventory?

General Rule: Legal Title – ownership, control, not

necessarily physical possession

1. Goods owned and on hand – (store, warehouse)

2. Goods in transit – goods not yet received
FOB Shipping Pt. FOB Destination
Buyer included x
Seller x included
3. Consigned Goods - consignor, consignee
Accounting Inventory Systems:

Periodic - small peso items; high volume (SM, National

Bookstore)
- physical count every Dec 31 to determine the
ending inventory
- (total purchases – ending inventory = Cost of
Sales)
Perpetual – large peso items; low volume transactions
(Toyota Dealer – Fortuner, Vios, Innova)
- monitor (purchase, sale)
- stockcard; computers (running balance of the
inventory