CHAPTER 8: RECEIVABLE FINANCING
RECEIVABLE FINANCING – financial capability of
the business to raise money out of its receivables
FORMS OF RECEIVABLE FINANCING
a. Pledge
b. Assignment
c. Factoring
d. Discounting
PLEDGE OF ACCOUNTS RECEIVABLE
- Accounts receivable may be pledged as
security for the payment of loan
- Loan is recorded by debiting note payable
and crediting cash
Illustration: On Nov. 1, 2021, an entity borrowed a
P1M from PNB and issued a promissory note. The
term is 1 year and discounted at 12%. The entity
pledged A/R of P2M to secure the loan.
Journal Entry:
Cash
Discount on N/R
Notes Rec.
Nov. 1 N/P – Bank 1,000,000
Cash
1,000,000
Interest Income
100,000
Discount on N/P
100,000
ASSIGNMENT OF ACCOUNTS RECEIVABLE
- A borrower called the assignor to transfer
rights in some A/R to a lender called the
assignee
- When accounts are assigned on nonnotification basis, they aren’t informed
(customers continue to make payments to
the assignor)
- Notification Basis: Customers are notified to
make payments directly to the assignee
- Assignee usually charge interest and
requires service charge
Illustration: (NON-NOTIFICATION)
April
1 – Assigned P700K of A/R under non-notification.
The bank advances 80% less a service charge of
P5K. Promissory note and 1% interest per month
880,000
120,000
1,000,000
STATEMENT PRESENTATION
A/R – Assigned
A/R
700,000
700,000
On Dec. 31, 2021, the discount on note payable is
amortized as interest in two months
Cash
555,000
Service Charge
5,000
Notes Payable
Interest Expense
20,000
Discount on N/P
(120,000 x 2/12)
5 – credit memo for sales return to a customer
account assigned, P20,000
Presented as Current Liability:
Note Payable – Bank
Discount on N/P
Carrying Amount
-
20,000
1,000,000
(100,000)
900,000
Note to financial statement for pledging of
A/R
Journal Entry: (Side of Borrower)
2022
Sales Return
20,000
A/R – Assigned
560,000
20,000
10 – collect 300K of the assigned accounts less 2%
discount
Cash
Sales Discount
294,000
6,000
A/R – Assigned
300,000
30 – remitted total collections to the bank plus
interest for one month
N/P – Assigned
Int. Expense
Cash
294,000
5,600
299,600
May
7 – Assigned accounts of P15k proved worthless
Allowance for D/A
15,000
A/R – Assigned
15,000
20 – collect P300k of the assigned notes
Cash
300,000
A/R – Assigned
300,000
30 – remitted total amount due to bank plus interest
of one month
Cash
266,000
Interest Expense
2,660
N/P – Assigned
268,660
Jul. 1 A/R – Assigned
A/R
Cash
Service Charge
N/P
1,000,000
1,000,000
760,000
40,000
800,000
31- Receive notice from bank that P600k was
collected less 2% discount. Check was sent for
interest due.
Jul. 31 N/P
588,000
Sales Discount
12,000
A/R – Assigned
600,000
Interest Expense
Cash
8,000
8,000
August
31 – 300k of assigned were collected. Final
settlement was made together with uncollected
assigned accounts of 100k
Aug. 31Cash
85,880
Interest Expense
2,120
N/P – Bank
212,000
A/R – Assigned
300,000
Transfer remaining A/R
A/R
Total A/R Assigned
Less: Collections
Sales Discount
Sales Return
Worthless Account
Balance
A/R
65,000
A/R – Assigned
700,000
(594,000)
(6,000)
(20,000)
(15,000)
65,000
100,000
A/R – Assigned
100,000
Computation:
Loan from Bank
Less: July Collection
Balance Due
800,000
588,000
212,000
August Collection
Less: Loan Bal
Excess Collection
Less: Interest
Remittance from Bank
300,000
212,000
88,000
2,120
85,880
Statement Presentation:
A/R – Unassigned
4,000,000
65,000
Illustration: (NOTIFICATION)
July
1 – Assigned P1M of A/R. Banks loans 80% less 4%
charge. Signed promissory note and 1% interest per
month on unpaid loan balance
A/R – Assigned
ADA
N/P – Bank
1,000,000
100,000
400,000
A/R – Unassigned
A/R – Assigned
Total
ADA
Net Realizable Value
4,000,000
1,000,000
5,000,000
(100,000)
4,900,000
Equity in Assigned Accounts:
A/R – Assigned
Note Payable – Bank
Equity in Assigned Accounts
1,000,000
(400,000)
600,000
FACTORING
- Sale of A/R without a recourse, notification
basis
- Gain or loss is recognized for difference
between the proceeds and net carrying
amount of A/R
- Actually transfers ownership of A/R to the
factor
Casual Factoring – forced to factor it’s A/R at a
substantial discount to a bank to obtain much
needed cash
Example: Factored 100k of A/R with an ADA of
5,000 for 80k
Entry:
Cash
ADA
Loss on Factoring
A/R
Entry:
Cash
Sales Discount
Commission
Rec. from Factor
A/R
80,000
5,000
15,000
365,000
10,000
25,000
100,000
Computation:
Gross Amount
Less: Sales Discount
Commission
Factor’s holdback
Cash Received
500,000
500,000
10,000
25,000
100,000
365,000
Customer allowed credit of P50k for damaged
merchandise
Entry:
Sales return and allowances 50,000
Sales Discount
1,000
Rec. from Factor
49,000
All factors are collected with no further returns and
allowances
Entry:
Cash
51,000
Rec. from Factor
(100,000 – 49,000)
51,000
100,000
Factoring as a Continuing Agreement
- Factor may involve continuing agreement
where finance entity purchase all A/R of an
entity
- For compensation, factors usually charges a
commission of 5% to 20% for its service of
credit approval
Illustration:
Factored A/R of 500k with credit terms of 2/10, n/30.
The factor charged 5% commission based on gross
amount. The factor withheld 20% of A/R factored to
cover sales return and allowances.
Another Illustration:
Factored P3M of A/R. The factor of A/R subject to
recourse for nonpayment. Fair value is P100k. The
factor assessed a fee of 6% and retained holdback
equal to 10%. 12% charged interest on a weighted
average time to maturity of 50 days.
Computation:
A/R
Factor’s Holdback
Factoring Fee
3,000,000
(300,000)
(180,000)
Interest (3M x 12% x 50/365)
Cash Received
(49,315)
2,470,685
Credit card sales of P200,000. Minus a service
charge of 3%.
Factoring Fee
Interest
Recourse Obligation
Total Loss
180,000
49,315
100,000
329,315
Entries:
A/R – Diner’s Club
Sales
200,000
200,000
Cash
Service Charge
A/R – Diner’s Club
194,000
6,000
200,000
Journal Entry:
Cash
2,470,365
Due from Factor
300,000
Factoring Fee
180,000
Interest Exp.
49,315
Recourse Obligation 100,000
A/R
Recourse Liability
Another Illustration:
Factoring of Accounts Receivable
Credit card sale of P200k with a 5% service charge
3,000,000
100,000
Reverse Recourse Obligation assuming accounts
are fully collected
Recourse Liability
100,000
Loss on Recourse Obligation 100,000
Collect factor’s holdback
Cash
300,000
Due from Factor
300,000
Assuming Accounts aren’t Collected
Settle Recourse Obligation
Recourse Liability
100,000
Cash
100,000
Collect factor’s holdback
Cash
300,000
Due from Factor
300,000
CREDIT CARD
- Allows holder to obtain credit up to a
predetermined limit from the issuer of the
card
- Two entries are necessary: one entry at the
time of the sale and another entry when
payment is received from the card issuer
Illustration:
Entry:
Cash
Service Charge
Sales
190,000
10,000
200,000
CHAPTER 9: RECEIVABLE FINANCING
DISCOUNTING OF NOTE RECEIVABLE
- Payee may obtain cash before maturity date
by discounting the note at a bank
Endorsement
- Transfer of right to a negotiable instrument
by signing at the back of the instrument
- Legal parlance: secondary liability
- Accounting parlance: contingent liability
Terms Related to Discounting of Note
1. Net Proceeds – discounted value of the note
received (Maturity – Discount)
2. Maturity value – amount due on the note
(principal + interest)
3. Maturity date – note should be paid
4. Principal – face value
5. Interest – principal x rate x time
6. Interest rate – rate on face of the note
7. Time – period when interest shall accrue
8. Discount – interest deducted by the bank in
advance (maturity value x discount rate x
discount period)
9. Discount rate – if no discount rate is given,
the interest rate is assumed to be it
10. Discount period – date of discounting to
maturity date
Illustration – Discounting without Recourse
P1M, 180-day, 12% note dated July 1,
discounted without recourse on Aug. 30 at 15%
discount rate
Computation:
Principal
1,000,000
Add: Interest (1M x 12% x 180/360) 60,000
Maturity Date
1,060,000
Maturity Value
Multiply:
Discount rate
Discount Period (180 – 60)
Discount
Net Proceeds from Discounting
Maturity Value
Less: Discount
Net Proceeds
Carrying Amount of the N/R
Principal
Add: Accrued Interest
(1,000,000 x 0.12 x 60/360)
Carrying Amount
1,060,000
53,000
1,007,000
1,000,000
20,000
1,020,000
Gain or Loss on Note Discounting
Net Proceeds
1,007,000
Less: Carrying Amount
1,020,000
Loss on Discounting
13,000
ACCOUNTING FOR N/R DISCOUNTING
Journal Entry:
Cash
1,007,000
Loss on N/R Disc.
13,000
Note Receivable
1,000,000
Interest Income
20,000
-
Note receivable is credited directly because
the sale of the note is without recourse.
Interest income is credited on the date of
discounting.
Illustration:
P2.4M, 6 month, 12% note dated Feb. 1,
discounted on Mar. 1 at 15%
Principal
Add: Interest
Maturity Value
Multiply:
Discount
Maturity Value
Less: Discount
Net Proceeds
2,400,000
144,000
2,144,000
0.15 x 5/12
159,000
2,144,000
159,000
2,385,000
Interest (P2.4M x 12% x 1/12)
24,000
Principal
Add: Accrued Interest
2,400,000
24,000
1,060,000
0.15
120/360
53,000
Carrying Amount
2,424,000
Net proceeds
Less: Carrying Amount
Loss on N/R Discount
2,385,000
2,424,000
39,000
Interest Income
-
24,000
No gain or loss on discounting if secured
borrowing
NOTE IS PAID BY MAKER ON MATURITY
CONDITIONAL SALE
- If it is conditional, contingent liability is
recognized on Mar. 1
Entry:
Cash (Net Proceeds)
Loss on N/R Discount
N/R Discounted
Interest Income
Entry:
Liability for N/R Disc.
Note Receivable
NOTE IS DISHONORED BY MAKER
- Dishonored on Aug. 1, maturity value of
2,544,000 plus protest fee and other bank
charges of P6,000
2,385,000
39,000
2,400,000
24,000
Entry:
3. Payment of First Bank
A/R
2,550,000
Cash
2,550,000
NOTE IS PAID BY MAKER ON MATURITY
- Aug. 1, paid by maker, contingent liability is
simply extinguished
Entry:
N/R Discounted
Note Receivable
4. Derecognized the liability
Liability for N/R Disc. 2,400,000
Note Receivable
2,400,000
2,400,000
2,400,000
NOTE IS DISHONORED BY MAKER
- Dishonored on Aug. 1, maturity value of
2,544,000 plus protest fee and other bank
charges of P6,000
Entry:
1. Payment of First Bank
A/R
2,550,000
Cash
2,550,000
2. Cancel Contingent Liability
N/R Discounted
2,400,000
Note Receivable
2,400,000
SECURED BORROWING
- Note receivable is not derecognized but
instead an accounting liability, recorded at
an amount equal to the face amount of N/R
discounted
Entry:
Cash
2,385,000
Interest Expense
39,000
Liability for N/R Disc.
2,400,000
2,400,000
2,400,000
CONDITIONAL
BORROWING
SALE
OR
SECURED
CHAPTER 10: INVENTORIES
INVENTORIES – assets 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
-
-
It encompass goods purchased and held for
resale such as:
o Merchandise purchased by retailer
o Land and other property held for resale
It also encompass finished goods produced,
goods in process and materials and supplies
awaiting use in the production process
Classes of Inventories
- Classified into inventories of a trading
concern and inventories of manufacturing
concern
-
-
Trading Concern (buys and sells goods in
the same form purchased – merchandise
inventory)
Manufacturing Concern (one that buys
goods which are converted into other form)
o Consists of finished goods, goods in
process, raw materials, factory or
manufacturing supplies
Definitions
- Finished Goods (completed products
ready for sale)
- Goods in Process (partially completed
products which require further process
before they can be sold)
- Raw Materials (goods to be used in the
production process)
o Frequently raw materials are
restricted to materials that will be
physically incorporated in the
production of other goods
- Factory or Manufacturing Supplies
(relationship to end product is indirect)
o Indirect materials, not physically
incorporated in products, part of
manufacturing overhead
Goods includible in the Inventory
- All goods to which the entity has title shall be
included in the inventory, regardless of
location
- Passing of Title (legal language which
means the point of time at which ownership
changes)
o
o
Exception to the Legal Test
- Installment contracts may provide retention
of title by seller until the selling price is fully
collected.
- Goods sold on installment are still property
of the seller, and normally included in the
inventory
- Goods sold on installment are included in
the inventory of the buyer.
Who is the owner of goods in transit?
- FOB Destination (ownership of goods are
transferred upon receipt of goods by buyer
at the point of destination)
o Goods in transit are still property of
the seller
o Legally responsible of freight charge
- FOB Shipping Point (ownership are
transferred upon shipment of goods
o Goods in transit are property of the
buyer (responsible for freight
charges)
Freight Terms
- Freight Collect (freight charge on the goods
shipped is not yet paid)
o Charge is paid by buyer
- Freight Prepaid
o Freight charge on the goods are
already paid by the buyer
-
Legal Test
- Items included in the inventory:
o Goods owned and on hand
o Goods in transit and sold FOB
Destination
o Goods in transit and purchased FOB
Shipping Point
o Goods out on consignment to
consignee
Goods in the hands of salesmen or
agents
Goods held by customers on
approval or on trial
-
FOB Destination and Shipping Point
determines ownership of the goods in
transit, and party who is supposed to pay
Freight Collect and Prepaid determines the
party who actually paid the freight charge
Maritime Shipping Terms
- FAS or Free Alongside (seller bear all
expenses and risks involve in delivering the
goods to the dock next to the vessel on
which goods are to be shipped)
o
Buyer bears cost of loading and
shipment, title passes to the buyer
when carrier takes possession of the
goods
CIF or Cost, Insurance and Freight (buyer
agrees to pay in a lump sum the cost of
goods, insurance, and freight charge)
o In either case, the seller must pay for
the cost of loading, title and risk of
loss shall pass to the buyer
Ex-ship (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
running summary of inventory inflow and
outflow)
o Resulting balance represent the
inventory
o Book or perpetual inventories
o Commonly
treated
individually
represent or relatively large peso
investment such as jewelry and cars
o Stock cards are used to control both
units and costs
o Physical count of units on hand
should at least be made once a year
to confirm balance appearing on
stock cards
Consigned Goods
- Consignment (owner called the consignor
transfer physical possession of certain
goods to an agent called consignee who
sells them on the owner’s behalf)
o Consigned goods shall be included
in the consignor’s inventory
o Freight and other handling charges
on goods are part of the cost of
goods consigned
Illustration – Periodic System
1. Purchase of merchandise on account,
P300k
Purchases
300,000
A/P
300,000
-
-
-
Example: Consignee sells goods for P100k.
amount is remitted to consignor less
commission of P15k, and advertising of P2k
Entry:
Cash
83,000
Commission
15,000
Advertising
2,000
Sales
100,000
Accounting for Inventories
- Periodic System (physical counting of the
goods on hand at end of accounting period)
o Quantities are multiplied by unit
costs to get inventory value for
balance sheet purpose
o Generally use on small peso
investment such as groceries,
hardware and auto-parts
o Actual or physical inventories
- Perpetual System (maintenance of records
called stock cards that usually offer a
2. Payment of freight, P20k
Freight In
20,000
Cash
20,000
3. Return of merchandise, P30k
A/P
30,000
Purchase returns
30,000
4. Sale of merchandise on account, P400k at
40% gross profit
A/R
400,000
Sales
400,000
5. Return of merch sold from customer, P25k
Sales return
25,000
A/R
25,000
6. Adjustment of ending inventory, P65k
Inventory - End
65,000
Income Summary
65,000
Illustration – Perpetual System
1. Purchase of merchandise on account,
P300k
Merch. Inv.
300,000
A/P
300,000
2. Payment of freight, P20k
Merch. Inv.
20,000
Cash
20,000
3. Return of merchandise, P30k
A/P
30,000
Merch. Inv.
30,000
4. Sale of merchandise on account, P400k at
40% gross profit
A/R
400,000
Sales
400,000
COGS
Mer. Inv.
240,000
240,000
5. Return of merch sold from customer, P25k
Sales Return
25,000
A/R
25,000
Merch. Inv.
COGS
15,000
15,000
6. Adjustment of ending inventory, P65k
Inventory Shortage or Overage
- In the illustration, the merch inv account has
debit balance of P65k, if at the end of the
accounting period, a physical count
indicates a different amount, an adjustment
is necessary to recognize any inventory
shortage or overage. For example, the
physical count shows inventory on hand of
P55k.
Entry:
Inventory Shortage
Merch. Inv.
10,000
10,000
Trade Discounts and Cash Discounts
- Trade Discounts (deductions from list or
catalog price in order to arrive at the invoice
price which actually charged to the buyer)
o not recorded
o encourage increase sales
-
Cash Discounts (deductions from invoice
price when payment is made within the
discount period)
o Recorded as purchase discount
o Deducted from purchases to arrive at
net purchases and sales discount
from sales to arrive at net sales
revenue
Illustration:
List price of merch purchased is P500k less 20%
and 10% with credit terms of 5/10, n/30
List Price
First Trade Discount
Second Trade Discount
Invoice Price
Cash Discount
Payment (Discount Period)
Entry:
Purchases
A/P
500,000
(100,000)
400,000
(40,000)
360,000
(18,000)
342,000
360,000
360,000
Payment within discount period entry:
A/P
360,000
Cash
342,000
Purchase Discount
18,000
Methods of Recording Purchases
- Gross Method (purchases and A/P are
recorded at gross amount)
- Net Method (purchases and A/P are
recorded at net amount)
Illustration – Gross Method
1. Purchase on account, P200k, 2/10, n/30
Purchases
200,000
A/P
200,000
2. Payment within discount period
A/P
200,000
Cash
196,000
Purchase Discount
4,000
3. Payment beyond discount period
A/P
Cash
200,000
200,000
Illustration – Net Method
1. Purchase on account, P200k, 2/10, n/30
Purchases
196,000
A/P
196,000
declining prices, it would result to lowest net
income
Illustration – FIFO
01/01
01/08
01/18
01/22
01/31
2. Payment within discount period
A/P
196,000
Cash
196,000
3. Payment beyond discount period
A/P
196,000
Purchase Discount Loss 4,000
Cash
200,000
4. No payment is made, discount period is
expired
Purchase Discount Loss 4,000
A/P
4,000
-
Bal.
Sale
Pur.
Sale
Pur.
Unit
800
Cost
200
Total
160k
700
210
147k
500
220
110k
Sales
500
800
Ending Inventory is 700 units.
FIFO – Periodic
Unit
01/18
01/31
Total
Pur.
Pur.
Cost
200
500
700
210
220
Total
42,000
110,000
152,000
Cost of Goods Sold
Inventory – Jan. 01
Purchases (147k + 110k)
Goods Available for Sale
Inventory – Jan. 31
Cost of Goods Sold
160,000
257,000
417,000
(152,000)
265,000
FIFO – Perpetual
Date
CHAPTER 11: INVENTORY COST FLOW
Cost Formulas
- PAS 2, Par. 25 – cost of inventories shall be
identified using either:
o First in, First out
o Weighted Average
FIRST IN, FIRST OUT (FIFO)
- Goods first purchased are first sold, goods
remaining in the inventory are most recently
purchased or produced
- Inventory is stated at current replacement
cost
- Objection in this method is that it is improper
matching of cost against revenue resulting
in understatement of cost of sales
- In period of inflation, FIFO method will result
to the highest net income, deflation or
Jan.
1
8
18
Purchases
#
P
Sales
=
700
210
147k
500
200
110k
22
31
Balance
#
P
=
500
200
100k
300
500
200
210
60k
105k
#
800
300
300
700
P
200
200
200
210
=
160k
60k
60k
147k
200
200
500
210
210
220
42k
42k
110k
Nota Bene
- Under FIFO periodic and perpetual, the
inventory costs is same. The costs of good
sold is determined from the stock card as
follows:
Jan. 8
Sale
100,000
22
Sale (60k + 105k) 165,000
Costs of Goods Sold
265,000
Weighted Average – Periodic
Unit
01/01
01/18
Bal.
Pur.
Cost
800
700
200
210
Total
160,000
147,000
01/31
Pur.
Goods Available
500
2,000
220
110,000
417,000
Weighted Average Unit Cost (417k/2k)
208.5
Inventory Cost (700 x 208.5)
145,950
Date
Jan.
1
8
18
160,000
257,000
417,000
(145,950)
271,050
Weighted Average – Perpetual (Moving Average
Method)
- Keeping of inventory stock card in order to
monitor the moving unit cost after every
purchase
Jan
1
8
18
22
31
Total
Unit
Balance
Sale
Balance
Purchase
Total
Sale
Balance
Purchase
Cost
800
(500)
300
700
1000
(800)
200
500
700
200
200
200
210
207
207
207
220
216
Total
160,000
(100,000)
60,000
147,000
207,000
(165,600)
41,400
110,000
151,400
Cost of Goods Sold from the Stock Card
Jan. 8
Sale
100,000
Jan. 22
Sale
165,600
Cost of Goods Sold
265,600
700
210
147k
500
200
Balance
#
P
=
500
200
100k
700
100
210
200
147k
20k
110k
#
800
300
300
700
P
200
200
200
210
=
160k
60k
60k
147k
200
200
500
200
200
220
40k
40k
110k
Another Illustration
Balance
Purchase
Sale
Sale Return
Purchase
Pur. Return
Ending Bal.
Unit
5,000
5,000
(7,000)
1,000
16,000
(2,000)
18,000
Cost
200
250
Total
1,000,000
1,250,000
150
150
2,400,000
300,000
FIFO – whether periodic or perpetual
Jan
10
30
Purchase
Purchase
Unit
4,000
14,000
18,000
Cost
250
150
Total
1,000,000
2,100,000
3,100,00
Moving Average – Perpetual
Jan
1
10
15
30
31
Balance
Purchase
Balance
Sale
Balance
Sale Return
Balance
Purchase
Balance
Pur. Return
Balance
Unit
5,000
5,000
10,000
(7,000)
3,000
1,000
4,000
16,000
20,000
(2,000)
18,000
Cost
200
250
225
225
225
225
225
150
165
150
167
Total
1,000,000
1,250,000
2,250,000
(1,575,000)
675,000
225,000
900,000
2,400,000
3,300,000
(300,000)
3,000,000
Weighted Average – Periodic
LIFO – Periodic
Unit
From Jan. 1 Bal.
Cost
700
200
Total
140,000
Cost of goods sold under LIFO - periodic
Inventory – Jan. 1
Purchases
Goods Available for Sale
Inventory – Jan. 31
Cost of goods Sold
LIFO – Perpetual
=
Jan
1
10
15
16
30
31
16
LAST IN, FIRST OUT (LIFO)
- Goods last purchased are first sold, cost of
goods sold is representative of recent or
new prices
Sales
P
22
31
Costs of Goods Sold
Inventory – Jan. 1
Purchases
Goods available for sale
Inventory – Jan. 31
Cost of Goods Sold
Purchases
#
160,000
257,000
417,000
(140,000)
277,000
Jan
1
10
30
31
Balance
Purchase
Purchase
Pur. Return
Unit
5,000
5,000
16,000
(2,000)
24,000
Cost
Wei. Ave. Unit Cost (4.350M/24k)
Cost of End. Inv. (18k x 181.25)
200
250
150
150
Total
1,000,000
1,250,000
2,400,000
(300,000)
4,350,000
181.25
3,262,500
CHAPTER 12: LOWER OF COST AND NET
REALIZABLE VALUE
LOWER OF COST AND NET REALIZABLE
VALUE
- PAS 2, Par. 9, inventory shall be measured
at lower cost and net realizable value
Net Realizable Value
- Estimated selling price in the ordinary
course of business less estimated cost of
completion and estimated cost of disposal
- Cost of inventories may not be recoverable
under:
o Damaged
o Wholly or partially obsolete
o Selling price have declined
o Estimated cost of completion or
estimated cost of disposal has
increased
Determination of Net Realizable Value
- Inventories are usually written down on an
item by item or individual basis
- Materials held for use in production are not
written down below cost if the finished
product are expected to be sold at higher
cost
Accounting for Inventory Writedown
- If cost is lower than NRV, there is no
accounting problem because the increase in
value is not recognized
- If NRV is lower than cost, inventory is
measured at NRV, and decreased in value
is recognized
Methods of Accounting for the Inventory
Writedown
- Direct Method or COGS Method
- Allowance Method or Loss Method
Direct Method
- 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
- Any loss on inventory writedown is
accounted for separately. This method is
also known as ‘loss method’ because a loss
account “loss on inventory writedown” is
debited and a valuation account “allowance
for inventory writedown” is credited.
- If the required allowance decreases, a “gain
on reversal of inventory writedown” is
recorded.
- PAS 2, Par. 36, disclosure of amount of
inventory writedown and amount of reversal
of inventory writedown
Illustration – Inventory Data on Dec. 31, 2021
Cost
Categ. 1
A
B
C
Subtotal
Categ. 2
D
E
Subtotal
Categ. 3
F
G
Subtotal
Grand Total
NRV
110,000
690,000
600,000
1,400,000
100,000
750,000
640,000
1,490,000
100,000
690,000
600,000
2,000,000
1,500,000
3,500,000
1,900,000
1,560,000
3,460,000
1,900,000
1,500,000
1,500,000
1,600,000
3,100,000
8,000,000
1,460,000
1,690,000
3,150,000
8,100,000
1,460,000
1,600,000
LCNRV Item by Item
Categ. 1
Categ. 2
Categ. 3
By Category
LCNRV by Total
-
LCNRV
Cost
1,400,000
3,500,000
3,100,000
Cost
8,000,000
7,850,000
7,850,000
NRV
1,490,000
3,460,000
3,150,000
LCNRV
1,400,000
3,460,000
3,100,000
7,960,000
NRV
8,100,000
LCNRV
8,000,000
The inventory is measured at lower cost and
NRV applied on an item by item
Cost – Dec. 31
NRV
Inventory Writedown
8,000,000
(7,850,000)
150,000
Direct Method
- Inventory is recorded at lower of cost or NRV
- Loss on inventory writedown is not
accounted for separately
- Effect of increase in COGS because NRV is
lower than cost
Entry:
Inventory – Dec. 31
7,850,000
Income Summary
7,850,000
Gain on Rev. of Inv. WD
Allowance Method
- Inventory is recorded at cost
Entry:
Inventory – Dec. 31
8,000,000
Income Summary
8,000,000
-
Loss on inventory writedown is accounted
for separately
Entry:
Loss on inv. writedown
150,000
Allowance for inv. Writedown 150,000
50,000
Another Illustration
Inventory – Jan. 1
Cost
NRV
Net Purchases
Inventory – Dec. 31
Cost
NRV
5,000,000
4,500,000
20,000,000
6,000,000
5,300,000
Direct Method
Inventory – Jan. 1
Net Purchases
Goods Available for Sale
Inventory – Dec. 31
Cost of Goods Sold
4,500,000
20,000,000
24,500,000
(5,300,000)
19,200,000
Allowance Method
-
Loss of inventory writedown is included in
the computation of COGS. Allowance for
inventory writedown is presented as a
deduction from the inventory.
Inventory – Dec. 31, at cost
Allowance for Inv. Writedown
NRV
8,000,000
(150,000)
7,850,000
Continuing Illustration
- Assume on Dec. 31, 2022, the total of
inventory is 8,500,000 and the NRV is
8,400,000
Direct Method
- Inventory is simply recorded at the lower
amount
Entry:
Inventory – Dec. 31, 2022
8,400,000
Income Summary
8,400,000
Inventory – Jan. 1, at cost
Net Purchases
Goods Available for Sale
Inventory – Dec. 31, at cost
Cost of Goods Sold before inv. WD
Loss on Inv. WD for current year
Cost of Goods Sold after inv. WD
Required Allowance – Dec. 31 (6M – 5.3M)
Required Allowance – Jan. 1 (5M – 4.5M)
Increase in Allowance – Loss on WD
5,000,000
20,000,000
25,000,000
(6,000,000)
19,000,000
200,000
19,200,000
700,000
(500,000)
200,000
Purchase Commitments
- Obligations of the entity to acquire certain
goods sometime in the future at a fixed price
and fixed quantity
Illustration
Contract purchase price is P500,000 and the
replacement cost at year-end is P450,000. The
market decline of P50,000 is recorded:
Entry:
Loss on Purchase Com.
50,000
Est. Liab for Purchase Com. 50,000
Allowance Method
Cost – Dec. 31, 2022
Net Realizable Value
Req. Allowance – Dec. 31, 2022
Allowance Bal. – Dec. 31, 2022
Decrease in Allowance
-
8,500,000
(8,400,000)
100,000
(150,000)
(50,000)
Decrease in allowance is reversal of
previous inventory writedown and recorded
as:
Entry:
Allowance for Inv. WD
50,000
-
When actual purchase is made in the
subsequent period and the current
replacement cost drops further to P420,000,
the entry is:
Entry:
Purchases
420,000
Loss on Purchase Com.
30,000
Est. Liab for Purchase Com. 50,000
Accounts Payable
500,000
o
LCNVR Adaptation
- If marker price rises, a gain on purchase
commitment would be recorded
- In the preceeding illustration, replacement
cost of the purchase commitment is
P600,000 when actual purchase is made,
the journal entry to record the actual
purchase is:
Entry:
Purchases
500,000
Est. Liab for Purchase Com. 50,000
Accounts Payable
500,000
Gain on Purchase Com.
50,000
-
If the replacement cost of the purchase
commitment is P480,000 when the actual
purchase is made, the journal entry to record
the actual purchase is:
Journal:
Purchases
480,000
Est. Liab for Purchase Com. 50,000
Accounts Payable
500,000
Gain on Purchase Com.
30,000
-
The purchase is recorded at P480,000 only
because the replacement cost is lower than
the purchase commitment of P500,000.
o
Physical count is made to prove the
correctness
 Gross profit test
Interim financial statements are
made and not possible to physical
count
GROSS PROFIT METHOD
- Rate of gross profit remains approximately
the same from period to period, ratio of costs
of good sold and net sales is relatively
constant
Basic Formula under the Gross Profit Method
Goods Available for Sale
xxx
Less: COGS
xxx
Ending Inventory
xxx
Goods Available for Sale
Usual Items Affecting the Goods Available for Sale
Beginning Inv.
Purchases
Add: Freight In
Total
Less: Pur. Return, Allow, Disc.
Goods Available for Sale
xxx
xxx
xxx
xxx
xxx
xxx
xxx
COST OF GOODS SOLD
- COGS is computed as follows:
o (net sales) (cost ratio) – based on
sales
o (net sales) / (sales ratio) – based on
cost
CHAPTER 13: GROSS PROFIT METHOD
Illustration:
Estimate in Inventory Valuation
- Know approximate value if it is not possible
to take a physical count
- Two procedures in approximating value of
inventory:
o Gross Profit Method
o Retail Inventory Method
-
Common reasons for making an estimate:
o Inventory is destroyed by fire and
other catastrophe or theft of merch
Beg. Inventory
Net Purchases
Net Sales
Gross Profit rate based on sales
-
100,000
500,000
700,000
40%
The ending inventory is computed as
follows:
Beg. Inventory
Net Purchases
Goods Available for Sale
Less: COGS
Net Sales
Multiply by cost ratio
Ending Inventory
100,000
500,000
600,000
700,000
60%
420,000
180,000
-
Cost ratio is simply computed as 100%
minus gross profit rate on sales
Net Sales
COGS
Gross profit on Sales
Amount
700,000
420,000
280,000
Percent
100%
60%
40%
Net Sales
Cost of Goods Sold
Gross Profit on sales
Gross Profit on cost (20/80)
100%
80%
20%
25%
Another Illustration:
Beg. Inventory
Net Purchases
Net Sales
Gross Profit rate based on cost
-
The ending inventory is computed as
follows:
Beg. Inventory
Net Purchases
Goods Available for Sale
Less: COGS
Net Sales
Divided by Sales ratio
Ending Inventory
-
200,000
1,000,000
1,260,000
40%
200,000
1,000,000
1,200,000
700,000
140%
900,000
300,000
Illustration:
Beg. Inventory
Purchases
Purchases Return
Purchase Allowance
Purchase Discount
Freight In
Sales
Sales Return
Sales Allowance
Sales Discount
-
Gross profit rate is based on cost, COGS
would be 100%, and therefore the sales ratio
or percent of sales is 140%
Net Sales
COGS
Gross profit on Cost
Amount
1,260,000
900,000
360,000
Percent
140%
100%
40%
COMPUTATION OF GROSS PROFIT RATE
Net Sales
Cost of Goods Sold
Gross Profit
1,000,000
750,000
250,000
Gross Profit Rate:
o Cost: Gross Profit / COGS
o Sale: Gross Profit / Net Sales
 Common way of quoting
gross margin
GROSS PROFIT RATE ON COST TO GROSS
PROFIT ON SALES
- Convert gross profit rate from one basis to
another, if gross profit on cost is 25%, the
gross profit rate on sales is computed:
Net Sales
Cost of Goods Sold
Gross Profit on cost
Gross Profit on sales (25/125)
125%
100%
25%
20%
GROSS PROFIT RATE ON SALES TO GROSS
PROFIT ON COST
- if gross profit on sale is 20%, the gross profit
rate on cost is computed:
Ending inventory is computed under each of
the following assumptions:
o Gross profit rate is 25% on sales
o Gross profit rate is 25% on cost
Gross Profit Rate based on Sales
Goods Avail.
Less: COGS
Sales
Sales Return
Net Sales
Divide:
End. Inven.
-
600,000
2,530,000
15,000
5,000
10,000
50,000
3,100,000
100,000
50,000
150,000
3,150,000
Sales ratio
3,100,000
(100,000)
3,000,000
125%
2,400,000
750,000
Cost ratio is determined by deducting the
gross profit of 25% from the sales of 100%
or 75%
Amount
3,000,000
2,250,000
750,000
(750K/3M)
Net Sales
COGS
Gross Profit
Gross Profit on Sales
Percent
100%
75%
25%
25%
Gross Profit Rate based on Cost
Beg. Inv
Purchases
Add: Freight In
Total
Less: Pur. Ret.
Pur. Allowance
Pur. Discount
Goods Avail.
Less: COGS
Sales
Sales Return
Net Sales
Multiply:
600,000
2,530,000
50,000
2,580,000
15,000
5,000
10,000
30,000
Cost Ratio
3,100,000
(100,000)
3,000,000
75%
2,550,000
3,150,000
2,250,000
End. Inven.
-
900,000
Sales ratio is determined by adding the
COGS of 100% and the gross profit of 25%
or 125%
Amount
3,000,000
2,400,000
600,000
(600K/2.4M)
Net Sales
COGS
Gross Profit
Gross Profit on Cost
Percent
125%
100%
25%
25%
Illustration
Goods Avail.
Less: COGS
Sales
Sales Return
Sales Allow.
Sales Disc.
Net Sales
COGS
Ending Inv.
3,150,000
3,100,000
100,000
50,000
150,000
75% x 2.8M
-
xxx
xxx
xxx
xxx
xxx
Cost Ratio: Goods available for sale at cost
divided by goods available for sale at retail
300,000
2,800,000
2,100,000
1,050,000
1,000,000
700,000
300,000
Assuming that the goods available for sale
amount to P700,000. Following the gross
method, the ending inventory:
Goods Available for Sale
COGS
Ending Inventory
Goods Available for Sale at retail price
Less: Net Sales (Gross Sales - Sales
Return Only)
Ending Inventory at selling price
Multiply: cost ratio
Ending Inventory at Cost
-
Corollary Illustration
Sales
COGS
Gross Profit
Basic Formula
- Very similar to the gross profit method
o Difference: gross profit is stated at
cost while retail inventory method is
at selling price
700,000
(700,000
-
CHAPTER 14: RETAIL INVENTORY METHOD
Retail Inventory Method – other method of
estimating the value of inventory
o Generally employed by department
stores, supermarkets etc.
o Selling price or retail price is tagged
to them
Information Required:
- beginning inventory at cost at retail price
- Purchases during period at cost and at retail
- Adjustments to original retail price such as
markups
- Other adjustments such as breakage,
shrinkage, damage goods, and employee
discount
Illustration:
Beg. Inv
Purchases
Freight In
Purchase Return
Purchase Allowance
Purchase Discount
GOODS AVAIL. FOR SALE
Cost Ratio (480k/800k) = 0.6
Less: (Sales – Sales return)
End. Inventory at Retail
End. Inventory at Cost (200 x 0.6)
Cost
150,000
400,000
10,000
(55,000)
(5,000)
(20,000)
480,000
Retail
230,000
650,000
(80,000)
800,000
600,000
200,000
120,000
Treatment of Items:
- Purchase
Discount
(deducted
from
purchase at cost only)
- Purchase Return (deducted from purchase
at cost and at retail)
- Purchase Allowance (deducted from
purchase at cost only)
- Freight In (addition to purchases at cost
only)
- Departmental Transfer In or Debit ((addition
to purchases at cost and at retail)
- Sales
Discount
and
Allowance
(disregarded)
- Sales Return (deducted from sales)
- Employee Discount (added to sales)
- Normal shortage, shrinkage, spoilage,
breakage (deducted from goods available
for sale at retail)
- Abnormal shortage, shrinkage, spoilage,
breakage (deducted from goods available
for sale at retail and at cost)
Items related to retail method
- Initial markup (original markup of cogs)
- Original retail (sales price)
- Additional markup (increase in sales price
above original sales price)
- Markup cancellation (decrease in sales price
that does not decrease the sales price below
the original sales price)
- Net markup (markup minus markup
cancellation)
- Markdown (decrease in sales price below
original price)
- Markdown cancellation (increase in sales
price that does not increase the sales price
above the original sales price
- Net markdown (markdown minus markdown
cancellation)
- Maintained markup (difference between
cost and sales price) (markon)
Illustration:
Cost
Initial Markup
Original Retail
Additional Markup
New Sales Price
Markup Cancelation
New Sales Price
Net Markup (260 -240)
Markup cancelation
Markdown
New Sales Price
Markdown cancelation
New Sales Price
Net Markdown (30-20)
Maintained Markup
200
40
240
60
300
(40)
260
60
20
30
(50)
210
20
230
10
30
Approaches in the use of retail method
- Conservative or conventional or lower cost
and NRV approach
- Average cost approach
- FIFO approach
Beg. Inv
Net Purchases
Additional Markup
Markup Cancelation
Markdown
Markdown Cancelation
Sales
Sales return
Sales allowance
Sales discount
Employee discount
Spoilage and breakage
Cost
180,000
1,020,000
Retail
250,000
1,575,000
200,000
25,000
140,000
15,000
1,450,000
50,000
10,000
20,000
40,000
35,000
Conservative and Average Cost
Beg. Inv
Net Purchases
Additional Markup
Markup Cancelation
GAS – Conservative
Cost Ratio (1.2M/2M) = 0.6
Markdown
Markdown Cancelation
GAS - Average
Cost Ratio (1.2M/1.875M) = 0.64
Less: Sales
Sales return
Employee discount
Spoilage and breakage
Ending Inventory at Retail
Conservative Cost (400K x 0.6)
Average Cost (400K x 0.64)
-
Cost
180,000
1,020,000
1,200,000
Retail
250,000
1,575,000
200,000
(25,000)
2,000,000
1,200,000
(140,000)
15,000
1,875,000
1,450,000
(50,000)
40,000
35,000
1,475,000
400,000
240,000
256,000
Ending inventory at retail is same at either
conservative or average approach
Computation of COGS
Goods Avail. For Sale
Ending Inventory
COGS
Conservative
1,200,000
(240,000)
960,000
Average
1,200,000
(256,000)
940,000
FIFO Retail Approach
- Considers both net markup and net
markdown on computing cost ratio
- Current cost ratio is determined every year
considering the net purchases during the
year and excluding the beginning inventory
Beg. Inv
Purchases
Net Markup
Net Markdown
Net Sales
Cost
495,000
1,800,000
Retail
900,000
3,300,000
300,000
600,000
2,700,000
Computation using the FIFO Retail
Illustration:
Beg. Inv
Cost
495,000
Retail
900,000
Purchases
Net Markup
Net Markdown
Net Purchases
Current Cost Ratio (1.8M/3M) = 0.6
GAS
Less: Net Sales
Ending Inventory at Retail
FIFO Cost (1.2M x 0.6)
1,800,000
1,800,000
2,295,000
3,300,000
300,000
(600,000)
3,000,000
3,900,000
2,700,000
1,200,000
720,000
Computation of COGS
Goods Available for Sale
Ending Inventory at FIFO Cost
COGS
2,295,000
(720,000)
1,575,000