LEARNING OUTCOME The students should be able to account and prepare entries for inventory transactions using different inventory systems. Moreover, the students should be able to properly measure the inventories at LCNRV. The students should be able to prepare an inventory cost flow using different cost formulas such FIFO, LIFO, specific identification, and weighted average whether under periodic or perpetual method. INTRODUCTION AND CORE VALUES INTEGRATION In any business or organization, all functions are interlinked and connected to each other and are often overlapping. Some key aspects like supply chain management, logistics and inventory form the backbone of the business delivery function. Therefore, these functions are extremely important to marketing managers as well as finance controllers. Inventory management is a very important function that determines the health of the supply chain as well as the impacts the financial health of the balance sheet. Every organization constantly strives to maintain optimum inventory to be able to meet its requirements and avoid over or under inventory that can impact the financial figures. Inventory is always dynamic. Inventory management requires constant and careful evaluation of external and internal factors and control through planning and review. Most of the organizations have a separate department or job function called inventory planners who continuously monitor, control and review inventory and interface with production, procurement and finance departments. “Meditating on God’s word makes you wiser than your enemies, gives you more insight than your teachers and gives you more understanding than your elders.” INVENTORIES PAS 2, paragraph 6, defines inventories as 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 services. Classes of Inventories 1. Inventories of a trading entity – one that buys and sells in same form purchased. 2. Inventories of manufacturing entity – 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 materials and factory or manufacturing supplies refer to the inventories of a manufacturing entity. The general rule is that “all goods to which the entity has title shall be included in the inventory regardless of location.” Inventories shall be presented as one-line item in the statement of financial position but the details of the inventories shall be disclosed in the notes to financial statements. FOB destination – means that the ownership of the goods purchased is vested in the buyer upon receipt thereof. FOB shipping point – means that the ownership of the goods purchased vested in the buyer upon the shipment thereof. Freight collect – means that the freight charge on the goods shipped is not yet paid. Under this, the freight charge is actually paid by the buyer. Freight prepaid - means that the freight charge on the goods shipped is already paid by the seller. Consignment is a method of marketing goods in which the owner known as the consignor transfers physical possession of certain goods to an agent known as the consignee who sells the goods on the owner’s behalf. Goods on consignment shall be included in the consignor’s inventory and excluded from the consignee’s inventory. Systems of Accounting for Inventories 1. Periodic or Physical System – calls for the physical counting of goods on hand at the end of the accounting period to determine quantities. It is generally used when the individual inventory items have small peso investment such as groceries, hardware and auto parts. 2. Perpetual System – requires the keeping of stock cards that summarize inventory inflow and outflow. Under this approach, the cost of goods sold is computed every time of sale. A physical count of the units on hand should at least be made once a year or at frequent intervals to confirm the balances appearing on the stock cards. Methods of recording purchases 1. Gross Method – the purchases are recorded at the gross amount of the invoice. 2. Net Method – the purchases are recorded at net amount, meaning the cost of purchases is measured net of cash discounts allowable whether taken or not taken. The cost of an inventory comprises: 1. Cost of Purchase – comprises the purchase price, import duties and irrevocable taxes, freight, handling and other cost directly attributable to the 2. 3. acquisition of finished goods, materials and services. Trade discounts, rebates and other similar items are deducted in determining the cost of purchase. Cost of Conversion – includes direct labor and systematic allocation of fixed (normal capacity) and variable production overhead that is incurred in converting materials into finished goods. Other cost incurred in bringing the inventory to its present location and condition. Abnormal amounts of wasted materials, labor and other production costs, storage cost, distribution cost, administrative overheads that do not contribute in bringing inventories to their present location and condition are expensed and are excluded from the cost of inventory. However, storage costs related to goods in process or part finished goods are inventoriable. INVENTORY VALUATION PAS 2 provides the following clearcut principles concerning measurement of inventory: a. Paragraph 9, LCNRV or Lower of cost and net realizable value b. Paragraph 25, FIFO (first-in, first-out) method or weighted average method. LIFO (last-in, last-out) is prohibited in PAS 2. c. Paragraph 23, Specific Identification Method FIFO method assumes that goods first purchased are first sold. The inventory is thus expressed in terms of recent or new prices while the COGS is representative of earlier or sold prices. Weighted Average Method Periodic weighted method Moving average method (Perpetual System) The cost of the beginning inventory plus A new weighted average unit cost must be the total cost of purchase during the computed after every purchase and period is divided by the total units purchase return. purchased plus those in the beginning inventory to get a weighted average unit cost. LIFO method assumes that goods last purchased are first sold. The inventory is thus expressed in terms of earlier or old prices while the COGS is representative of recent or new prices. Specific Identification method – means that specific costs are attributed to identified items of inventory. It is used when the cost of inventory is not ordinarily interchangeable and inventories that are segregated for specific projects. Net Realizable Value or NRV is the estimated selling price in the ordinary course of business less the estimated cost of completion and estimated cost of disposal. Inventories are usually written down to NRV on an item by item or individual basis. If the cost is lower than the NRV, the inventory is stated at cost and the increase in value is not recognized. If NRV is lower than the cost, the inventory is measured at NRV and the decrease in value is recognized as expense. Method of accounting for inventory writedown to NRV 1. Direct Method – recorded at the lower of cost or net realizable value. It is known as the “cost of goods sold method” because any loss in inventory writedown is not accounted for separately but buried in the COGS. 2. Allowance Method – recorded at cost and any loss on inventory writedown is accounted for separately. It is also known as “loss method method” because a loss amount, “loss on inventory writedown” is debited and a valuation account “allowance for inventory writedown” is credited for the inventory writedown. When agricultural crops have been harvested or mineral ores have been extracted and a sale is assured under a forward contract or a government guarantee, PAS 2, paragraph 4, provides that inventories of agricultural forest and mineral products are measured at NRV. PAS 2, paragraph 3, provides that commodities of broker-traders are measured at fair value less cost of disposal. Standard costs are predetermined product cost established on the basis of normal levels of materials and supplies, labor, efficiency and capacity utilization. Relative sales price method of inventory is based on the philosophy that cost is proportionate to selling price. Purchase Commitments are obligations of an entity to acquire certain goods sometime in future at a fixed price and fixed quantity. REFERENCES Intermediate Accounting Part 1A by Zeus B. Millan, latest edition Intermediate Accounting Volume 1 First Part by Valix, Peralta, Valix (latest edition)