CHAPTER 10 INVENTORIES
Inventories
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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 to be
consumed in the production process or in the
rendering of services
encompass goods purchased and held for
resale:
i.
merchandise purchased by a retailer
and held for resale
ii.
land and other property held for resale
by a subdivision entity and real estate
developer
encompass finished goods produced, goods in
process and materials and supplies awaiting use
in the production process
CLASSES OF INVENTORIES
1) Inventories of a trading concern
→ one that buys and sells goods in the
same form purchased
→ merchandise inventory
∟ generally applied to goods held
by a trading concern
2) Inventories of manufacturing concern
→ one that buys goods which are altered
or converted into another form before
they are made available for sale
→ inventories of a manufacturing concern
i. finished goods
ii. goods in process
iii. raw materials
iv. factory
or
manufacturing
supplies
Finished goods


completed products which are ready for sale
have been assigned their full share of
manufacturing costs
Goods in process (work in process)

partially completed products which require
further process or work before they can be sold
Raw materials

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
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goods that are to be used in the production
process
no work or process has been done on them as
yet by the entity inventorying them
cover all materials used in the manufacturing
operations
restricted to materials that will be physically
incorporated in the production of other goods
and which can be traced directly to the end
product of the production process
Factory or manufacturing supplies



similar to raw materials but their relationship to
the end product is indirect
indirect materials
cost part of the manufacturing overhead
Goods includible in the inventory

all goods to which the entity has title regardless
of location
Passing of title

a legal language which means the point of time
at which ownership changes
Legal test
1. goods owned and on hand
2. goods in transit and sold FOB destination
3. goods in transit and purchased FOB shipping
point
4. goods out on consignment
5. goods in the hands of salesmen or agents
6. goods held by customers on approval or on trial
Exception to the legal test: installment contracts
Cost, insurance and freight (CIF)

FOB destination
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ownership of goods purchased is transferred
only upon receipt of the goods by the buyer at
the point of destination
the goods in transit are still the property of the
seller
the seller shall legally be responsible for freight
charges and other expenses up to the point of
destination
the buyer agrees to pay in a lump sum the cost
of the goods, insurance cost and freight charge
Ex-ship

a seller who delivers the goods ex-ship 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
Consignment
FOB shipping point


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ownership is transferred upon shipment of the
goods
the goods in transit are the property of the
buyer
the buyer shall legally be responsible for freight
charges and other expenses from the point of
shipment to the point of destination
Freight collect


freight charge on the goods shipped is not yet
paid
paid by the buyer
Freight prepaid

freight charge on the goods shipped is already
paid by the seller
Free alongside (FAS)
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a seller who ships FAS must bear all expenses
and risk involved in delivering the goods to the
dock next or alongside the vessel on which the
goods are to be shipped
the buyer bears the cost of loading and
shipment
title passes to the buyer when the carrier takes
possession of the goods

a method of marketing goods in which the
owner (consignor) transfers physical possession
of certain goods to an agent (consignee) who
sells them on the owner’s behalf
Consigned goods

shall be included in the consignor’s inventory
and excluded from the consignee’s inventory
Cost of goods consigned

includes freight and other handling charges on
goods out on consignment
Memorandum entry

means by which consigned goods are recorded
by the consignor
STATEMENT PRESENTATION
Current assets

classification of inventories
One line item

presentation of inventories in the statement of
financial position but the details shall be
disclosed in the notes to financial statements
ACCOUNTING FOR INVENTORIES
I.
II.
PERIODIC SYSTEM
 calls for the physical counting of goods on hand
at the end of the accounting period to
determine quantities
∟ quantities are then multiplied by the
corresponding unit costs to get the
inventory value for balance sheet
purposes
 this approach gives actual or
physical inventories
 generally used when the individual inventory
items have small peso investment
PERPETUAL SYSTEM
 requires the maintenance of records (stock
cards) that usually offer a running summary of
the inventory inflow and outflow
∟ inventory increases and decreases are
reflected in the stock cards and the
resulting balance represents the
inventory
 this approach gives book or
perpetual inventories
 commonly used where the inventory items
treated individually represent a relatively large
peso investment
 a physical count of the units on hand should at
least be made once a year to confirm the
balances appearing on the stock cards
Inventory shortage or average

a physical count indicates a different amount
with the balance
Trade discounts
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
deductions from the list or catalog price in
order to arrive at the invoice price which is the
amount actually charged to the buyer
not recorded
purpose is to encourage trading or increase
sales
suggest to the buyer the price at which the
goods may be resold
Cash discounts
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deductions from the invoice price when
payment is made within the discount period
purpose is to encourage prompt payment
recorded as purchase discount by the buyer and
sales discount by the seller
METHODS OF RECORDING PURCHASES
1) Gross method
 purchases and accounts payable are
recorded at gross
 in practice, most entities record
purchases at gross invoice amount
 violates the matching principle because
discounts are recorded only when taken
or when cash is paid rather than when
purchases that give rise to the discounts
are made
 does not allocate discounts taken
between goods sold and goods on hand
 supported on practical grounds
 more convenient from a bookkeeping
standpoint
Normal shrinkage and breakage in inventory

inventory shortage is closed to cost of goods
sold
Abnormal and material shortage

shall be separately classified and presented as
other expense
2) Net method
 purchases and accounts payable are
recorded at net
 the cost measured represents the cash
equivalent price on the date of
payment (the theoretically correct
historical cost)
Cost of inventories shall comprise:

1. cost of purchase
→
→
→
→
comprises the purchase price, import
duties and irrevocable taxes, freight,
handling and other costs directly
attributable to the acquisition of
finished goods, materials and services
trade discounts, rebates, etc are
deducted
not
include
foreign
exchange
differences
inventories purchased with deferred
settlement terms, the difference is
recognized as interest expense over the
period of financing
Allocation of variable production overhead
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→
→
→
includes cost directly related to the
units of production such as direct labor
includes a systemic allocation of fixed
and variable production overhead that
is incurred in converting materials into
finished goods
fixed production overhead
∟ the indirect cost of production
that remains relatively constant
regardless of the volume of
production
variable production overhead
∟ the indirect cost of production
that varies directly with the
volume of production
Allocation of fixed production overhead


the allocation of fixed production overhead to
the cost of conversion is based on the normal
capacity of the production facilities
normal capacity
∟ the production expected to be achieved
on average over a number of periods or
seasons under normal circumstances
taking into account the loss of capacity
resulting from planned maintenance
variable production overhead is allocated to
each unit of production on the basis of the
actual use of the production facilities
by-products
∟ measured at net realizable value and
this value is deducted from the cost of
the main product
3. other cost incurred in bringing the inventories
to their present location and condition
→
2. cost of conversion
→
unallocated fixed overhead
∟ recognized as expense in the period in
which it is incurred
the following costs are excluded from
the cost of inventories and recognized
as expense in the period when
incurred:
1. abnormal amounts of wasted
materials, labor and other
production costs
2. storage costs
3. administrative overheads
4. distribution or selling costs
Cost of inventories of a service provider


consists primarily of the labor and other costs of
personnel directly engaged in providing the
service, including supervisory personnel and
attributable overhead
labor and other costs relating to sales and
general administrative personnel
∟ not included but are recognized as
expenses in the period in which they
incurrred