INTERMEDIATE ACCOUNTING 1 https://www.pkf.com/media/8d891e8144 729e5/ias-2-inventories.pdf I. INVENTORIES IAS 2 (Inventories) contains the requirements on how to account for most types of inventories. - Its objective is to prescribe the accounting treatment for inventories. It provides guidance for determining the cost of inventories and for subsequently recognizing an expense, including any write-down to net realizable value. It also provides guidance on the cost formulas that are used to assign costs to inventories. Inventories include: - - Assets held for sale in the ordinary course of business (finished goods); Assets in the production process for sale in the ordinary course of business (work in process); and Materials and supplies that are consumed in production (raw materials). Classes of Inventories 1. Inventories of a Trading Concern – one that buys and sells goods from the same form purchased - Merchandise inventory 2. Inventories of a Manufacturing Concern – buys goods which are altered or converted into another form However, IAS 2 excludes certain inventories from its scope: [IAS 2.2] - Work in process arising under construction contracts (see IAS 11 Construction Contracts) - Financial instruments (see IAS 39 Financial Instruments: Recognition and Measurement) - Biological assets related to agricultural activity and agricultural produce at the point of harvest (see IAS 41 Agriculture). - The buyer shall be responsible for freight charges 2. FOB Destination – ownership shall be transferred only upon receipt of the goods by the buyer which means that the goods in transit are still the property of the seller - The seller shall be responsible for freight charges Note: When a product is fabricated to order for a particular customer, or it was a custom/special order from a customer, the goods once completed are already part of the ownership of the customer. Freight Terms: - Goods includible in the inventory: RULE: “All goods to which the entity has a title, shall be included in the inventory, regardless of the location.” Ownership of the goods in transit FOB – free on board 1. FOB Shipping Point – default if the problem does not include fob terms - Ownership is transferred upon shipment therefore the goods in transit are property of the buyer. - Freight Collect – freight charge on the goods is not yet paid. Thus, the expense is actually paid by the buyer. Freight Prepaid – the freight charge is already paid by the seller. Note: FOB destination and shipping point determines the ownership of the goods in transit and the party who is supposed to pay the freight charges while freight terms collect and paid determines the party who actually paid the freight charge. Maritime Shipping Terms - FAS or Free Alongside – seller must bear all the expenses and risks - - involved in delivering the goods to the dock CIF or Cost, Insurance, and Freight – buyer agrees to pay in a lump sum the cost of goods, insurance cost and freight charge. But the seller must pay the cost of loading. Ex-ship – the seller must bear all the expenses and risks involved until the goods are unloaded at which time the title and risk of loss shall pass to the buyer. Consignment Sale - Trade agreement in which one party (consignor) provides goods to another party (consignee) to sell. - However, the consignee has the right to return unsold goods back to the consigner. - In other words, a consignment sale is an agreement in which a third party is entrusted with selling goods on behalf of the owner. Consignment sales are also called goods on consignment. If there’s commission: Cash Commission Sales revenue Sale of Consigned goods Cash Sales Revenue xx - xx xx Unsold consigned goods No entry required - Abnormal waste Storage costs Administrative overheads unrelated to production Distribution or selling costs Foreign exchange differences arising directly from the recent acquisition of inventories invoiced in a foreign currency; and Interest cost when inventories are purchased with deferred settlement terms. Measurement: - xx Inventory cost should not include: [IAS 2.16 and 2.18] NRV Formula: Journal Entries for Consignment Sale Transfer of physical possession No entry required xx - - - xx xx De-recognition of inventory Cost of Goods Sold Inventory - estimated costs of completion and the estimated costs necessary to make the sale. Inventories are measured at the lower of cost and net realizable value (NRV). (IAS 2.9) The cost of inventories comprises all costs of purchase, costs of conversion, and other costs incurred in bringing the inventories to their present location and condition. Net realizable value (NRV) is the estimated selling price in the ordinary course of business less the Accounting for Inventories 1. Periodic Inventory System – does not update every purchase and sale. All purchases are debited to the purchases account. Ending inventory is determined at the end of the period by a physical count. COGS Formula Cost of goods sold = Beginning inventory + Purchases – Closing Inventory Journal Entries for Periodic System xx Accounts payable Purchases returns allowances are xx returned is by When expenses are incurred to obtain goods for sale – freight-in, insurance etc.: xx xx collected from Inventory Cash/Accounts payable xx xx When payment is made to supplier: xx & xx xx xx xx xx xx xx Accounts payable Cash/Bank End of the period When goods supplier: xx xx are Accounts payable Inventory xx xx returned to xx xx When goods are sold to customers: to When goods are sold to customers: Accounts receivable Sales When cash customers: returned Inventory (ending balance) xx Cost of goods sold (balancing xx figure) Purchases Inventory (beginning) xx When payment is made to supplier: Accounts payable Cash/Bank Cash Accounts receivable When expenses are incurred to obtain goods for sale – freight-in, insurance etc.: When goods supplier: are xx Freight-in Insurance Cash/Accounts payable When goods customers: Sales returns and allowances Accounts receivable When goods are purchased from supplier: Purchases Accounts payable 2. Perpetual Inventory System – maintaining inventory records that provides a running balance of cost of goods available for sale and cost of goods sold for a period. No purchases account is maintained because any transaction that has an impact in the inventories is directly debited or credited in the inventory account. When goods are purchased from supplier: Inventory Accounts payable xx xx Accounts receivable Sales xx Cost of goods sold Inventory xx When goods customers: xx xx are returned Sales returns and allowances Accounts receivable xx Inventory xx xx by Cost of goods sold xx When a difference between the balance of inventory account and physical count of inventory is found: Inventory overage/shortage Inventory xx xx Note: Shortage = Physical count < balance of inventory account - Shortage must be deducted at the inventory account and added to the cost of goods sold Overage = Physical count > balance of inventory account - Overage must be added to the inventory account and deducted to the cost of goods sold Discounts Trade discount – incentive given to buyers in the form of concession. Usually in case of bulk orders. - These are deductions from the list or catalog price to arrive at the invoice price which is the actual amount charged to the buyer - Its purpose is to encourage trading or increase sales. - Trade discounts are not recorded. - Benefit of trade discount is given to all customers. - Calculated on the sale price of the goods. Cash discount – incentive given by the sellers to prompt quick/cash payments. - 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. - Benefit of cash discount is for those customers who can make prompt payment only. - Calculated on the amount remaining after deducting the trade discount. Note: Purchase discount is deducted from purchases to arrive at net purchases and sales discount is deducted from sales to arrive at net sales revenue. Methods of Recording Purchases 1. Gross Method – purchases and accounts payable are recorded at gross amount of invoice. Purchases on account, 9.09% trade discount, and cash discount of 2/10, n/15: Purchases A/P 1,000,000 1,000,000 Assuming payment is made within the discount period: A/P Cash Purchases Disc. 1,000,000 980,000 20,000 Assuming payment is made beyond the discount period: A/P Cash 1,000,000 1,000,000 2. Net method – purchases and accounts payable are recorded at net amount of the invoice. Purchases on account, 9.09% trade discount, and cash discount of 2/10, n/15: Purchases A/P 980,000 Assuming payment is made within the discount period: A/P Cash 980,000 980,000 980,000 Assuming payment is made beyond the discount period: A/P Purchases Disc. loss Cash 980,000 20,000 1,000,000 If ending inventory is overstated, net income, retained earnings and working capital are overstated in that period as well. True, If ending inventory is overstated, cost of goods sold will be understated and thus net income and retained earnings are overstated.
