7
U
S
L
BLUE NOTES
CHAPTER
Inventories are 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 rendering of services.
Measurement of Inventory
Initial Measurement = Cost*
Subsequent Measurement = Lower of Cost or Net Realizable Value**
Note: **Net Realizable Value (NRV) is the estimated selling price in the ordinary course of business less estimated cost of completion
and the estimated cost necessary to make the sale.
Measurement of Cost*
Purchase
 Purchase price
 Import duties
 Irrevocable Taxes
 Freight
 Handling
 Other Cost Directly attributable to the
purchase
Deduct
- Trade Discounts
- Rebates
- Other Similar Items
Conversion
 Direct materials
 Direct Labor
 Fixed and variable production overhead
 Abnormal amounts of waste and spoilage
 Storage costs
 Administrative Overheads
 Selling Costs
Note: When purchased with deferred settlement terms, the
difference between the purchase price for normal
credit terms and the amount paid is recognized as
interest expense over the period of financing.
Freight on Board (Fob) Terms
a. FOB destination – ownership of goods purchased is transferred only upon the receipt of goods by the buyer at
the point of destination. The seller shall be responsible for the freight charges and other charges up to the
point of destination.
b. FOB shipping point – ownership is transferred upon shipment of the goods. The buyer shall be responsible for
the freight charges and other charges up to the point of destination.
c. Freight collect – freight charge is paid by the buyer.
d. Freight prepaid – freight charge is paid by the seller.
Maritime Shipping Terms
a. Free alongside (FAS) – seller must bear the risk involved in delivering the goods to the dock next to or
alongside the vessel on which the goods are to be shipped. The buyer bears the cost of loading and shipment
and thus, title passes to the buyer when the carrier takes possession of the goods.
Theory of Accounts Practical Accounting 1
22
USL Blue Notes
Chapter 7 – Inventories
b. Cost, insurance and freight (CIS) – buyer agrees to pay in a lump sum the cost of the goods, insurance cost and
freight charges. The seller must pay for the cost of loading. Thus, title and risk of loss shall pass to the buyer
upon delivery of the goods to the carrier.
c. Ex-ship (super FOB destination) - seller bears all expenses and risk of loss until the goods are unloaded at which
time and risk of loss shall pass to the buyer.
Consigned Goods
Consignment –method of marketing of goods in which the owner called the consignor transfers physical
possession of certain goods to an agent called the consignee who sells them on the owner’s behalf.
Rule: Consigned goods shall be included in the consignor’s inventory and excluded from the consignee’s inventory.
Freight and other charges on goods out on consignment are part of the cost of goods consigned.
Periodic System and Perpetual System
Periodic System – calls for the physical counting of goods on hand at the end of the accounting period to determine
quantities. This procedure is generally used when the individual inventory items turn over rapidly and have
small peso investment such that it may prove impractical or inconvenient to record inventory inflow and
outflow, such as groceries, hardware and auto parts.
Perpetual System – requires the maintenance of records called stock cards that usually offer a running summary of
the inventory inflow and outflow. This procedure is commonly used where the inventory items treated
individually represent a relatively large peso investment. This is designed for control purposes.
Trade Discounts and Cash Discounts
Trade discounts
 deductions from the list catalog price in order to arrive at the invoice price which is the amount actually
charged to the buyer
 to encourage trading or increase sale.
Cash discounts
 deductions from the invoice price when payment is made within the discount period
 to encourage prompt payment.
Inventory Costing Methods
First in, First out (FIFO) Method
 Goods first purchased are first sold
 Inventory is stated at current replacement cost.
 In the period of inflation, FIFO method would result to the highest net income. I
 In a period of deflation or declining prices, FIFO method would result to the lowest net income.
Note: Under FIFO-periodic and FIFO-perpetual, the inventory costs are the same.
Weighted Average – Periodic
 The cost of beginning inventory plus the total costs of purchases during the period is divided by the total
number of units purchased plus those in the beginning inventory to get the weighted average unit cost. Such
weighted average unit cost is then multiplied by the units on hand to derive the inventory value.
Weighted Average – Perpetual (moving average method)
 A new weighted average unit cost must be computed every after purchase. Such weighted average unit cost is
then multiplied by the units on hand to get the inventory cost.
Practical Accounting 1 Theory of Accounts
Chapter 7 – Inventories
USL Blue Notes
23
Specific Identification
 The cost of inventory is determined by simply multiplying the units on hand by their actual unit cost.
 Appropriate for inventories that are segregated for a specific project and inventories that are not ordinarily
interchangeable.
Accounting for Inventory Write-down
Direct Method
 Loss on inventory write-down is not
accounted for separately but buried in the
cost of goods sold.
Allowance Method
 Loss on inventory write-down is accounted
for separately and credited to “allowance
for inventory write-down
 The loss on inventory write down and gain
on reversal is included in the computation
of COGS
Note: Gain on reversal of inventory write-down is
limited only to the extent of the allowance
balance.
Relative Sale Price Method
When different commodities are purchased at a lump sum, the single cost is apportioned among the commodities
based on their respective sale price.
Purchase Commitments
Purchase commitments are obligations of the entity to acquire certain goods sometime in the future at a fixed
price and fixed quantity.
 market price = gain on purchase commitment
market price = loss on purchase commitment
Agricultural, Forest and Mineral Products
 measured at net realizable value at certain stages of production(PAS 2, par 4)
 This occurs when agricultural crops have been harvested or mineral products have been harvested and a sale is
assured under a forward contract or a government guarantee, or when a homogenous market exists and there
is a negligible risk of failure to sell.
Commodities of Broker-Traders
 measured at fair value less cost to sell.
Note: Broker-traders are those who buy and sell commodities for others or on their own account for the purpose of selling them in the
near future and generating a profit from fluctuations in price or broker-traders’ margin.
Inventory Estimation
Reasons:
 inventory is destroyed by fire and other catastrophe, or theft
 to prove the correctness or reasonableness of physical count
 for interim financial statements
Gross Profit Method
Retail Inventory Method
This method is based on the assumption that the rate of This method is generally employed by department stores,
gross profit remains approximately the same from period supermarkets and other retail concerns where there is a
Theory of Accounts Practical Accounting 1
24
USL Blue Notes
Chapter 7 – Inventories
to period and therefore the ratio of cost of goods sold to wide variety of goods because keeping track of unit cost
net sales is relatively constant from period to period.
at all times is difficult.
1. Gross profit rate “based on sales”
1. Conservative Cost Approach (conventional or
2. Gross profit rate “based on cost”
lower of average cost or market approach)
 Include mark-up, exclude mark-down
Note: Sales Allowances and Sales Discounts are ignored in
computing the net sales for purposes of using gross profit
rate method in computing COGS.
2. Average Cost Approach
 Mark-up and mark-down are included
3. FIFO Approach
4. LIFO Approach
Note: PAS 2 requires either the FIFO or Average Cost
Approach
Cost ratio = Goods available for sale at cost
Goods available for sale at selling price
Terminologies:
Initial Mark-up - Original mark-up on the cost of goods
Original Retail - Sales price at which the goods are first offered for sale
Additional mark-up - Increase in sales price above the original sales price
Mark-up Cancelation - Decrease in sales price that does not decrease the sales price below the original sales price
Net additional mark-up or net mark-up - Mark-up minus mark-up cancelation
Markdown - Decrease in sales price below the original sales price
Markdown Cancelation - Increase in sales price that does not increase the sales price above the original sales price
Net Markdown - Markdown minus markdown cancelation
Maintained Mark-up or mark-on - Difference between cost and sales price after adjustment for all the above items
Treatment of other items:
Purchase Discount – deducted from purchases at cost only
Purchase Return – deducted from purchases at cost and at retail
Purchase Allowance – deducted from purchases at cost only
Freight in – addition to purchases at cost only
Departmental transfer in or debit – addition to purchases at cost and at retail
Departmental transfer out or credit – deduction from purchases at cost and at retail
Sales discount and sale allowance – disregarded, meaning, not deducted from sales
Sales return – deducted from sales. If the account is “sales return and allowances”, the same should be deducted from
sales.
Employee discounts – added to sales.
Normal shortage, shrinkage, spoilage and breakage – this are deducted from goods available for sale at retail.
Abnormal shortage, shrinkage, spoilage and breakage – this are deducted from goods available for sale both at cost
and at retail so as not to distort the cost ratio. Any abnormal amount is recorded separately as loss.
Illustrative Problems
1. Sterling Company is preparing its 2013 year-end financial statements. Prior to any adjustments, inventory is
valued at P7, 600,000. The following information has been found relating to certain inventory transactions:

Goods valued at P1, 000,000 are on consignment with a customer. These goods are not included in the
Practical Accounting 1 Theory of Accounts
Chapter 7 – Inventories

USL Blue Notes
25
year-end inventory.
Goods costing P250, 000 were received from a vendor on January 5, 2014. The related invoice was
received and recorded on January 12, 2014. The goods were shipped on December 31, 2013, terms FOB
shipping point.

Goods costing P850, 000 were shipped on December 31, 2013, and were delivered to the customer on
January 2, 2014. The terms of the invoice was FOB shipping point. The goods were included in ending
inventory for 2013 even though the sale was recorded 2013.

A P350, 000 shipment of goods to a customer on December 31, 2013, terms FOB destination, was not
included in the year-end inventory. The goods cost P260, 000 and were delivered to the customer on
January 8, 2014. The sale was properly recorded in 2014.

An invoice for goods costing P350, 000 was received and recorded as a purchase on December 31, 2013.
The related goods, shipped FOB destination, were received on January 2, 2014, and thus were not included
in the physical inventory.

Goods valued at P650, 000 are on consignment from a vendor. The goods are not included in the year-end
inventory.

A P1, 050, 000 shipment of goods to a customer on December 30, 2013, terms FOB destination, was
recorded as a sale in 2013, the goods, costing P840, 000 and delivered to the customer on January 6, 2014,
were not included in 2013 ending inventory.
What is the correct inventory in 2013?
Inventory before adjustment
Goods out on consignment
Goods purchased, FOB shipping point
Goods sold, FOB shipping point
Goods sold, FOB destination
Goods sold, FOB destination
Correct Inventory, 2013
7, 600, 000
1, 000, 000
250, 000
( 850, 000)
260, 000
840, 000
9, 100, 000
2. The list price of merchandise purchased is P500, 000 less 20% and 10%, with credit terms of 5/10, n/30.
Compute for the payment within the discount period.
List price
First trade discount (20% x 500, 000)
500, 000
(100, 000)
400, 000
Second trade discount (10% x 400, 000) (40, 000)
Invoice Price
360, 000
Cash Discount (5% x 360, 000)
(18, 000)
Payment within the discount period
342, 000
Theory of Accounts Practical Accounting 1
26
USL Blue Notes
Chapter 7 – Inventories
3. Assume the following data:
January 1
10
15
16
30
31
Beginning balance
Purchase
Sale
Sales return
Purchase
Purchase return
Ending Balance
Units
5, 000
5, 000
(7, 000)
1, 000
16, 000
(2, 000)
18, 000
Unit Cost
200
250
Total Cost
1, 000, 000
1, 250, 000
150
150
2, 400, 000
300, 000
Units
4, 000
14, 000
18, 000
Unit Cost
250
150
Total Cost
1, 000, 000
2, 100, 000
3, 100, 000
Solutions:
FIFO (Periodic or Perpetual)
January 10
30
Purchase
Purchase
Inventory, End
Weighted Average – Periodic
January 1
10
30
31
Beginning Balance
Purchase
Purchase
Purchase return
Units
5, 000
5, 000
16, 000
(2, 000)
24, 000
Weighted average unit cost (4, 350, 000 / 24, 000 units)
Cost of ending inventory (18, 000 x 181.25)
Moving Average
Units
January 1
Beginning balance
5, 000
10
Purchase
5, 000
Balance
10, 000
15
Sale
(7, 000)
16
Sales Return
1, 000
Balance
4, 000
30
Purchase
16, 000
Balance
20, 000
31
Purchase return
(2, 000)
Balance
18, 000
4. Assume the following data for the current year:
Practical Accounting 1 Theory of Accounts
Unit Cost
200
250
150
150
Total Cost
1, 000, 000
1, 250, 000
2, 400, 000
(300, 000)
4, 350, 000
181.25
3, 2262, 500
Unit Cost
200
250
225
225
225
225
150
165
150
167
Total Cost
1, 000, 000
1,250, 000
2, 250, 000
(1, 575, 000)
225, 000
900, 000
2, 400, 000
3, 300, 000
(300, 000)
3, 000, 000
Chapter 7 – Inventories
USL Blue Notes
Inventory, January 1:
Cost
NRV
Net Purchases
Inventory, December 31:
Cost
NRV
27
5, 000, 000
4, 500, 000
20, 000, 000
6, 000, 000
5, 900, 000
Solutions:
Direct Method – cost of goods sold
Inventory, January 1
Net Purchases
Goods available for sale
Inventory, December 31
Cost of goods sold
4, 500, 000
20, 000, 000
24, 500, 000
5, 900, 000
18, 600, 000
Allowance Method – cost of goods sold
Inventory, January 1 at cost
Net Purchases
Goods Available for Sale
Inventory, December 31 at cost
COGS before reversal of writedown
*Gain on reversal of inventory writedown
COGS after reversal of writedown
5, 000, 000
20, 000, 000
25, 000, 000
6, 000, 000
19, 000, 000
(400, 000)
18, 600, 000
*Required allowance – December 31 (6, 000, 000 – 5, 900, 000)
Required allowance – January 1 (5, 000, 000 – 4, 500, 000)
Reversal of inventory writedown – decrease in allowance
100, 000
500, 000
(400, 000)
5. On July 1, Dash Company purchased a tract of land for P12, 000, 000. Dash incurred additional cost of P3, 000,
000 during the remainder of the year in preparing the land for sale. The tract was subdivided into residential
lots as follows:
Lot class
A
B
C
Number of lots
100
100
200
Sale price per lot
240, 000
160, 000
100, 000
Using the relative sales price method, what amount of cost should be allocated to Class A lots?
Class
A (100 x 240, 000)
B (100 x 160, 000)
C (200 x 100, 000)
Sales price
24, 000, 000
16, 000, 000
20, 000, 000
Fraction
24/60
16/60
20/60
Allocated Cost
6, 000, 000
4, 000, 000
5, 000, 000
Theory of Accounts Practical Accounting 1
28
USL Blue Notes
Chapter 7 – Inventories
60, 000, 000
15, 000, 000
Cost each class A lot is 6, 000, 000 divided by 100 lots or 60, 000.
6. Assume contract price of 500, 000 and replacement cost at year-end, 450, 000. Entry is as follows:
Loss on purchase commitment
50, 000
Estimated liability for purchase commitment
50, 000
Case 1.When the actual purchase commitment is made in the subsequent period and the current replacement
cost drops further to 420, 000.
Purchases
Loss on purchase commitment
Estimated liability on purchase commitment
Accounts payable
420, 000
30, 000
50, 000
500, 000
Case 2. If the replacement cost of the purchase commitment is 600, 000 when the actual purchase is made.
Purchases
Estimated liability on purchase commitment
Accounts payable
Gain on purchase commitment
500, 000
50, 000
500, 000
50, 000
Case 3. If the replacement cost of the purchase commitment is 480, 000 when the actual purchase is made.
Purchases
Estimated liability on purchase commitment
Accounts payable
Gain on purchase commitment
480, 000
50, 000
500, 000
30, 000
The loss on purchase commitment is classified as other expense and the estimated liability on purchase
commitment is classified as current liability. The gain on purchase commitment is classified as other income.
7. The following data are gathered for the current year:
Inventory beginning
600, 000
Purchases
2, 530, 000
Purchase return
15, 000
Purchase allowance
5, 000
Purchase discount
10, 000
Freight in
50, 000
Sales
3, 100, 000
Sales return
100, 000
Practical Accounting 1 Theory of Accounts
Chapter 7 – Inventories
USL Blue Notes
Sales allowance
Sales discount
29
50, 000
150, 000
Gross profit is computed under each of the following assumptions:
a. Gross profit rate is 25% based on sales
b. Gross profit rate is 25% based on cost
Gross profit rate “based on sales”
Inventory beginning
Purchases
Freight in
Total
Less: Purchase return
Purchase allowance
Purchase Discount
Goods available for sale
Less: Cost of sales:
Sales
Less: Sales return
Net Sales
Multiply by cost ratio
Ending inventory
600, 000
2, 530, 000
50, 000
2, 580, 000
15, 000
5, 000
10, 000
Gross profit rate “based on cost”
Goods available for sale
Less: Cost of sales:
Sales
Less: Sales return
Net Sales
Divided by sales ratio
Ending inventory
30, 000
3, 100, 000
100, 000
3, 000, 000
75%
2, 500, 000
3, 150, 000
2, 250, 000
900, 000
3, 150, 000
3, 100, 000
100, 000
3, 000, 000
125%
2, 250, 000
750, 000
Note: Sales allowance and sales discount are ignored, that is, not deducted from sales. While these items decrease the amount of sales,
they do not affect the physical volume of goods sold. They do not increase the physical inventory of goods, unlike sales return
where there is an actual addition to goods on hand.
8. Cost
Retail
Beginning Inventory
Net purchases
Additional mark up
Mark up cancelation
Markdown
Markdown cancelation
Sales
180, 000
1, 020, 000
250, 000
1, 575, 000
200, 000
25, 000
140, 000
15, 000
1, 450, 000
Theory of Accounts Practical Accounting 1
30
USL Blue Notes
Chapter 7 – Inventories
Sales return
Sales allowance
Sales discount
Employee discount
Spoilage and breakage
50, 000
10, 000
20, 000
40, 000
35, 000
Retail method – Conservative and Average Cost Approach
Cost
Beginning inventory
180, 000
Net Purchases
1, 202, 000
Additional Mark-up
Mark-up cancelation
GAS – Conservative
1, 200, 000
Cost ratio (1, 200, 000 / 2, 000, 000) 60%
Markdown
Markdown cancelation
GAS – Average
1, 200, 000
Cost ratio (1, 200, 000 / 1, 875, 000) 64%
Less: Sales
1, 450, 000
Sales return
(50, 000)
Employee discount
40, 000
Spoilage and breakage
35, 000
Ending Inventory at retail
Conservative cost
Average Cost
9.
Beginning inventory
Purchases
Net mark-up
Net markdown
Sales
(400, 000 x 60%)
(400, 000 x 64%)
Cost
495, 000
1, 800, 000
Retail
250, 000
1, 575, 000
200, 000
(25, 000)
2, 000, 000
(140, 000)
15, 000
1, 875, 000
1, 475, 000
400, 000
240, 000
256, 000
Retail
900, 000
3, 300, 000
300, 000
600, 000
2, 700, 000
Solution:
Cost
495, 000
1, 800, 000
Beginning inventory
Purchases
Net mark-up
Net markdown
Net Purchases
1, 800, 000
Current year ratio cost
(1, 800, 000 / 3, 000, 000) 60%
Practical Accounting 1 Theory of Accounts
Retail
900, 000
3, 300, 000
300, 000
(600, 000)
3, 000, 000
Chapter 7 – Inventories
Goods available for sale
Less: Sales
Ending inventory at retail
FIFO Cost
(1, 200, 000 x 60%)
USL Blue Notes
2, 295, 000
31
3, 900, 000
2, 700, 000
1, 200, 000
720, 000
Theory of Accounts Practical Accounting 1