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IAS 2- INVENTORIES
Book References: The Intermediate Accounting Vol. 2 (Robles, Empleo); Intermediate Accounting1-A (Millan)
IAS 2, INVENTORIES
Inventories are:
a. Held for sale in the ordinary course of business
(finished goods);
b. In the process of production for such sales
(work in process); or
c. In the form of materials or supplies to be
consumed in the production process or in the
rendering of service (raw materials)
Classes of Inventories
Inventories may be classified as:
a. Trading Concern- buy & sell (merchandise
inventory)
b. Manufacturing Concern- conversion of one
material to another
Recognition
Inventories are recognized when they meet the
definition of inventory and qualify for recognition as
assets, such as when the entity obtains control over
them.
Control stems from legally enforceable rights, and legal
title normally passes to buyer when taken by physical
possessions over the goods.
Other relevant facts/circumstances other than control:
a. Goods in Transit
b. Consigned Goods
c. Inventory Financing Agreement
d. Sale with unusual right of return
e. Sale on Trial/Approval
f. Installment Sale
g. Bill & Hold Sale
h. Lay-away Sale
Goods in Transit
a. FOB (Free on Board) Shipping Point
- Legal title and economic control pass with the
loading of goods at the point of shipment.
- Buyer should include such goods in inventory
and a corresponding liability is recognized.
- Freight cost is for the account of the buyer.
b. FOB Destination Point
- Legal title is not transferred until the goods are
delivered to the buyer’s destination.
Freight cost is for the account of the seller.
Freight
a. Freight Prepaid- seller pays freight in advance
b. Freight Collect- freight not paid upon shipment
c. FAS (free alongside)- risk of loss shifts from the
seller to the buyer at a named port alongside a
vessel designated by the buyer.
d. Ex-ship- seller assumes all expenses until the
goods are unloaded from the carrier.
e. CIF (cost, insurance, freight)- buyer pays in
lump sum the CIF
f. CF (cost, freight)- buyer pays in lump sum the
CF
who undertakes to sell the goods to end customers on
behalf of the consignor.
The consignor retains control over consigned goods
until they are sold to end customers.
The consignee is entitled to a commission on the sales.
Commissions are accounted as expense by the
consignor.
Inventory Financing Agreements
a. Product Financing Agreement- a seller sells
inventory to a buyer but assumes an obligation
to repurchase it at a later date. Seller retains
ownership.
b. Pledge of Inventory- a borrower uses its
inventory as collateral security for a loan. No
transfer of ownership.
c. Loan of Inventory- an entity borrows inventory
from another entity to be replaced with the same
kind of inventory. Borrower owns the loaned
assets.
Segregated Goods
Special order goods manufactured according to
customer specifications should be considered as sold
when completed, therefore excluded from seller’s
inventory.
Goods that are customarily manufactured and constitute
stock items of the enterprise, even if physically
segregated, are considered unsold.
Sale with Unusual Right of Return
The buyer normally recognizes goods purchased under a
sale with right of return at the time of sale, unless the
goods purchased does not qualify for recognition as
asset (i.e., unsalable or defective goods or if the buyer
intends to return the goods to the seller within the time
limit allowed.
Sale on Trial/Approval
No transfer of ownership until approval of customer or
if the goods are not returned within reasonable period of
time.
Installment Sale
The possession of the goods is transferred to the buyer
but the seller retains legal title solely to protect the
collectability of the amount due is considered as a
regular sale.
Bill & Hold Arrangement
A contract of sale in which a seller bills a customer but
retains physical possession of the goods until transferred
to the customer at a future date.
The goods are excluded from the seller’s inventory and
included in the buyer’s inventory upon billing, provided:
a. the reason for the bill & hold is substantive
b. the goods are identified separately to customer
c. the seller can’t use/sell the goods to other
customer
Consigned Goods
Consignment is an arrangement where an entity
(consignor) delivers goods to another party (consignee)
Lay-away Sale
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The goods are delivered only when the buyer makes the
final payment in a series of installment.
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●
TYPES OF
ARRANGEMENT
FOB Shipping Point
FOB Destination
Consigned Goods
Product Financing
Pledge of Inventory
Loan of Inventory
Sale with unusual
right of return
Sale on
Trial/Approval
Installment Sale
Bill & Hold
Arrangement
Lay-away Sale
INCLUDED IN
THE INV OF:
IN POSSESSION
OF:
Buyer
Seller
Consignor
Seller
Borrower
Borrower
Buyer (except
when unsalable)
Seller
None
None
Consignee
Seller
Borrower
Borrower
Depends
Seller
Buyer
Buyer
Seller
Seller
Seller (if unpaid)
Buyer
Financial Statement Presentation
Under single line item captioned “Inventories”
The breakdown (FG, WIP, RM, MS) is disclosed in the
notes.
Classified as current assets after “Trade & Other
Receivables”
●
●
●
●
●
Trade and Cash Discounts
1. Gross Method- Purchase is recorded at gross
amount. Purchase discount is recognized when
payment is made within the discount period.
2. Net Method- Purchase is recorded at net of cash
discounts, whether taken or not.
The discount not taken is recorded in
“Purchase Discount Lost”, and included as part
of “other expense” or as “Finance Cost”
3.
Objectives of Inventory Accounting
a. Proper determination of periodic income
through the recognition of appropriate costs that
are matched with revenue.
b. Proper representation of inventories recognized
as assets in the financial statements.
Systems of Inventory Recording
Perpetual Inventory System
Inventory account is updated each time a purchase or
sale is made through the use of stock cards and stock
ledger cards.
Commonly used for inventories that are specifically
identifiable and are relatively high valued.
Periodic Inventory System
Physical counting at the end of accounting period,
applicable for low-value inventories.
Cost of Inventories
Abnormal amounts of wasted materials, labor or
other production costs
Storage costs, unless those necessary in the
production process prior to a further production
stage
Administrative overheads that do not contribute
to bringing the inventories to their present
location and
condition
Selling costs
Costs relating to sales and general
administrative personnel
Profit margins or non-attributable overheads
Borrowing costs are recognized as finance costs
Allowance method
Purchases are recorded at net prices
Accounts payable are recorded at gross prices
Difference is debited to allowance account
*Net method produces the correct inventory cost
Cost Formulas
Specific Identification Generally:
 High valued; low quantity
 Costs are not interchangeable
 Goods produced are segregated for
specific projects
Illustration 1.
Step 1. Cost of Goods Sold (COGS)
1.
Sale Date
Oct. 6
Oct. 9
Oct. 16
Oct. 17
Oct. 27
Oct. 31
Total Units
x cost per unit
Batch A
@50
4,000
500
1,000
1,500
5,000
45
55
67,500
275,000
387,500
500
40
20,000
Sales (units sold x selling price per unit) 7,500 x 75
Less: Cost of goods sold
GROSS PROFIT
562,500
(387,500)
175,000
500
50
25,000
COGS
Conversion Costs
Costs directly related to the units of production such as
direct labor and fixed and variable production overhead.
Step 3. Ending Inventory
Exclusions from Cost of Inventories
Batch D
@40
500
Step 2. Gross Profit
Other Costs
Only to the extent that they are incurred in bringing the
inventories to their present location and condition.
Batch C
@55
500
Purchase Cost
Purchase price, import duties and other taxes, and
transport, handling and other costs directly attributable
to the acquisition of finished goods, materials and
services.
Costs of Agricultural Produce Harvested from
Biological Assets
Initially recognized at fair value less cost to sell
Batch B
@45
1,000
Beg. Inventory
Purchases
Less: Units Sold
Total rem. units
x cost per unit
Ending Inventory
Checking:
Batch A
@50
2,000
(500)
1,500
50
75,000
Batch B
@45
Batch C
@55
Batch D
@40
5,000
6,000
(1,500)
(5,000)
3,500
1,000
45
55
157,500
55,000
347,500
2,000
(500)
1,500
40
60,000
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Beg. Inventory (2,000x50)
Purchases B (5,000x45)
C (6,000x55)
D (2,000x40)
CGAS
or
COGS
End. Inventory
CGAS
2.
100,000
225,000
330,000
80,000 635,000
735,000
387,500
347,500
735,000
First-in, First-out (FIFO)
 Inventories that were purchased or
produced first are sold first.
 Inventories at the end of the period are
those most recently purchased or
produced.
 Appropriate measurement of inventory
is achieved, but no proper matching of
cost against revenue since earliest costs
are matched to current revenues.
Period of inflation:
 Lowest COGS
 Highest EI and Profit
Period of deflation:
 Highest COGS
 Lowest EI and Profit
*FIFO always reports the HIGHEST ending
inventory
3.
Weighted Average
Cost of sale and ending inventory are
determined based on the weighted average cost
of similar items at the beginning of a period &
the cost of similar items purchased or produced
during the period.
a. Periodic - Simple Average
b. Perpetual- Moving Average
Net Realizable Value
Inventories are measured at the lower of cost and net
realizable value.
Net realizable value is the estimated selling price in the
ordinary course of business less the estimated costs
completion and the estimated costs necessary to make
the sale.
This measurement is in line with the basic accounting
concept that an asset shall not be carried at an amount
that exceeds its recoverable amount.
Write-down of Inventory
Usually carried out on an item-by-item basis. In some
circumstances, it may be appropriate to group similar
items, but not in the basis of their classification.
Only written down if the cost exceeds its NRV.
Raw materials inventory is not written down below cost
if the finished goods in which they will be incorporated
are expected to be sold at or above cost.
A previous write-down is reversed if the NRV
subsequently increases. The amount of reversal shall not
exceed the previous write-down.
Measurement of Inventories Subsequent to Initial
Recognition
Inventories
● should be measured at LCNRV
● are written down to NRV on an item-by-item
basis
With items of inventory relating to the same product line
that have similar purposes or end uses, produced and
marketed in the same geographical area, and cannot be
practicably evaluated separately from other items in that
product line, they are written down in group basis.
Total cost - LCNRV = Write Down
Write Down of Inventory
Amount of write down is recognized as an expense in
the period it occurs
1. Direct Method
● EI is recorded at LCNRV
● Write down of inventory is absorbed by
COGS
● Incase of write down - will always
report higher COGS
● Incase of recovery (maximum: cost) will report a lower COGS
2. Allowance Method
● Ending Inventory is recorded at cost
● Write down of inventory is reported as
other non-operating expense
● Incase of write down - will always
report lower COGS
● Incase of recovery - will report a higher
COGS
Ending balance of Allowance = EI@Cost - LCNRV
Purchase Commitments
Purchase commitments may be subject to revision or
cancellation before the end of the contract period. Other
PC are non-cancellable and are not subject to revision.
Disclosure is required for a purchase contract subject to
revision or cancellation if:
a. A future loss is possible
b. The amount of commitment can be reasonably
estimated
c. The amount is material
Contract price (maximum amount you are going to
recognize at purchases, but will always be your payable)
*Bawal mag recognize ng gain as adjusting entry
*Sa date of delivery, pwede na mag record gain or loss
*Ang basis is yung previous/last MV
Effects of Inventory Errors
BI and Purchases (Expenses) - Inversely related to
profit
Ending Inventory - Directly related to profit
Disclosure Requirements
● Accounting policies adopted in measuring
inventories, including the cost formula used
● Total carrying amount of inventories and the
carrying amount in classifications appropriate to
the entity
● Carrying amount of inventories carried at FV CTS
● Amount of inventories recognized as an
expense during the period
● Amount of any write-down of inventories
recognized as expense in the period
● Amount of any reversal of any write-down that
is recognized as expense in the period
● Circumstances or events that led to the reversal
of a write-down of inventories
● Carrying amount of inventories pledged as
security for liabilities
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INVENTORY ESTIMATION
Used when physical count of inventory is not
practicable. Uses of inventory value estimation include:
1. Interim Financial Statement- period shorter than 1yr
2. Inventory Reasonableness
3. Catastrophe & other extraordinary circumstance
Inventory estimation methods
1. Gross profit method
Allows expressing and using a gross profit
percentage based on either cogs or net sales to
estimate inventory value.
Major assumption: GP rate is constant over time
Disadvantage: Uses past percentage
Calculation of inventory:
Beginning Inv.
Add: Net Purchases
xx
xx
CGAS
Less: COGS
xx
(xx)
Ending Inv.
xx
a.
Freight-in
Addition to purchases at cost
b.
Purchase discounts and allowances
Deduction from purchases at cost
c.
Purchase returns
Deducted from cost and retail purchases
d.
Sales returns
Deducted from retail sales
e.
Sales discounts and allowances
Not deducted from retail sales
f.
Departmental transfer-in (debit) Addition
to both cost and retail amounts of purchases
g.
Departmental transfer-out (credit)
Deduction from both cost and retail amount
of purchases
h.
Normal losses, shortage, shrinkage
Deducted from TGAS at retail, after
computing cost ratio
Abnormal losses
Deducted from both cost and retail
amounts of purchases, before
computing the cost ratio
Gross profit rate based on sales = Sales is 100%
Deduct: Sales returns
Ignore: Sales discounts and allowances
*Special discount: add sa sales
Gross profit rate based on cost = COGS is 100%
GP rate based on sales
Net Sales
Cost of Goods Sold
Gross Profit
2.
i.
GP rate based on cost
100%
100%
Retail inventory method
Applies retail (sales price) info to determine its
relationship with costs (cost ratio) and ultimately,
the estimated ending inventory.
j.
Discounts to employees and favored
customers
Deducted from TGAS at retail, after
computing the cost ratio (addition to
sales)
Original selling prices may be modified as a
result of some market and economic forces
Often used for measuring inventories of large
numbers or rapidly changing items that monitoring
of costs would be burdensome.
●
●
Original Retail - first selling price
Markup - increase in the selling
price over the original retail price
Cost of inventory is determined by reducing sales
value of the inventory by the appropriate percentage
gross margin.
●
Markdown - decrease in the selling
price below the original retail price
●
Markup cancellation - decrease in
the SP which does not bring new SP
below the original retail price
●
Markdown cancellation - increase
in the SP which does not bring the
new SP above the original retail
price
●
Net Markup - Markup less markup
cancellation
●
Net Markdown - Markdown less
markdown cancellation
Beginning Inventory at retail price
Add: Net Purchases at retail price
xx
xx
CGAS at retail price
Less: Net Sales
xx
(xx)
Est. Ending Inventory at retail price
Multiply: cost-to-retail ratio
xx
xx%
Est. Ending Inventory at cost
xx
Methods of Retail Inventory Estimation
a. Conservative Method
- considers all effects of price markups
but doesn’t consider price markdowns
b. Average Method
- considers both price markups and
markdowns
c. FIFO Method
- cost-to-retail ratio is only based on
current period purchases which
excludes beginning inventory
- markups and markdowns are applied
only to purchases and not on beg. inv.
*Cost - magkano nirecord sa books
*Retail - may tubo na
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Steps in Retail inventory method:
1. Conservative Method
*figures presented are just examples
Step 1. Find the conservative goods available for sale (markups only)
Cost
Retail
Beginning Inventory
965,000
1,227650
Net Purchases
2,598,657
3,300,296
Add’l Markup
113,500
Markup Cancellation
(32,667)
Conservative GAS
3,563,657
4,608,779
Step 2. Find the conservative cost-to-retail ratio
Conservative GAS
3,563,657
4,608,779
divide
Conservative cost-to-retail ratio
77.3232%
Step 3. Find the GAS for estimation (markdowns included)
Conservative GAS
3,563,657
4,608,779
Markdown
(89,750)
Markdown Cancellation
13,974
GAS for estimation
3,563,657
4,533,003
Step 4. Solve for the ending inventory at cost
GAS for estimation
3,563,657
4,533,003
Less: Net Sales
(2,771,048)
End Inv at retail price
1,761,955
x cost-to-retail ratio
77.3232%
End Inv at cost
1,362,400
2. Average Method
*figures presented are just examples
Step 1. Find the GAS (markups and downs included)
Cost
Retail
Beginning Inventory
965,000
1,227650
Net Purchases
2,598,657
3,300,296
Add’l Markup
113,500
Markup Cancellation
(32,667)
Markdown
(89,750)
Markdown Cancellation
13,974
GAS for estimation
3,563,657
4,533,003
Step 2. Find the average cost-to-retail ratio
GAS for estimation
3,563,657
4, 533,003
divide
Average cost-to-retail ratio
78.6158%
Step 3. Solve for the ending inventory at cost
GAS for estimation
3,563,657
4,533,003
Less: Net Sales
(2,771,048)
End Inv at retail price
1,761,955
x cost-to-retail ratio
78.6158%
End Inv at cost
1,385,175.09
3. FIFO Method
*figures presented are just examples
Step 1. Find the purchases during the period
Cost
Retail
Net Purchases
2,598,657
3,300,296
Add’l Markup
113,500
Markup Cancellation
(32,667)
Markdown
(89,750)
Markdown Cancellation
13,974
Purchases during the period
2,598,657
3,305,353
Step 2. Find the FIFO cost-to-retail ratio
Purchases during the period
2,598,657
3,305,353
divide
Average cost-to-retail ratio
78.6197%
Step 3. Find the GAS
Purchases during the period
2,598,657
3,305,353
Beginning Inventory
965,000
1,227650
GAS for estimation
3,563,657
4,533,003
Step 4. Solve for the ending inventory at cost
GAS for estimation
3,563,657
4,533,003
Less: Net Sales
(2,771,048)
End Inv at retail price
1,761,955
x cost-to-retail ratio
78.6197%
End Inv at cost
1,385,243.74