VEGA, NICOLE ANGELA O.
CHAPTER 14
INVENTORIES
CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS
OBJECTIVE:
To prescribe the accounting treatment for
inventories,
providing
guidance
on
determination of cost and subsequent
recognition as an expense, including any
write-down to net realizable value (NRV).
I.
DEFINITION
AND
CLASSIFICATION
INVENTORIES
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
in
the
rendering of services.
PAS 2 applies to all
inventories except:
Work in progress under
construction contracts.
Financial instruments.
Biological assets related to
agricultural
activity
and
agricultural produce at the
point of harvest.
Classes of inventories
TRADING CONCERN
MANUFACTURING
CONCERN
Trading concern is one that
buys and sells goods in the
same form purchased. The
“term
merchandising”
is
generally applied to goods
held by a trading concern
Manufacturing concern is one
that buys goods which are altered
or converted into another form
before they are made available
for sale. The term “finished
goods”, “goods in process”, “raw
materials”, and “factory or
manufacturing supplies” refer to
inventories of a manufacturing
concern.
II.
COST OF
INVENTORIES
COST OF
INVENTORIES
COST OF
INVENTORIES
1. Cost of purchase
2. Cost of conversion
3. Other cost incurred in
bringing the inventories
to
their
present
location and condition
indirect materials
COST
Inventories shall
be measured at
the lower of cost
and NRV.
Excluded from the cost
of inventories: (ASAS)
1. Abnormal amounts of wasted materials, labor and other
production costs.
2. Storage costs, unless necessary in the production process
prior to a further production stage. Storage cost on goods in
process are capitalized but storage costs on finished goods
are expensed.
3. Administrative overheads
4. Selling costs or distribution
Cost of purchase
1. Comprises the purchase price, import duties and
irrecoverable taxes, freight handling and other
costs directly attributable to the acquisition of
finished goods, materials and services.
2. Trade discounts, rebates and other similar items
are deducted in determining the cost of purchase.
Cost of conversion
1. Includes cost directly related to the units of production such as
direct labor.
2. It also includes a systematic allocation of fixed and variable
production overhead that is incurred in converting materials
into finished goods.
Other Costs: Costs necessary to bring the inventories
to their current location and condition.
Fixed production overhead - is the
indirect cost of production that
remains
relatively
constant
regardless of the volume of
production.
Variable production overhead - is
the indirect cost of production that
varies directly with the volume of
production.
Excluded from the cost
of inventories: (ASAS)
Excluded from the cost
of inventories: (ASAS)
III.
INVENTORY
VALUATION METHODS
COST FORMULAS
First in, first out (FIFO) - The FIFO
method assumes that the oldest
inventory items (the first ones
purchased or produced) are
sold first. This method is widely
used in various industries and for
different types of inventory.
The inventory is thus expressed in terms of
recent or new prices while the cost of
goods sold is representative of earlier or
old prices.
FIFO METHOD
Illustration Problem
1. Input given
data and
multiply the
unit cost
and units to
identify
COGAS
2. Identify COGS (total units of
COGAS minus total units of
ending inventory )
3. Identify COGS (basis would
start sa first/earlier product to
accumulate the units sold
then copy the rate and
multiply the COGS units and
rate for the COGS)
4. Identify Ending Inventory
(basis would start sa naay
remaining purchases to
accumulate the units for
ending inventory then copy
the rate and multiply the units
units and rate for the ending
inventory)
COST FORMULAS
Weighted average - The cost of the beginning
inventory plus the total cost of purchases
during the period is divided by the total units
purchased plus those in the beginning
inventory to get a weighted average unit cost.
Such weighted average unit cost is then
multiplied by the units on hand to derive the
inventory value.
The average unit cost is computed by dividing
the total cost of goods available for sale by the
total number of units available for sale.
WEIGHTED AVERAGE METHOD
1. Input beginning balance
2. Sales (input it sa issues column then copy the rate sa beg. balance then
multiply qty issues and rate for the amount )
3. Input Balance (sales minus beg. balance then copy rate sa issues and
multiply qty balance and rate for the amount)
4. Purchase (input it sa receipts column then copy the rate sa given data then multiply qty
receipts and rate for the amount )
5. Input Balance (receipts plus current balance then to get the rate sa balance is add the prev
balance amt and receipts amt divided by total current balance and then multiply the rate and
current balance for the amount)
6. Sales (input it sa issues column then copy the rate sa current nceance then
multiply qty issues and rate for the amount )
7. Input Balance (sales minus current balance then copy rate sa issues and multiply
qty balance and rate for the amount)
8. Purchase (input it sa receipts column then copy the rate sa given data then multiply qty receipts and rate for
the amount )
9. Input Balance (receipts plus current balance then to get the rate sa balance is add the prev balance amt and
receipts amt divided by total current balance and then multiply the rate and current balance for the amount)
10. Sales (input it sa issues column then copy the rate sa current nceance then multiply qty
issues and rate for the amount )
11. Input Balance (sales minus current balance then copy rate sa issues and multiply qty
balance and rate for the amount)
IV.
MEASUREMENT OF
INVENTORIES
Lower of Cost and Net Realizable Value
(LCNRV)
NRV - Estimated selling price in the ordinary course of business less
the estimated costs of completion and the estimated costs
necessary to make the sale.
NRV provides a conservative valuation approach to avoid overstating
the value of inventory.
Ensures that inventory is not carried at a value higher than what can
be realized from its sale.
Aligns with the principle of prudence, where assets should not be
overstated and liabilities should not be understated.
Components of
NRV Calculation:
1. Estimated Selling Price: Price expected from selling
inventory.
2. Costs of Completion: Costs needed to bring
inventory to a saleable condition.
3. Costs Necessary to Make the Sale: Costs directly
associated with selling the inventory.
LCNRV CALCULATION: if NRV is given
1. For each item,
compare the unit
cost to the NRV
and take the
lower value
2. Multiply the lower value (either cost or NRV)sa number of units for each
item to determine the inventory value
LCNRV CALCULATION: if NRV is not given
NRV=Estimated Sales Price−Cost of Disposal
Step 1: Calculate Net Realizable Value (NRV)
The NRV is calculated as: NRV=Estimated Sales Price−Cost of Disposal
Step 2: Compare Cost and NRV
For each item, compare the unit cost to the NRV and take the lower value
Step 3: Multiply the lower value (either cost or NRV) by the number of units for each
item to determine the inventory value
What to do if NRV is lower than its cost?
If the NRV of inventory is lower than its cost, you must write down the inventory to its NRV. This writedown is recognized as an expense in the period it occurs, ensuring that inventory is not overstated on
the balance sheet.
Write-Down Amount = Cost − NRV = 150 − 140 =10 per unit
Total Write-Down Amount = 1,200 units × 10= 12,000
Accounting for inventory writedown
If the cost is lower than the net realizable value, there is no
accounting problem because the inventory is stated at cost
and the increase in value is not recognized.
If the net realizable value is lower than the cost, the inventory
is measured at net realizable value.
The writedown of inventory to net realizable value is
accounted for using the allowance method.
Journal Entry for Write-Down
Journal Entry:
Debit: Inventory Write-Down Expense (or Cost of Goods Sold)
for $12,000
Credit: Inventory for $12,000
This entry reflects the reduction in the value of the inventory on the
balance sheet and the recognition of the expense on the income
statement.
Allowance method
The inventory is recorded at cost and any loss on inventory
writedown is accounted for separately.
Also known for loss method
If the required allowance increases, an additional loss is recognized.
If the required allowance decreases, a gain on reversal of inventory
writedown is recorded.
The gain is limited only to the extent of the allowance balance
DISCLOSURES
The accounting
inventories.
policies
adopted
for
measuring
The total carrying amount of inventories and the carrying
amount in classifications appropriate to the entity.
The amount of inventories recognized as an expense
during the period.
The amount of any write-down of inventories recognized
as an expense and the amount of any reversal of any
write-down recognized as a reduction in the amount of
inventories recognized as an expense.
The carrying amount of inventories pledged as security for
liabilities.
Nicole Angela O. Vega
THANK
YOU
PAS 2 Valix