FATHER SATURNINO URIOS UNIVERSITY

ACCOUNTANCY PROGRAM

I. INVENTORIES – PAS 2 states that Inventories are 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.

As a rule, all goods to which the entity has TITLE (ownership) shall be INCLUDED in the INVENTORY,
regardless of location.

Goods to be included as INVENTORY:

a. Goods owned and on hand
b. Goods in transit and sold FOB DESTINATION (FOB Buyer)
c. Goods in transit and purchased FOB SHIPPING PINT (FOB Seller)
d. Goods out on consignment
e. Goods in the hands of salesmen or agents
f. Goods held by customers on approval or on trial
g. Goods PURCHASED on INSTALLMENT.

Freight Terms
1. FOB Destination – Seller should pay the freight. The title of the goods is transferred upon
receipt of the goods by the buyer at the point of destination.
2. FOB Shipping Point – Buyer should pay the freight. The title of the goods is transferred upon
shipment of the goods.
3. Freight Collect – Freight charge is actually paid by the buyer.
4. Freight Prepaid – Freight charge is actually paid by the seller.
5. FAS (Free Alongside) – Seller Dock Carrier
Seller Buyer
6. CIF (Cost, Insurance & Freight) – Title is transferred upon delivery of the goods to the carrier.
7. Ex -Ship – Title is transferred when the goods are unloaded.

Freight Terms Seller’s Point of View Buyer’s Point of View

FOB Destination, Freight Freight out xx
Prepaid Cash xx No entry
FOB Destination, Freight Freight out xx Accounts Payable xx
Collect Accounts Receivable xx Cash xx
FOB Shipping Point, Freight Freight – in xx
Collect No entry Cash xx
FOB Shipping Point, Freight Accounts Receivable xx Freight- in xx
Prepaid Cash xx Accounts Payable xx

Accounting of Inventories:
a. Periodic Inventory System
Beginning Inventory xx
Net Purchases:
Purchases xx
Purchase returns, discounts & Allowances (xx)
Freight – In xx xx
Goods Available for sale xx
Ending Inventory (xx)
Cost of sales xx

b. Perpetual Inventory System – cost of sale can be computed immediately base on the entries

Formulas:
 List Price xx
Trade discount (xx)
Invoice Price xx
Cash discount (xx)
Net Amount xx

Cost of Inventory:
*Cost of Purchase xx
Cost of conversion xx
** Other costs incurred that are necessary xx
Cost of Inventory xx

* Cost of purchase:
Purchase price xx
Import duties xx
Irrecoverable taxes xx
Freight xx
Handling xx
Directly attributable cost xx
Trade discount (xx)
Rebates (xx)
Cost of purchase xx

** Other costs – Incurred in bringing the inventories to their present condition. Example is storage of
cost on goods in process.

The following are cost/items that are expensed outright:

a. Abnormal cost c. Administrative overhead
b. Storage cost on Finished goods d. Distribution or selling costs

II. INVENTORY COST FLOW

PAS 2, par 25, expressly provides that the cost of inventories shall be determined using:
a. FIFO – first in , first out (“ first come, first sold”)
b. Weighted Average

a. FIFO:
FIFO Periodic = FIFO Perpetual
If there is inflation it would result to HIGHEST INCOME
If there is deflation it would result to LOWER INCOME

End units x Recent cost per unit = Inventory, end

Sold units x Oldest cost per unit = Cost of Sale

b. WEIGHTED AVERAGE

* Weighted Average Periodic:

Goods Available for sale / Units available for sale = Weighted average cost per unit

* Weighted Average Perpetual ( “Moving Weighted Average”)

New Weighted Average unit cost must computed after every PURCHASE and PURCHASE returns.

Specific Identification
- Specific costs are attributed to identified items of inventory
- PAS 2, par 33, appropriate for inventories that are segregated for a specific project
Relative Sales Price
- Proportionate the basket Price/cost according to the relative sales price.

III. LOWER OF COST AND NET REALIZABLE VALUE

PAS 2, par 9, provides that inventories shall be measured at the LOWER of Cost or Net Realizable
Value (LCNRV). The practice of writing inventories down below cost to net realizable value is
consistent with the view that assets shall not be carried in excess of amounts expected to be realized from their
sale or use.

Net Realizable Value = Estimated Selling Price – Est. cost of completion – Est. cost of disposal

Inventories are usually written down to net realizable value on an item by item or individual basis.

Accounting for Inventory Writedown:

Cost < NRV = The inventory is measured at cost and the increase in value is not recognized
NRV < Cost = The inventory is measured at NRV and the decrease in value is recognized

Methods of accounting for inventory writedown

a. Direct method or cost of goods sold method
b. Allowance Method or Loss method (Preferred method, supported by PAS 2,par 36)

*Note that whether direct writeoff method or allowance method, the cost of goods sold must be the same.

Direct method or cost of goods sold method

The inventory is recorded lower of cost or net realizable value. Any loss on inventory
writedown is not accounted separately but “buried” in the cost of goods sold.

Inventory – end xx
Income summary xx

Allowance method or loss method

The inventory is recorded at COST and any loss on inventory writedown is accounted for
separately.
Loss on inventory writedown = COST > NRV

Entry:
Loss on inventory writedown xx
Allowance for inventory writedown xx

The allowance account is adjusted at every end of the year. If the required allowance increases, an
additional loss is recognized. If the required allowance decreases, a gain on reversal of inventory
writedown is recorded. However, the gain is limited only to the extent of the allowance balance.

Entry: If there is increase in the required allowance

Loss on inventory writedown xx
Allowance for inventory writedown xx

Entry: If there is decrease in the required allowance

Allowance for inventory writedown xx

Gain on reversal of inventory writedown xx
Loss on inventory writedown account – included in the computation of cost of goods sold.

Allowance for inventory writedown account – is presented as deduction from the inventory recorded
at COST.

Gain on reversal of inventory writedown account – is presented as the deduction from cost of goods
sold (PAS 2, par 34).

Purchase Commitments
- Are obligations of the entity to acquire certain goods sometimes in the future at a fixed price
and fixed quantity. Note that Purchase Commitments must be NONCANCELABLE.
- If there is decline in purchase price after a purchase commitment has been made, a loss is
recorded in the period of price decline.
Loss on purchase commitment xx
Estimated Liability for purchase commitment xx
Loss on purchase commitment account is classified as OTHER EXPENSE
Estimated Liability for purchase commitment account is classified as CURRENT LIABILITY

- If the market price rises by the time the entity makes the purchase, a gain on purchase
commitment would be recorded. However, the amount of gain to be recognized is limited
to the loss on purchase commitment previously recorded. Gain on purchase commitment
account is classified as OTHER INCOME.

Entry for actual purchase if there is additional loss:

*Purchases xx
Loss on purchase commitment xx
Estimated liability for purch. comm xx
**Accounts Payable xx

Entry for actual purchase if there is gain:

*Purchases xx
Estimated liability for purch. comm xx
**Accounts Payable xx
Gain on purch. comm xx

* Amount is Lower between the fixed price and replacement cost(Actual cost of Purhase)
** Amount to be recorded is the fixed price based on the purchase commitment/agreement.

IV. GROSS PROFIT METHOD

Gross profit method is based on the assumption that the rate of gross profit remains
approximately the same from period to period and therefore the ratio of cost of goods to net sales is
relatively constant from period to period.

GOODS AVAILABLE FOR SALE (GAS) xx

COST OF GOODS SOLD (xx)
ENDING INVENTORY xx

FORMULAS:

*NET SALES xx Gross profit rate = Gross Profit / Net Sales

COS (xx) Cost of sale rate = Cost of sale / Net Sales
Gross Profit xx
Gross Profit Rate BASED ON SALES: Sales is 100%

*NET SALE 100% Gross profit rate = 30% / 100% = 30%

COS (70%) Cost of sale rate = 70% / 100% = 70%
Gross Profit 30%

Gross Profit Rate BASED ON COSTS: Cost of sale is 100%

*NET SALE 130% Gross profit rate = 30% / 130% = 23.08%

COS (100%) Cost of sale rate = 100% / 130% = 76.92%
Gross Profit 30%

* NET SALES = Gross Sales – Sales Return

Only Sales return is deducted because there is an actual addition to the goods on hand. Sales allowances and sales
discount are ignored because they do not affect the physical volume of the goods, but it deceases the amount of sales.

If the problem is silent, it is assumed that the gross profit rate is computed BASED ON SALES.

Illustration:

In December 2019, Unanimous Company had a significant portion of inventory stolen. The entity
determined the cost of inventory not stolen to be 100,000.

2019 2018
Purchases 5,200,000 5,000,000
Purchase returns and allowances 240,000 200,000
Sales 7,880,000 8,200,000
Sales Returns 80,000 200,000
Sales allowances 100,000 50,000
Beginning Inventory 1,200,000 2,000,000
Operating Expenses 800,000 750,000

1. What is the estimated cost of the stolen inventory? 600,000.

Compute first the Gross Profit Rate for 2018, which is also applied for 2019.

Beginning, Inventory 2,000,000

Purchases 5,000,000
Purchase returns and allowances (200,000) 4,800,000
Goods Available for Sale 6,800,000
Ending, Inventory *(1,200,000)
Cost of Sale (COS) 5,600,000

*The beginning Inventory for 2019 is the ending inventory for year 2018.

Sale 8,200,000
Sales returns (200,000) 8,000,000 100%
COS 5,600,000 5,600,000/8,000,000 = 70%
Gross Profit for 2018 2,400,000 2,400,000/8,000,000 = 30%

Compute for the Ending Inventory for 2019

Beginning, Inventory 1,200,000

Purchases 5,200,000
Purchase returns and allowances (240,000) 4,96,000
Goods Available for Sale 6,160,000
 Sales 7,880,000
Sales Return (80,000)
Net Sales 7,800,000
COS rate x 70%
Cost of Sales (COS) 5,460,000

Goods Available for Sale 6,160,000

COS (5,460,000)
TOTAL ENDING INVENTORY 700,000
Cost of inventory not stolen (100,000)
COST OF INVENTORY STOLEN 600,000

2. How much is the net income for year 2019 and 2018. 1,360,000; 1,600,000

2019 2018
Sales 7,880,000 8,200,000
Sales Returns (80,000) (200,000)
Sales Allowances (100,000) (50,000)
Net Sales 7,620,000 7,950,000
COS (5,460,000) (5,600,000)
Gross Profit 2,160,000 2,350,000
Operating Expenses ( 800,000) ( 750,000)
NET INCOME 1,360,000 1,600,000

V. RETAIL INVENTORY METHOD

Retail Inventory method is another method in estimating the value of the inventory. PAS 2, par
22, provides that this method is often used in the retail industry for measuring inventory of large number
of rapidly changing items with similar margin for which it I impracticable to use other costing method.

FORMULA:

Goods Available for Sale at RETAIL or SELLING PRICE xx

Net Sales (Gross sales minus sales returns only) xx
Ending inventory at SELLING PRICE xx
Multiply by: COST RATIO* xx
Ending Inventory at COST xx

* COST RATIO = Goods available for sale AT COST

Goods available for sale AT RETAIL

APPROACHES in the use of RETAIL METHOD

1. Conservative or Conventional or Lower of cost and Net Realizable Value Approach – This
approach only considers the net Mark-up ( Mark-up minus Mark-up Cancellation)

2. Average cost Approach – This approach considers Net Mark-up and Net Mark-down ( Mark
down minus Mark-down cancellation). This the approach often used by retail departments.
Therefore, if the problem is silent use this approach.
3. FIFO Approach – This approach both consider Net Mark-up and Net Mark-down in computing
cost ratio, but the beginning inventory is excluded in the computation of the cost ratio ONLY.
 Cost Retail
Beginning Inventory xx xx
Purchases xx xx
Purchase discounts (xx) -
Purchase returns (xx) (xx)
Purchase allowances (xx) -
Freight In xx -
Departmental transfer in or debit xx xx
Departmental transfer out or credit (xx) (xx)
Additional Mark-up - xx
Mark-up Cancellation - (xx)
Goods Available for Sale – Conservative xx / xx = Cost ratio - conservative
Mark down - (xx)
Mark down cancellation - xx
Goods Available for Sale – Average xx / xx = Cost Ratio Average
Normal shortage, shrinkage, spoilage,breakage - (xx)
Abnormal shortage, shrinkage, spoilage,breakage (xx) (xx)
GAS xx xx
Sales xx
Sales Return (only sales return) (xx)
Employee Discounts xx (xx)
Ending Inventory AT RETAIL xx
Multiply cost ratio: xx
ENDING INVENTORY at COST xx

For the illustration kindly refer to the book.