Intermediate Accounting Volume 1 (Inventories) by Valix PDF

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CHAPTER 10INVENTORIESINVENTORIES assets held for sale in the extraordinary 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.  encompass goods purchased and held for resale...

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Intermediate Accounting 1 | BSA-2201 CHAPTER 10 INVENTORIES

INVENTORIES 

assets held for sale in the extraordinary 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.



encompass goods purchased and held for resale, for example: a. Merchandise purchased by a retailer and held for resale. b. Land and other property held for resale by a subdivision entity and real estate developer.



also encompass finished goods produced, goods in process and materials and supplies awaiting use in the production process.

CLASSES OF INVENTORIES 1. Inventories of a trading concern 

one that buys and sells goods in the same form purchased



“Merchandise Inventory” is the term generally applied to goods held by a trading concern.

2. Inventories of manufacturing concern 

one that buys goods which are altered or converted into another form before they are made available for sale

INVENTORIES OF A MANUFACTURING CONCERN 1. Finished Goods 

completed products which are ready for sale



have been assigned their full share of manufacturing costs

2. Goods in Process (Work in Process) 

partially completed products which require further process or work before they can be sold

3. Raw Materials 1 |Chapter 10 – Inventories

Intermediate Accounting 1 | BSA-2201 

goods that are to be used in the production process

4. Factory or Manufacturing Supplies 

similar to raw materials but their relationship to the end product is indirect



may be referred to as “Indirect Materials” because they are not physically incorporated in the products being manufactured



these supplies find their way into the product cost as part of the manufacturing overhead

GOODS INCLUDIBLE IN THE INVENTORY RULE: all goods to which the entity has title shall be included in the inventory, regardless of the location. ”PASSING OF TITLE” – a phrase that is a legal language which means “the point of time at which ownership changes”. LEGAL TEST Is the entity the owner of the goods to be inventoried? If the answer is: 

affirmative, the goods shall be included in the inventory.



negative, the goods shall be excluded in the inventory.

Applying the legal test, the following items are includible in inventory: a. Goods owned and on hand b. Goods in transit and sold FOB destination c. Goods in transit and purchased FOB shipping point d. Goods out on consignment e. Goods in the hands of salesman or agents f. Goods held by customers on approval or on trial

WHO IS THE OWER OF GOODS IN TRANSIT? FOB – free on board 1. FOB destination 

ownership of goods purchased is transferred only upon receipt of goods by the buyer at the point of destination

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thus, the goods in transit are still the property of the seller



accordingly, the seller shall legally be responsible for freight charges and other expenses up to the point of destination

2. FOB shipping point 

ownership is transferred upon shipment of the goods



therefore, the goods in transit are the property of the buyer



accordingly, the buyer shall legally be responsible for freight charges and other expenses from the point of shipment to the point of destination

FREIGHT TERMS 1. Freight collect 

freight charge on the goods shipped is not yet paid



common carrier shall collect the same from the buyer



thus, the freight charge is actually paid by the buyer

2. Freight prepaid 

freight charge on the goods shipped is already paid by the seller

FOB destination and FOB shipping point  determine the ownership of the goods in transit and the party who is supposed to pay the freight charge and other expenses from the point of shipment to the point of destination

Freight Terms FOB destination, Freight prepaid FOB shipping point, Freight collect FOB destination, Freight collect FOB shipping point, Freight prepaid MARITIME SHIPPING TERMS 1. FAS or Free alongside

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Freight collect and Freight prepaid  determine the party who actually paid the freight charge but not the party who is supposed to legally pay the freight charge

Who Shoulders the Transportation Costs? seller buyer seller buyer

Who Pays the Shipper? seller buyer buyer seller

Intermediate Accounting 1 | BSA-2201 

A seller who ships FAS must bear all expenses and risks 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.

2. CIF or Cost, insurance and freight 

The buyer agrees to pay in a lump sum the cost of the goods, insurance and freight charge.



The shipping contract may be modified as CF which means that the buyer agrees to pay in lump sum the cost of the goods and freight charge only.



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.

3. Ex-ship 

A seller who delivers the goods ex-ship bears all expenses and risk of loss until the goods are unloaded at which time title and risk of loss shall pass to the buyer,

CONSIGNED GOODS A consignment is a method of marketing 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. Consigned goods shall be included in the consignor’s inventory and excluded from the consignee’s inventory. Freight and other handling charges on goods out of consignment are part of the cost of goods consigned. When consigned goods are sold by the consignee, a report is made to the consignor together with a cash remittance for the amount of sales minus commission and other expenses chargeable to the consignor.

STATEMENT PRESENTATION Inventories are generally classified as current assets.

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Intermediate Accounting 1 | BSA-2201 The inventories shall be presented as one line item in the statement of financial position but the details of the inventories shall be disclosed in the notes to financial statements. ACCOUNTING FOR INVENTORIES 1. Periodic System calls for the physical counting of goods on hand at the end of the accounting period to



determine quantities The quantities are then multiplied by the corresponding unit costs to get the inventory



value for balance sheet purposes. 

This approach gives actual or physical inventories.



this procedure is generally used when the individual inventory items have small peso investment

2. Perpetual System requires the maintenance of records called stock cards that usually offer a running



summary of the inventory inflow and outflow Inventory increases and decreases are reflected in the stock cards and the resulting



balance represents the inventory. 

This approach gives book or perpetual inventories.



this procedure is commonly used where the inventory items treated individually represent a relatively large peso investment when used, a physical count of the units on hand should at least be made once a year



to confirm the balances appearing on the stock cards

ILLUSTRATION Periodic System

Perpetual System

Purchases xxx Accounts payable xxx

Freight in Cash

xxx xxx

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Purchase of merchandise on account

Merchandise inventory xxx Accounts payable xxx

Payment of freight Merchandise inventory xxx Cash xxx on the purchase

Intermediate Accounting 1 | BSA-2201

Accounts payable Purchase return

xxx xxx

Accounts receivable xxx Sales xxx

Sales return xxx Accounts receivable xxx

Merchandise inventory-end xxx Income summary xxx

Return of merchandise purchased to supplier

Sale of merchandise on account

Return of merchandise sold from customer

Adjustment of ending inventory

Accounts payable xxx Merchandise inventory xxx

Accounts receivable Sales

xxx xxx

Cost of goods sold xxx Merchandise inventory xxx

Sales return xxx Accounts receivable xxx Merchandise inventory xxx Cost of goods sold xxx

RULE: the ending balance is not adjusted. The balance of the merchandise inventory account represents the ending inventory.

INVENTORY SHORTAGE OR OVERAGE If at the end of the accounting period, a physical count indicates a different amount, an adjustment is necessary to recognize any inventory shortage of overage. The inventory shortage is usually closed to cost of goods sold because this is often the result of normal shrinkage and breakage in inventory. However, abnormal and material shortage shall be separately classified and presented as other expense.

TRADE DISCOUNTS AND CASH DISCOUNTS 1. Trade discounts 

deductions from the list or catalog price in order to arrive at the invoice price which is the amount actually charged to the buyer

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thus, not recorded



its purpose is to encourage trading or increase sales



also suggest to the buyer the price at which the goods may be resold

2. Cash discounts 

deductions from the invoice price when payment is made within the discount period



its purpose is to encourage prompt payment



recorded as purchase discount by the buyer and sales discount by the seller -

Purchase discount is deducted from the purchases to arrive at net purchases.

-

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



in practice, most entities record purchases at gross invoice amount



technically, this violates the matching principle because discounts are recorded only when taken or when cash is paid rather than when purchases that give rise to the discounts are made



this procedure does not allocate discounts taken between goods sold and goods on hand



despite theoretical shortcomings, this is supported on practical grounds



more convenient than the net method from a bookkeeping standpoint



if applied consistently over time, it usually produces no material errors in the financial statements

2. Net method 

purchases and accounts payable are recorded at net



cost measured represents the cash equivalent price on the date of payment and therefore the theoretically correct historical cost

ILLUSTRATION Purchases

Gross Method 200,000

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Purchases

Net Method 196,000

Intermediate Accounting 1 | BSA-2201 Accounts Payable

200,000

Purchase on account, P200,000, 2/10, n/30.

Accounts Payable

196,000

Accounts payable 200,000 Cash 196,000 Purchase discount 4,000

Assume payment is made between within the discount period.

Accounts payable 196,000 Cash 196,000

Accounts payable 200,000 Cash 200,000

Assume payment is made beyond the discount period,

Accounts payable 196,000 Purchase disc. lost 4,000 Cash 200,000

-

Assume at the end of accounting period, no payment is made and the discount period has expired.

Purchase disc. lost 4,000 Cash 4,000

COST OF INVENTORIES a. Cost of Purchase 

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



trade discounts, rebates and other similar items are deducted



shall not include foreign exchange differences which arise directly from the recent acquisition of inventories involving a foreign currency



when inventories are 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

a. Cost of Conversion 

includes cost directly related to the units of production such as direct labor

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also includes a systematic allocation of fixed and variable production overhead that is incurred in converting materials into finished goods. a. Fixed production overhead – the indirect cost of production that remains relatively constant regardless of the volume of production. EXAMPLES: depreciation and maintenance of factory building and equipment, and administration. b. Variable production overhead – the indirect cost of production that varies directly with the volume of production. EXAMPLES: indirect labor and indirect materials.

Allocation of fixed production overhead Allocation of variable production overhead  to cost of conversion, is based on  allocated to each unit of production normal capacity of the production on the basis of the actual use of the facilities production facilities Normal Capacity – is the production expected  A production process may result in to be achieved on average over a number of more than one product being periods or seasons under normal circumstances produced simultaneously. taking into account the loss of capacity EXAMPLE CASE: when joint products are resulting from planned maintenance. produced or where there is a main product and  the amount to each unit of a by-product. production is not increased as  When the costs of conversion are consequence of low production or not separately identifiable, they are idle plant allocated between the products on a Unallocated fixed overhead – is recognized as rational and consistent basis. expense in the period in which it is incurred.  Most by-products by their nature are not material. By-products – are measured at net realizable value and this value is deducted from the cost of the main product. 3. Other Cost 

included in the cost of inventories only to the extent that it is incurred in bringing the inventories to their present location and condition



For example, it may be appropriate to include the cost of designing product for specific customers in the cost of inventories.



However, the following costs are excluded from the cost of inventories and recognized as expenses in the period when incurred:

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Intermediate Accounting 1 | BSA-2201 a. Abnormal amounts of wasted materials, labor and other production costs. b. Storage costs, unless these costs are necessary in the production process prior to a further production stage. Thus, storage costs on goods in process are capitalized but storage costs on finished goods are expensed. c. Administrative overheads that do not contribute to bringing inventories to their present location and condition. d. Distribution or selling costs

COST OF INVENTORIES OF A SERVICE PROVIDER 

consists primarily of the labor and other costs of personnel directly engaged in providing the service, including supervisory personnel and attributable overhead



Labor and other costs relating to sales and general administrative personnel are not included but are recognized as expenses in the period in which they are incurred.

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Intermediate Accounting 1 | BSA-2201 PROBLEMS

Problem 10-9 (AICPA Adapted)

Hero Company reported inventory on December 31, 2020 at P6,000,000 based on a physical count of goods priced at cost, and before any necessary year-end adjustment relating to the following:



Included in the physical count were goods billed to a customer FOB shipping point on December 31, 2020.

These goods had a cost of P125,000 and were picked up by the carrier on January 10, 2021.



Goods shipped FOB shipping point on December 28, 2020 from a vendor to Hero Company were received on January 4, 2021. The invoice cost was P300,000.

What amount should be reported as inventory on December 31, 2020?

a. 5,875,000 b. 6,000,000 c. 6,175,000 d. 6,300,000

Problem 10-10 (AICPA Adapted)

Empty Company reported inventory on December 31, 2020 at P2,500,000 based on physical count priced at cost and before any necessary adjustment for the following;

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Merchandise costing P100,000, shipped FOB shipping point from a vendor on December 30, 2020 was received and recorded on January 5, 2021.



Goods in the shipping area were excluded from inventory although shipment was not made until January 5, 2021.

The goods billed to the customer FOB shipping point on December 30, 2020 had a cost of P400,000.

What amount should be reported as inventory on December 31, 2020?

a. 2,500,000 b. 2,600,000 c. 2,900,000 d. 3,000,000

Problem 10-11 (AICPA Adapted)

Dignity Company had the following consignment transactions during the current year: Inventory shipped on consignment to a consignee Freight paid by Dignity Company Inventory received on consignment from a consignor Freight prepaid by consignor

No sales of consigned goods were made during the current year.

What amount should be reported as consigned inventory at year-end?

a. 700,000 b. 650,000 c. 850,000 12 |Chapter 10 – Inventories

600,000 50,000 800,000 50,000

Intermediate Accounting 1 | BSA-2201 d. 600,000

Problem 10-12 (AICPA Adapted)

Kindness Company regularly buys sweaters and is allowed a trade discount of 20% and 10%.

The entity made a purchase on March 20 and received an invoice with a list price of P900,000, a freight charge of P50,000, and payment terms of net 30 days.

What is the cost of the purchase?

a. 648,000 b. 630,000 c. 698,000 d. 680,000

Problem 10-13 (AICPA Adapted)

On June 1, Compassion Company sold merchandise with a list price of P1,000,000 to a customer.

The entity allowed trade discounts of 20% and 10%. Credit terms were 5/10, n/30 and the sale was made FOB ship...