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NOTES ON INVENTORYDefinition Inventories include assets held for sale in the ordinary course of business (finished goods), assets in the production process for sale in the ordinary course of business (work in process), and materials and supplies that are consumed in production (raw materials). [IAS ...

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NOTES ON INVENTORY Definition Inventories include assets held for sale in the ordinary course of business (finished goods), assets in the production process for sale in the ordinary course of business (work in process), and materials and supplies that are consumed in production (raw materials). [IAS 2.6] However, IAS 2 excludes certain inventories from its scope: [IAS 2.2] 1. work in process arising under construction contracts (see IAS 11 Construction Contracts) 2. financial instruments (see IAS 39 Financial Instruments: Recognition and Measurement) 3. biological assets related to agricultural activity and agricultural produce at the point of harvest (see IAS 41 Agriculture).  



Also, while the following are within the scope of the standard, IAS 2 does not apply to the measurement of inventories held by: [IAS 2.3] producers of agricultural and forest products, agricultural produce after harvest, and minerals and mineral products, to the extent that they are measured at net realizable value (above or below cost) in accordance with well-established practices in those industries. When such inventories are measured at net realizable value, changes in that value are recognized in profit or loss in the period of the change commodity brokers and dealers who measure their inventories at fair value less costs to sell. When such inventories are measured at fair value less costs to sell, changes in fair value less costs to sell are recognized in profit or loss in the period of the change.

Fundamental principle of IAS 2  Inventories are required to be stated at the lower of cost and net realizable value (NRV). [IAS 2.9]  NRV (Estimated Selling Price – Cost to Sell – Cost to complete) Measurement of inventories  Cost should include all: [IAS 2.10] costs of purchase (including taxes, transport, and handling) net of trade discounts received, costs of conversion (including fixed and variable manufacturing overheads) and other costs incurred in bringing the inventories to their present location and condition except for abnormal cost. Inventory cost should not include: [IAS 2.16 and 2.18]: abnormal waste, storage costs, administrative overheads unrelated to production, selling costs, foreign exchange differences arising directly on the recent acquisition of inventories invoiced in a foreign currency, interest cost when inventories are purchased with deferred settlement terms.

The standard cost and retail methods may be used for the measurement of cost, provided that the results approximate actual cost. [IAS 2.21-22]  For inventory items that are not interchangeable, specific costs are attributed to the specific individual items of inventory. [IAS 2.23] 

For items that are interchangeable, IAS 2 allows the FIFO or weighted average cost formulas. [IAS 2.25] The LIFO formula, which had been allowed prior to the 2003 revision of IAS 2, is no longer allowed.



The same cost formula should be used for all inventories with similar characteristics as to their nature and use to the entity. For groups of inventories that have different characteristics, different cost formulas may be justified. [IAS 2.25]

Write-down to net realisable value (NRV)  NRV is the estimated selling price in the ordinary course of business, less the estimated cost of completion and the estimated costs necessary to make the sale. [IAS 2.6]  Any write-down to NRV should be recognized as an expense in the period in which the write-down occurs. Any reversal should be recognized in the income statement in the period in which the reversal occurs. [IAS 2.34] Expense recognition IAS 18 Revenue addresses revenue recognition for the sale of goods. When inventories are sold and revenue is recognized, the carrying amount of those inventories is recognized as an expense (often called cost-of-goods-sold). Any write-down to NRV and any inventory losses are also recognized as an expense when they occur. [IAS 2.34] Disclosure Required disclosures: [IAS 2.36]: 1. accounting policy for inventories 2. carrying amount, generally classified as merchandise, supplies, materials, work in progress, and finished goods. The classifications depend on what is appropriate for the entity 3. carrying amount of any inventories carried at fair value less costs to sell 4. amount of any write-down of inventories recognized as an expense in the period 5. amount of any reversal of a write-down to NRV and the circumstances that led to such reversal 6. carrying amount of inventories pledged as security for liabilities 7. cost of inventories recognized as expense (cost of goods sold).  IAS 2 acknowledges that some enterprises classify income statement expenses by nature (materials, labor, and so on) rather than by function (cost of goods sold, selling expense, and so on). Accordingly, as an alternative to disclosing cost of goods sold expense, IAS 2 allows an entity to disclose operating costs recognized during the period by nature of the cost (raw materials and

consumables, labor costs, other operating costs) and the amount of the net change in inventories for the period). [IAS 2.39] This is consistent with IAS 1 Presentation of Financial Statements, which allows presentation of expenses by function or nature. Goods in transit (Goods still on road) Use the following information for the next two questions: ABC Co. purchased goods with invoice price of ₱3,000 on account on December 27, 2021. The related shipping costs amounted to ₱50. The seller shipped the goods on December 31, 2021. ABC Co. received the goods on January 2, 2022 and settled the account on January 5, 2022. How much is the capitalizable cost of the inventory purchased if the terms of the shipment are FOB shipping point, freight prepaid? a. 3,050 b. 3,000 c. 2,950 d. 0 A (3,000 cost of purchase + 50 freight-in)

As of December 31, 2021 FOB Shipping Point Prepaid FOB Shipping Point Collect

FOB Destination- Prepaid FOB Destination- Collect Merchandising Inventory Beginning Inventory Purchases Purchase Return Purchase Discount Purchase Allowance Freight In Net Purchases Available for Sale

Buyer (ABC) Inventory 3,000 Freight In 50 A/P 3,050 Inventory 3,000 Freight In 50 A/P 3,000 Cash 50 No Entry No Entry

XX XX (XX) (XX) (XX) XX XX XX

A/R Sales Cash A/R Sales

seller 3,050 3,000 50 3,000 3,000

Freight Out Cash No Entry

50 50

Beginning Inventory

+

Net Purchases

= Cost of Goods Sold

+

Ending Inventory

How much is the net cash payment to the supplier if the terms of the shipment are FOB destination, freight collect? a. 3,050 b. 3,000 c. 2,950 d. 0 C (3,000 cost of purchase - 50 reimbursement of freight by purchaser to seller)

Total inventory ABC Co. provided you the following information for the purpose of determining the amount of its inventory as of December 31, 2021: Goods located at the warehouse (physical count) 3,400,000 Goods located at the sales department (at cost) 15,800,000 Goods in-transit purchased FOB Destination 2,400,000 Goods in-transit purchased FOB Shipping Point 1,600,000 Freight incurred under “freight prepaid” for the goods purchased under FOB Shipping Point 80,000 Goods held on consignment from XYZ, Inc. 1,800,000 How much is the total inventory on December 31, 2021? a. 25,080,000 b. 25,080,000 c. 20,880,000 C Solution: Goods located at the warehouse (physical count) Goods located at the sales department (at cost) Goods in-transit purchased FOB Shipping Point Freight incurred under “freight prepaid” for the goods purchased under FOB Shipping Point Total inventory - Dec. 31, 2021

d. 20,800,000

3,400,000 15,800,000 1,600,000 80,000 20,880,000

Consigned goods ABC Co. consigned goods costing ₱14,000 to XYZ, Inc. Transportation costs of delivering the goods to XYZ totaled ₱3,000. Repair costs for goods damaged during transportation totaled ₱1,500. To induce XYZ, Inc. in accepting the consigned goods, ABC Co. gave XYZ ₱2,000 representing an advance commission.

How much is the cost of the consigned goods? a. 20,500 b. 18,500 c. 17,000 d. 14,000 C 17,000 (14,000 + 3,000) Consignor 100

Cost Part of InventoryInvoice, Handling, Insurance, Transportation 10

Consigne e

Cost part of Expense – Transportation, Handling

Buyer

Entry of ABC Inventory 3,000 Repair Expense 1,500 Advances to Consignee 2,000 Cash 6,500

Correct inventory and accounts payable Use the following information for the next two questions: On December 31, 2021, ABC Co. has a balance of ₱240,000 in its inventory account determined through physical count and a balance of ₱90,000 in its accounts payable account. The balances were determined before any necessary adjustment for the following: a. Segregated goods in the shipping area marked “Bill and hold sale” were included in inventory because shipment was not made until January 4, 2022. The goods were sold to the customer on a “bill and hold” sale for ₱20,000. The cost of the goods is ₱10,000. The goods were already packed and ready for shipment. Both ABC and the buyer acknowledged the shipping term. b. A package containing a product costing ₱80,000 was standing in the shipping area when the physical inventory was conducted. in the inventory although it was marked “Hold for shipping instructions.” The sale order was dated December 17 but the package was shipped and the customer was billed on January 4, 2022. c. Merchandise costing ₱10,000, shipped FOB destination from a vendor on December 30, 2021, was received and recorded on January 5, 2022. d. Goods shipped F.O.B. shipping point on December 27, 2021, from a vendor to ABC Co. were received on January 6, 2022. The invoice cost of ₱30,000 was recorded on December 31, 2021 and included in the count as “goods in-transit.”

How much is the adjusted balance of inventory? a. 240,000 b. 230,000 c. 160,000 d. 200,000

B (See solutions below)

Unadjusted balances a. Bill and hold sale b. Unshipped goods counted c. FOB destination properly excluded d. FOB shipping point properly included Adjusted balances

Inventor y 240,000 (10,000) -

Accounts payable 90,000 -

-

-

-

-

230,000

90,000

How much is the adjusted balance of accounts payable? a. 90,000 b. 80,000 c. 60,000 d. 100,000 A Inventories under financing agreement, Installment sales The records of ABC Co. show the following: 1. Goods sold on an installment basis to XYZ, Inc., title to the goods is retained by ABC Co. until full payment is made. XYZ, Inc. took possession of the goods. 2. Goods sold to Alpha Co., for which ABC Co. has the option to repurchase the goods sold at a set price that covers all costs related to the inventory. 3. Goods sold where large returns are unpredictable. 4. Goods received from Beta Co. for which an agreement was signed requiring ABC Co. to replace such goods in the near future. How much is included as part of inventory? a. 50,000 b. 120,000 c. 270,000 d. 330,000 B (70,000 + 50,000) = 120,000

150,000 280,000 70,000

50,000

Bill and hold and Lay away The following are among the transactions of ABC Co. during the year: a. Purchased goods costing ₱20,000 from XYZ, Inc. Billing was received although delivery was delayed per request of ABC Co. The goods purchased were segregated and ready for delivery on demand. b. Purchased goods costing ₱35,000 from Alpha Corp. on a lay away sale agreement. The goods were not yet delivered until after ABC makes the final

payment on the purchase price. ABC Co. made total payments of ₱34,920 during the year. How much of the goods purchased above will be included in ABC’s year-end inventory? a. 55,000 b. 54,920 c. 34,920 d. 0 A Errors in inventory ABC Co. uses the periodic inventory system. In the current year, ABC’s ending inventory is understated by ₱20,000. Which of the following statements is correct? a. ABC’s cost of goods sold is understated by ₱20,000. b. ABC’s gross income is understated by ₱20,000. c. ABC’s net purchases are understated by ₱20,000. d. ABC’s profit is overstated by ₱20,000. B

Assume ending inventory of 2020 is P 2,000 Understated. 2020

Sales COGS: Beg Net Purchases Available Ending COGS Gross Profit Income

2021

In Error Correct 100,000 100,000 20,000 80,000 100,000 (18,000)

20,000 80,000 100,000 (20,000 )

82,000 80,000 18,000 20,000 Under by 2,000

In Error 120,000

Correct 120,000

18,000 90,000 108,000 (12,000)

20,000 90,000 110,000 (12,000)

96,000 24,000

98,000 22,000

Over by 2,000

Observation: a. If the ending inventory is in error, the effect is the same to that of Income b. If the beginning inventory and Purchases are in error, the effect is opposite to that of Income c. Just a reminder, the ending of a period is the beginning of the following period.

Cost of purchase ABC Co., a VAT payer, imported goods from a foreign supplier. Costs incurred by ABC include the following: purchase price, ₱250; import duties, ₱20; value added tax, ₱15 ; transportation and handling costs, ₱5; and commission to broker, ₱2. How much is the cost of purchase of the imported goods? a. 292 b. 277 c. 257 d. 255 B 277 excluding VAT (250 + 20 + 5 + 2). Deferred payment On January 1, 2021 ABC Co. acquired goods for sale in the ordinary course of business for ₱250,000, excluding ₱5,000 refundable purchase taxes. The supplier usually sells goods on 30 days’ interest-free credit. However, as a special promotion, the purchase agreement for these goods provided for payment to be made in full on December 31, 2021. In acquiring the goods transport charges of ₱2,000 were incurred; these were due on January 1, 2021. An appropriate discount rate is 10 per cent per year. How much is the initial cost of the inventories? a. 229,273 b. 224,727 c. 250,000 d. 257,000 A Solution: Purchase price excluding refundable purchase taxes 250,000 Multiply by: PV of P1 @10%, n=1 (or simply divide by 110%) 0.90909 Cash price equivalent of inventory purchased 227,273 Transport costs (Freight-in) Initial cost of inventories Jan 1 ? 227,273

2,000 229,273 Dec 31 250,000

ABC Co. acquired a tract of land for ₱2,000,000. The land was developed and subdivided into residential lots at an additional cost of ₱200,000. Although the subdivided lots are relatively equal in sizes, they were offered at different sales prices due to differences in terrain and locations. Information on the subdivided lots is shown below: Lot group No. of lots Price per lot A 4 480,000 B 10 240,000 C 15 192,000 During the year, 2 lots from the A group, 3 lots from the B group and 12 lots from the C group were sold.

How much gross income is recognized during the year? a. 2,766,667 b. 2,783,333 c. 2,860,000

d. 2,877,333

A

Solution: Lot No. grou of p lots

Price Total per lot price

A

4

480,0 00

B

10

240,0 00

C

15

192,0 00

Lot group A B C

No. of lots sold 2 3 12 Total Sales

Allocatio n

2.2M x 1,920 (1.920/7. ,000 2) 2,400 2.2M x ,000 (2.4/7.2) 2.2M x 2,880 (2.88/7.2 ,000 ) 7,200 ,000

Price per lot 480,000 240,000 192,000

Allocated costs/cost per lot 586,667 / 4 =146,667 733,333/10 = 73,333 880,000/15= 58,667 2,200,000

Allocat ed costs

Cost of sale

Sale revenue 960,000 720,000 2,304,000 3,984,000

Lot group A

586,66 7

B

733,33 3

C

880,00 0 2,200,0 00

586,667 x 2/4

293,333

733,333 x 3/10

220,000

880,000 x 12/15

704,000 1,217,333 COGS

Sale revenue Cost of sale Gross income

3,984,000 (1,217,333) 2,766,667

Solution: Weighted average unit cost = (342,208 ÷ 11,400) refer to solution previous problem = 30.02 Ending inventory in units refer to solution previous problem Multiply by: Weighted average unit cost Ending inventory at cost Total goods available for sale in pesos (refer to previous table) Ending inventory at cost Cost of goods sold

4,000 30.02 120,080 342,208 (120,080) 222,128

Cost formulas Use the following information for the next four questions: ABC Co. is a wholesaler of guitar picks. The activity for product “Pick X” during August is shown below:

Date 1-Aug 7

Transaction Inventory Purchase

12

Sales

13

Purchase

14

Sales return

22

Sales

29

Purchase

30

Purchase return

Units Unit cost 2,000 ₱ 28.80 3,000 29.76 4,200 4,800

Total cost ₱ 57,600 89,280

30.40

145,920

30.88

58,672

600 3,800 1,900 300

30.88

Total goods available for sale Solutions: Beginning inventory in units Net purchases in units (3,000 + 4,800 + 1,900 – 300)

(9,264) ₱ 342,208

2,000 9,400

Total goods available for sale in units

11,400

Total goods available for sale in units Quantity of goods sold (4,200 – 600 + 3,800) Ending inventory in units

11,400 (7,400) 4,000

Units Ending inventory to be allocated Allocated as follows: From Aug. 29 net purchases (1,900 - 300)

Total cost

30.8 8

49,408

4,000

(1,600 )

Bal. to be allocated to the next most recent purchase date

2,400

From Aug. 13 purchase

(2,400 )

Ending inventory at cost

Unit cost

-

30.4 0

72,960 122,36 8

Total goods available for sale in pesos (refer to previous table) Ending inventory at cost Cost of goods sold

342,208 (122,368) 219,840

a. How much are the ending inventory and cost of goods sold under the FIFO – periodic cost flow formula? Ending inventory Cost of goods sold a. 219,840 122,368 b. 112,341 229,867 c. 122,368 219,840 d. 122,386 219,804 C b. How much are the ending inventory and cost of goods sold under the FIFO – perpetual cost flow formula? Ending inventory Cost of goods sold a. 219,840 122,368 b. 112,341 229,867 c. 122,368 219,840

d. 122,386 219,804 C (Same with the immediately preceding problem) c. How much are the ending inventory and cost of goods sold under the weighted average – periodic cost flow formula? (Average Periodic) Ending inventory Cost of goods sold a. 229,840 112,160 b. 126,468 215,740 c. 120,080 222,128 d. 120,072 222,153 C WA Cost / Unit = Total Cost Available / Units Available = 342,208 / 11,400 ( see table above) = 30.02 ( rounded off ) 1. Ending Inventory = 4,000 units x 30.02 = P 120,080 2. COGS = 342,208 – 120,080 = 222,128 d. How much are the ending inventory and cost of goods sold under the moving average – perpetual cost flow formula? (Average Perpetual) Ending inventory Cost of goods sold a. 121,813 220,395 b. 122,468 219,740 c. 122,017 220,191 d. 123,384 218,824 A

Date 1-Aug 7

Transaction Inventory Purchase

12

Sales

13

Purchase

14

Sales return

22

Sales

29

Purchase

30

Purchase return

Units Unit cost Total cost 2,000 ₱ 28.80 ₱ 57,600 3,000 29.76 89,280 4,200 4,800

30.40

145,920

30.88

58,672

600 3,80...