CHAPTER 12 (LCNRV)

MEASUREMENT OF INVENTORY Direct Method – inventory is recorded at the lower of

cost or NRV
- PAS 2 provides that inventories shall be measured at
the lower of cost and net realizable value or LCNRV – also known as COGS method because any loss
on inventory writedown or gain on reversal of
NET REALIZABLE VALUE
inventory writedown is not accounted for
Net realizable value (NRV) – is the estimated selling separately but “buried” in the COGS.
price in the ordinary course of business less the
Allowance Method – inventory is recorded at cost and
estimated cost of completion and the estimated
any loss on inventory writedown is accounted
cost of disposal.
for separately
Cost of inventory may not be recoverable under the ff:
– also known as “loss method” because a loss
a. Inventories are damaged account “loss on inventory writedown” is
b. Inventories have become wholly or partially debited and a valuation account “allowance for
obsolete inventory writedown” is credited
c. Selling prices have declined
– This allowance account is adjusted upward or
d. Estimated cost of completion or the estimated
downward depending on the difference
cost of disposal has increased
between the cost and net realizable of the
*The practice of writing inventories down below cost to inventory at year-end.
NRV is consistent with the view that assets shall not be
– If the required allowance increases, an
carried in excess of amounts expected to be realized
additional loss is recognized.
from the sale or use
– If the required allowance decreases, a gain or
DETERMINATION OF NRV
reversal of inventory writedown is recorded.
- Inventories are usually written down to net realizable
Illustration: Inventory data on December 31, 2020
value on an item by item individual basis.
Cost NRV LCNRV
Catergory 1
- It is not appropriate to write down inventories based A 110,000 100,000 100,000
on a classification of inventory B
C
690,000
600,000
750,000
640,000
690,000
600,000
Subtotal 1,400,000 1,490,000
- It may only be appropriate to group similar or related
Category 2
items D 2,000,000 1,900,000 1,900,000
E 1,500,000 1,560,000 1,500,000
Subtotal 3,500,000 3,460,000
- Materials are written down ONLY when a decline in
Category 3
the price of materials indicates that the cost of the FG F 1,500,000 1,460,000 1,460,000
G 1,600,000 1,690,000 1,600,000
exceeds NRV Subtotal 3,100,000 3,150,000
Grand Total 8,000,000 8,100,000 7,850,000
- in such case, replacement cost of materials may be the LCNRV indiv. 7,850,000

best evidence of the NRV Cost NRV LCNRV

Category 1 1,400,000 1,490,000 1,400,000
Category 2 3,500,000 3,460,000 3,460,000
ACCOUNTING FOR INVENTORY WRITEDOWN Category 3 3,100,000 3,150,000 3,100,000
LCNRV category 7,960,000
- cost < NRV = no accounting problem because
Cost NRV LCNRV
inventory is measured at cost and the increase in value LCNRV Total 8,000,000 8,100,000 8,000,000

is not recognized

- cost > NRV = inventory is measured at NRV and *The inventory is measured at the lower of cost and
decrease in value is recognized NRV applied on an individual basis

METHODS OF ACCOUNTING FOR INVENTORY

WRITEDOWN

Direct Method or
COGS method
Methods
Allowance Method
or loss method
 – any losses expected to arise and
noncancelable commitments shall be
recognized

Illustration

The contract purchase price is P500,000 and the

replacement cost at year-end is P450,000. The market
decline of P50,000 is recorded as follows:

Loss on purchase commitment 50,000

Estimated Liability for PC 50,000
Another illustration
The loss of PC is classified as other expense and the
Inventory – January 1:
estimated liability for PC is classified as current liability
Cost 5,000,000
When the actual purchase is made in the subsequent
Net Realizable Value 4,500,000 period and the current replacement cost drops further
to P420,000, the journal entry is:
Net Purchases 20,000,000
Purchases 420,000
Inventory – December 31:
Loss on purchase commitment 30,000
Cost 6,000,000 Estimated Liability for PC 50,000
Accounts Payable 500,000
Net Realizable Value 5,300,000

Direct Method LCNRV ADAPTATION

Inventory – January 1 4,500,000 – The recognition of a loss on PC is an
Net Purchases 20,000,000 adaptation of the measurement at LCNRV
Goods Available for Sale 24,500,000
Inventory – December 31 (5,300,000) – market price rises by the time the entity
Cost of Goods Sold 19,200,000 makes the purchase = record gain on PC
*Note that under direct method, the inventory, whether – amount of gain to be recognized is limited to
beginning or ending, is presented at the lower amount. the loss on PC previously recorded
Allowance Method Preceding Illustration
Inventory – January 1, at cost 5,000,000
Net purchases 20,000,000 Replacement cost of PC will become P600,000 when the
Goods Available for Sale 25,000,000 actual purchase is made, journal entry of actual
Inventory – December 31, at cost (6,000,000) purchase is:
Cost of goods sold before inventory writedown 19,000,000
Loss on inventory writedown for current year 200,000 Purchases 500,000
Cost of goods sold after inventory writedown 19,200,000 Estimated Liability for PC 50,000
Accounts Payable 500,000
Required allowance – December 31
Gain on PC 50,000
(6,000,000 – 5,300,000) 700,000 Purchase is recorded at P500,000 because the purchase
Required allowance – January 1 commitment of P500,000 is LOWER than the
(5,000,000 – 4,500,000) 500,000 replacement cost of P600,000
Increase in allowance – loss on writedown 200,000
*Note that whether direct method or allowance Gain on PC is classified as other income
method, the cost of goods sold must be the same If replacement cost is P480,000:
PURCHASE COMMITMENTS Purchases 480,000
Estimated Liability for PC 50,000
Purchase Commitments – are obligations of the entity
Accounts Payable 500,000
to acquire certain goods sometime in the future at a
Gain on PC 30,000
fixed price and fixed quantity Purchase is recorded at P480,000 because the
– Made for future delivery of goods with fixed replacement cost of P480,000 is LOWER than the
price and quantity purchase commitment of P500,000

– significant or unusual = disclose to notes to The gain on PC is the increase in market price of
financial statements P450,000 at year-end to P480,000 on the date of the
actual purchase
 CHAPTER 13 (GROSS PROFIT METHOD)

USE OF ESTIMATE IN INVENTORY VALUATION Cost of Goods Sold

- It is necessary to know the approximate value of (gross profit rate based on SALES)
inventory when it is not possible to take a
Net Sales xxx
physical count
Multiply: Cost Ratio xxx
- There are two widely accepted procedures for
COST OF GOODS SOLD xxx
approximating the value of inventory

Gross Profit Method (gross profit rate based on COST)

Procedures Net Sales xxx

Retail Inventory Divide: Sales Ratio xxx
Method COST OF GOODS SOLD xxx

- Approximation or estimation of inventory is

Illustration # 1
made for varied reasons like:
a. Inventory is destroyed by fortuitous Beginning inventory 100,000
events and is required for insurance Net purchases 500,000
purposes Net sales 700,000
b. Gross profit test – physical count of Gross Profit based on sales 40%
goods on hand is made and is necessary The ending inventory is computed as follows:
to prove the correctness or Beginning inventory 100,000
reasonableness of such count by Net purchases 500,000
making an estimate Goods Available for Sale 600,000
c. Interim financial statements are Less: Cost of Goods Sold:
prepared and physical count of goods Net sales 700,000
on hand is not necessary Multiply by cost ratio 60% 420,000
ENDING INVENTORY 180,000
GROSS PROFIT METHOD
*if gross profit rate of 40% is based on sales,
Gross Profit Method – based on assumption that the arithmetically, net sales would be 100% and therefore,
rate of gross profit remains approximately the the “cost ratio” is 60%
same from period to period and therefore the
Observe the following:
ratio of cost of goods sold to net sales is Amount Percent
relatively constant from period to period Net sales 700,000 100%
Basic formula under gross profit method Cost of Goods Sold 420,000 60%
Gross profit on sales 280,000 40%
GOODS AVAILBLE FOR SALE (GAS) xxx *the COGS is computed by multiplying the net sales by
Less: COST OF GOODS SOLD (COGS) xxx the cost ratio.

Thus, P700,000 times 60% equals P420,000.

ENDING INVENTORY xxx

Goods available for sale Illustration # 2

Beginning Inventory xxx Beginning inventory 200,000

Purchases xxx Net purchases 1,000,000
Add: Freight In xxx Net sales 1,260,000
Total xxx Gross Profit based on cost 40%
Less: Purchase return, allowance and The ending inventory is computed as follows:
discount xxx xxx Beginning inventory 200,000
Goods Available for Sale xxx Net purchases 1,000,000
Goods Available for Sale 1,200,000
Less: Cost of Goods Sold:
Net sales 1,260,000
Divide by sales ratio 140% 900,000
ENDING INVENTORY 300,000
*if gross profit rate of 40% is based on cost,
arithmetically, COGS would be 100% and therefore, the
“sales ratio” is 140%
 Observe the following: Gross profit rate based on sales
Amount Percent
Net sales 1,260,000 140% Inventory – beginning 600,000
Cost of Goods Sold 900,000 100% Purchases 2,530,000
Gross profit on cost 360,000 40% Add: Freight in 50,000
Total 2,580,000
*the COGS is computed by dividing the net sales by the
Less: Purchase R. 15,000
sales ratio
Purchase A. 5,000
Thus, P1,260,000 divided by 140% equals P900,000. Purchase D. 10,000 30,000 2,550,000
Goods available for sale 3,150,000
COMPUTATION OF GROSS PROFIT RATE Less: Cost of goods sold:
𝐺𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡 Sales 3,100,000
GP rate based on sales = Sales return (100,000)
𝑁𝑒𝑡 𝑠𝑎𝑙𝑒𝑠
Net sales 3,000,000
𝐺𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡 Multiply by cost ratio 75% 2,250,000
GP rate based on cost =
𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝑆𝑜𝑙𝑑 Ending inventory 900,000
CONVERTING GP RATE FROM ONE BASIS TO ANOTHER
𝐺𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡 𝑜𝑛 𝑐𝑜𝑠𝑡 % Gross profit rate based on sales
GP rate based on sales =
𝑁𝑒𝑡 𝑠𝑎𝑙𝑒𝑠 % Goods available for sale 3,150,000
𝐺𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡 𝑜𝑛 𝑠𝑎𝑙𝑒𝑠 % Less: Cost of goods sold:
GP rate based on cost = Sales 3,100,000
𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝑆𝑜𝑙𝑑
Sales return (100,000)
GP RATE BASED ON SALES Net sales 3,000,000
Divided by sales ratio 125 2,400,000
Illustration
%
Inventory, beginning 600,000 Ending inventory 750,000
Purchases 2,530,000
Purchase return 15,0000
Purchase allowance 5,000 SALES ALLOWANCE AND SALES DISCOUNT
Purchase discount 10,000 - Sales allowance and sales discount are ignored.
Freight in 50,000 They are not deducted from sales
Sales 3,100,000 - They do not affect the physical volume of goods
Sales return 100,000 sold
Sales allowance 50,000
- They do not increase the physical inventory of
Sales discount 150,000
goods, unlike in sales return where there is an
Compute for the ending inventory under each of the
actual addition of goods on hand
following assumptions:
- To deduct the from sales would result to
1. Gross profit rate is 25% on sales overstatement of inventory
2. Gross profit rate is 25% on cost
 CHAPTER 14 (RETAIL INVENTORY METHOD)

Retail Inventory Method – it is the other method of d. Freight in – addition to purchases at cost only
estimating the value of inventory e. Departmental transfer in or debit – addition to
purchases at cost and at retail
– is often used in the retail industry for
f. Departmental transfer out or credit – deduction
measuring inventory of large number of rapidly
from purchases at cost and at retail
changing items with similar margin for which it
g. Sales discount and sales allowance - disregarded
is impracticable to use other costing method
h. Sales return – deducted from sales
– retail means “selling price” i. Employee discounts – added to sales
j. Normal shortage, shrinkage, spoilage, breakage
INFORMATION REQUIRED – deducted from GAS at retail
a. Beginning inventory at cost and at retail price k. Abnormal shortage, shrinkage, spoilage,
b. Purchases during the period at cost and at retail breakage – deducted from GAS at retail and at
price cost
c. Adjustments to the original retail price (markup, ITEMS RELATED TO RETAIL METHOD
markup cancelation, markdown, and markdown
cancelation) a. Initial markup – original markup on the COG
d. Other adjustments b. Original retail – first sales price
c. Additional markup – increase in sales price
BASIC FORMULA above the original sales price
- Similar to the formula of gross profit method d. Markup cancelation – decrease in sales price
- difference: GPM – inventory end is stated at but not below original sales price
cost; RIM – inventory is stated in terms of e. Net additional markup or net markup – markup
selling price minus markup cancelation
f. Markdown – decrease in sales price below
Observe the following basic formula for the retail original sales price
method: g. Markdown cancelation – increase in sales price
GAS at retail or selling price xxx
but still below original sales price
Less: Net sales xxx
h. Net markdown – markdown minus markdown
Ending inventory at selling price xxx
cancelation
Multiply by cost ratio xxx
i. Maintained markup/ “markon” – difference
Ending inventory at cost xxx
between cost and sales price after adjustments
for all above items
𝐺𝐴𝑆 𝑓𝑜𝑟 𝑠𝑎𝑙𝑒 𝑎𝑡 𝑐𝑜𝑠𝑡
Cost Ratio = Cost 200
𝐺𝐴𝑆 𝑎𝑡 𝑠𝑒𝑙𝑙𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒
a. Initial markup 40
Illustration using assumed figures b. Original retail or sales price 240
c. additional markup 60
Cost Retail New sales price 300
Beginning inventory 150,000 230,000 d. Markup cancelation (40)
Purchases 400,000 650,000 New sales price 260
Freight in 10,000 e. Net markup (60-40) 20
Purchase return (55,000) (80,000)
Marked down to 210
Purchase allowance (5,000)
Markup cancelation 20
Purchase discount (20,000)
f. Markdown 30 50
GAS 480,000 800,000
New sales price 210
Cost ratio (480k/800k) 60% g. markdown cancelation 20
Less: Sales 630,000 New sales price 230
Sales return (30,000) 600,000
h. Net markdown (30 -20) 10
Ending Inventory at retail 200,000
i. Maintained markup (230 - 200) 30
Ending inventory at cost 120,000

APPROACHES IN THE USE OF RETAIL METHOD

TREATMENT OF ITEMS
a. Conservative or conventional or LCNRV
a. Purchase discount – deducted from purchases
approach
at cost only
b. Average cost approach
b. Purchase return – deducted from purchases at
c. FIFO approach
cost and at retail
c. Purchase allowance – deducted from purchases
at cost only
Illustration Ending inventory is computed as follows:

Cost Retail Cost Retail

Beginning inventory 180,000 250,000 Beginning inventory 495,000 900,000
Net purchases 1,020,000 1,575,000 Purchases 1,800,000 3,300,000
Additional markup 200,000 Net markup 300,000
Markup cancelation 25,000 Net markdown (600,000)
Markdown 140,000 Net purchases 1,800,000 3,000,000
Markdown cancelation 15,000 Current year cost ratio
Sales 1,450,000 (1.8M/3M) 60%
Sales return 50,000 Goods available for sale 2,295,000 3,900,000
Sales allowance 10,000 Less: Net sales 2,700,000
Sales discount 20,000 Ending inventory at retail 1,200,000
Employee discount 40,000
FIFO cost (1,200,000 x 60%) 720,000
Spoilage and breakage 35,000

CONSERVATIVE AND AVERAGE COST Computation of cost of goods sold

Cost Retail Goods available for sale 2,295,000

Beginning inventory 180,000 250,000 Ending inventory at FIFO cost (720,000)
Net purchases 1,020,000 1,575,000 Cost of goods sold 1,575,000
Additional markup 200,000
Markup cancelation (25,000)
GAS – conservative 1,200,000 2,000,000
Cost ratio (120k/2M) 60%
Markdown (140,000)
Markdown cancelation 15,000
GAS – average 1,200,000 1,875,000
Cost ratio (120k/1.875M) 64%
Less: Sales return 1,450,000
Sales allowance (50,000)
Employee discount 40,000
Spoilage and breakage 35,000 1,475,000
Ending inventory at retail 400,000
Conservative cost 240,000
Average cost 256,000

Computation of cost of goods sold

Conservative Average
Goods Available for Sale 1,200,000 1,200,000
Ending inventory (240,000) (256,000)
Cost of Goods Sold 960,000 944,000

FIFO RETAIL APPROACH

- Current cost ratio is determined every year

considering the net purchases during the year
excluding the beginning inventory
- Based on the assumption that markup and
markdown apply to goods purchased during the
year

Illustration

Cost Retail
Beginning 495,000 900,000
inventory
Purchases 1,800,000 3,300,000
Net markup 300,000
Net markdown 600,000
Net sales 2,700,000