CHAPTER 8

Inventories; Intangibles; Agricultural Assets

Answers to Questions

1. Inventories affect all aspects of a merchandising or manufacturing entity.

Usually inventories represent a significant proportion of total assets on the
statement of financial position and exert a significant influence on reported net
income. As a consequence, management should be concerned with accounting
for inventories. From this, it follows that the company accountant and the
independent auditors should be concerned with inventory valuation, the flow of
inventory costs, and control of inventories.
2. The general rule is that all goods which the business owns at inventory date,
regardless of their particular location at that time, should be included in
inventory.
3.
Include in Inventory
Yes No
a. Goods held by our agents for us. x
b. Goods held by us for sale on commission. x
c. Goods held by us but awaiting return to
vendor due to damaged condition. * x
d. Goods returned to us from buyer, reason
unknown to date. ** x
e. Goods out on consignment. x
f. Goods held on consignment. x
g. Merchandise at our branch for sale. x
h. Merchandise at conventions for display
purposes. x
* Do not include in regular inventory. If the goods can be returned
make no entry. If the goods cannot be returned, the purchaser should
include the damaged goods in special inventory – damaged goods.
** Inclusion or exclusion depends on the provisions of the sale
agreement.
4. A merchandising company acquires goods for resale and does not alter their
physical form, so it needs only one type of inventory account, usually called
Merchandise Inventory. A manufacturing company does change the physical
form of the goods, and typically needs at least three inventory accounts to reflect
the stage of completion. The three accounts are usually called: (1) Raw
Materials Inventory; (2) Goods in Process Inventory; and (3) Finished Goods
Inventory.
5. The general rule for determining whether an item should be included in
inventory is to include all items that are legally owned, regardless of their
location. Goods in transit shipped F.O.B. destination should be included in the
inventory of the seller until they are received by the buyer, and should be
included in the inventory of the buyer when they are actually received. Goods
in transit shipped F.O.B. shipping point are no longer included in the seller’s
inventory, and are included in the inventory of the buyer. Goods on
consignment, plus the handling and shipping costs incurred in delivery to the
consignee, should be included at cost in the inventory of the consignor, since the
consignor retains legal ownership.
6.
a. Goods in transit purchased F.O.B. shipping point for which the invoice has
been received would be included in the Raw Materials Inventory account
since they are in transit and are legally owned.
b. Raw materials would be included in the Raw Materials Inventory account.
c. Since the consignor retains ownership of goods out on consignment, these
would be included in its Consignment-Out Inventory account.
d. Since ownership of goods shipped F.O.B. destination does not transfer to
the purchaser until the goods are actually received, these would be included
in the inventory of the seller while in transit.
e. Manufacturing supplies may be included in Raw Materials Inventory, but
could also be isolated in a separate account entitled Manufacturing
Supplies, Factory Supplies, or Indirect Materials.
7.
a. Sales commission should not be included in the determination of inventory
cost.
b. A supervisor’s salary, if directly related to the production of inventory,
should be included in the determination of inventory cost.
c. Freight-in charges should be included in inventory cost, unless they are the
result of shipping errors, such as sending merchandise to the wrong
warehouse and having it sent back. Freight-out charges should be included
in selling costs.
d. Indirect factory production labor, such as the salaries of machine
maintenance personnel, should be included in inventory cost if it can be
allocated in a reasonable manner.
e. Storage costs should be included in inventory cost if they are necessary in
the production process prior to a further production stage. Otherwise,
exclude from inventory cost.
f. The salaries of corporate executives should be treated as a period expense
and not be included in the determination of inventory cost.
8. The primary purpose in selecting a particular inventory cost flow method is to
establish a definite policy as to the assumed flow of costs for inventory and cost
of goods sold.
 The selection is particularly important because it determines the manner in
which the matching principle is to be applied in recognizing the cost of goods
sold amount and in measuring the asset, inventory. The method selected affects
(a) cost of goods sold, (b) expenses (including income tax expense), (c) net
income, (d) inventory valuation, and (e) cash flow (through income taxes
payable).
9. Damaged or obsolete goods should be valued at their net realizable value, that
is, sales value less all costs to sell and to make ready for sale. This has the effect
of recording the economic loss in inventory value when it occurs rather than at
the point of sale and presents overstatement of assets (inventory) and retained
earnings.
10. Selling prices are acceptable for valuing inventory where there is an effective
government-controlled market at a fixed monetary value and for inventories
consisting of agricultural, mineral, and other products, composed of
interchangeable units with an immediate marketability at quoted prices where
appropriate costs are difficult to obtain.
Inventory costs include the total cash outlay made to acquire the goods and
prepare them for sale. In the case of the clothing store, this would include
freight-in, as well as the costs of unpacking, ironing, and hanging the clothes.
Salaries for the buyers and cashiers, on the other hand, would be a period cost.
Costs for shipping out mail order items would be a period marketing expense.
11. Biological assets are “living animals and living plants.”
12. Agricultural produce is the harvested produce on the entity’s biological assets.

13.
a. Biological assets are measured on initial recognition and at the end of each
reporting period at fair value less costs to sell (NRV). Companies record a
gain or loss due to changes in the NRV of biological assets in income when
it arises.

b. Agricultural produce (which are harvested from biological assets) are

measured at fair value less costs to sell (NRV) at the point of harvest. Once
harvested, the NRV of the agricultural produce becomes its cost and this
asset is accounted for similar to other inventories held for sale in the normal
course of business.
14. Biological transformation comprises the processes of growth, degeneration,
production, and procreation that cause qualitative and quantitative changes in a
biological asset.
15. (a) the entity controls the asset as a result of past events;
(b) it is probable that future economic benefits associated with the asset will
flow to the entity; and
(c) the fair value or cost of the asset can be measured reliably.
16. Upon purchase of a biological asset gains and losses can result on its initial
recognition since the fair value less estimated cost to sell could be more or lesser
than the total purchase price which is exclusive for transaction and
transportation cost. The gain or loss arising on initial recognition of a biological
asset at fair value less costs to sell and from a change in fair value less costs to
sell of a biological asset shall be included in profit or loss for the period in
which it arises.
17. Some animals and plants may not be considered biological assets but would be
classified and accounted for as other type of assets. For example, a pet shop may
hold an inventory of dogs purchased from breeders that it then sells. Because the
pet shop is not breeding the dogs, the dogs are not considered biological assets.
As a result, the dogs are accounted for as Inventory held for sale at lower of cost
and net realizable value.

18. The distinguishing characteristics of intangible assets are (a) they lack physical
substance, (b) they represent future benefits, (c) their useful life is difficult to
determine, and (d) they are usually acquired for operational use. The primary
distinguishing characteristic is (a).
Intangible assets that do not satisfy the definition of current assets are reported
with other intangible assets as noncurrent. Noncurrent intangibles are variously
reported under such captions as Operational intangible assets, Intangible assets,
Intangibles, Deferred charges and Other assets.

19. Most intangible assets are identifiable. Those assets that can be sold separately
without affecting the continuity of ownership of the entity to which they belong
are identifiable. Examples of identifiable intangibles include copyrights,
patents, trademarks, and franchises. Unidentifiable intangible assets are those
which cannot be separately sold without affecting the continuity and ownership
of the entity. The principal intangible which lacks separate identifiability is
goodwill; it is impossible to sell goodwill without also selling the enterprise.
20. A franchise confers the right to do business at a particular location or in a given
territory. Some franchises are exclusive or monopolistic, while others are not.
Some franchises are granted by governmental units – these often relate to the right
to render some kind of utility service. Other franchises enable businesses to sue
distinctive names, décor, advertising, etc. Many motels and fast-food outlets
operate under franchises.
Trademarks are distinctive names, symbols, or other product identifications
which can be registered to afford protection. Both trademarks and franchises are
intangible assets.
21. Expenditures incurred in connection with the original organization of a business
such as legal fees, incorporation fees, accounting fees, promotion expenditures
and clerical expenses incidental to organizing are properly capitalized as
 organization costs. Under PAS 38, an intangible asset should be recognized if
and only if:
1) It is probable that the future economic benefits attributable to the asset will
flow to the enterprise; and
2) The cost of the asset can be measured reliably.
Organization costs do not meet the first criterion and they are charged to
expense as they are incurred.
22. A trademark “includes any word, name, symbol, or device, or any combination
thereof adopted and used by a manufacturer or merchant to identify his goods
and distinguish them from those manufactured or sold by others.” A copyright,
on the other hand, confers on an author (or assignee) exclusive right to derive
economic benefit from literary, artistic, musical, or dramatic works. They are
similar in both must be obtained from (different) agencies of the government,
are intangibles, and therefore are subject to amortization and reporting rules.
They are dissimilar in that they relate to different kinds of rights. Both
trademarks and copyrights should be amortized over their useful lives, subject to
an amortization period of not more than 40 years.

23. Impairment of value means that the book or carrying value of an asset
(intangible in this case) is significantly above its market value or its utility value
to the owning entity. In such situations the asset must be written down to the
lower market or utility value.
Entry to record impairment loss:
Impairment loss on intangible asset........... 14,000
Accumulated patent amortization
(or Patent)................................................ 14,000
Computation:
Cost of patent............................................. P50,000
Accumulated amortization......................... 35,000
Book value.................................................. P15,000
Value to remain in accounts....................... 1,000
Increase in accumulated amortization
account (or decrease in patent account). . P14,000

24. Depreciable assets and natural resources are similar in that both are capitalized
as assets and are written off to expense subsequent to their acquisition. The
process of writing off depreciable assets is called depreciation; the process is
writing off natural resources is called depletion or amortization. Natural
resources are wasting assets in that they are consumed physically in production.
Depreciable assets are used in the production process, but do not waste in the
same way that natural resources do. Depreciable assets can be acquired or
 purchased in a market, but natural resources are replaced only by discovery of a
new source of the resource. The depletion base (the amount capitalized as the
cost of the natural resource) can vary greatly depending on what costs are
included in the capitalization. Also, natural resources are depleted over the
estimate of recoverable units of the resource (thus depletion expense depends on
the number of units produced), whereas depreciable assets are generally
depreciated over the estimated useful life of the asset. This latter process does
not depend on level of production, but the depletion process does.
25. The amount of depletion for any period is the product of the unit depletion rate
times the units of production. The unit depletion rate is determined as the total
depletion base divided by the estimate of recoverable units of the resource.

Answers to Multiple Choice Questions

1. D 11. A 21. A 31. D 41. D 51. B 61. B

2. D 12. D 22. B 32. A 42. A 52. D 62. D
3. B 13. C 23. C 33. A 43. C 53. C 63. D
4. D 14. B 24. B 34. B 44. D 54. A
5. D 15. D 25. C 35. A 45. C 55. D
6. B 16. C 26. A 36. D 46. B 56. D
7. A 17. B 27. A 37. D 47. D 57. D
8. C 18. C 28. D 38. D 48. B 58. B
9. C 19. G 29. D 39. A 49. C 59. D
10. D 20. G 30. C 40. D 50. A 60. D