Chapter 7 Inventories

(Intermediate Accounting 1A)
LECTURE AID
2019
ZEUS VERNON B. MILLAN

Chapter 7 Inventories
Related standard: PAS 2 Inventories
Learning Objectives
1. Define inventory and identify the timing
of its recognition.
2. Differentiate between the periodic and
the perpetual inventory systems.
3. Measure inventories and apply the cost
formulas.
4. Account for inventory write-down and the
reversal thereof.
INTERMEDIATE ACCTG 1A (by:
MILLAN)
Inventories
Inventories are assets that are:

a. Held for sale in the ordinary course of business
(Finished Goods);
b. In the process of production for such sale (Work In
Process); or
c. In the form of materials or supplies to be consumed in
the production process or in the rendering of services
(Raw materials and manufacturing supplies).

MILLAN)
Recognition
• Inventories are recognized when they meet the definition of

inventory and they qualify for recognition as assets, such as
when legal title is obtained by the buyer from the seller.
• Legal title normally passes when possession over of the
goods is transferred.
• However, there may be cases where the transfer of control
(ownership) does not coincide with the transfer of physical
possession.

MILLAN)
Goods in transit
• FOB Shipping Point - ownership over the goods is
transferred upon shipment. Therefore, the goods in
transit form part of the buyer’s inventories.
• FOB Destination - ownership over the goods is

transferred only when the goods are received by the
buyer. Therefore, the goods in transit still form part of
the seller’s inventories.

MILLAN)
Consigned goods
• Consigned goods are included in the consignor’s

inventory.
• The consignee records the consigned goods received through
memo entry only.
• Freight and other incidental costs of transferring consigned
goods to the consignee form part of the cost of the
consigned goods. Repair costs for damages during shipment
and storage and other maintenance costs are charged as
expense.
MILLAN)
Inventory held or sold under financing
agreements
• Ownership is normally not transferred when inventories are used
as collateral security for a loan. Therefore, the inventory remains in
the borrower’s (pledgor’s) inventory.

MILLAN)
Retention of legal title under installment sale
A seller is not precluded from transferring ownership over an

inventory sold in an installment sale where possession is transferred to
the customer but the seller retains legal title solely to protect the
collectability of the amount of consideration.
In such case, the inventory is excluded from the seller’s inventory and
included in the buyer’s inventory.

MILLAN)
Bill & hold arrangement
• A bill-and-hold arrangement is a contract (of sale) under which the seller bills
the buyer for goods sold but the seller retains physical possession until the
goods are transferred to the buyer at a future date.
• The goods sold under a bill and hold sale are excluded from the seller’s
inventory and included in the buyer’s inventory at the time of sale when
title passes to the buyer and he accepts billing, provided:
a. the reason for the bill-and-hold arrangement must be substantive (for
example, the buyer has requested the arrangement);
b. the product must be identified separately as belonging to the buyer;
c. the product currently must be ready for physical transfer to the buyer; and
d. the seller does not have the ability to use the goods or to direct them to
another customer.

MILLAN)
Lay away sale
• Lay away sale is a type of sale in which goods are delivered only
when the buyer makes the final payment in a series of installments.
This is different from a regular installment sale wherein goods are
delivered to the buyer at the time of sale.
• The goods sold under a lay away sale are included in the seller’s
inventory until the goods are delivered to the buyer. Delivery is
made after the final installment payment is paid. However, when
significant payments have already been made, the goods may be
included in the buyer’s inventory, provided delivery is probable.

MILLAN)
Financial statement presentation
• All items that meet the definition of inventory are

presented on the statement of financial position as one
line item under the caption “Inventories.” The
breakdown (as finished goods, WIP and Raw materials)
is disclosed in the notes.

MILLAN)
Inventory systems
1. Perpetual inventory system – All transactions involving the

acquisition, purchase returns, incurrence of freight-in, sales and
sales returns are recorded in the “Inventory” account (real account)
and the “Cost of sales” account, as appropriate.
2. Periodic inventory system – Uses the “Purchases,” “Purchase
returns,” and “Freight-in” accounts (nominal accounts). Cost of
sales is determined only after a physical count is performed.

MILLAN)
Inventory systems - continuation
• Under the periodic inventory system, cost of sales is

determined using the following formula:
Beg. Inventory xx
Add: Net purchases xx
Total goods available for sale xx
Less: End. Inventory (Physical count) (xx)
Cost of sales xx

MILLAN)
Inventory errors under the periodic system
• Ending inventory : Profit ------ Direct relationship
 If ending inventory is overstated, Profit is also overstated.

MILLAN)
Measurement
• Inventories are measured at the lower of cost and net
realizable value (NRV).
• The cost of inventories comprises all costs of purchase, costs of

conversion and other costs incurred in bringing the inventories
to their present location and condition.
• Net realizable value (NRV) is the estimated selling price in the
ordinary course of business less the estimated costs of completion
and the estimated costs necessary to make the sale.

MILLAN)
Costs that are EXPENSED when incurred
1. Abnormal amounts of wasted materials, labor or other

production costs.
2. Selling costs, for example, advertising and promotion costs and
delivery expense or freight out.
3. Administrative overheads that do not contribute to bringing
inventories to their present location and condition.
4. Storage costs, unless those costs are necessary in the production
process before a further production stage.

MILLAN)
Recording the acquisition of inventory
• Trade discounts and Cash discounts

• Gross method vs. Net method

MILLAN)
Cost of inventories purchased in lump sum
• The cost of different inventories having different values purchased

on a lump sum basis is allocated to such inventories using their
relative sales prices.

MILLAN)
Cost Formulas
1. Specific identification - is used for inventories that are not
ordinarily interchangeable (i.e., inventories that are unique). Cost
of sales is the cost of the specific inventory that was sold.
2. FIFO – cost of sales is based on the cost of inventories that were
purchased first. Consequently, ending inventory represents the cost
of the latest purchases.
3. Weighted Average Cost – cost of sales is based on the average
cost of all inventories purchased during the period.
 Wtd. Ave. Cost = (TGAS in pesos ÷ TGAS in units)

MILLAN)
Write down of inventories
• Inventories are usually written down to net realizable value on an

item by item basis.
• If the cost of an inventory exceeds its NRV, the inventory is written
down to NRV, the lower amount. The excess of cost over NRV
represents the amount of write-down.

MILLAN)
Reversal of write-downs
• The amount of reversal to be recognized should not

exceed the amount of the original write-down
previously recognized.

MILLAN)
The Inventory T-account
Accounts payable Inventory

xx beg. beg. xx
Payments xx xx Net purchases Net purchases xx xx COGS
end. xx xx end.

MILLAN)
APPLICATION OF CONCEPTS

PROBLEM 2: FOR CLASSROOM DISCUSSION
INTERMEDIATE ACCTG 1A (by: MILLAN)

OPEN FORUM
QUESTIONS????
REACTIONS!!!!!

END

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(Intermediate Accounting 1A)

ZEUS VERNON B. MILLAN

Inventories are assets that are:

INTERMEDIATE ACCTG 1A (by:

• Inventories are recognized when they meet the definition of

INTERMEDIATE ACCTG 1A (by:

• FOB Destination - ownership over the goods is

INTERMEDIATE ACCTG 1A (by:

• Consigned goods are included in the consignor’s

INTERMEDIATE ACCTG 1A (by:

A seller is not precluded from transferring ownership over an

INTERMEDIATE ACCTG 1A (by:

INTERMEDIATE ACCTG 1A (by:

INTERMEDIATE ACCTG 1A (by:

• All items that meet the definition of inventory are

INTERMEDIATE ACCTG 1A (by:

1. Perpetual inventory system – All transactions involving the

INTERMEDIATE ACCTG 1A (by:

• Under the periodic inventory system, cost of sales is

INTERMEDIATE ACCTG 1A (by:

• Ending inventory : Profit ------ Direct relationship

 If ending inventory is overstated, Profit is also overstated.

INTERMEDIATE ACCTG 1A (by:

• The cost of inventories comprises all costs of purchase, costs of

INTERMEDIATE ACCTG 1A (by:

1. Abnormal amounts of wasted materials, labor or other

INTERMEDIATE ACCTG 1A (by:

• Trade discounts and Cash discounts

INTERMEDIATE ACCTG 1A (by:

• The cost of different inventories having different values purchased

INTERMEDIATE ACCTG 1A (by:

INTERMEDIATE ACCTG 1A (by:

• Inventories are usually written down to net realizable value on an

INTERMEDIATE ACCTG 1A (by:

• The amount of reversal to be recognized should not

INTERMEDIATE ACCTG 1A (by:

Accounts payable Inventory

INTERMEDIATE ACCTG 1A (by:

PROBLEM 2: FOR CLASSROOM DISCUSSION

INTERMEDIATE ACCTG 1A (by: MILLAN)

INTERMEDIATE ACCTG 1A (by: MILLAN)

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