INVENTORYALCANTARA

ALORIA

Inventories

According to PAS 2, paragraph 6

Assets which are held for sale in the ordinary course of business, in the process of production for such sale in the form of materials or supplies to be consumed in the production process or in the rendering of services.

Current Asset

Classes of inventories

Trading entity

- is one that buys and sells goods in the same form purchased.

- Merchandise inventory or inventory

Manufacturing entity

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

- Raw materials, Work in process & Finished goods

Cost of Inventories

The cost of inventories should comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition.

The cost of purchase of inventories comprise the purchase price, import duties and other taxes, and transport, handling and other costs directly attributable to the acquisition of finished goods, materials, and services.

Trade discounts, rebates and other similar items are deducted in determining the cost of purchase.

The cost of conversion of inventories include costs directly related to the units of production.

The cost of inventories of a service provider consists primarily of the labor and other costs of personnel directly engaged in providing the service.

Two methods of recording purchases

Gross method

-Purchases are recorded at the gross amount of the invoice.

-Cash discounts taken are recorded in a purchases discount account at the time of payment.

Net method

-The purchase are recorded at net amount, meaningn the cost of purchases is measured net of cash discounts allowable whether or nottaken.

FOB(Free On Board) It is an term that indicates when the ownership of

Merchandise/Goods is transfer from the seller to the buyer.

FOB Shipping Point

FOB Destination

Transportation Cost

Buyer of the Merchandise/ Goods Pays the transportation cost.

The cost is added in merchandise inventory.

Seller of the Merchandise/ Goods pays the transportation cost.

The cost is recorded as a “Delivery Expense/Cost” separately.

FOBSipping point

FOBDestinatio

n

Consignment

Is a method of marketing goods in which the owner known as the consignor transfers physical possession of certain goods to an agent known as the consignee who sells the goods on the owner’s behalf

Goods on consignment shall be included in the consignor’s inventory and excluded from the consignee’s inventory

Freight and other handling charges are part of the cost of the inventory of consigned goods.

Inventory

Accounting

Method

Inventory

Accounting

Method

PerpetualMethod

Periodic/PhysicalMethod

Perpetual System:

All Transaction including Costs of merchandise are recorded immediately as they occur. Record is up-to- date all the time.

Periodic System:

No effort is made to keep records up-to-date neither inventory nor Cost of goods sold and are only updated at the end of interim period.

Perpetual inventory systemThe following example contains several journal entries used to account

for transactions in a perpetual inventory system:

Purchase of Merchandise:Purchase of inventory is recorded at cost.

To record a purchase of $5,000 of 5 items that are stored in inventory each item has cost $1,000.

 

 

Perpetual inventory system

Sales of Merchandise:

Sold 3 items $1200 each, for $3,600. for which the cost is 3,000.

Gross Profit: 3600 – 3000 = $600Let Expenses are $200. Then,Net Income = 600 – 200 = $400

If inventory is purchased and sold on account, Then entries will be:

Purchase of Inventory: (On Account)

Selling of Inventory: (On Account)Debit Credit

A/C Receivables $3600

Revenue $3600Inventory Record:

Debit Credit

Cost of Goods Sold $3000

Inventory

$3000

Account Title Debit Credit

Inventory $5000

A/C Payable $5000

Payment of A/C Payables to Suppliers: Debit Credit

A/C Payables $5000

Cash $5000

Collection of Accounts Receivable from Customers:

Debit Credit

Cash $3600

A/C Receivable $3600

Periodic Inventory System:

Example

The inventory on hand at the end of 2011 cost $20000.

During 2012, purchases of merchandise for resale of customers totaled $100000

Inventory on hand at the end of 2012 cost $15000.

Recording Purchases of Merchandises:Suppose from total purchases of $100,000 the first purchase

was of $10,000 so purchase entry will be:

Debit Credit

Purchases 10000

Cash 10000

Computing the cost of goods sold:

Inventory(beginning of the year 2012)………… $20000

Add : Purchases……………………....................100000

Cost of goods available for sale………………..$120000

Less : Inventory (end of the year 2012)………….15000

Cost of goods sold…………………………….$105000

Disclosure Requirements

Accounting policies adopted in measuring inventories, including the cost method used;

The total carrying amount of inventories and the carrying amount in classification appropriate to the enterprise

The total carrying amount of inventories carried at fair value less cost to sell;

The amount of inventories recognized as an expense during the period;

The amount of any write down of inventories recognized as an expense in the period;

The amount of any reversal of any write down that is recognized as income in the period and the circumstances or events that led to the reversal of a write down;

The circumstances or events that led to the reversal of a write down of inventories; and

The carrying amount of inventories pledged as security for liabilities.

INVENTORY VALUATION

MEASUREMENT OF INVENTORY

• Shall be measured at LCNRV

• Cost of Inventories: All costs of purchase

Cost of conversion

Other costs incurred in bringing the inventories to their present location and condition

The objective in accounting for inventories is the proper determination of COGS

DETERMINING COST OF INVENTORIES

FIFO WEIGHTED AVERAGE/ MOVING AVERAGE METHOD SPECIFIC IDENTIFICATION METHOD LIFO

FIFO METHOD

“GOODS ARE SOLD IN THE ORDER THEY ARE PURCHASED”

FIFO METHOD

INVENTORY = RECENT OR NEW PRICES

COGS = EARLIER OR OLD PRICES

However... It violates the matching principle

Inflation = highest net income

Deflation = lowest net income

understatement

WEIGHTED AVERAGE METHOD (WAM)

Average unit cost = TCGAS ÷ total units available for sale

MOVING AVERAGE METHOD (MAM)

Average unit cost = TGAS after every purchase and purchase return

÷ total units available for sale

SPECIFIC IDENTIFICATION

Appropriate for inventories that are segregated for a specific project and inventories that are not ordinarily interchangeable.

Specific costs are attributed to identified items of inventory

Cost of inventory = units on hand x actual unit cost

NET REALIZABLE VALUE (NRV)

• The estimated selling price in the ordinary course of business less the estimated cost of completion and the estimated cost of disposal.

Why LCNRV?

assets shall not be carried in excess of amounts expected to be realized from their sale or use.

ACCOUNTING FOR INVENTORY WRITEDOWN

Cost is lower than NRV The increase in value is not recognized

Cost is greater than NRV The proper treatment of the writedown of the inventory to net realizable value

DIRECT METHOD

ALLOWANCE METHOD

DIRECT METHOD

• The inventory is recorded at the lower of cost or NRV

• Also known as the “Cost of goods sold method” because any loss on inventory writedown is not accounted for separately but “buried” in the cost of goods sold.

NRV is lower than cost increase COGS

ALLOWANCE METHOD

The inventory is recorded at cost and any loss on inventory writedown is accounted for separately.

If the required allowance increases, an additional loss is recognized

If the required allowance decreases, a gain on reversal of inventory writedown is recorded; provided that the gain is only to the extent of the allowance balance.

Preferable method because the effects of writedown and reversal of writedown can be clearly identified.

OTHER INVENTORY ISSUE: PURCHASE COMMITMENTS

Are obligations of the entity to acquire certain goods sometime in the future at a fixed price and fixed quantity

A decline in purchase price after a purchase commitment has been made, a loss is recorded in the period of the price decline (non-cancelable)

Loss on purchase commitments xxx

Estimated liability for purchase commitment xxx

INVENTORY ESTIMATION

METHODS: GROSS PROFIT METHOD

Use of estimate in inventory valuation

Insurance purposes (fire, theft)

To prove the reasonableness of the physical count done

Interim financial statements are prepared

Use of approximate value of inventory when it is not possible/inconvenient to take a physical count

GROSS PROFIT METHOD

The rate of gross profit remains approximately the same from period to period and therefore the ratio of cost of goods sold to net sales is relatively constant from period to period.

GAS xxx

Less: Cost of sales xxx

Ending inventory xxx

Net sales * cost ratio - based on sales

Net sales ÷ sales ratio - based on cost

INVENTORY ESTIMATION

METHODS: RETAIL INVENTORY METHOD

Uses both the retail value and cost of items for sale to calculate a cost to retail ratio.

EndingInventoryat Retail

EndingInventoryat Retail

EndingInventoryat Cost

EndingInventoryat Cost

Must know . . .• Sales for the period.• Beginning inventory at retail and

cost.• Net purchases at retail and cost.

Problem

Webb, Inc. uses the retail method to estimate inventory at the end of each month. For the month of May the controller gathers the following information:

Let’s estimate inventory at May 31.

Cost RetailBeg. Inventory 27,000$ 45,000$ Net Purchases 180,000 300,000 Net Sales n/a 310,000

Solution

Cost RetailInventory, May 1 27,000$ 45,000$ Net purchases for May 180,000 300,000 Goods available for sale 207,000 345,000

Cost RetailInventory, May 1 27,000$ 45,000$ Net purchases for May 180,000 300,000 Goods available for sale 207,000 345,000 Cost ratio (207,000 ÷ 345,000)

60%

Cost RetailInventory, May 1 27,000$ 45,000$ Net purchases for May 180,000 300,000 Goods available for sale 207,000 345,000 Cost ratio (207,000 ÷ 345,000)

60%Sales for May 310,000 Ending inventory at retail 35,000$

Cost RetailInventory, May 1 27,000$ 45,000$ Net purchases for May 180,000 300,000 Goods available for sale 207,000 345,000 Cost ratio (207,000 ÷ 345,000)

60%Sales for May 310,000 Ending inventory at retail 35,000$ Cost ratio 60%Ending inventory at cost 21,000$