MODULE 3: Inventories

RELATED STANDARDS: PAS 2 – Inventories

INTRODUCTION
This module focuses on the accounting and reporting of inventories in
accordance with PAS 2. It introduces the learner to the subject, guides the
learner through the official text, develops the learner’s understanding of the
requirements through the use of examples and indicates significant
judgements that are required in accounting for inventories.

Furthermore, the module includes questions designed to test the learner’s

knowledge of the requirements to develop the learner’s ability to account for
inventories.

Learning Objectives:
1. Describe inventories of manufacturing companies and servicing
companies.
2. Describe the initial recognition, initial measurement, subsequent
measurement, derecognition and financial presentation of inventories.
3. Identify the situation in which periodic or perpetual system is appropriate.
4. Compare and contrast periodic and perpetual inventory system.
5. Account properly purchase commitments.

 Definition of Terms
 Inventories – are assets held for sale in the ordinary course of business;
in the process of production for such sale; or in the form of materials or
supplies to be consumed in the production process or in the rendering of
services.
 Net realizable value – 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.
 Fair value – The price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market participants at
the measurement date.

 Measurement of inventories
 Inventories shall be measured at the lower of cost and net realizable
value.
 The cost of inventories shall comprise all costs of purchase, costs of
conversion and other costs incurred in bringing the inventories to their
present location and condition.
 Costs of purchase include:
a. The costs of purchase of inventories comprise the purchase price,
import duties and other non-recoverable taxes, and transport,
handling and other costs directly attributable to the acquisition of
finished goods, materials and services.
b. Trade discounts, rebates and other similar items are deducted in
determining the costs of purchase.
 Costs of conversion include:
a. The costs of conversion of inventories include costs directly related
to the units of production, such as direct labor.
b. They also include a systematic allocation of fixed and variable
production overheads that are incurred in converting materials into
finished goods.
 Other costs include:

Module 3 Page 1 of 12
Inventories

a. Other costs are included in the cost of inventories only to the extent
that they are incurred in bringing the inventories to their present
location and condition.
b. For example, it may be appropriate to include non-production
overheads or the costs of designing products for specific customers
in the cost of inventories.
 Costs excluded from inventory (expensed outright)
a. Abnormal amounts of wasted materials, labor or other production
costs;
b. Storage costs, unless those costs are necessary in the production
process before a further production stage;
c. Administrative overheads that do not contribute to bringing inventories
to their present location and condition; and
d. Selling costs.

 Illustration for inventory count

Indicate whether each item is included or excluded from the inventory count
at year-end.
o Goods counted in the warehouse – included
o Merchandise on counter for sale – included
o Merchandise in the store currently used for window display – included
o Unsold items in the hands of the consignee – included
o Goods held on consignment – excluded
o Items specifically segregated per contract of sale – excluded
o Ordered goods received from supplier but not yet invoiced – included
o Ordered goods invoiced but not yet received from supplier - excluded if
freight is on seller, included if freight is on buyer
o Items sold and still in the shipping department – included
o Purchased goods in transit, FOB shipping point – included
o Purchased goods in transit, FOB destination – excluded
o Sold merchandise in transit, FOB shipping point – excluded
o Sold merchandise in transit, FOB destination – included
o Defective goods segregated as ‘return to vendor’ – excluded
o Returned merchandise received from customers – included
o Uncompleted goods in the production department – included
o Unsalable goods in the storage room – excluded
o Inventories pledged as security for liabilities – included

 Illustration for inventory cost measurement

Indicate whether each item is included or excluded from the cost of inventory
o Factory overhead – included
o Price of direct materials – included
o Factory supplies used in production – included
o Store supplies used in sales and promotion – excluded
o Customs duties and taxes – included
o Value added tax on purchases – excluded
o Value added tax on sales – excluded
o Brokerage commission for arranging imports – included
o Sales commission to agents – excluded
o Freight on purchases, FOB shipping point – included
o Freight on purchases, FOB destination – excluded
o Freight on sales, FOB shipping point – excluded
o Freight on sales, FOB destination – excluded

Module 3 Page 2 of 12
Inventories

o Warranty cost on items sold – excluded

o Salaries and wages of factory personnel - included as FOH
o Salaries and wages of store personnel – excluded
o Trade and term discounts on purchases - (deducted from purchase price)
o Purchase price of the goods bought from suppliers – included
o Handling cost related to imports – included
o Packaging cost for shipment to customer – excluded
o Special handling charges on shipments to customer – excluded
o Insurance on shipment for purchased goods – included
o Handling cost of purchased items – included
o Insurance on factory building - included as FOH
o Insurance on store building – excluded
o Abnormal spoilage – excluded
o Rework cost of defective finished goods – included

 Accounting Procedures for Inventories

 Inventory accounts classification
a. Merchandise inventory
b. Raw materials inventory
c. Work-in-process inventory
d. Finished goods inventory
e. Indirect materials

 Accounting for inventory movement

a. Periodic method – It does not record the inventory inflow or outflow
and requires physical count to determine the inventory balance.
b. Perpetual method – It accounts for the inflow and outflow of the
inventories.

 Recording methods for purchases

a. Gross method – Purchases and accounts payable is recorded at gross
amount. Purchase discount is accounted when availed.
b. Net method – Purchases and accounts payable is recorded at the
amount net of purchase discount.

 Freight terms
Terms Who pays the Who owns
shipment cost? goods in
transit?
FOB shipping point Buyer Buyer
FOB destination Seller Seller
Free Alongside (FAS) Buyer Buyer
Cost, Insurance & Buyer Buyer
Freight (CIF)

Terms Who actually Who should Accounting

pays the pay the Treatment
shipment cost? shipment
cost?
Freight Buyer Seller Decrease AR of seller
collect and AP of buyer
Freight Seller Buyer Increase AR of seller
prepaid and AP of buyer

Module 3 Page 3 of 12
Inventories

 Purchase commitments
 Result from legally enforceable contracts to purchase specific
quantities of goods at fixed prices in the future.
 Loss on purchase commitment is recorded for decline in purchase
price after the commitment is made.
 Gain on purchase commitment may be recorded for price escalation.
However, the amount of gain is limited to loss on purchase
commitment previously recorded.

 Consignment
 An arrangement in which goods are left in the possession of
another party (consignee) to sell. 
 Consignor is the owner of the unsold goods out on consignment.
 Consignee would recognize accounts payable to consignor only
when the goods are sold to customers.

Module 3 Page 4 of 12
Inventories

*******************************************************
Illustrative Problems
1. Inventories are assets (choose the incorrect one)
A. In the process of production for such sale.
B. Held for sale in the ordinary course of business.
C. In the form of materials or supplies to be consumed in the production
process or in the rendering of services.
D. Held for speculation and appreciation.

2. Net realizable value is

A. Fair value less cost to sell
B. Estimated selling price less normal margin and cost to sell
C. Estimated selling price less cost to complete and cost to sell
D. Fair vale less normal margin and cost to complete.

3. At reporting date, inventories are measured at

A. Net realizable value
B. Lower of cost and market value
C. Lower of cost and net realizable value
D. Higher of cost and net realizable value.

4. The cost of purchase of inventory does not include

A. Purchase price
B. Import duties and taxes
C. Freight, handling and other costs directly attributable to the acquisition
of goods
D. Trade discounts, rebates and other similar items

5. Costs that are incurred in bringing the inventories to their present location
and condition are capitalized as cost of inventories and these include
A. Cost of designing products for specific customers.
B. Abnormal amount of wasted materials, labor and production cost
C. Storage cost not necessary in the production process before a further
production stage
D. Selling cost

6. The amount of any writedown of inventory to net realizable value and all
losses of inventory shall be
A. Recognized as operating expense in the period the writedown or loss
occurs.
B. Recognized as other expense in the period the writedown or loss
occurs.
C. Recognized as component of cost of sales in the period the writedown
or loss occurs.
D. Deferred until the related inventory is sold.

7. Commodities of broker-traders are measured at

A. Fair value C. Cost
B. Fair value less cost to sell D. Net realizable value

8. From a theoretical viewpoint, which of the following costs would be

considered inventoriable?
I. Freight
II. Warehousing
A. I only

Module 3 Page 5 of 12
Inventories

B. II only
C. Both I and II
D. Neither I nor II

9. When using periodic inventory method, which of the following generally

would not be separately accounted for in the computation of cost of goods
sold?
A. Trade discounts applicable to purchases during the period.
B. Cash discounts taken during the period.
C. Purchase returns and allowances of merchandise during the period.
D. Cost of transportation in for merchandise purchased during the period.
E.
10. Which of the following is not an acceptable basis for valuation of certain
inventories in published financial statements?
A. Historical cost
B. Prime cost
C. Current replacement cost
D. Current selling price less cost of disposal
E.
11. How should the following costs affect a retailer’s inventory?
Freight in Interest on inventory loan
A. Increase No effect
B. Increase Increase
C. No effect Increase
D. No effect No effect

12. When a portion of inventories has been pledged as security on a loan

A. The value of the portion pledged should be subtracted from the debt.
B. An equal amount of retained earnings should be appropriated.
C. The fact should be disclosed but the amount of current assets should
not be affected.
D. The cost of the pledged inventories should be transferred from current
assets to noncurrent assets.

13. A consignee paid the freight costs for goods shipped from a consignor.
These freight costs are to be deducted from the consignee’s payment to
the consignor when the consignment goods are sold. Until the consignee
sells the goods, the freight costs should be included in the consignee’s
A. Cost of goods sold C. Selling expenses
B. Freight out cost D. Accounts receivable

14. Goods on consignment should be included in the inventory of

A. The consignor but not the consignee
B. The consignee but not the consignor
C. Both the consignor and the consignee
D. Neither the consignor nor the consignee

15. The credit balance that arises when a net loss on a purchase commitment
is recognized should be
A. Presented as a current liability
B. Subtracted from ending inventory
C. Presented as an appropriation of retained earnings
D. Presented in the income statement

16. According to the net method, which of the following items should be
included in the cost of inventory?

Module 3 Page 6 of 12
Inventories

(1) Freight costs and (2) Purchase discounts not taken

A. Yes and No C. No and Yes
B. Yes and Yes D. No and No

17. On December 28, Year 2, Kerr Manufacturing Co. purchased goods

costing P50,000. The terms were FOB destination. Some of the costs
incurred in connection with the sale and delivery of the goods were as
follows:
Packaging for shipment P1,000; shipping P1,500; and special handling
charges P2,000. These goods were received on December 31, Year 2. In
Kerr’s December 31, Year 2 balance sheet, what amount of cost for these
goods should be included in inventory?
A. 54,500 B. 53,500 C. 52,000 D. 50,000

18. On June 1, Year 2, Pitt Corp. sold merchandise with a list price of P5,000
to Burr on account. Pitt allowed trade discounts of 30% and 20%. Credit
terms were 2/15, n/40 and the sale was made FOB shipping point. Pitt
prepaid P200 of delivery costs for Burr as an accommodation. On June
12, year 2, Pitt received from Burr a remittance in full payment amounting
to
A. 2,944 B. 2,940 C. 2,744 D. 3,140

19. The following information pertains to Deal Corp.’s Year 2 cost of goods
sold:
Inventory, 12/31/Y1 P90,000; Year 2 purchases P124,000; Year 2 write-off
of obsolete inventory P34,000; and Inventory, 12/31/Y2 P30,000 The
inventory written off became obsolete due to an unexpected and unusual
technological advance by a competitor. In its Year 2 income statement,
what amount should Deal report as cost of goods sold?
A. 218,000 B. 150,000 C. 184,000 D. 124,000

20. The following information pertained to Azur Co. for the year:
Purchases P102,800; Purchase discounts P10,280; Freight in P15,420;
Freight out P5,140; Beginning inventory P30,840; and Ending inventory
P20,560. What amount should Azur report as cost of goods sold for the
year?
A. 102,800 B. 118,220 C. 123,360 D. 128,500

21. Y COMPANY reported P5,000,000 of physical inventory on December 31,

Year 1:
 Goods sold to a customer on December 31, Year 1 which are being
held for the customer to call at the customer’s convenience with a cost
of P150,000 and included in the account.
 Excluded from the physical count were goods billed to a customer,
FOB shipping point, on December 31, Year 1. The goods had a cost of
P200,000 and had been billed at P350,000. The shipment is ready for
pick-up
by the delivery contractor on January 15, Year 2.

Module 3 Page 7 of 12
Inventories

 Goods were in transit from a vendor. The invoice cost was P300,000
and goods were shipped FOB seller on December 31, Year 1.
 Work in process costing P400,000 was sent to an outside processor
for finishing on December 31, Year 1.
 Goods out on consignment with sales price of P1,000,000 and markup
of 25% on cost.
 Shipping cost amounted to P50,000.
What is the correct inventory on December 31, Year 1?
A. 6,900,000 B. 6,850,000 C. 6,600,000 D. 6,750,000

22. Z COMPANY incurred the following costs during the current year:
Cost of purchases based on invoices 5,000,000
Trade discount already deducted from invoices 500,000
Import duties 400,000
Freight and insurance on purchases 600,000
Other handling costs on imports 100,000
Commission paid to agents for arranging imports 200,000
Sales commission paid to sales agents 300,000
Salaries of accounting department 1,000,000
After sales warranty costs 250,000
What is the total cost of purchases?
A. 6,300,000 C. 6,100,000
B. 5,800,000 D. 6,600,000

23. On July 1, Year 1, F COMPANY recorded purchases of inventory of

P3,000,000 and P2,000,000 under credit terms of 2/15, net 30. The
payment due on the P3,000,000 purchase was remitted on July 16. The
payment due on the P2,000,000 purchase was remitted on July 31. Under
the gross method and net method, respectively, these purchases should
be included at what amount in the determination of cost of goods available
for sale?
A. 4,900,000 and 4,940,000 C. 4,940,000 and 4,900,000
B. 4,900,000 and 5,000,000 D. 5,000,000 and 4,900,000

24. C COMPANY reported inventory on December 31, Year 1 at P6,000,000

based on a physical count at cost and before any necessary year-end
adjustments relating to the following:
 Included in the physical count were goods billed to a customer FOB
shipping point on December 31, Year 1. These goods had a cost of
P125,000 and were picked up by the carrier on January 7, Year 2.
 Goods shipped FOB shipping point on December 28, Year 1 from a
vendor to C COMPANY were received on January 4, Year 2. The
invoice cost was P300,000.
What amount should be reported as inventory on December 31, Year 1?
A. 5,875,000 C. 6,175,000
B. 6,000,000 D. 6,300,000

25. D COMPANY reported accounts payable on December 31, Year 1 at

P4,500,000 before any necessary year-end adjustments relating to the
following transactions:
 On December 27, Year 1, the entity wrote and recorded checks to
creditors totaling P2,000,000 causing an overdraft of P500,000 in the
entity’s bank account on December 31, Year 1. The checks were
mailed on January 10, Year 2.

Module 3 Page 8 of 12
Inventories

 On December 28, Year 1, the entity purchased and received goods for
P750,000, terms 2/10, n/30. The entity recorded purchases and
accounts payable at net amount. The invoice was recorded and paid
January 3, Year 2.
 Goods shipped FOB destination on December 20, Year 1 from a
vendor to the entity were received January 2, Year 2. The invoice cost
was P325,000.
On December 31, Year 1, what amount should be reported as accounts
payable?
A. 7,575,000 C. 7,235,000
B. 7,250,000 D. 7,553,500

26. G COMPANY reported accounts payable of P2,200,000 on December 31,

Year 1 before considering the following data:
 Goods shipped to the entity on December 31, Year 1 FOB shipping
point were lost in transit. The invoice cost of P40,000 was not
recorded. On January 15, Year 2, the entity filed a P40,000 claim
against the common carrier.
 On December 31, Year 1, a vendor authorized the entity to return for
full credit goods shipped and billed at P70,000 on December 15, Year
1. The returned goods were shipped by the entity on December 31,
Year 1. A P70,000 credit memo was received and recorded by the
entity on January 15, Year 2.
 On December 31, Year 1 the entity has a P500,000 debit balance in
accounts payable to a supplier resulting from an advance payment for
goods to be manufactured to the entity’s specifications.
What amount should be reported as accounts payable on December 31,
Year 1?
A. 2,170,000 B. 2,680,000 C. 2,730,000 D. 2,670,000

27. During the current year, L COMPANY purchased a tract of land for
P12,000,000. The entity incurred additional cost of P3,000,000 in
preparing the land for sale. The tract of land was subdivided into
residential lots as 100 Class A lots with sale price of P240,000 per lot, 100
Class B lots with the sale price of P160,000 per lot, and 200 Class C lots
with sale price of P100,000 per lot. What amount of the costs should be
allocated to Class A lots?
A. 3,000,000 B. 3,750,000 C. 6,000,000 D. 7,200,000

28. M COMPANY provided the following data for the current year:
Inventory – January 1:
Cost 3,000,000
Net realizable value 2,800,000
Net purchases 8,000,000
Inventory – December 31:
Cost 4,000,000
Net realizable value 3,700,000
What amount should be reported as cost of goods sold under lower of cost
and NRV?
A. 7,000,000 B. 7,100,000 C. 7,300,000 D. 7,200,000

29. N COMPANY provided the following information during the current year:
Product 1 Product 2
Materials and Conversion cost 3,000,000 3,600,000
Selling price 4,000,000 6,000,000
Estimated selling cost 1,200,000 1,400,000

Module 3 Page 9 of 12
Inventories

General administration cost 600,000 1,600,000

Normal profit margin on sales 1,000,000 1,500,000
At year end, the manufacturer of the products has been completed but no
selling cost has yet been incurred. What total amount should be reported
as inventory at year-end?
A. 6,400,000 B. 6,600,000 C. 4,900,000 D. 5,800,000

30. The closing inventory of Q COMPANY amounted to P284,000 at

December 31, Year 1. This total includes two inventory lines about which
the inventory taker is uncertain.
• 500 items which had a cost of P15 each and which were included at
P7,500. These items were found to have been defective at the balance
sheet date. Remedial work after the balance sheet date cost P1,800
and they were then sold for P20 each. Selling expenses were P400.
• 100 items that had cost P10 each but after the balance sheet date,
these were sold for P8 each with selling expenses of P150
What figure should appear in Q’s statement of financial position for
inventory?
A. 283,650 B. 283,950 C. 284,000 D. 284,300

31. The closing inventory of R COMPANY amounted to P116,400 excluding

the following two inventory lines:
• 400 items, which had cost P40 each. All were sold after the balance
sheet date for P30 each, with selling expenses of P2,000 for the batch
• 200 different items, which had cost P30 each. These items were found
to be defective at the balance sheet date. Rectification work after the
balance sheet date amounted to P1,200, after which they were sold for
P35, with selling expenses totaling P300.
What figure should appear in R’s statement of financial position for
inventory?
A. 116,400 B. 126,400 C. 132,400 D. 131,900

32. On January 1, Year 2, Card Corp. signed a three-year noncancelable

purchase contract, which allows Card to purchase up to 500,000 units of a
computer part annually from Hart Supply Co. at P0.10 per unit and
guarantees a minimum annual purchase of 100,000 units. During Year 2,
the part unexpectedly became obsolete. Card had 250,000 units of this
inventory at December 31, Year 2, and believes these parts can be sold
as scrap for P0.02 per unit. What amount of probable loss from the
purchase commitment should Card report in its Year 2 income statement?
A. 24,000 B. 20,000 C. 16,000 D. 8,000
B.
33. On December 1, Year 1, B COMPANY entered into a commitment to
purchase 100,000 barrels of aviation fuel for P55 per barrel on March 31,
Year 2. The entity entered into this purchase commitment to protect itself
against the volatility in the aviation fuel market. By December 31, Year 1,
the purchase price of aviation fuel had fallen to P50 per barrel. However,
by March 31, Year 2, when the entity took delivery of the 100,000 barrels
the price of aviation fuel had risen to P58 per barrel. What amount should
be recognized as gain on purchase commitment for Year 2?
A. 500,000 C. 800,000
B. 300,000 D. -0-

34. On October 20, Year 2, Grimm Co. consigned forty freezers to Holden Co.
for sale at P1,000 each and paid P800 in transportation costs. On
December 30, Year 2, Holden reported the sale of ten freezers and

Module 3 Page 10 of 12
Inventories

remitted P8,500. The remittance was net of the agreed 15% commission.
What amount should Grimm recognize as consignment sales revenue for
Year 2?
A. 7,700 B. 8,500 C. 9,800 D. 10,000

35. On December 1, Year 2, Alt Department Store received 505 sweaters on

consignment from Todd. Todd’s cost for the sweaters was P80 each, and
they were priced to sell at P100. Alt’s commission on consigned goods is
10%. At December 31, Year 2, five sweaters remained. In its December
31, Year 2 balance sheet, what amount should Alt report as payable for
consigned goods?
A. 49,000 B. 45,400 C. 45,000 D. 40,400

- end of discussion

“A long habit of not thinking a thing wrong gives it a superficial appearance of

being right.” Thomas Paine

Module 3 Page 11 of 12
Inventories

ANSWER KEY:
1. D 13. D 25. C
2. C 14. A 26. D
3. C 15. A 27. C
4. D 16. A 28. B
5. A 17. D 29. A
6. C 18. A 30. A
7. B 19. B 31. D
8. C 20. B 32. C
9. A 21. C 33. A
10. B 22. A 34. D
11. A 23. C 35. C
12. C 24. D

Module 3 Page 12 of 12