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    Chapter 14 - Inventories

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    Ferb Cruzada
    1) Inventories are assets held for sale, in production, or in the form of materials. They are initially measured at cost and subsequently at the lower of cost or net realizable value. 2) Cost includes purchase costs, conversion costs like direct labor, and systematically allocated fixed and variable overheads. 3) Common costing methods are specific identification, FIFO, and weighted average.

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    Chapter 14 - Inventories

    Uploaded by

    Ferb Cruzada
    260 views5 pages
    1) Inventories are assets held for sale, in production, or in the form of materials. They are initially measured at cost and subsequently at the lower of cost or net realizable value. 2) Cost includes purchase costs, conversion costs like direct labor, and systematically allocated fixed and variable overheads. 3) Common costing methods are specific identification, FIFO, and weighted average.

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    1) Inventories are assets held for sale, in production, or in the form of materials. They are initially measured at cost and subsequently at the lower of cost or net realizable value. 2) Cost includes purchase costs, conversion costs like direct labor, and systematically allocated fixed and variable overheads. 3) Common costing methods are specific identification, FIFO, and weighted average.

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    © All Rights Reserved
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    Download as docx, pdf, or txt
    260 views5 pages

    Chapter 14 - Inventories

    Uploaded by

    Ferb Cruzada
    1) Inventories are assets held for sale, in production, or in the form of materials. They are initially measured at cost and subsequently at the lower of cost or net realizable value. 2) Cost includes purchase costs, conversion costs like direct labor, and systematically allocated fixed and variable overheads. 3) Common costing methods are specific identification, FIFO, and weighted average.

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    of 5

    CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS

    CHAPTER 14

    INVENTORIES

    STANDARD

    IAS 2 – Inventories

    DEFINITION

    Inventories are assets:

    (a) held for sale in the ordinary course of business;


    (b) in the process of production for such sale; or
    (c) in the form of materials or supplies to be consumed in the production process or in the
    rendering of services.

    MEASUREMENT

    Initial Measurement: Cost

    Subsequent Measurement: Lower of cost and net realizable value (LCNRV)

    Cost of Inventories

    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.

    Cost of Purchase

    The costs of purchase of inventories comprise the purchase price, import duties and other taxes
    (other than those subsequently recoverable by the entity from the taxing authorities), 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 costs
    of purchase.

    Cost of Conversion

    The costs of conversion of inventories include costs directly related to the units of production, such
    as direct labor. They also include a systematic allocation of fixed and variable production
    overheads that are incurred in converting materials into finished goods. Fixed production overheads
    are those indirect costs of production that remain relatively constant regardless of the volume of
    production, such as depreciation and maintenance of factory buildings and equipment, and
    the cost of factory management and administration. Variable production overheads are those
    indirect costs of production that vary directly, or nearly directly, with the volume of production, such
    as indirect materials and indirect labor.

    Other Costs

    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. 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.
    Non-inventoriable costs

    Examples of costs excluded from the cost of inventories and recognized as expenses in the period in
    which they are incurred are:

    (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.

    Cost of inventories of a service provider

    To the extent that service providers have inventories, they measure them at the costs of their
    production. These costs consist primarily of the labor and other costs of personnel directly
    engaged in providing the service, including supervisory personnel, and attributable
    overheads. Labor and other costs relating to sales and general administrative personnel are not
    included but are recognized as expenses in the period in which they are incurred.

    COST FORMULAS

    1. Specific Identification - the cost of inventories of items that are not ordinarily
    interchangeable and goods or services produced and segregated for specific projects shall be
    assigned by using specific identification of their individual costs. Specific identification of cost
    means that specific costs are attributed to identified items of inventory. This is the
    appropriate treatment for items that are segregated for a specific project, regardless of
    whether they have been bought or produced.

    2. First-In First-Out (FIFO) - The FIFO formula assumes that the items of inventory that were
    purchased or produced first are sold first, and consequently the items remaining in
    inventory at the end of the period are those most recently purchased or produced.

    Example:

    The following data pertain to an inventory item:

    Units Unit Cost Total Cost Sales (in units)


    Jan. 1 Beginning Balance 800 200 160,000
    Jan. 8 Sale 500
    Jan. 18 Purchase 700 210 147,000
    Jan. 22 Sale 800
    Jan. 31 Purchase 500 220 110,000

    The ending inventory is 700 units.

    Cost of ending inventory under FIFO:

    Units Unit Cost Total Cost


    From Jan. 18 Purchase 200 210 42,000
    From Jan. 31 Purchase 500 220 110,000
    Ending Balance 700 152,000
    Cost of Goods Sold under FIFO:

    Inventory – January 1 160,000


    Purchases 257,000
    Goods Available for Sale 417,000
    Ending Inventory (152,000)
    Cost of Goods Sold 265,000

    Or

    Units Unit Cost Total Cost


    Jan. 8 Sale (from Jan. 1 Balance) 500 200 100,000
    Jan. 22 Sale (from Jan. 1 Balance) 300 200 60,000
    Jan. 22 Sale (from Jan. 18 Purchase) 500 210 105,000
    Cost of Goods Sold 1,300 265,000

    Cost of ending inventory under LIFO:

    Units Unit Cost Total Cost


    From Jan. 18 Purchase 700 200 140,000
    Ending Balance 700 140,000

    Cost of Goods Sold under LIFO:

    Inventory – January 1 160,000


    Purchases 257,000
    Goods Available for Sale 417,000
    Ending Inventory (140,000)
    Cost of Goods Sold 277,000

    3. Weighted Average - Under the weighted average cost formula, the cost of each item is
    determined from the weighted average of the cost of similar items at the beginning of a period
    and the cost of similar items purchased or produced during the period. The average may be
    calculated on a periodic basis, or as each additional shipment is received, depending upon the
    circumstances of the entity.

    Example:

    The following data pertain to an inventory item:

    Units Unit Cost Total Cost Sales (in units)


    Jan. 1 Beginning Balance 800 200 160,000
    Jan. 8 Sale 500
    Jan. 18 Purchase 700 210 147,000
    Jan. 22 Sale 800
    Jan. 31 Purchase 500 220 110,000

    The ending inventory is 700 units.

    Computation of weighted average unit cost and ending inventory:

    Units Unit Cost Total Cost


    Jan. 1 Balance 800 200 160,000
    Jan. 18 Purchase 700 210 147,000
    Jan. 31 Purchase 500 220 110,000
    Total Goods Available for Sale 2,000 417,000
    Weighted Average Unit Cost (417,000 / 2,000) 208.50
    Ending Inventory (700 x 208.50) 145,950

    Cost of Goods Sold

    Inventory – January 1 160,000


    Purchases 257,000
    Goods Available for Sale 417,000
    Ending Inventory (145,950)
    Cost of Goods Sold 271,050

    Or

    Total Units Sold 1,300


    Weighted average unit cost 208.50
    Cost of Goods Sold 271,050

    Accounting for Inventory Write-down

    Inventories are written-down if the net realizable value is lower than cost. Net realizable value 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. Inventories are usually written
    down to net realizable value item by item.

    Methods for Accounting for Inventory Write-down

    1. Allowance Method or Loss Method – the inventory is recorded at cost and any loss on
    inventory write-down is accounted for separately. In subsequent years, this allowance account
    is adjusted upward or downward depending on the difference between the cost and net
    realizable value of the inventory at year-end. The loss on inventory write-down shall be
    included in the cost of goods sold. Any gain on reversal of inventory write-down is limited only
    to the extent of allowance balance.

    2. Direct Write-off Method or Cost of Goods Sold Method – the inventories are directly
    recorded at lower of cost and net realizable value. Any loss or gain or reversal is not
    accounted for separately, as the amount is already buried in the cost of goods sold since the
    inventories are already recorded at LCNRV.

    Regardless of the method used, the amount of cost of goods sold remains to be the same.

    Example

    Inventory Item Total Cost NRV LCNRV


    A 2,000,000 1,900,000 1,900,000
    B 1,500,000 1,550,000 1,500,000
    C 2,500,000 2,100,000 2,100,000
    D 3,000,000 3,200,000 3,000,000
    Total 9,000,000 8,750,000 8,500,000

    Total Cost 9,000,000


    LCNRV 8,500,000
    Inventory write-down 500,000
    Journal Entries:

    1. Allowance Method

    Inventory, December 31, 2020 9,000,000


    Income Summary 9,000,000

    Loss on inventory write-down 500,000


    Allowance for inventory write-down 500,000

    2. Direct Method

    Inventory, December 31, 2020 8,500,000


    Income Summary 8,500,000

    Balance Sheet

    1. Allowance Method

    Inventory, December 31, 2020 9,000,000


    Allowance for inventory write-down (500,000)
    Inventories – net 8,500,000

    2. Direct Method

    Inventories – net 8,500,000

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