CHAPTER 10

INVENTORIES

Definition

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

Classes of Inventories

Inventories are broadly classified into two, namely inventories of a trading concern and inventories of
manufacturing concern.

A trading concern is one that buys and sells goods in the same form purchased.

The term “merchandise inventory” is generally applied to goods held by a trading concern.

A manufacturing concern is one that buys goods which are altered and converted into another term
before they are made available for sale.

The inventories of a manufacturing concern are:

a. Finished goods

b. Goods in process

c. Raw materials

d. Factory or manufacturing supplies

Definition

Finished goods are completed products which are ready for sale.

Goods in process or work in process are partially completed products which required further process or
work they can be sold.

Raw materials are goods that are to be used in the production process.

Frequently raw materials are restricted to materials that will physically incorporated in the production
of other goods and which can be traced directly to the end product of the production process.

Factory or manufacturing supplies are similar to raw materials but their relationship to the end product
is indirect.

Factory or manufacturing supplies may be referred to as indirect materials.

Goods includible in the inventory

As a rule, all which the entity has title shall be included in the inventory, regardless of location.

The phrase “passing of title” is a legal language which means “the point of time which ownership
changes”.
Legal test

Is the entity the owner of the goods to be inventoried?

If the answer is affirmative, the goods shall be included in the inventory.

If the answer is negative, the goods shall be excluded from the inventory.

Who is the owner of the goods in transit?

This will depend on the terms, whether FOB destination or FOB shipping point. FOB means free on
board.

Under FOB destination, ownership of goods purchased is transferred only upon receipt of the goods by
the buyer at the point of destination.

Thus, under FOB destination, the goods in transit are still the property of the seller.

Accordingly, the seller shall legally responsible for freight charges and other expenses up to the point of
destination.

On the other hand, if the term is FOB shipping point, ownership is transferred upon shipment of the
goods and therefore, the goods in transits are properties of the buyer.

Accordingly, the buyer shall legally responsible for freight charges and other expenses point of shipment
to the point of destination.

Freight terms

Freight collect – this means that the freight charges on the goods shipped is not yet paid. The common
carrier shall collect the same from the buyer. Thus, under this, the freight charge is actually paid by the
buyer.

Freight prepaid – this means that the freight charges on the goods shipped is already paid by the seller.

The term “FOB destination” and “FOB shipping point” determine the ownership of the goods in transit
and the party who is supposed to be paid the freight charge.

Consigned goods

A consigned goods is a method of marketing goods in which the owner called the consignor transfers
physical possession of certain goods to an agent called consignee who sells them on the owner’s behalf.

Consigned goods shall be included on the consignor’s inventory and excludes in the consignee’s
inventory.

Freight and other handling charges on goods out on consignment are part of the cost of goods
consigned.

When consigned goods are sold by the consignee, a report is made to the consignor together with a
cash remittance for the amount of sales minus the commission and other expenses chargeable to the
consignor.
For example, a consignee sells consigned goods for P100,000. This amount is remitted to the consignor
less the commission of P15,000 and advertising of P2,000.

The consignor simply records the remittance from the consignee as follows:

Cash 83,000

Commission 15,000

Advertising 2,000

Sales 100,000

Incidentally, consigned goods are recorded by the consignor by means of a memorandum entry.

Statement presentation

Inventories are generally classified as current assets.

The inventories shall be presented as one line item in the statement of financial position but the details
of the inventories are disclosed in the notes to financial statements.

Accounting for inventories

Two systems are offered in accounting for inventories, namely periodic system and perpetual system.

The periodic system calls for physical counting of goods on hand at the end of accounting period to
determined quantities.

On the other hand, the perpetual system requires the maintenance of records called stock cards usually
offer a running summary of inventory inflow and outflow.

Illustration – Periodic system

1. Purchased of merchandise on account, P300,000.

Purchases 300,000

Accounts payable 300,000

2. Payment of freight on the purchase, P20,000

Freight in 20,000

Cash 20,000

3. Return of merchandise purchased to supplier, P30,000

Accounts payable 30,000

Purchase return 30,000

 4. Sale of merchandise on account, P400,000, at 40% gross profit.

Accounts payable 400,000

Sales 400,000

5. Return of merchandise sold from customer, P25,000.

Sales return 25,000

Accounts receivable 25,000

6. Adjustment of ending inventory, P65,000

Merchandise inventory – end 65,000

Income summary 65,000

Illustration – Perpetual system

1. Purchased of merchandise on account, P300,000.

Merchandise inventory 300,000

Accounts payable 300,000

2. Payment of freight on the purchase, P20,000

Merchandise inventory 20,000

Cash 20,000

3. Return of merchandise purchased to supplier, P30,000

Accounts payable 30,000

Merchandise inventory 30,000

4. Sale of merchandise on account, P400,000 at gross profit of 40%. The cost of merchandise sold
is 60% or P240,000

Accounts receivable 400,000

Sales 400,000

Cost of goods sold 240,000

Merchandise inventory 240,000

Under the perpetual system, the cost of merchandise sold is immediately recorded because this
is clearly determinable from the stock card.
 5. Return of merchandise sold from customer, P25,000. The cost of merchandise returned is 60%
or P15,000.

Sales return 25,000

Accounts receivable 25,000

Merchandise inventory 15,000

Cost of goods sold 15,000

6. Adjustment of ending inventory

As a rule, the ending merchandise inventory is not adjusted. The balance of merchandise
inventory account represents the ending inventory.

Inventory shortage or overage

In the illustration, the merchandise inventory account has debit balance of P65,000.

For example, if the physical count shows inventory on hand P55,000, the following adjustments is
necessary:

Inventory shortage 10,000

Merchandise inventory (65,000 – 55,000) 10,000

The inventory shortage is usually closed to cost of goods sold because this is often the result of normal
shrinkage and breakage in inventory.

However, abnormal and material shortage shall be separately classified and presented as other
expense.

Trade discounts and cash discount

Trade discounts are deductions from the list of catalog price in order to arrive at the invoice price which
is the amount actually charge to the buyer.

Thus, trade discounts are not recorded.

Cash discounts are deduction from the invoice price when payment is made within the discount period.

Cash discounts are recorded as purchase discount by the buyer and sales discount by the seller.

Illustration

The list price of a merchandise purchased is P500,000 less 20% and 10%, with credit terms of 5/10 n/30.

This means that trade discounts are 20% and 10%, and the cash discount of 5% if payment is made in 10
days.

The full payment of the invoice is paid if the payment is made after 10 days and within the credit period
of 30 days.
List price 500,000

First trade discount (20% x 500,000) (100,000)

400,000

Second trade discount (10% x 400,000) ( 40,000)

Invoice price 360,000

Cash discount (5% x 360,000) ( 18,000)

Payment within the discount period 342,000

The journal entry to record the purchases is:

Purchases 360,000

Accounts payable 360,000

Note that the trade discounts are not recorded. The journal entry to record the payment within the
discount period is:

Accounts payable 360,000

Cash 342,000

Purchase discount 18,000

Methods of recording purchases

1. Gross method – purchases and accounts payable are recorded at gross.

2. Net method - purchases and accounts payable are recorded at net.

Illustration – Gross method

1. Purchases on account, P200,000, 2/10 n/30.

Purchases 200,000

Accounts payable 200,000

2. Assume payment is made within the discount period.

Accounts payable 200,000

Cash 196,000

Purchase discount 4,000

3. Assume payment is made beyond the discount period.

Accounts payable 200,000

Cash 200,000
Illustration – Net method

1. Purchases on account, P200,000, 2/10 n/30.

Purchases 196,000

Accounts payable 196,000

2. Assume payment is made within the discount period.

Accounts payable 196,000

Cash 196,000

3. Assume payment is made beyond the discount period.

Accounts payable 196,000

Purchase discount 4,000

Cash 200,000

4. Assume it is the end of accounting period, no payments is made and the discount period has
expired.

Purchase discount loss 4,000

Accounts payable 4,000

Cost of inventories

The cost of inventories shall comprise:

a. Cost of purchase

b. Cost of conversion

c. Other cost incurred

Cost of purchase

The cost of purchase of inventories comprise the purchase price, import duties and irrecoverable taxes,
freight, handling and other cost 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.

Cost of conversion

The cost of conversion of inventories includes cost directly related to the units of production such as
direct labor.

It is also includes a systematic allocation of fixed and variable production overhead that is incurred in
converting materials into finished goods.
Fixed production overhead is the indirect cost of production that remains relatively constant.

Variable production overhead is the indirect cost of production that varies with the volume of
production.

Other cost

Other cost is included in the cost of inventories only to the extent that it is incurred in bringing the
inventories.

Cost of inventories of a service provider

The cost of inventories of a service provider consists of primarily of the labor and other cost of
personnel directly engaged in providing service, including supervisory personnel and attributable
overhead.

Labor and other costs relating to sales and general administrative personnel are not included but are
recognized as expense in the period which they incurred.
 PROBLEMS

INVENTORIES

PROBLEM 1
Anan Company provided the following data:

Items counted in the bodega 4,000,000

Items included in the count specifically segregated
per sale contract 100,000
ltems in receiving department, returned by customer, in good condition 50,000
Items ordered and in the receiving department 400,000
Items ordered, invoice received but goods not received.
Freight is on account of seller. 300,000
Items shipped today, invoice mailed, FOB shipping point 250,000
Items shipped today, invoice mailed, FOB destination 150,000
Items currently being used for window display 200,000
Items on counter for sale 800,000
Items in receiving department, refused because of damage 180,000
Items included in count, damaged and unsalable 50,000
Items in the shipping department 250,000

What is the correct amount of inventory?

a. 5,700,000 b. 6,000,000 C. 5,800,000 d. 5,150,000

Solution : Answer a

Items counted in the bodega 4,000,000

Items included in count specifically segregated (100,000)
Items returned by customer Items ordered and in receiving department 50,000
Items shipped today, FOB destination 400,000
Items for display 150,000
Items on counter for sale 200,000
Damaged and unsalable 800,000
items included in count (50,000)
Items in the shipping department 250,000
5,700,000

PROBLEM 2
Hero Company reported inventory on December 31, 2018 at P6,000,000 based on a physical count of
goods priced 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 30, 2018. These goods had
a cost of P125,000 and were picked up by the carrier on January
7, 2019.
* Goods shipped FOB shipping point on December 28, 2018,
from a vendor to Hero were received and recorded on January
4, 2019. The invoice cost was P300,000.
What amount should be reported as inventory on December 31, 2018?
a. 5,875,000
b. 6,000,000
c. 6,175,000
d. 6,300,000

Solution Answer d
Physical count 6,000,000
Goods shipped FOB shipping point on December 30, 2018
to Hero and received January 4, 2019 300,000
Inventory, December 31, 2018 6,300,000

The goods costing P125,000 are properly included in the December 31,2018 physical count because the
goods are shipped FOB shipping point only on January 7,2019 (picked up by common carrier).

PROBLEM 3

Corolla Company incurred the following costs:

Materials 700,000
Storage costs of finished goods 180,000
Delivery to customers 40,000
Irrecoverable purchase taxes 60,000

At what amount should the inventory be measured?

a. 880,000 b. 760,000 c. 980,000 d. 940,000

Solution : Answer b
Materials 700,000
Irrecoverable purchase taxes 60,000
Total cost of inventory 760,000

PROBLEM 4

At year-end, Kerr Company purchased goods costing P500,000 FOB destination. These goods were
received at year-end. The costs incurred in connection with the sale and delivery of the goods were:

Packaging for shipment 10,000

Shipping 15,000
Special handling charges 25,000

What total cost should be included in inventory?

a. 545,000
b. 535,000
c. 520,000
d.500,000
Solution : Answer d
When goods are purchased FOB destination, the seller is responsible for costs incurred in transporting
the goods to the buyer.

PROBLEM 5
Stone Company had the following transactions during December:

Inventory shipped on consignment to Beta Company 1,800,000

Freight paid by Stone 90,000
Inventory received on consignment from Alpha Company 1,200,000
Freight paid by Alpha 50,000
No sales of consigned goods were made in December.

What amount should be included in inventory on December 31?

a. 1,200,000
b. 1,250,000
C. 1,800,000
d. 1,890,000

Solution : Answer d
Inventory shipped on consignment to Beta Freight paid by Stone 1,800,000
Total cost of consigned inventory 90,000
1,890,000
PROBLEM 6
On December 1, 2018, Alt Department Store received 505 on consignment from Todd.
Todd's cost for the sweaters was P800 each, and they were priced to sell at P1,000.
Alt's commission on consigned goods is 10%. On December 31,2018
5 sweaters remained.
On December 31, 2018, what amount should be reported as payable for consigned goods?
a. 490,000
b. 454,000.
c. 450,000
d. 404,000

Solution : Answer c
Payable for consigned goods (500,000-50,000 commission) 450,000

PROBLEM 7
On August 1, Stella Company recorded purchases of inventory of P800,000 and P1,000,000 under credit
terms of 2/15, net 30.
The payment due on the P800,000 purchase was remitted on August 16. The payment due on the
P1,000,000 purchase was remitted on August 31.

Under the net method and the gross method, these purchases should be included at what respective
amounts in the determination of cost of goods available for sale?

Net Method Gross method

a. 1,784,000 1,764,000
b. 1764,000 1 800,000
d. 1,764,000 1,784,000
c. 1,800,000. 1,764,000
.
Solution : Answer c

Net method
Purchases (800,000 + 1,000,000) 1,800,000
Purchase discount taken (2%x 800,000) (16,000)
Purchase discount not taken (2% x 1,000,000) (20,000)
Net amount 1,764,000

Under the net method, the purchase discount is deducted from purchases regardless of whether taken
or not taken.

Gross method
Purchases 1,800,000
Purchase discount taken (16,000)
Net purchases 1,784,000

Under the gross method, the purchases are recorded at gross and only the purchase discount taken is
deducted from purchases in determining Cost of goods available for sale.

PROBLEM 8
Dean Sportswear regularly buys sweaters from Mill Company and is allowed trade discounts of 20% and
10% from the list price.
Dean made a purchase during the year and received an invoice with a list price of P600, 000 , a freight
charge of P15,000 and payment terms of 2/10, n/30.

What is the cost of the purchase?

a. 432,000
b. 447,000
c. 438,360
d. 435,000

Solution : Answer b
List price 600,000
Trade discount (20% x 600,000) (120,000)
Balance 480,000
Trade discount(10% x 480,000) (48,000)
Invoice price 432,000
Freight charge 15,000
Total cost of purchase 447,000
PROBLEM 9
Baritone Company counted and reported the ending inventory on December 31, 2018 at P2,000,000
None of the following items were included when the total of the ending inventory was computed:

Goods located in the entity's warehouse that are

amount consignment from another entity 150,000

Goods sold by the entity and shipped FOB destination were in transit
on December 31, 2018 and received by the
customer on January 2, 2019 200,000

Goods purchased by the entity and shipped

FOB seller were in transit on December 3 1, 2018
and received by the entity on January 2, 2019 300.000

Goods sold by the entity and shipped

FOB shipping point were in transit
on December 31, 2018 and received by the
Customer on January 2, 2019 400.000

What is the correct amount of inventory on December 31, 2018?

a. 2,500,000 b. 2,350,000 C. 2,900,000 d. 2,750,000

Solution 27-4 Answer a

Reported inventory 2,000,000
Goods sold in transit, FOB destination 200,000
Goods purchased in transit, FOB seller 300,000

Correct amount of inventory 2,500,000

The term FOB seller is the same as FOB shipping point.

PROBLEM 10
Ashwood Company reported accounts payable on December at P900,000 before any necessary year-
end adjustments relating to the following:

Goods were in transit from a vendor to Ashwood on Den 31, 2018. The invoice cost was P50,000 and the
shipped FOB shipping point on December 29, 2018, There were received on January 4, 2019.

Goods shipped FOB shipping points on December 20, 2018 a vendor to Ashwood were lost in transit.

The invoice cost was P25,000. On January 5, 2019, Ashwood filed a P25, 000 claim against the common
carrier.
Goods shipped FOB destination on December 21, 2018 from vendor to Ashwood were received on
January 6, 2019. The invoice cost was P15,000.
What amount should be reported as accounts payable on December 31, 2018?
a. 925,000 b. 940,000 C., 950,000 d. 975,000

Solution Answer d
Accounts payable per book 900,00
Goods in transit FOB shipping point 50,000
Goods shipped FOB shipping point lost. in transit 25,000

Adjusted accounts payable 975,000

The goods shipped FOB destination on December 31, 2018 excluded because the goods were received
on January 6, 2019