INVENTORIES

KEY TERMS:

 Inventories are assets in the form of materials or supplies for production process; to be consumed or distributed
in the rendering of services; held for sale or distribution in the ordinary course of operations; or in the process of
production for sale or distribution.
 Semi-expendable property are tangible items with estimated service life of more than one year not within the
capitalization threshold of P15,000.00 or the amount is less than P15,000.00
 Current replacement cost is the cost the entity would incur to acquire the asset on the reporting date. The
current replacement cost would be the value or amount you have to pay for the asset at reporting day. Example, the
current market price you would pay to purchase the inventory.
 Net Realizable Value is the estimated selling price in the ordinary course of operations, less the estimated costs
of completion and the estimated costs necessary to make the sale, exchange, or distribution. Net realizable value or
NRV means the expected selling price in the ordinary course of business minus any costs to complete and dispose.
It is the net amount the entity expects to realize from the sale of inventory in the ordinary course of operations.
 Fair Value - is the amount for which an asset could be exchanged or a liability settled, between knowledgeable,
willing parties in an arm’s length transaction.

CLASSIFICATION OF INVENTORIES:

1. For Manufacturing 3. For Distribution

2. For Sale 4. For Consumption

The Department of Education purchased an air-conditioning unit amounting to P13,000.00 for the use of their accounting
office.

Recognition of issuance of the air-conditioning units to accounting office

 Inventories shall be measured at the Lower of Cost and Net Realizable Value, except where inventories are
acquired through a non-exchange transaction, and then the cost shall be measured at Fair Value at the date
of acquisition. However, the inventories shall be measured at the lower of cost and current replacement
cost if they are held for distribution at no charge or for a nominal charge or consumption in the production
process of goods to be distributed at no charge or for a nominal charge.
  The cost of inventories comprises all costs of purchase, costs of conversion and other costs. Costs of
Purchase are purchase price, import duties and other taxes, transport, handling and other attributable cost
while the Costs of Conversion are cost of converting work-in-progress into finished goods such as costs
directly related to units of production, and allocation of fixed production overhead.

Exercise: COST OF INVENTORY

1. On January 7, 2015 Agency A acquired goods for sale for P 100,000, including a P5,000 non refundable
purchase taxes. In acquiring the goods, transport charges of P2,000 were incurred. What is the cost of
purchase?

2. On February 3, 2015 Agency B purchased 50 units of air-conditioning unit at P13,500.00 per unit. The
supplier delivered the items on Feb 10, 2015. Immediately after delivery the agency issued 30 units of
aircon to Departments B and C. On February 20, 2015, the entity purchased an additional 20 units, this time
for P13, 000.00 only per unit. Only a week after, the Agency further purchased 15 units @ P13,200.00 per
unit. At the end of the month, the Agency issued 25 units to Department A. What is the unit cost of
inventory at the end of February 2015.

3. Entity F purchased goods for distribution on account with list price amounting to P100, 000. The supplier
grants trade discounts of 20% and 10%, with credit terms of 5/10, n/30. Payment is made after fifteen (15)
days after the date of purchase. Compute the cost of the purchased goods for distribution.

4. Entity G incurred the following cost in connection with the production of 1,000 pairs of shoes:
a. Direct Materials - 100,000
b. Direct labor - 20,000
c. Overhead - 10,000
In addition the entity paid P5,000 for wasted materials and other production costs. Furthermore, the Sales
Department incurred P10, 000 for the promotion of its new line of shoes Suzane. What is the unit cost for
each pair of shoes?

METHODS OF ACCOUNTING FOR INVENTORIES

• Perpetual inventory - Continually records all the changes in inventory

• Periodic inventory - All acquisition are recorded by debits to purchases

An asset is said to be impaired if the cost of inventories held for sale is higher than the net realizable value or
the cost of inventories held for distribution or consumption is higher than the current replacement cost. The
difference between the cost and net realizable value/current replacement cost shall be recognized as an
expense in the financial statement.

The computation of the Net Realizable Value is Estimated Selling Price less Estimated Cost of Disposal

When inventories are sold, exchanged, or distributed, the carrying amount of those inventories shall be
recognized as an expense in the period in which the related revenue is recognized. If there is no related
revenue, the expense is recognized when the goods are distributed or the related service is rendered.

The amount of any write-down of the inventories and all losses shall be recognized also as an expense in the
period the write-down or loss occurs.
DISCLOSURES:

1. The accounting policies adopted in measuring inventories, including the cost formula used;
2. The total carrying amount of inventories and the carrying amount in classifications appropriate to the entity
3. The carrying amount of inventories carried at fair value less costs to sell;
4. The amount of inventories recognized as an expense during the period.
5. The amount of any write-down of inventories recognized an expense in the period;
6. The amount of any reversal of any write down that is recognized in the statement of financial performance
in the period;
7. The circumstances or events that led to the reversal of a write- down of inventories;
8. The carrying amount of inventories pledged as security for liabilities.

Financial Instruments

• is any contract that gives rise to both a financial asset of one entity and a financial liability or equity
instrument of another entity.

Characteristics of a Financial Instrument

 There must be a contract

 With at least two parties
 financial asset of one party and financial liability or equity instrument of another

Financial Asset
 Cash
 An equity instrument of another entity.
 A contractual right
 A contract that will or maybe settled in the entity’s own equity instrument

Examples:

 Trade Account Receivable  Bonds Receivable

 Loans Receivable  Trading Securities

Financial Liability

• A contractual obligation :

• To deliver cash or another financial asset to another entity

• To exchange financial assets or financial liabilities with another entity under conditions that are
potentially unfavourable to the entity

Examples of financial liabilities are:

• Accounts payable • Notes Payable
• Treasury Bills Payable • Loans Payable-Domestic/Foreign
• Interest Payable • Bonds Payable-Domestic/Foreign

EQUITY INSTRUMENT - A contract that evidences a residual interest in the assets of an entity after deducting all of
its liabilities.
Equity instruments include:

1. Ordinary Share; 2. Preferred Share; 3. Other Share Capital;

Accounting for Financial Assets

Criteria for Recognition

 An entity shall recognize a financial asset in its statement of financial position when it becomes a party to
the contractual provisions of the instrument.

 Financial assets are classified into four categories namely:

1. Financial asset designated at fair value through surplus or deficit, a common example of which is a
held-for-trading asset ;
2. Held-to-maturity investments, a non-derivative financial assets with fixed or determinable payments
and fixed maturity;
3. Loans and receivables, non-derivative financial assets with fixed or determinable payments not
quoted in an active market such as loans, investments in debt instruments, trade receivables and bank
deposits;
4. Available-for-sale financial assets, non-derivative financial assets designated as available for sale or
not classified as any of the three categories mentioned above.

Initial Measurement of Financial Assets

Financial Asset at Fair Value Through Surplus or Deficit – FV

Financial Asset NOT at Fair Value Through Surplus or Deficit – FV + TC

FINANCIAL LIABILITY

• An entity shall recognize a financial Liability in its statement of financial position when it becomes a party to
the contractual provisions of the instrument.

Initial Measurement of Financial Liability

Financial Asset at Fair Value Through Surplus or Deficit – FV
Financial Asset NOT at Fair Value Through Surplus or Deficit – FV + TC

Subsequent

Example:

Face value of the bond P100,000.00

Term 5-years
Selling price 95,787.63
Issue Date 1-Jan-15
Nominal Rate 5% annually
Effective interest rate 6%

Equity Instruments
• Equity security encompasses any instrument representing ownership shares and right, warrants or options
to acquire or dispose of ownership shares at a fixed or determinable price
Property, Plant and Equipment

PPSAS definition of PPE 1) tangible items; 2) held for use in the production or supply of goods or services, for rental
to others, or for administrative purposes; and 3) expected to be used during more than one reporting period.
(Compare the 2 definition explain the difference)

Criteria for Recognizing PPE

• future economic benefits will flow to the entity
• cost or fair value can be measured reliably
• beneficial ownership and control rest with the entity
• used to achieve government objectives
• meets the capitalization threshold of P15,000.00

Exercise:
1. Entity A purchase the following PPE:
a. Medical equipment amounting to P20,000.00.
b. Computer set amounting to P40,000 broken as follows: Monitor – P10,000; CPU – P26,000; Key board –
P2,500 and Mouse – P1,500.
c. 50 pcs. monoblock chair amounting to P25,000.00.
2. Determine the initial cost of the PPE and prepare the accounting entries.

1.

2.

3.

Purchase:

• Cash basis – initially recorded at cost plus cost incurred in bringing the asset to its intended use and location.
• On Account – if acquired on account subject to a cash discount, the cost of the asset is equal to the purchase
price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates.
Invoice price minus the discount regardless of whether the discount is taken or not. Cash discounts are
generally considered as reduction of cost and not as income. If the discount is not taken, shall be recognized as
Other Losses.
• On installment - The cost is the cash price equivalent or its fair value at the recognition date. However, if
acquired through installment and payment is deferred beyond normal credit terms, the difference between the
cash price equivalent and the total payment is recognized as interest over the period of credit, unless such
interest capitalized as allowed in PPSAS 5, Borrowing Cost
• With promotional items - If item received is the same as the PPE purchased, the total purchase cost shall be
allocated to the total quantity purchased plus the promotional item. However if item received is different from
the PPE purchased, the cost of the promo item shall be its fair value - It shall be deducted from the total cost of
the items purchased and the balance shall be allocated to the total quantity purchased.
• Lump sum price - cost shall be apportioned to the asset acquired in order to have proper basis for computing
depreciation. The purchase cost shall be distributed based on the relative fair value of the assets acquired. The
cost of several PPE purchased at lump sum price per set/group/lot shall be allocated to each PPE based on the
breakdown of cost reflected in the invoice, if any. In the absence of such breakdown the allocation of cost shall
be based on the relative fair value of the assets acquired.

LEASES

Lease is a an agreement whereby lessor conveys the right to use an asset for an agreed period of time o lease term
to lessee, in return for a payment or a series of payments.

1. The date from which the lessee is entitled to exercise its right to use the leased asset is the
a. Inception of the lease c. Commencement of the Lease Term
b. Lease Term

2. This is the earlier of the date of the lease agreement and the date of commitment by the parties to the principal
provisions of the lease.
a. Inception of the lease c. Commencement of the Lease Term
b. Lease Term

3. The period over which an asset is expected to yield economic benefits or service potential to one or more users
a. Useful Life c. Economic Life
b. Lease Term

4. The non-cancellable period for which the lessee has contracted to lease the asset
a. Inception of the lease c. Commencement of the Lease Term
b. Lease Term

5. Refers to an additional payment made by a lessee in property, cash, or both when a lease terminates
a. Unguaranteed Residual Value c. Minimum Lease Payments
b. Guaranteed Residual Value

6. That portion of the residual value of the leased asset, the realization of which by the lessor is not assured or is
guaranteed solely by a party related to the lessor.
a. Unguaranteed Residual Value c. Minimum Lease Payments
b. Guaranteed Residual Value
7. The aggregate of, the minimum lease payments receivable by the lessor under a finance lease; and any
unguaranteed residual value accruing to the lessor.
a. Useful Life c. Gross Investment in the Lease
b. Net Investment in the Lease

8. Payments over the lease term that the lessee is, or can be, required to make
a. Minimum Lease Payments c. Contingent Rent
b. Initial Direct Costs

9. This is the discount rate that, at the inception of the lease, causes the aggregate present value of: the MLP; and
the unguaranteed residual value to be equal to the FV of the leased asset and any initial direct costs
a. Lessee’s incremental borrowing rate of interest
b. Interest Rate Implicit in the Lease
c. Borrowing Rate

10. The gross investment in the lease discounted at the interest rate implicit in the lease.
a. Inception of the lease
b. Net Investment in the Lease
c. Minimum Lease Payments

CLASSIFICATION OF LEASE:
1. Operating Lease 2. Finance Lease

FINANCE LEASE
• Ownership transferred at the end of lease term
• Option to purchase the asset at a price < FV
• Lease term is = > major part of economic life of asset
• Present value of MLP = > close to fair value
• Leased assets are of such a specialized nature
• Leased assets cannot easily be replaced
• Lessor’s losses shall be borne by lessee
• Gains/losses from the fluctuation in the FV of the residual accrue to the lessee
• ability to continue the lease for a secondary period at a rent substantially lower than market rent

Situation No. 1

On January 1, 2014, an entity entered, as lessee, into a five-year non-cancellable lease of a machine that has an
economic life of five years. On the same date (the inception of the lease), the fair value of the machine is P100,000.
On December 31 for each of the first four years of the lease term, the lessee is required to pay the lessor P23,000.
At the end of the lease term, ownership of the machine passes to the lessee upon payment of the final lease
payment of P23,539. The interest rate implicit in the lease is 5 per cent per year. This rate approximates the lessee’s
incremental borrowing rate.

Situation No. 2
On January 1, 2014, an entity entered as lessee into a five-year non-cancellable lease of farmland with a fair value of
P100,000. The lessee is required to pay the lessor P5,000 per year.

Situation No. 3
On January 1, 2014, an entity entered as lessee into a five-day non-cancellable lease of a motor vehicle that has an
economic life of five years. On the same date (the inception of the lease), the fair value (cash cost) of the motor
vehicle is P100,000. The lessor charges the lessee P120 per day for the use of the motor vehicle. At the end of the
lease term, the lessee returns the motor vehicle to the lessor.
Situation No. 4
On January 1, 2014, an entity entered as lessee into a five-year non-cancellable lease of a machine that has an
economic life of five years. On January 1, 2014 (the inception of the lease) the fair value (cash cost) of the machine
is P100,000. On December 31 for each of the first four years of the lease term the lessee is required to pay the
lessor P23,000. Ownership of the machine does not automatically pass to the lessee at the end of the lease.
Instead, the lease provides the lessee with an option to acquire the machine from the lessor on January 1, 2019 for
P1.

Situation No. 5
An entity entered, as lessee, into a two-year non-cancellable lease over a motor vehicle that has an economic life of
five years. At the inception of the lease, the present value of the minimum lease payments approximates the fair
value of the motor vehicle. Ownership of the motor vehicle passes to the lessee at the end of the lease term

Sample Problem: Finance Lease

• Lease Term – 7 years
• Useful Life – 7 years
• FV of Equipment – P100,000
• Annual Payment – P21,912 (due every Dec. 31, 2014 - Dec. 2020)
• Lessee’s incremental borrowing rate – 13%
• Implicit interest rate (known to lessee) – 12%

AMORTIZATION:

JOURNAL ENTRIES:

Sample Problem: Operating Lease

A 5-year operating lease is initiated on January 1st, 2015. Payments are P10,000.00 per year, payable on
December 31st each year. Cost of Equipment is P50,000 with a useful life of 8 years. Give journal entries for the
1st year.
JOURNAL ENTRIES: