NORTHEASTERN COLLEGE
COLLEGE OF ACCOUNTANCY & BUSINESS ADMINISTRATION
FINANCIAL ACCOUNTING I
INVENTORIES
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Inventories
- PAS 2 defines Inventories are assets which are
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 in the rendering of services.
Classes of inventories
1. Trading concern is one that buys and sells goods
in the same form purchased. The “term
merchandising” is generally applied to goods held by
a trading concern.
2. Manufacturing concern is one that buys goods
which are altered or converted into another form
before they are made available for sale. The term
“finished goods”, “goods in process”, “raw
materials”, and “factory or manufacturing supplies”
refer to inventories of a manufacturing concern.
Goods includible in the inventory
As a rule, all goods to which the entity has title shall
be included in the inventory, regardless of location.
Where title has already passed from the seller to the
buyer, the goods form part of the inventory of the
latter.
The phrase “passing of title” is a language which
means “the point of time at which ownership
changes”
** Goods owned and on hand, goods in transit and
sold FOB destination, goods in transit and purchased
FOB shipping point, goods out on consignment,
goods in the hands of salesmen or agents, goods
held by customers on approval or on trial, are all
includible in inventory”
Who is the owner of 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 this, the goods in transit are still the property
of the seller. Accordingly, the seller shall legally be
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 transit is the property of
the buyer. Accordingly, the buyer shall legally be
responsible for freight charges and other expenses
up to the point of destination.
Freight terms:
Freight collect – This means that the freight charge
on the goods shipped is not yet paid. The common
carrier shall collect the same from the buyer. Thus,
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under this, the freight charge is actually paid by the
buyer
Freight prepaid – This means that the freight charge
on the goods shipped is already paid by the seller.
Note:
The terms “FOB Destination” and “FOB Shipping
point” determine ownership of the goods in transit
and the party who is supposed to pay the freight
charge and other expenses from the point of
shipment to the point of destination.
The terms “freight collect” and “freight prepaid”
determine the party who actually paid the freight
charge but not the party who is supposed to legally
pay the freight charge.
Consigned Goods
A consignment is a method of marketing goods in
which the owner called the consignor transfers
physical possession of certain goods to an agent
called the consignee who sells them on the owner’s
behalf.
Freight and other handling charges on goods out on
consignment are part of the cost of goods consigned.
When the 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 commission and other expenses
chargeable to the consignor.
Illustration A:
A consignee sells consigned goods for 100,000.
This amount is remitted to the consignor less
commission of 15,000 and advertising of 2,000.
Prepare entry to record the remittance of consignee.
Accounting for inventories
Two systems are offered in accounting for
inventories, namely periodic system and perpetual
system
The periodic system calls for the physical counting of
goods on hand at the end of the accounting period to
determine the quantities. The quantities are then
multiplied by the corresponding unit cost to get the
inventory value for balance sheet purposes.
The periodic inventory procedures is generally used
when the individual inventory items turn over rapidly
and have small peso investment such that it may
prove impractical or inconvenient to record inventory
inflow and outflow, such as groceries, hard wares
and auto parts.
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On the other hand, the perpetual system required
the maintenance of records called stock cards that
usually offer running summary of the inventory
inflow and outflow. The perpetual inventory
procedure is commonly used where the inventory
items treated individually represent a relatively large
pesos investment such as jewelry and cars. This
procedure is designed for control purposes.
Illustration B:
1. Purchase of merchandise on account, under FOB
shipping point, 300,000.
2. Payment of freight charge on the purchase,
20,000.
3. Return of merchandise purchased to supplier,
30,000.
4. Sale of merchandise on account, 400,000, at 40%
gross profit.
5. Return of merchandise sold from customer,
25,000.
6. At the end of the accounting period, the physical
counts for inventories was made amounting to
65,000.
Required: Prepare entries to record the above
transactions, assume the company uses:
a. Periodic system
b. Perpetual system
Trade Discounts and Cash Discounts
Trade discount are deductions from the list or
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.
The purpose of trade discounts is to encourage
trading or increase sales. Trade discounts also
suggest to the buyer the price at which the goods
may be sold.
Cash discounts are deduction from the invoice price
when payment is made within the discount period.
The purpose of cash discounts is to encourage
prompt payment.
Cash discount is recorded as purchase discount by
the buyer and sales discount by the seller. Purchase
discount is deducted from purchases to arrive at net
purchases and sales discount is deducted from sales
to arrive at net sales revenue.
Illustration C
The list price of merchandise purchased is 500,000
less 20% and 10%, with credit terms of 5/10, n30.
Required: The entry to record purchases is?
Methods of recording purchases
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There are two methods of recording purchases,
namely:
1. Gross Method – Purchases and accounts payable
are recorded at gross.
2. Net Method - Purchases and accounts payable are
recorded at net.
Illustration D
1. Purchased of merchandise on account, 200,000,
2/10, n/30.
2. Assume payment is made within the discount
period.
3. Assume payment is made beyond the discount
period.
Required: Prepare journal entries, assuming the
company uses: a. Gross Method and b, Net Method
in recording purchases.
Measurement of inventory
PAS2 provides the following clear cut principles
concerning measurement of inventory:
a. Inventories shall be measured at the lower of
cost or net realizable value.
b. The cost of inventories shall be determined by
using either the FIFO method or weighted average
method.
c. The cost of inventories that are not ordinarily
interchangeable and inventories that are segregated
for specific projects shall be determined by using
specific identification method.
Cost of inventories
The cost of inventories shall comprise:
a. Cost of purchase – comprises the purchase price,
import duties and irrecoverable taxes, freight,
handling and other costs directly attributable to the
acquisition of finished goods, materials and services
b. Cost of conversion – includes cost directly related
to the units of production such as direct labor. It also
includes a systematic allocation of fixed and variable
production overhead that is incurred in converting
materials into finished goods.
c. Other cost incurred in bringing the inventories to
their present location and condition – Other cost is
included in the cost of inventories only to the extent
that is incurred in bringing the inventories to their
present location and condition. For example, it may
be appropriate to include the cost of designing
product for specific customers in the cost of
inventories
However, the following costs are excluded from the
cost of inventories and recognized as expenses in the
period in which they are incurred:
a. Abnormal amounts of wasted materials, labor and
other production costs
b. Storage costs, unless these costs are necessary in
the production process prior to a further production
stage
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c. Administrative overheads that do not contribute to
bringing inventories to their present location and
condition
d. Ditribution or selling costs

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