Inventories

InventoriesIAS 2 | 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 process or in the rendering of services.OBJECTIVEIAS 2 Inventories prescribes the accounting treatment for inventories.

The standard provides guidance on the determination of cost and its subsequent recognition as an expense, including any write-down to net realisable value.SCOPEIAS 2 applies to all inventories, except:

work in progress arising under construction contracts including directly related service contracts refer IAS 11 Construction Contracts

financial instruments refer IAS 32 Financial Instruments: Presentation and IAS 39 Financial Instruments: Recognition and Measurement

biological assets related to agricultural activities and agricultural produce at the point of harvest refer IAS 41 AgricultureKinds of InventoriesIn merchandising,Goods purchased and held for resale

In manufacturing,Raw Materials and suppliesGoods in processFinished goods

In service provider,The cost of service for which related revenue is not yet recognized (labor and other cost of personnel directly engaged in providing the service)

Goods includible in the inventoryAs a rule, all goods to which the entity has title shall be included in the inventory regardless of location.

Passing of title legal language which means the point of time at which ownership changesLegal TestIs the entity the owner of the goods to be inventoried?Who is the owner ofgoods in transit?Free on Board (FOB)FOB destination goods purchased is transferred only upon receipt.

FOB shipping point ownership is transferred upon shipment.Who is the owner ofconsigned goods?ConsignmentA method of marketing goods in which the owner called consignor transfer physical possession if certain goods to an agent called the consignee who sells them on the owners behalf.Exception to the legal testInstallment Contracts- retention of the title by the seller until selling price is fully collected.

However, it is an accepted accounting principle to record installment sale as regular sale involving deferred income on the part of the seller.ActivityIdentify which inventories are included:

Goods in transit and purchased FOB shipping pointGoods in transit and sold FOB shipping pointGoods on consignmentGoods in the hand of an agentGoods held by consignmentGoods held by customers on approvalGoods held by customers on trialRecognition and measurementIAS 2 requires inventories to be measured at the lower of cost and net realisable value on an item by item basis. Expense recognitionUpon the sale of inventories, the carrying amount of those inventories is to be recognised as an expense in the statement of comprehensive income in the period in which the related revenue is recognised.

If net realisable value falls below the cost of inventories the write-down is expensed in the statement of comprehensive income in the period in which the write-down occurs. An increase in net realisable value that reverses a previous write-down is to be recognised as a reduction in the amount of inventories recognised as an expense in the period the reversal occurs.Accounting for inventoriesPeriodic system calls for the physical counting of goods on hand at the end of the accounting period.

Perpetual system requires the maintenance of records called stock cards that usually offer running summary of the inventory inflow and outflow.Purchase of Merchandise on accountPeriodic SystemPerpetual SystemPurchasesAccounts PayableMerchandise InventoryAccounts PayablePayment of freight on purchasePeriodic SystemPerpetual SystemFreight InCashMerchandise InventoryCashReturn of merchandise purchasedPeriodic SystemPerpetual SystemAccounts PayablePurchase ReturnAccounts Payable Merchandise InventorySale of merchandise on accountPeriodic SystemPerpetual SystemAccounts receivableSalesAccounts ReceivableSales

Cost of Goods SoldMerchandise InventoryReturn of merchandise soldPeriodic SystemPerpetual SystemSalesAccounts receivableSalesAccounts ReceivableMerchandise InventoryCost of Goods SoldSale of merchandise on accountPeriodic SystemPerpetual SystemMerchandise Inventory-endIncome SummaryNo entry.Measurement of inventoryLower of Cost or Net Realizable Value (LCNRV)

Either First In or First Out (FIFO) or weighted average method

Specific Identification MethodCost of inventoryThe cost of inventories is the aggregation of the:

costs of purchase net of trade discounts and rebates(e.g. purchase price, import duties, transportation and handling costs)

the costs of conversion into finished products(e.g. labor and production overhead costs)

other costs in bringing the inventories to their present location and condition excluding the cost of abnormal wastage, storage, administration and selling.Cost of purchaseComprises the purchase price, import duties and irrecoverable taxes, freight, handling and other costs directly attributable to the acquisition.

Trade discounts, rebates and other similar items are deducted from the cost of purchase.

Shall not include foreign exchange differences.DiscountsTRADE DISCOUNTCASH DISCOUNTDeductions from the list or catalog price in order to arrive at the invoice price which is actually charged to the buyer.Deductions from invoice price when payment is made within the discount period.The list price of a merchandise purchased is P500,000 less 20% and 10%, with credit terms of 5/10, n/30.

List Price500,000First trade discount (20% of 500,000) ( 100,000)400,000Second trade discount (10% of 400,000)(40,000)Invoice Price360,000Cash discount (5% of 360,000)18,000Payment within the discount period342,000Methods of recording purchasesGROSS METHODNET METHODPurchases and accounts payable are recorded at gross.Purchases and accounts payable are recorded at net.

Purchase of merchandise on accountPurchases360,000Accounts Payable360,000Purchases 342,000Accounts Payable342,000GROSS METHODNET METHODAssume payment is made beyond the discount periodAccounts Payable360,000Cash360,000Accounts Payable 342,000Purchase Discount Loss 18,000Cash 360,000

The purchase discount loss account is classified as other expense.GROSS METHODNET METHODAssume payment is made within the discount periodAccounts Payable360,000Cash342,000Purchase discount 18,000Accounts Payable342,000Cash 342,000GROSS METHODNET METHODAssume it is the end of accounting period, no payment is made and the discount has expired.No entry.Purchase Discount Loss 18,000 Accounts Payable 18,000GROSS METHODNET METHODCost of conversionCost directly related to the units of production such as direct labor.

Includes a systematic allocation of fixed and variable production overhead.Fixed production overheadVariable production overheadIndirect cost of production that remains relatively constant regardless of the volume of production.Indirect cost of production that varies directly with the volume of production.Other costCost of inventories only to the extent that it is incurred in bringing the inventories to their present location and condition.

Exclude the following from cost of inventory and recognize as expense:Abnormal amounts of wasted materials, labor and other production costsStorage cost, unless necessary for productionAdministrative overheadsDistribution or selling costsNet realizable valueEstimated selling price in the ordinary course of business less the estimated cost of completion and the estimated cost necessary to make the sale.

The cost may not be recoverable, - If inventories are damaged, wholly or partially obsolete or if their selling prices have declined.- If the estimated cost of completion or the estimated cost to sell has increased.The practice of writing inventories down below cost to net realizable value is consistent with that assets shall not be carried in excess of amounts expected to be realized from their sale or use.

Inventories are usually written down to net realizable value on an item or individual basis.But if not appropriate, based on a classification.LCNRV If cost < NRVIf cost > NRVInventory is stated at cost. Increase in value is not recognized.Inventory is measured at net realizable value. Write-down inventory to net realizable value.Accounting for inventory write-downDirect MethodAllowance MethodInventory is recorded at LCNRV. Any loss on inventory write-down is not accounted for separately but buried in the cost of goods sold.Inventory is recorded at cost and any loss on inventory write-down is accounted for separately.As of December 31, 2014, Cost = P800,000and NRV = P785,000Direct MethodAllowance MethodInventory, 12/31/14785,000Income summary785,000Inventory, 12/31/14800,000Income summary800,000

Loss on inventory15,000Allowance forinventory write-down15,000As of December 31, 2015, Cost = P1,000,000and NRV = P990,000Direct MethodAllowance MethodInventory, 12/31/15990,000Income summary990,000Allowance forInventory write-down5,000Gain on reversal ofinventory write-down5,000Methods of valuationFirst In, First Out (FIFO)Weighted AverageGoods first purchased are first sold.

The inventory is thus expressed in terms of recent or new prices and COGS are in terms of old or earlier prices.Coat of beginning inventory plus cost of purchases divided by the total number of units.

Weighted average methodPeriodicPerpetualAverage unit cost =Total cost of COGS Total no. of COGSPeriodic basis, upon purchase of new inventory.Apply AVCO method of inventory valuation on the following information, first in periodic inventory system and then in perpetual inventory system to determine the value of inventory on hand on Mar 31 and cost of goods sold during March.

Specific identificationSpecific costs are attributed to identified items of inventory.

Inventories that are segregated for a specific project and inventories that are not ordinarily interchangeable.Biological Assets

IAS 41: AGRICULTUREApplied to account for the following when they relate to agricultural activity:

Biological assetsAgricultural produce (@ point of harvest)Government grant related to biological assetsDefinition of termsBIOLOGICAL ASSETS living animals and living plants

AGRICULTURAL PRODUCE harvested product of an entitys biological assets

HARVEST detachment of produce from a biological asset or cessation of a biological assets life processes

Productafter harvest

YarnCheeseTeaWineFruit cocktail

AgriculturalProduce

WoolMilkLeafGrapesPicked fruitBiologicalAsset

SheepDiary cattleBushesVinesFruit treesAgricultural activity (Agriculture)This is the management by an entity of the biological transformation and harvest of biological assets for sale or for conversion into agricultural produce or into additional biological assets.

Examples of agricultural activity

Features of agricultural activityCAPABILITY TO CHANGE biological transformation

MANAGEMENT OF CHANGE enhancing or at least stabilizing conditions necessary for the process to take place

MEASUREMENT OF CHANGE measured and monitored as a routine management functionBiological TransformationComprises the process of growth, degeneration, production and procreation that cause qualitative or quantitative changes in a biological asset.

Results from:

Asset changesGrowthDegenerationProcreation

Production

RecognitionEntity controls the asset as a result of past event

Flow of probable future economic benefits associated with the asset

Fair value or cost can be measured reliably MeasurementInitial recognition and at the end of reporting periodAt fair value less cost to sell

(Agricultural produce @ FV costs at the point of harvest)

Cost to sell incremental costs directly attributable to the disposal of an asset, excluding finance costs and income taxesDetermination of Fair ValueQuoted price in an active marketMost recent market transaction priceMarket price for similar assetsSector benchmarkPresent value of expected net cash flow from the assetGain or LossOn initial recognition,

Biological AssetsLoss, when Cost to Sell is greater than FVGain, on precreation

Agricultural produceDepends on the result of harvesting