Practical Accounting 1

Trade Cash
P1.001_Inventories Objective Generate sales Encourage prompt payment
Accounting Not recorded separately Recording using either Gross or Net method
(Purchases/Sales net of trade discount)
LECTURE NOTES:
Gross and net method of recording purchases
Nature of Inventories
Gross Net
Inventories are assets which are: Cash discounts Deducted from purchases/cost of inventory Deducted from purchases/cost of inventory
• held for sale in the ordinary course of business (finished goods), when taken whether taken or not
• in the process of production for sale in the ordinary course of business (work in process) Cash discounts Deducted from purchases/cost of inventory Not accounted for separately since already
• in the form of materials or supplies to be consumed in the production process or in the rendering of services taken (purchase discounts) deducted from purchases
(raw materials) Cash discounts not Included in purchases/cost of inventory Reported as other expense (Purchase
taken discount lost)
Recognition
Rule: All goods to which the entity has title shall be included in the inventory.
Inventory Cost Formulas
1. Freight Terms
➢ FOB Shipping Point The purpose of an inventory valuation is to allocate the total cost of goods sold available for sale during the period
➢ FOB Destination between cost of goods sold and ending inventory.
2. Goods on Consignment
3. Maritime Terms • Specific identification
➢ Free alongside (FAS) Units of hand x Specific unit cost
➢ Ex ship
➢ Cost, Insurance or Freight
4. Installment sales
• First-in, first-out method (FIFO)
Units on hand x Unit cost of latest purchases
5. Conditional Sales

Measurement and Valuation • Weighted Average

Units on hand x Weighted Average Unit Costs
Inventories are required to be stated at the lower of cost and net realizable value. *WAUC = Total cost of GAS/Total units available for sale

Cost should include Net Realizable Value

• Cost purchase Net Realizable Value is the estimated selling price in the ordinary course of business less the estimated costs of
▪ Purchase price completion and the estimated costs necessary to make the sale.
▪ Import duties and other non-refundable taxes
▪ Transport, handling and other costs Accounting of Inventory Write down
*trade discounts, rebates and other similar items are deducted in determining cost of purchase
• Cost of conversion (direct labor and variable and fixed manufacturing overhead). The cost of inventories may not be recoverable if:
• Other costs incurred in bringing the inventories to their present condition. a. Those inventories are damaged
b. They have become wholly or partially obsolete
Inventory cost should not include c. Their selling prices have declined
d. The estimated costs of completion or the estimated costs to be incurred to make the sale have increase
• abnormal waste
• storage cost Why write down to NRV?
• admin overhead unrelated to production The practice of writing inventories down below cost to net realizable value is consistent with the view that assets should
• selling costs, not be carried in excess of amounts expected to be realized from their sale or use.
• foreign exchange differences arising directly on the recent acquisition of inventories invoiced in foreign currency
How to write down to NRV?
• interest cost when inventories are purchased with deferred installment terms.
Inventories are usually written down to net realizable value item by item or individual basis.
Trade and Cash Discounts
What if the NRV is lower than the cost? Compute the amount to be presented as “Inventories” under current assets.
If the NRV is lower than cost, the methods of accounting used for the write down are:

o Direct Method – known as “Cost of Goods Sold Method” as any loss on inventory write down is not accounted
separately and buried in the cost of goods sold.
o Allowance Method – known as “Loss Method”, as inventory are recorded at cost and any loss on inventory
write down is accounted separately.
Reversal of inventory write down
When the circumstances that previously caused inventories to be written down below no longer exist or when there is a
clear evidence of an increase in NRV, the amount of write down is reversed (i.e. the reversal is limited to the amount of
the amount of original write-down) so that the new carrying amount is the lower of cost and the revised net realizable
value.
Write down to NRV of materials and production supplies
Materials and other supplies held for use in the production of inventories are not written down below cost if the finished
products in which they will be incorporated are expected to be sold at or above cost. However, when the decline in
the price of materials indicates that the cost of the finished products exceeds net realizable value, the materials are
written down to Net Realizable Value. In such circumstances, the replacement cost of the materials may be the best
available measure of their net realizable value.
Purchase Commitment
Purchase commitments are obligations of the entity to acquire certain goods sometime in the future at a fixed price
and fixed quantity. Purchase contract has already been made for future delivery of goods fixed in price and in
quantity.
2. Nachobimby Company asks you to review its December 31, 2015, inventory values and prepare the necessary
adjustments to the books. The following information is given to you.
a. Nachobimby uses the periodic method of recording inventory. A physical count reveals P2,348,900 inventory
on hand at December 31, 2015.
b. Not included in the physical count of inventory is P134,200 of merchandise purchased on December 15 from
Standing. This merchandise was shipped f.o.b. shipping point on December 29 and arrived in January. The
invoice arrived and was recorded on December 31.
c. Included in inventory is merchandise sold to Oval on December 30, f.o.b. destination. This merchandise was
shipped after it was counted. The invoice was prepared and recorded as a sale on account for P128,000 on
December 31. The merchandise cost P73,500, and Oval received it on January 3.
d. Included in inventory was merchandise received from Owl on December 31 with an invoice price of P156,300.
The merchandise was shipped f.o.b destination. The invoice, which has not yet arrived, has not been
recorded.
e. Not included in inventory is P85,400 of merchandise purchased from Oxygen Industries. The merchandise was
received on December 31 after the inventory had been counted. The invoice was received and recorded
on December 30.
f. Included in inventory was P104,380 of inventory held by Nachobimby on consignment from Ovoid Industries.
g. Included in inventory is merchandise sold to Kemp f.o.b. shipping point. This merchandise was shipped after it
was counted. The invoice was prepared and recorded as a sale for P189,000 on December 31. The cost of
this merchandise was P105,200, and Kemp received the merchandise on January 5.
h. Excluded from inventory was carton labeled “Please accept for credit.” This carton contains merchandise
costing P15,000 which had been sold to a customer for P25,000. No entry had been made to the books to
reflect the return, but none of the returned merchandise seemed damaged.

Recognition of loss on purchase commitment is an adaptation of the measurement at the lower of cost or NRV The adjusted inventory cost of Nachobimby Company at December 31, 2015 should be

Illustrative Problems
3. The inventory on hand at December 31 for Petmalu Company valued at a cost of P947,800. The following items
1. Werpa Company included the following items under inventories: were not included in this inventory amount:
a. Purchased goods, in transit, shipped FOB destination invoice price P32,000 which included freight
Materials P1,400,000 charges of P1,600.
Advance for materials ordered 200,000 b. Goods held on consignment by Petmalu Company at a sales price of P28,000, including sales
Goods in process 650,000 commission of 20% of the sales price.
Unexpired insurance on inventories 60,000 c. Goods sold to Garcia Company, under terms FOB destination, invoiced for P18,500 which includes P1,000
Advertising catalogs and shipping boxes 150,000 freight charges to deliver the goods. Goods are in transit.
Finished goods in factory 2,000,000 d. Purchased goods in transit, terms FOB seller, invoice price P48,000, freight cost, P3,000.
Finished goods in company-owned retail stores, including 50% profit e. Goods out on consignment to Manil Company, sales price P36,400 cost of P2,000.
on cost 750,000
Finished goods in hands of consignees including 40% profit on sales 400,000
Assuming that the company’s selling price is 140% of inventory cost, the adjusted cost of Petmalu Company’s
Finished goods in transit to customers, shipped FOB destination, at cost 250,000
inventory at December 31 should be
Finished goods out on approval, at cost 100,000
Unsalable finished goods at cost 50,000
Office supplies 40,000
Use the following information for the next two questions:
Materials in transit shipped FOB shipping
point excluding freight of P30,000 330,000
Potato Corner Corporation began operations in 2015. In 2015 it incurred the following expenditures in
Goods held on consignment, at sales
purchasing materials for producing its product:
price, cost P150,000 200,000
• Purchase price of raw materials = P3,000,000
• Import duty and other non-refundable purchase taxes = P800,000
 • Refundable purchase taxes = P100,000
• Freight costs for bringing the goods from the supplier to the factory raw material storeroom = If the entity used the gross method of recording purchases instead of the net method, the reported cost of goods
P300,000 sold would have been _______________________________________.
• Cost of unloading the materials into the raw material storeroom = P2,000
• Packaging = P200,000
Use the following information for the next two questions.
On 31 December 2015 the entity received P53,000 volume rebate from a supplier for purchasing more than
P1,500,000 from the supplier during the year. Transactions for the month of June were:

The entity incurred the following additional cost in the production run: Purchases Units Unit cost Total cost
• Salary of the machine workers in the factory = P500,000 June 1 (balance) 400 P3.20 P 1,280
3 1,100 3.10 3,410
• Salary of factory supervisor = P300,000
7 600 3.30 1,980
• Depreciation of the factory building and equipment used for production process = P60,000
15 900 3.40 3,060
• Consumables used in the production process = P20,000 22 250 3.50 875
• Depreciation of vehicle used to transport the goods from the raw materials storeroom to the 3,250 P10,605
machine floor = P40,000
• Factory electricity usage charges = P30,000
• Factory rental = P100,000 Sales
• Depreciation and maintenance of the entity’s vehicle used by the factory supervisor (50 per cent for June 2 300 @ P5.50
official use and 50 per cent for personal use) = P20,000 6 800 @ 5.50
Private use of the vehicles is an employee benefit. 9 500 @ 5.50
During 2015 the entity incurred the following administration expenses: 10 200 @ 6.00
• Depreciation of the administration building = P50,000 18 700 @ 6.00
• Depreciation and maintenance of vehicles used by the administrative staff = P15,000 25 150 @ 6.00
• Salaries of the administration personnel = P305,000 2,650

8. Assuming that perpetual inventory records are kept in pesos, the ending inventory on a FIFO basis is
Of the administration expenses 20 per cent are attributable to administering the factory. The rest of the
administration expenses are attributable, in equal proportion, to the sales and other non-production
9. Assuming that perpetual inventory records are kept in units only, the ending inventory on an average-cost basis is
operations (eg financing, tax and corporate secretarial functions).

In 2015 the entity incurred the following selling expenses:

Use the following information for the next two questions.
• Advertising costs = P30,000
• Depreciation and maintenance of vehicles used by the sales staff = P10,000
Sayun ra uses the perpetual inventory system. Sayun ra ’s inventory transactions for the month of August were as
• Salary of the administration personnel = P600,000
follows:

4. The total costs of purchase is No. Unit cost Total cost

01 Aug. Beg. Inventory 20 P4.00 P80.00
5. The total costs of conversion is 07 Aug. Purchases 10 4.20 42.00
10 Aug. Purchases 20 4.30 86.00
12 Aug. Sales 15 ? ?
6. Pabili po Co. regularly buys shirts from Vendor Company and is allowed trade discounts of 20% and 10% from the 16 Aug. Purchases 20 4.60 92
list price. Pabili po purchased shirts from Vendor on May 27 and received an invoice with a list price of P100,000 20 Aug. Sales 40 ? ?
and payment terms 2/10, n/30. If Pabili po uses the net method of recording purchases, the journal entry to 28 Aug. Sales returns 3 ? ?
record the payment on June 8 will include a debit/credit to _________________________.
10. Using the information, assume that the Sayun ra uses the FIFO cost flow method and that the sales returns relate to
7. Babangon at Lalaban Werpa Corp. purchased merchandise during 2015 on credit for P200,000; terms 2/10, n/30. the 20 August sales. The sales return should be costed back into inventory at what unit cost?
All of the gross liability except P40,000 was paid within the discount period. The remainder was paid within the 30- ____________________________________________.
day term. At the end of the annual accounting period, December 31, 2015, 90% of the merchandise had been
sold and 10% remained in inventory. The entity has no beginning inventory. The entity uses net method of
recording purchases.
11. Assuming that Sayun ra uses the weighted average cost flow method, the 12 August sales should be costed at 16. The GOGOGO Corporation included the following in its unadjusted trial balance as of December 31, 2015:
what unit cost? Inventory, 12/31/14 P 19,450,000
Purchases 127,850,000
Available for sale P147,300,000
Use the following information for the next two questions.
The inventory at December 31,2015 was counted at a cost of P14.5 million. This includes P500,000 of slow
Tawag ng tanghalan Co. wholesales bicycles. It uses the perpetual inventory system. The company's reporting date is moving inventory that is expected to be sold for a net amount of P300,000.
31 December. At 1 December 2015, inventory on hand consisted of 350 bicycles at P820 each and 43 bicycles at P850
each. During the month ended 31 December 2015, the following inventory transactions took place (all purchase and The cost of sales for the year ended December 31,2015 is
sales transactions are on credit):

Dec. 02 Sold 300 bicycles for P1,200 each. 17. Easypizzyyy Company installs replacement siding, windows, and louvered glass doors for family homes. At
03 Five bicycles were returned by a customer. They had originally cost P820 each and December 31, 2015, the balance of inventory account was P502,000, and the allowance for inventory writedown
were sold for P1,200 each. was P33,000. The inventory cost and other data at December 31, 2015, are as follows: (amounts in thousands)
09 Purchased 55 bicycles at P910 each.
13 Purchased 76 bicycles at P960 each. Replacem
15 Sold 86 bicycles for P1,350 each. ent Cost Sales Normal
16 Returned one damaged bicycles to the supplier. This bicycle had been purchased on Item Cost Price NRV Profit
9 December. A P 89 P 86 P 91 P 87 P 5
22 Sold 60 bicycles for P1,250 each. B 94 92 93 85 7
26 Purchased 72 bicycles at P980 each. C 125 135 129 111 10
29 Two bicycles, sold on 22 December, were returned by a customer. The bicycles were D 194 114 205 197 20
badly damaged so it was decided to write them off. They had originally cost P910 Total P502 P427 P518 P480 P32
each.
The gain on reversal of inventory writedown is
12. The cost of goods sold for the month of December using FIFO method is
18. Eowwwpoxxx Development Corporation bought a 10-hectare land in Novaliches, to be improved, subdivided into
13. The cost of inventory as of December 31, 2015 using moving average method is (Round unit costs to the nearest lots, and eventually sold. Purchase price of the land was P58,000,000. Taxes and documentation expenses on the
peso) transfer of the property amounted to P800,000. The lots were classified as follows:

Lot Number Selling price Total

14. An entity has partially-completed inventory located in its factory, to which the following estimates relate: class of lots per lot clearing costs
Production costs incurred to date P268,000 A 10 P1,000,000 None
Production costs to complete 20,000 B 20 800,000 P1,000,000
Transport costs to customer 5,000 C 40 700,000 3,000,000
Future selling costs 10,000 D 50 600,000 8,000,000
Selling price 300,000

At what amount should the entity report the inventory on its statement of financial position? Use the following information for the next two questions.

15. The closing inventory at cost of a company at 31 December 2015 amounted to P284,700. The following items were
included at cost in the total:
• 400 coats, which had cost P80 each and normally sold for P150 each. Owing to a defect in
manufacture, they were sold after reporting date at 50% of their normal price. Selling expenses
amounted to 5% of the proceeds
• 800 skirts, which had cost P20 each. These too were found to be defective. Remedial work in February
2016 cost P5 per skirts, and selling expenses for the batched totaled P800. They were sold for P28 each.
What should the inventory value be according to PAS 2 Inventories after considering the above items?
On November 15, 2015, NO NAME entered in to a commitment to purchase 200,000 units of raw material X for
P8,000,000 on March 15, 2016. NO NAME entered into this purchase commitment to protect itself against the volatility
in the price of raw material X. By December 31, 2015, the purchase price of material X had fallen to P35 per unit.
19. How much will be recognized as loss on purchase commitment on March 15, 2016 if the price of the material had
fallen further to P32 per unit?
20. How much will be recognized as gain on purchase commitment on March 15, 2016 if the price of the material had
risen to P42 per unit?
21. On January 1, 2015, Pastille Corp. signed a three-year noncancelable purchase contract, which allows Pastille to
purchase up to 500,000 units of computer part annually from Pyramid Supply Co. at P10 per unit and guarantees a
 minimum annual purchase of 100,000 units. During 2015, the part unexpectedly became obsolete. Pastille had
250,000 units of this inventory at December 31, 2015, and believes these parts can be sold as scrap for P2 per unit.
What amount of probable loss from the purchase commitment should Pastille report in its 2015 profit or loss?

22. The following information for Bagulin Industries was taken from the company's financial statements (amounts in
thousands):

2015 2014
Sales P24,000 P18,000
Cost of goods sold 19,600 13,900
Inventory 1,400 1,200
Accounts receivable 3,900 3,600
Net income 560 320

What is the inventory turnover for the year 2015?