ACCOUNTING NOTES

INVENTORY- current assets

OVERVIEW

INVENTORIES ARE ASSETS THAT ARE EITHER: (PAS 2.6)

a. Held for sale in the ordinary course of business (finished goods)
b. In the process for production ( work in process)
c. In the form of materials or supplies to be consumed in the production process (raw
materials and manufacturing supplies)
EXAMPLES:
 Merchandise purchased and held for resale
 Land and other property held for sale.
 Finished goods, goods undergoing production, and raw materials
ORDINARY COURSE OF BUSINESS- normal business activities
RECOGNITION OF INVENTORY – when the entity obtains CONTROL over them.

DETERMINING OWNERSHIP OF GOODS:

1.GOODS IN TRANSIT -seller has already shipped but the buyer has not yet received.
 FOB shipping point – ownership transferred UPON SHIPMENT.
 Buyer’s inventories
 Recorded on shipment date.
 FOB destination – ownership’s transferred when the BUYER RECEIVES.
 Goods still part of seller’s inventories.
a. FREIGHT PREPAID – seller pays the freight IN ADVANCE BEFORE shipment.
b. FREIGHT COLLECT – not yet paid upon shipment.
  Buyer pays the freight.
c. FAS ( free alongside) – seller assumes all the expenses in delivering the goods to the
dock. Buyer assumes loading and shipping costs. Ownership passes UPON
SHIPMENT.
d. EX-SHIP – seller assumes all expenses until goods are unloaded from the carrier.
e. CIF ( cost, insurance and freight) – buyer pays in lump sum the cost of goods,
insurance and freight.
f. CF (cost and freight) – buyer pays in lump sum the cost of goods and freight.

(either both CIF or CF, seller must deliver the goods to the carrier and pay costs of loading.
Title passes to the buyer upon delivery of goods to the carrier)

BASIC RULE: the entity who owns the goods being shipped should pay for the shipping
costs.
SPECIAL ACCOUNTING :
a. FOB Shipping point, freight prepaid – buyer owns the goods being shipped but the
seller already paid the shipping costs.
b. FOB destination, freight collect – seller owns the goods being shipped but the buyer
pays the shipping costs.

2. CONSIGNED GOODS
Consignor- delivers the goods to another party.
 Retains control over the consigned goods until sold to end
customers.
REMINDER!!
Consigned goods will still remain to the consigner’s inventory until the sale.
Consignee- receives the goods.
 Undertakes to sell the goods to end customers on behalf of
the consignor.
 Recorded in memo entry.
COMMISSION – considered as expense by the consignor.
 Income by the consignee.

3. INVENTORY FINANCING AGREEMENTS

 A. PRODUCT FINANCING AGREEMENT -seller sells inventory to a buyer but
assumes an obligation to repurchase at a later date.
 Seller retains ownership over inventory bc it does not result
transfer of control
B. PLEDGE OF INVENTORY – borrower uses inventory as collateral security for a
loan.
 Borrower retains ownership.
o WAREHOUSE FINANCING – third party holds the inventory and
acts as creditor’s agent.
C. LOAN OF INVENTORY – entity borrows inventory from another entity ot be replace
with the same kind of inventory.
-results transfer of control over asset.
4. INSTALLMENT SALE – possession of goods is transferred to the buyer but the seller
retains legal title to protect the collectability of the amount due.
- buyer to include upon possession
- seller to exclude inventory despite legal title
5. BILL AND HOLD ARRANGEMENT -contract that the seller bills the customer but
retains physical possession of the goods until transferred to the customer.
- goods excluded from seller’s and included in the buyer upon billing when:
a. bill and hold arrangement reason is substantive
b goods are identified separately as belonging to the customer
c. Seller cant use or sell the goods to another customer
6. LAY -AWAY SALE – type of sale in which goods are delivered when the buyer makes the
final payment.
- included in the seller’s inventory until the goods are delivered.

REMEMBER!!!
Type of arrangement Included in the inventory of:
FOB Shipping Point  Buyer
FOB Destination  Seller
Consigned goods  Consignor
Product financing & pledge  Borrower
Sale with unusual right of return  Buyer,except when unsalable
Sale on trial(or approval)  Seller
Bill and hold  Buyer
Lay away  seller

PERPETUAL INVENTORY SYSTEM – inventory is updated when sale is made.

 Shows a continuing or running balance of the goods on
hand.
  Usually used in high valued products such as cars,
machineries, furniture and heavy equipment.
Physical count is performed only as an internal control to determine the accuracy of the
balance per record.
COGS is updated each time a sale or sale return is made.
PERIODIC INVENTORY SYSTEM – inventory account is only updated when a physical
count is performed. Basically, it is determined PERIODICALLY.
 Used in low valued items such as grocery items, electrical
parts, office supplies,etc.

Ending inventory and profit have a DIRECT RELATIONSHIP.

MEASUREMENT OF INVENTORIES:
 Lower of cost
 Net realizable value
COST OF FORMULAS – “cost flow assumptions” – pertain to the flow of costs not the
actual physical flow.
1. Specific Identification – used for inventories that are not ordinarily interchangeable
and segregated for specific projects.
 Cost of sales- actual costs of the specific items sold
 Ending inventory – actual costs of the specific items on hand.
2. First in, First out (FIFO) – inventories produced or purchased first must be sold first.
 Cost of sales- costs from earlier purchases
 Ending inventory – costs from most recent purchases.
3. Weighted Average – cost of sales and ending inventory are based on weighted
average costs of beg. Inventory.
(PAS 2 does NOT permit the use of Last-in First Out( LIFO))

NET REALIZABLE VALUE (NRV) – estimated selling price less estimated costs of
completion and estimated costs to sell.
 net amount that an entity expects to realize from the sale of
inventory.
FAIR VALUE – price in which the principal market agrees.
WRITE-DOWN INVENTORY – item by item basis.
-applied when the costs exceeds its NRV.
( the excess of cost over NRV represents the amount of write-down, which is recognized as
expense)
REVERSAL OF WRITE-DOWNS -previous write down is reversed if the NRV
subsequently increases.
-amount of reversal shall not exceed the previous write-down.
CHAPTER 8 – INVENTORY ESTIMATION
The value of inventories must be estimated:
 at interim dates
 when records of investment are incomplete and inventories must be approximated.
Under PAS 2, estimates are allowed if they approximate the cost.
The cost of inventories may be estimated using either the:
(a) Gross profit method – gross profit is assumed to be relatively constant from period
to period.
 Gross Profit Rate (GPR) – used to determine the cost ratio which in turn is
used to estimate the inventory and the cost of goods sold.

This can be expressed as a percentage:

a. Based on sales
Formula : Gross Profit / net sales
b. Based on cost of goods sold
Formula : Gross Profit / cost of goods sold
Cost Ratio is derived from the gross profit rate as follows:
 Cost ratio from GPR based on sales = 100% net sales – GPR based on sales
 Cost ration from GPR based on cost = 100% Cost of goods sold / Net sales
(100%+ GPR based on cost)
Net sales:
 Only sales returns are deducted from gross sales when computing for net sales.
 Sales discounts and allowances are not deducted because these do not affect the
physical inventory of goods.

ACCOUNTS OF A MANUFACTURING ENTITY

 Inventory includes raw materials,work in process and finished goods
 (b) Retail method
 This is often used in retai industry such as supermarkets and
department store for measuring large quantities of
inventories.
The following are peculiar to retail methods:
 Cost ratio – computed directly without regard to the gross profit rate.
 Net mark-ups and mark-downs
 Net mark-ups – net increase above the original retail
price.
 Markup- increase above the original retail price
 Original retail price – selling price at which the
goods are first offered for sale.
 Markup cancellation- decrease in selling price
that does not reduce the selling price below the
original retail price.
 Net markdowns- net decreases below the original retail
price.
 Markdown- decrease below the original retail
price.
 Markdown cancellation- increase in selling price
that does not reaise the selling price above the
original retail price.
Application for retail method:
 1. Average cost method
Total goods available for sale at cost ( beginning inventory + net purchases) is
determined and divided by the Total goods available for sale at sales price to come
up with the cost ratio.

Cost of goods sold= Net sales x cost ratio

Ending inventory at cost= ending inventory at retail x cost ratio
FIFO cost method
o similar to the application of Average cost method, however the computation of
cost ratio is different.
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CHAPTER 20 – AGRICULTURE
AGRICULTURE- farming or the process of producing crops and raising livestock. PAS
41 prescribes the accounting and disclosures for agricultural and relate activity.

PAS 41 applies to the following when they relate to agricultural activity:

a. biological assets, except bearer plants
b. agricultural produce at the point of harvest; and
c. unconditional government grants related to a biological asset measured at its fair
value less cost to sell
PAS 41 does not apply to the following:
a. land related to agricultural activity (PAS 16 and PAS 40)
b. bearer plants (PAS 16). However, PAS 41 applies to the produce on those bearer
plants
c. government grants related to bearer plants(PAS 20)
d. intangible assets related to agricultural activity (PAS 38)
remember:
PAS 41 applies to agricultural produce only at the point of harvest.
BIOLOGICAL ASSEt – “a living animal or plant.” (PAS 41.5)
It can either be:
a. consumable biological assets- “those that are to be harvested as agricultural produce
or sold as biological assets.” (PAS 41.44)

Examples:
 livestock intended for the procution of meat
 livestock held for sale
 fish in famrs
 crops such as maize and wheat
 produce on a bearer plant
 trees being grown for lumber (PAS 41.44)

b. bearer biological assets – those that are held to bear produce.

Examples:
 livestock from which milk is produced
 fruit tress from which fruit is harvested (PAS 41.44)
Bearer plants are classified as PPE.
A. is used in the production or supply of a agricultural produce;
B. Is expected to bear produce for more than one period; and
C. Has a remote likelihood of being sld as agricultural produce, except for incidental
scrap sales (PAS 41.5)
ITEMS APPLICABLE STANDARD
Bearer and Consumable animals PAS 41
Consumable plants PAS 41
Bearer plants PAS 16
Produce growing on bearer plants PAS 41

AGRICULTURAL PRODUCE – harvested produce of the entity’s biological assets. (PAS

41.5)
COMMON FEATURES OF AGRICULTURAL ACTIVITIES:
a. Capability to change – living animals and plants are capables of biological
transformation
b. Management of change – management facilitates biological transformation by
enhancing, or at least stabilizing, conditions necessary for the process to take place.
c. Measurement of change- change in quality or quantity brought about by biological
transformation.
RECOGNITION:
A biological asset or agricultural produce is recognized when it meets the asset recognition
criteria, including the reliable measurement of its fair value or cost.

MEASUREMENT:
Biological assets are initially and subsequently measured at fair value less costs to sell.
Agricultural produce is initially measure at fair value less costs to sell at the point of
harvest and subsequently measured under PAS2 Inventories or other applicable standard.

Cost to sell includes:

a. Commissions to brokers
b. Levies by regulatory agencies and commodity exchanges
c. Transfer taxes and duties

Does not include:

a. Transport costs
b. Advertising costs
c. Income taxes
d. Interest expenses
GOVERNMENT GRANTS
- Measured at fair value less costs to sell, accounted for under PAS 41.
Under PAS 41, if government grant is :
a. Unconditional – grant is recognized in profit or loss when it becomes receivable
b. Conditional – grant is recognized in profit or loss when the attached conditions are
met.
c. Conditional but the terms of the grant allow part of it to be retained according to the
time that has elapsed – a portion of the grant is recognized in profit or loss as time
passes.
ENCOURAGED DISCLOSURES
Disclosure of the following information is encouraged but not required:
1. Disclosure of consumable and bearer biological assets
2. Disclosure of mature and immature biological assets
 Mature biological assets- “those that have attained
harvestable specifications (for consumable biological
assets) or are able to sustain regular harvests (for bearer
biological assets).” (PAS 41.5)
3. Disclosure of breakdown of total “ Gain (loss) from changes in FVLCS” during the
period attributable to price change and physical change
 Due to price change – differences between prices at the
beginning and en of the period without considering changes
in price due to physical growth of biological assets.

 Due to physical change- difference between prices at the

end of the period considering changes in price due to
physical growth.

CHAPTER 17 – DEPLETION OF MINERAL RESOURCES

PFRS 6 addresses the accounting for expenditures on exploration for and evaluation of
mineral resources.
 Exploration for and evaluation of mineral resources is “ the search for mineral
resources, including minerals, oil, natural gas and similar non-regenerative resources
after the entity has obtained legal rights to explore in a specific area, as well as the
determination of the technical feasibility and commercial viability of extracting the
mineral resource.” (PFRS 6)

 Exploration and evaluation expenditures – “expenditures incurred by an entity in

connection with the exploration for and evaluation of mineral resources before the
technical feasibility and commercial viability of extracting a mineral resource are
demonstrable.” (PFRS 6)
INITIAL MEASUREMENT:
Exploration and evaluation assets – recognized as assets in accordance with the entity’s
accounting policy. (PFRS 6)

SUBSEQUENT MEASUREMENT:
Exploration and evaluation assets are subsequently measure using either the cost model or
the revaluation model.

CHANGES IN ACCOUNTING POLICIES

An entity may subsequently change its accounting policy if the change makes the financial
statements more relevant and no less reliable, or more reliable and no less relevant.

CLASSIFICATION OF EXPLORATION AND EVALUATION ASSETS

Exploration and evaluation assets are initially classified as a separate class of assets and
considered as tangible or intangible depending on the nature of assets.
NATURAL RESOURCES ( mineral resources)
- Often called “wasting assets” , include petroleum, minerals and timber.
2 main features:
1. The complete removal (physical consumption) of the asset, and
2. The replacement of the asset only by an act of nature.
COST OF NATURAL RESOURCES:
 Purchase price including direct costs and restoration costs.
 Exploration costs- amounts paid to find the natural resource after legal right to
explore has been obtained. These costs are accounted for under PFRS 6.
 Development costs- amounts paid to prepare the resources site for mining.
ACQUISITION COST – price paid to obtain the property right to search and find an
undiscovered natural resource.
RESTORATION COST – cost entities incur to restore property to its natural state after
extraction has occurred.
- These are capitalized as part of the cost of natural resource to the extent the entity has
a present obligation to restore the property.
EXPLORATION COSTS – accounted for in accordance with the entity’s accounting policy
developed based on management’s judgment.
DEVELOPMENT COSTS
1. Tangible equipment costs – all of the transportation and other heavy equipment
needed to extract the resource and get it ready for market.
- Not capitalized as cost of natural resource but capitalized as equipment
2. Intangible development costs – items as drilling costs, tunnels, shafts and wells.
- Capitalized as part of the cost of natural resource
DEPLETION
- Systematic allocation of the depletion base of a natural resource over the period the
natural resource is extracted.

Depletion base- capitalized cost of the natural resource less its residual value.
Depletion is computed using the units- of- production- method.
Liquidating dividends are those declared in excess of the balance of retained earnings.
Liquidating dividends are return of capital rather than return on capital.