Pas 2: Inventories

PAS 2 Inventories contains the requirements on how to

account for most types of inventory.

- The standard requires inventories to be measured

at the lower of cost and net realizable value (NRV)
and outlines acceptable methods of determining
cost, including specific identification (in some
cases), first-in first-out (FIFO) and weighted average
cost.

Objective of PAS 2 - The objective of PAS 2 is to prescribe the

accounting treatment for inventories. It provides guidance (continuous or running balances) of inventory and cost of
for determining the cost of inventories and for subsequently goods sold are maintained under this system.
recognizing an expense, including any write-down to net Under periodic inventory system, the “Inventory” account is
realizable value. It also provides guidance on the cost updated only when a physical count is performed. Thus, the
formulas that are used to assign costs to inventories. amounts of inventory and cost of goods sold are determined
Scope only periodically.

Inventories include assets held for sale in the ordinary

course of business (finished goods), assets in the production
process for sale in the ordinary course of business (work in
process), and materials and supplies that are consumed in
production (raw materials). However, PAS 2 excludes certain
inventories from its scope: Fundamental Principles of Pas 2

• Work in process arising under construction contracts (PAS - Inventories are initially measured at cost.
11 Construction Contracts) - In subsequent measurement, inventories are
required to be stated at the lower of cost and net
• Financial instruments (PAS 39 Financial Instruments: realizable value (NRV).
Recognition and Measurement)
Cost
• Biological assets related to agricultural activity and
agricultural produce at the point of harvest (PAS 41 Cost should include all:
Agriculture) • Costs of purchase (including import duties and non-
Also, while the following are within the scope of the standard, recoverable taxes, transport, and handling) net of trade
discounts received
PAS 2 does not apply to the measurement of inventories held
by: • Costs of conversion (including direct labor and fixed and
variable manufacturing overheads) and
• Producers of agricultural and forest products, agricultural
produce after harvest, and minerals and mineral products, • Other costs incurred in bringing the inventories to their
to the extent that they are measured at net realizable value present location and condition
(above or below cost) in accordance with well-established PAS 23 Borrowing Costs identifies some limited
practices in those industries. circumstances where borrowing costs (interest expense) can
• Commodity brokers and dealers who measure their be included in cost of inventories that meet the definition of
inventories at fair value less costs to sell. a qualifying asset.

Accounting for Inventories: Illustration

Accounting for Inventories is done under either through ABC Company, a VAT payer, imported goods from a foreign
supplier. Costs incurred by ABC include the following:
a) Perpetual Inventory System or
Purchase price P 100
b) Periodic Inventory System
Import duties 10
Under perpetual inventory system, the inventory account is
updated for each purchase and sale of inventory. Records Value Added Tax 13
called “stock card” that show the perpetual balances Transportation and handling costs 5
Commission to broker 2 Write-down to Net Realizable Value

P 130 Net Realizable Value (NRV) – is the estimated selling price in

the ordinary course of business, less the estimated cost of
How much is the cost of purchase of the imported goods? completion and the estimated costs necessary to make the
The answer is P 117 excluding only the VAT sale

The entry to record the purchase is as follows If the cost of an inventory exceeds its NRV, the inventory is
written down to NRV, the lower amount. The excess of cost
Inventory 117 over NRV represents the amount of write-down. If the cost of
an inventory is lower than its NRV, no write-down is
Input VAT 13

Cash in bank 130

* It should be noted that if the purchaser is not a VAT payer,

the VAT paid forms part of the cost of inventory

Cost

Inventory cost should not include:

• Abnormal waste

• Storage costs
necessary.
• Administrative overheads unrelated to production
Reversal of write-down
• Selling costs
Sample Problem
• Foreign exchange differences arising directly on the recent
acquisition of inventories invoiced in a foreign currency Based on the physical inventory taken on Dec. 31, 2021,
Marian Company has an ending inventory costing P
• Interest cost when inventories are purchased with
950,000but with a fair value less cost to sell of P 750,000.
deferred settlement terms.
During the year 2022, Marian Co. has yet to sell this
Cost Formulas inventory due primarily to the nature of the business. On Dec.
31, 2022, the inventory has a fair value less cost to sell of P
1. Specific Identification 1,200,000.
2. First-in, First-out (FIFO) Cost Formula PAS 7 – Statement of Cash Flows
3. Weighted Average Cost Formula PAS 7 Statement of Cash Flows requires an entity to present
a statement of cash flows as an integral part of its primary
The LIFO formula, which had been allowed prior to the 2003
financial statements. Cash flows are classified and
revision of PAS 2, is no longer allowed. The same cost
presented into operating activities (either using the 'direct' or
formula should be used for all inventories with similar
'indirect' method), investing activities or financing activities,
characteristics as to their nature and use to the entity. For
with the latter two categories generally presented on a gross
groups of inventories that have different characteristics,
basis.
different cost formulas may be justified.
Objective of PAS 7
Specific identification - shall be used for items that are not
ordinarily interchangeable or for items that are individually - The objective of PAS 7 is to require the presentation
unique and goods or services produced and segregated for of information about the historical changes in cash
specific projects. and cash equivalents of an entity by means of a
statement of cash flows, which classifies cash flows
Sample Problem
during the period according to operating, investing,
FIFO & Weighted Average Method Suppose you own a and financing activities
furniture store and you purchase 200 chairs for P10 per unit.
Fundamental Principle of Pas 7
The next month, you buy another 300 chairs for P20 per unit.
At the end of an accounting period, let's assume you sold - All entities that prepare financial statements in
300 total chairs. conformity with PFRSs are required to present a
statement of cash flows.
Presentation of the Statement of Cash Flows • Materiality. Information is material if omitting, misstating
or obscuring it could reasonably be expected to influence
Cash flows must be analyzed between: decisions that the primary users of general purpose financial
1. Operating, statements make on the basis of those financial statements,
which provide financial information about a specific
2. Investing and reporting entity.
3. Financing activities. Prior period errors - are omissions from, and misstatements
in, an entity's financial statements for one or more prior
Key principles specified by PAS 7 for the preparation of a periods arising from a failure to use, or misuse of, reliable
statement of cash flows are as follows: information that was available and could reasonably be
• Operating activities are the main revenue-producing expected to have been obtained and taken into account in
activities of the entity that are not investing or financing preparing those statements. Such errors result from
activities, so operating cash flows include cash received mathematical mistakes, mistakes in applying accounting
from customers and cash paid to suppliers and employees policies, oversights or misinterpretations of facts, and fraud.

• Investing activities are the acquisition and disposal of long- Objective

term assets and other investments that are not considered The objective of PAS 8 is to prescribe the criteria for selecting
to be cash equivalents and changing ACCOUNTING POLICIES, changes in
• Financing activities are activities that alter the equity ACCOUNTING ESTIMATES and CORRECTION OF ERRORS to
capital and borrowing structure of the entity enhance relevance, reliability and comparability of the
financial statements of an entity over time as well as with the
• interest and dividends received and paid may be classified financial statements of other entities.
as operating, investing, or financing cash flows, provided
that they are classified consistently from period to period Selection of Accounting Policies

• cash flows arising from taxes on income are normally - When a standard specifically applies to a
classified as operating, unless they can be specifically transaction, the accounting policy applied to an
identified with financing or investing activities affected account shall be determined by applying
the standard. In the absence of a standard that
• For operating cash flows, the direct method of applies to a transaction, management shall use its
presentation is encouraged, but the indirect method is judgement in developing and applying accounting
acceptable policy that is relevant and reliable.
The operating cash flows section of the statement of cash Consistency of Accounting Policies
flows under the direct method would appear something like
this (Pas 7) Once selected, accounting policies must be applied
consistently for similar transactions, unless a standard
The operating cash flows section of the statement of cash specifically requires otherwise. An entity shall change an
flows under the indirect method would appear something accounting policy if the change
like this (Pas 7)
(a) Is required by a standard, or
PAS 8 – Accounting Policies, Changes in Accounting
Estimates and Errors (b)Results in the FS providing more relevant and reliable
financial information
PAS 8 – Accounting Policies, Changes in Accounting
Estimates and Errors is applied in selecting and applying Changes in Accounting Policies
accounting policies, accounting for changes in estimates A change in accounting policy that is required by a standard
and reflecting corrections of prior period errors. shall be applied in accordance with the transitional
Key definitions provisions therein. If a standard contains no transitional
provisions or if an accounting policy is changed voluntarily,
•Accounting policies are the specific principles, bases, the change shall be applied restrospectively (as if the policy
conventions, rules and practices applied by an entity in had always been applied) as adjustment to opening balance
preparing and presenting financial statements. of each affected component of equity (e.g. retained
earnings) for the earliest prior period presented.
•A change in accounting estimate is an adjustment of the
carrying amount of an asset or liability, or related expense, For purposes of PAS 8, the following are NOT considered as
resulting from reassessing the expected future benefits and changes in accounting policies:
obligations associated with that asset or liability.
(1) Application of accounting policies for events that differ in
substance from those previously occurring
(2)Application of a new accounting policy for transactions PAS 10 – Events after the Reporting Period
that did not occur previously or were immaterial
PAS 10 Event After the Reporting Period contains
EXCEPTION TO THE RULE. When it is impracticable for an to requirements for when events after the end of the reporting
apply to apply a new accounting policy restrospectively, the period should be adjusted in the financial statements.
entity applies the new policy prospectively from the start of Adjusting events are those providing evidence of conditions
the earliest period practicable. existing at the end of the reporting period, whereas non-
adjusting events are indicative of conditions arising after the
APPLICATION OF NEW STANDARDS. When an entity has not reporting period (the latter being disclosed where material).
applied a new standard that has been issued but is not yet
effective, the entity shall disclose this fact, and the Key definitions
reasonably estimable information relevant to assessing the
possible impact that application of the new standard will • Event after the reporting period: An event, which could be
have on the entity’s financial statement in the period of initial favourable or unfavorable, that occurs between the end of
application. the reporting period and the date that the financial
statements are authorized for issue.
Changes in Estimates
• Adjusting event: An event after the reporting period that
The effect of a change in an accounting estimate shall be provides further evidence of conditions that existed at the
recognized prospectively by including it in profit or loss end of the reporting period, including an event that indicates
during the period of the change (if the change affects that that the going concern assumption in relation to the whole
period only) or the period of the change and future periods or part of the enterprise is not appropriate.
(if the change affects both).
• Non-adjusting event: An event after the reporting period
Examples of Changes in Estimates Due to uncertainties that is indicative of a condition that arose after the end of
inherent in business activities, many items in financial the reporting period.
statement cannot be measured with precision but can only
be estimated. Accounting

Common examples include: •Adjust financial statements for adjusting events - events
after the balance sheet date that provide further evidence of
1. Bad debts and inventory obsolescence conditions that existed at the end of the reporting period,
including events that indicate that the going concern
2. Fair value of financial assets or financial liabilities assumption in relation to the whole or part of the enterprise
3. Useful lives of depreciable assets; and is not appropriate.

4. Provision for warranty obligations •Do not adjust for non-adjusting events - events or
conditions that arose after the end of the reporting period.
Correction of Errors
Going concern issues arising after end of the reporting
An entity shall correct material prior period errors period
retrospectively as an adjustment to the opening balances of
retained earnings and affected assets and liabilities. An entity shall not prepare its financial statements on a going
concern basis if management determines after the end of
If comparative statements are presented, the FS of prior the reporting period either that it intends to liquidate the
period shall be restated to reflect the retrospective entity or to cease trading, or that it has no realistic
application of the prior period errors. If the error occurred alternative but to do so.
before the earliest period presented, the opening balances
of assets, liabilities and equity for the earliest period Disclosure
presented shall be restated. Non-adjusting events should be disclosed if they are of such
Materiality importance that non-disclosure would affect the ability of
users to make proper evaluations and decisions. The
In applying the concept of materiality: required disclosure is
1. Accounting policies in the PFRS need not be applied when (a) The nature of the event and
the effect of applying them is immaterial
(b) An estimate of its financial effect or a statement that a
2. FS do not comply with PFRS if they contain material errors, reasonable estimate of the effect cannot be made.
whether due to omissions or misstatements
A company should update disclosures that relate to
3. Material prior period errors should be corrected conditions that existed at the end of the reporting period to
retrospectively in the first set of FS authorized for issue after reflect any new information that it receives after the
their discovery reporting period about those conditions. Companies must
disclose the date when the financial statements were b) Costs of introducing a new product or service (including
authorized for issue and who gave that authorization. If the costs of advertising and promotional activities);
enterprise's owners or others have the power to amend the
financial statements after issuance, the enterprise must c) Costs of conducting business in a new location or with a
disclose that fact. new class of customer (including costs of staff training); and

PAS 16 – Property, Plant and Equipment d) Administration and other general overhead costs.

PAS 16 Scope The income and related expenses of incidental operations

during construction or development of an item of property,
Property, plant and equipment accounted for under this plant and equipment are recognized in profit or loss if those
operations are not necessary to bring the item to its intended
Section are tangible assets that: location and operating condition.
a) Are held for use in the production or supply of goods or Exchange of Assets
services, for rental to others, or for administrative purposes;
and An item of property, plant or equipment may be acquired in
exchange for a non-monetary asset, or assets, or a
b) Are expected to be used during more than one period. combination of monetary and non-monetary assets. An entity
Recognition shall measure the cost of the acquired asset at fair value
unless
Items such as spare parts, stand-by equipment and servicing
equipment are property, plant and equipment if the entity (a) the exchange transaction lacks commercial substance or
expects to use them during more than one period or if they (b) the fair value of neither the asset received nor the asset
can be used only in connection with an item of property, given up is reliably measurable.
plant and equipment. Otherwise, such items are classified
as inventories. In that case, the asset’s cost is measured at the carrying
amount of the asset given up.
Land and buildings are separable assets, and an entity shall
account for them separately, even when they are acquired Measurement after Initial Recognition
together.
An entity shall choose as its accounting policy either the cost
Measurement at recognition model or the fair value model and shall apply that policy to
an entire class of property, plant and equipment. A class of
An entity shall measure an item of property, plant and property, plant and equipment is a grouping of assets of
equipment at initial recognition at its cost. similar nature and use in an entity’s operations.
Elements of Cost An entity shall recognize the costs of day-to-day servicing
The cost of an item of property, plant and equipment (repairs and maintenance) of an item of investment property
comprises all of the following: in profit or loss in the period in which the costs are incurred.

a) Its purchase price, including legal and brokerage fees, Cost Model - An entity shall measure an item of property,
import duties and non-refundable purchase taxes, after plant and equipment after initial recognition at cost less any
deducting trade discounts and rebates; and accumulated depreciation and any accumulated impairment
losses.
b) Any costs directly attributable to bringing the asset to the
location and condition necessary for it to be capable of Depreciable amount and depreciation period
operating in the manner intended by management. An entity shall allocate the depreciable amount of an asset
These can include the costs of site preparation, initial on a systematic basis over its useful life. The depreciable
delivery and handling, installation and assembly, and testing amount is cost minus accumulated depreciation and
of functionality. accumulated impairment losses, and minus residual value.
The residual value of an asset is the estimated amount that
If payment is deferred beyond normal credit terms, the cost an entity would currently obtain from disposal of an asset,
is the present value of all future payments. after deducting the estimated costs of disposal, if the asset
was already of the age and in the condition expected at the
The following costs are not costs of an item of property, plant end of its useful life.
and equipment, and an entity shall recognize them as an
expense when they are incurred: The depreciation charge for each period shall be recognized
in profit or loss unless another section of this Framework
a) Costs of opening a new facility; requires the cost to be recognized as part of the cost of an
asset. For example, the depreciation of manufacturing
property, plant and equipment is included in the costs of d) a reconciliation of the carrying amount at the beginning
inventories. and the end of the reporting period showing separately:

Depreciation Method i) additions; ii) disposals; iii) acquisitions through business

combinations; iv) impairment losses recognized or reversed
An entity shall select a depreciation method that reflects the in profit or loss; v) depreciation; vi) other changes.
pattern in which it expects to consume the asset’s future
economic benefits. The possible depreciation methods This reconciliation need not be presented for prior periods.
include the straight-line method, the diminishing balance
method and a method based on usage such as the units of Disclosure (Fair Value Model)
production method. Entities applying the fair value model shall disclose the
Fair value model following:

An entity shall measure an item of property, plant and a) whether an independent value was involved;
equipment at fair value at each reporting date with changes b) the methods and significant assumptions applied in
in fair value recognized in profit or loss. determining the fair value of investment property;
If a reliable measure of fair value is no longer available c) for each class of property, plant and equipment, the
without undue cost or effort for an item of property, plant and carrying amount that would have been recognized had the
equipment measured using the fair value model, the entity assets been carried under the cost model; and
shall thereafter account for that item under the cost model.
The carrying amount of the property, plant and equipment on d) a reconciliation between the carrying amounts of property,
that date becomes its cost. It is a change of circumstances plant and equipment at the beginning and end of the period,
and not a change in accounting policy. showing separately:

Derecognition i) additions, disclosing separately those additions resulting

from acquisitions through business combinations;
An entity shall derecognize an item of property, plant and
equipment: ii) net gains or losses from fair value adjustments;

a) on disposal; or iii) transfers to cost model when a reliable measure of fair

value is no longer available without undue cost or effort
b) when no future economic benefits are expected from its
use or disposal. iv) transfers to and from inventories and investment
property.
An entity shall recognize the gain or loss on the derecognition
of an item of property, plant and equipment in profit or loss v) other changes.
when the item is derecognized. The entity shall not classify
such gains as revenue. This reconciliation need not be presented for prior periods.

For a straightforward disposal of an item of property, plant

and equipment for cash, the date of disposal is usually the Disclosure
date when the risks and rewards of ownership of the asset
have passed. The entity shall also disclose the existence and carrying
amounts of property, plant and equipment to which the entity
An entity shall determine the gain or loss arising from the has restricted title or that is pledged as security for liabilities.
derecognition of an item of property, plant and equipment as
the difference between the net disposal proceeds, if any, and
the carrying amount of the item.

Disclosure (Cost Model)

Entities applying the cost model shall disclose the following

for each class of property, plant and equipment:

a) the depreciation methods used;

b) the useful lives or the depreciation rates used;

c) the gross carrying amount and the accumulated

depreciation (aggregated with accumulated impairment
losses) at the beginning and end of the reporting period; and