jsc notes #3

INVENTORIES
Divided into ten (10) sub-topics: (6) Inventory estimation
(1) Composition of Inventory • Gross profit method
• Inclusion and exclusions ü Computation of estimated ending inventory or inventory loss caused
ü Computation of correct inventory balance by calamities
(2) Inventory systems • Retail method
ü Computation of estimated ending inventory (1) FIFO (2)
• Periodic inventory system
Conservative/LCNRV (3) Average
ü Correct journal entry using periodic inventory system
ü Computation of cost of goods sold using (1) FIFO (2)
• Perpetual inventory system
Conservative/LCNRV (3) Average
ü Correct journal entry using perpetual inventory stem
(7) Consignment of goods
(3) Purchase discounts
ü Computation of inventory ending
• Gross method
ü Computation of total cash remittance and receivable from the
ü Correct journal entry using gross method
consignee
• Net method
ü Correct journal entry using net method (8) Inventory error
ü Net effect of errors to (1) net income (2) cost of goods sold (3) ending
(4) Cost flows / cost formulas
inventory balance
• FIFO perpetual / FIFO periodic
ü Computation of ending inventory balance (9) Purchase commitment
ü Computation of cost of goods sold ü Computation of estimated liability on purchase commitment
• Weighted Average ü Computation of loss on purchase commitment
ü Computation of ending inventory balance
(10) Biological asset
ü Computation of cost of goods sold
• Moving Average ü Sariling sikap
ü Computation of ending inventory balance
ü Computation of cost of goods sold

(5) Inventory measurement

• Writedown of inventory to LCNRV
ü Computation of correct inventory account with impairment
ü Computation of NRV (1) raw material (2) work in process (3) finished
goods/merchandise inventory
ü Computation of required allowance for inventory decline
ü Computation of impairment loss and reversal of impairment
ü Computation of cost of goods sold involving writedown
(1) COMPOSITION OF INVENTORY consignee
GOODS IN TRANSIT AND SPECIAL TERMS 9. Insurance in transit (9) Selling and administrative
Term Buyer Seller expenses
FOB shipping point Included Excluded 10. Import duties and non-recoverable (10) Insurance after transit
FOB seller Included Excluded taxes
FOB FAS Included Excluded 11. Commission to brokers / advisers (11) Storage cost after completion
FOB CIF Included Excluded fee / professional fee
FOB place of the seller Included Excluded 12. Normal amount of wasted material (12) Financing expense / interest
Bill and hold arrangement Included Excluded incurred / borrowing cost
Sold on installment Included Excluded (13) VAT
Sale on with high probability of return Included Excluded (14) Abnormal amount of wasted
Goods manufactured at customer’s specification Included Excluded material
Special order Included Excluded
FOB destination Excluded Included (2) INVENTORY SYSTEMS:
FOB buyer Excluded Included Periodic Perpetual
FOB ex-ship Excluded Included dr. Purchases xx dr. Inventory xx
cr. Accounts payable xx cr. Accounts payable xx
FOB place of the buyer Excluded Included
To record purchases on account
Lay away sales Excluded Included dr. Freight in xx dr. Inventory xx
Sale with buyback agreement Excluded Included cr. Cash xx cr. Cash xx
Sale under inventory financing Excluded Included To record payment of freight FOB shipping point
“Hold for shipping instruction” Excluded Included dr. Accounts payable xx dr. Accounts payable xx
Sale on trial / sale on approval Excluded Included cr. Purchase return xx cr. Inventory xx
Inventory pledged Excluded Included To record purchase return
dr. Accounts receivable xx dr. Accounts receivable xx
COMPOSITION OF INVENTORY cr. Sales xx cr. Sales xx
Inclusions Exclusions
1. Raw materials (1) Freight out dr. Cost of goods sold xx
2. Work in process (2) Goods held/received on cr. Inventory xx
To record sales on account
consignment
dr. CGS / income summary xx No adjusting entry / closing entry
3. Finished goods (3) Mark up dr. Inventory, end xx
4. Merchandise inventory (4) Gross profit dr. Purchase returns xx
5. Factory supplies (5) Advances to supplier dr. Purchase discounts xx
6. Freight in / transportation / (6) Trading securities/investments in cr. Inventory, beg xx
handling shares/bonds cr. Purchases xx
cr. Freight in xx
7. Goods sent out on consignment (7) Office supplies
To adjust the inventory, recognize cost of sales and close nominal accounts
8. Freight of sending the goods to (8) Marketing supplies
PERPETUAL INVENTORY SYSTEM (2) FIFO perpetual
• No purchases account is used. (3) Weighted average – periodic
• Requires two journal entries to record the sales and sales return. (4) Weighted average – perpetual (moving average)
• Stock cards are maintained under this system (5) Specific identification
• Physical count, is optional and is only use for for internal control to determine the FIFO
accuracy of inventory records. • Computation of (1) Ending inventory in pesos; (2) cost of sales in pesos
• In case the physical count and the perpetual record has discrepancy, the physical • FIFO periodic and FIFO perpetual have different formulas and computation but will
count will prevail. yield to same ending inventory and cost of sales.
• Commonly used for inventories that are relatively high valued. ü Compute the ending inventory first,
ü then compute for the cost of sales.
PERIODIC INVENTORY SYSTEM
Beginning inventory in units xxxx
• Physical count is necessary to determine the amount of inventory to be presented in
Net purchases in units xxxx
the financial statements. Total goods available for sale units TGAS xxxx
• Inventory is updated only upon physical count. Cost of goods sold in units (xxxx)
• Cost of goods sold is a residual amount rather than an account. Ending inventory in units xxxx
Multiply: Unit cost of the last purchases of the period xx
(3) CASH DISCOUNT Ending inventory in pesos xxxx
Gross method Net method
dr. Purchases 100 dr. Purchases 98 Incase the last purchases is lower than the ending inventory:
cr. Accounts payable 100 cr. Accounts payable 98 Ending inventory in units xxxx
Number of units of the last purchases (xxxx)
To record purchases on account
Excess in units xxxx
dr. Accounts payable 100 dr. Accounts payable 98
Multiply: Unit cost of the second to the last purchases of the period xx
cr. Cash 98 cr. Cash 98
Ending inventory coming from the second to the last purchases in pesos xxxx
cr. Purchase discount 2
Total cost of the last purchases in pesos xxxx
To record payment of purchased goods within the discount period
Ending inventory xxxx
dr. Accounts payable 100 dr. Accounts payable 98
cr. Cash 100 dr. Purchase discount forfeited 2 WEIGHTED AVERAGE
cr. Cash 100 • Computation of (1) ending inventory in pesos; (2) cost of sales in pesos
To record payment of purchased goods beyond the discount period ü Compute the ending inventory first,
GROSS METHOD VS. NET METHOD ü then compute for the cost of sales.
• Under gross method, discount lost is included as part of cost of sale & inventory. Total goods available for sale in pesos
Average unit cost
• Under net method, discount lost is included as part of operating expenses. Total goods available for sale in units
• Theoretically, net method is correct and should be followed. Beginning inventory in units xxxx
• Usually, generally, commonly, gross method is used. (silent) Net purchases in units xxxx
Total goods available for sale units TGAS xxxx
(4) COST FORMULAS / COST FLOWS Cost of goods sold in units (xxxx)
• Dividend into (5) different methods: Ending inventory in units xxxx
(1) FIFO periodic Multiply: Average unit cost xx
Ending inventory in pesos xxxx
 Total goods available for sale in pesos xxxx (5) INVENTORY MEASUREMENT
Ending inventory in pesos (xxxx) • Inventories are measured at lower of cost or net realizable value (NRV):
Cost of goods sold in pesos xxxx
COMPUTATION OF NRV
Cost of goods sold in units xxxx • For theories purposes, NRV is computed by, estimated selling price minus estimated
Multiply: Average unit cost Xx
cost to complete minus estimated cost to sell.
Cost of goods sold in pesos xxxxx
• For problems purposes, NRV is computed by
(1) Raw material, current replacement cost
MOVING AVERAGE
• In weighted average, you will compute for the average unit cost once at the end of the (2) Work in process, estimated selling price minus estimated cost to complete minus
period, in moving average you will compute for the average unit cost every time estimated cost to sell.
purchases are made. (3) Finished goods or merchandise inventory, estimated selling price minus estimated
cost to repair, if any, minus estimated cost to sell.
• Moving average is a long computation problem and there is no shortcut for it.
• Solve it slowly and carefully by preparing five (5) column computation:
COMPUTATION OF ALLOWANCE FOR INVENTORY IMPAIRMENT / INVENTORY
Date Transaction Units Unit cost Total Cost WRITEDWON
Feb. 1 -- 100 3 300 • Observe the following formula to compute allowance:
Feb. 3 Purchases 200 2.5 500 Historical cost / cost xxxx
Total Compute new unit cost 300 2.67* 800 Lower of cost or NRV (item by item basis) (xxxx)
Feb. 5 Sold 50 2.67 (133.5) Allowance for inventory decline, ending xxxx
* Computed by dividing total cost by the number of units
* the basis of the cost of unit sold is the latest average unit cost. COMPUTATION OF IMPAIRMENT LOSS AND REVERSAL OF IMPAIRMENT
• Impairment should be squeeze in the credit side of the allowance account, reversal
FIFO vs. LIFO vs. AVERAGE should be squeezed in the debit side of the allowance account
• In times of inflation (increasing prices)
Allowance for inventory writedown
(1) FIFO will yield highest income, highest inventory balance, lowest cost of sales xx Beginning balance
(2) LIFO will yield lowest income, lowest inventory balance, highest cost of sales Reversal of impairment during the year xx xx Impairment / writedown during the year
(3) Average will yield higher income than LIFO but lower income than FIFO, higher Xx Ending balance
inventory balance than LIFO but lower inventory balance than FIFO, lower cost of
sales than LIFO but higher cost of sales than FIFO. Alternative computation
kaya mo yan Allowance for inventory decline, beg xxxx
Allowance for inventory decline, ending (xxxx)
• In times of deflation (decreasing prices) Impairment loss (if increase) reversal of impairment (if decrease) xxxx
(1) FIFO will yield lowest income, lowest inventory balance, highest cost of sales
(2) LIFO will yield highest income, highest inventory balance, higher cost of sales
(3) Average will yield lower income than LIFO but higher income than FIFO, lower
inventory balance than LIFO but higher inventory balance than FIFO, higher cost of
sales than LIFO but lower cost of sales than FIFO.
COMPUTATION OF COST OF GOODS SOLD W/ ALLOWANCES ü Sixth, compute for the estimated ending inventory
Allowance method ü Seventh, compute the fire loss \
Inventory, beg @ cost xxxx
Purchases, xxxx COMPUTATION OF NET PURCHASES (a)
Inventory, end @ cost (xxxx) To compute for the net purchases, use the T-account of accounts payable then squeeze
Cost of sales before writedown xxxx gross purchases.
plus: Inventory writedown / impairment or minus: reversal of impairment xxxx/(xxxx) Accounts payable – trade
(a) Payment made to supplier Beginning balance
Cost of sales adjusted xxxx
(b) Purchase discount (a) Gross purchases
Direct method
(c) Purchase return (b) Freight, shipping point, prepaid
Inventory, beg @ nrv xxxx
Ending balance
Purchases, xxxx
Inventory, end @ nrv (xxxx) Gross purchases xxxx
Cost of sales adjusted xxxx minus: purchase discount (xxxx)
minus: purchase returns (xxxx)
(6) INVENTORY ESTIMATION
add: freight in xxxx
• Use to when / as
net purchases on account xxxx
(1) Inventory destroyed by major fire incident or other casualties
cash purchases xxxx
(2) Proof of the reasonableness and accuracy of the physical count
net purchases xxxx
(3) External and internal interim financial reporting
Alternative computation
(4) Rough test of the validity of an inventory cost determined under either periodic or
accounts payable, end xxxx
perpetual system
payment made to supplier xxxx
GROSS PROFIT METHOD accounts payable, beg (xxxx)
• Computation of estimated inventory loss caused by casualties or theft. net purchases on account xxxx
Inventory, beg xxxx
COMPUTATION OF NET SALES
Purchases, net (a) xxxx
• To compute for the net sales, use the T-account of accounts receivable then squeeze
Cost of sales [sales x (100-GPR] or [sales / (1+GPR)] (xxxx)
gross credit sales.
Estimated ending inventory xxxx
Trade Receivable – trade
Remaining inventory after fire (NRV of the remaining goods + goods in (xxxx) Beginning balance (a) Collection of AR
owned but in transit) (a) Sale on account (b) Collection of recovery
Fire loss xxxx (b) Recovery of written of AR (c) Write off of AR
(c) Freight FOB ship pt., prepaid (d) Discount taken
ü First, Inventory, beg is usually given.
ü Second, compute for the net purchases. (e) Sales actually returned
ü Third, compute for the net sales. (f) Other form of payment
ü Fourth, compute for the cost ratio Ending balance
ü Fifth, compute for the cost of sales *you can’t simply, collection made + AR, end – AR, beg = net sales you will arrive at
wrong net sales sometimes if the company has recovery and writeoffs
Gross sales xxxx COMPUTATION OF COST RATIO
minus: sales returns only (xxxx) Cost ratio under average approach
net sales on account xxxx TGAS @ cost
xx%
TGAS @ retail
cash sales xxxx
net sales xxxx
Cost ratio under LCNRV / conservative approach
COMPUTATION OF COST RATIO TGAS @ cost
xx%
Based on sale (gross profit) Based on cost (mark up) TGAS @ retail + markdown – markdown cancellation
Selling price 100% Selling price 100% + GP%
Cost ratio under FIFO approach
Cost of goods (CR%) Cost of goods (100%)
TGAS @ cost – inventory, beg @ cost
Gross profit GP% Gross profit GP% xx%
TGAS @ retail – inventory, beg @ retail
CGS Net sales x (100 – GPR) CGS Net sales / (1+GPR)
COMPUTATION OF NET SALES
RETAIL METHOD
To answer carefully the questions involving retail, need to follow the steps: Sales xxxx
Sales return (xxxx)
(1) Compute for the total goods available for sale (TGAS);
Employee discounts xxxx
(2) Compute for the cost to retail ratio; Normal losses from shoplifting xxxx
(3) Compute for the net sales; Normal losses from theft xxxx
(4) Compute for the cost of sales; Normal losses from shrinkage xxxx
(5) Compute for the ending inventory; Net sales xxxx
If the problem is silent, assume losses are normal.
COMPUTATION OF TGAS COST AND RETAIL “sales discount”; “sales allowance” and “freight out” should be ignored.
Cost Retail
Inventory, beg + + COMPUTATION OF COST OF SALES
Purchases + + Net sales xxxx
Purchase return – – Cost ratio xx%
Cost of sales xxxx
Purchase discount –
Purchase allowance –
COMPUTATION OF ENDING INVENTORY
Freight-in + TGAS at cost xxxx
Departmental trans-in + + Cost of sales (see computation above) (xxxx)
Departmental trans-out – – Inventory, end @ cost xxxx
Abnormal loss – – Alternative computation
TGAS at retail xxxx
Mark up +
Net sales (xxxx)
Mark up cancellation – Ending inventory @ retail xxxx
Mark down – Cost ratio xx%
Mark down cancellation + Inventory, end @ cost xxxx
TGAS xx xx
MANUFACTURING ENTITY CONSIGNMENT OF GOODS
• Computation of inventory balances and cost of goods sold under manufacturing • Receivable and sale is recognized upon selling of goods by the consignor.
companies: • Computation of ending inventory sent out on consignment:
Raw materials, beg xxxx Historical cost of inventory xxxx
Net purchases: Freight in to consignor xxxx
Gross purchases xxxx Total cost of goods sent out xxxx
Purchase discount (xxxx) Prorate of the remaining goods xx/xx
Purchase returns (xxxx) Inventory, end xxxx
Freight in xxxx xxxx
Raw materials, available for use xxxx • Computation of cash remittance from consignee or receivable from the consignee:
Raw materials, end (xxxx) Number of goods sent out on consignee xxxx
Raw materials, used xxxx Number of goods remaining in the hands out consignee (xxxx)
Direct labor xxxx Goods sold on consignment in units xxxx
OH % of direct labor (normal costing)/actual overhead (actual costing) Selling price of each goods xxxx
Indirect material xxxx Commission of the consignee (xxxx)
Indirect labor xxxx Total cash to be remitted xxxx
Factory supplies xxxx Cash remitted (xxxx)
Supervision xxxx Receivable form consignee xxxx
Depreciation of factory warehouse, equipment, machineries xxxx INVENTORY ERRORS
Factory real property taxes xxxx • Determine the inventory system that the company is using, it is important in
Factory rentals xxxx determining the effect of errors. If the problem is silent, assume periodic system is
Light, power and water xxxx being used.
Cost of factory management xxxx
PERIODIC SYSTEM
Maintenance / repair of factory equipment xxxx xxxx
Error Asset / WC Liability Cost of sale Net income
Manufacturing cost xxxx
Inventory, beg No effect No effect Same effect Opposite effect
Work in process, beg xxxx Purchase No effect Same effect Same effect Opposite effect
Total goods put in process xxxx Sale Same effect No effect No effect Same effect
Work in process, end (xxxx) Inventory, end Same effect No effect Opposite effect Same effect
Cost of goods manufactured xxxx PERPETUAL SYSTEM
Finished goods, beg xxxx Error Asset Liability Cost of sale Net income
Total goods available for sale xxxx Inventory, beg* No effect No effect No effect No effect
Finished goods, end (xxxx) Purchase Same effect Same effect No effect No effect
Cost of goods sold xxxx Sale Same effect No effect Same effect Same effect
Inventory, end* No effect No effect No effect No effect
*if not based on physical count or silent.
END OF JSC.NOTE_03