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ACCOUNTING FOR INVENTORIES

PURCHASE COMMITMENT

INVENTORY Purchase Commitments

- Are assets held for sale in the ordinary course of - Are obligations of the entity to acquire certain goods
business, in the process of production for such sale or sometime in the future at a fixed price and fixed
in the form of materials or supplies to be consumed in quantity.
the production process or in the rendering of services.

Measurement: LCNRV – Lower of Cost and Net Realizable 1. Contract with suppliers @ Fixed no. of units @ Fixed
Value Price
2. LCNRV
Who is the owner of goods in transit?
- FOB shipping point Market price is LOWER THAN Fixed - LOSS
- FOB destination Price
- On consignment Subsequent increase in Market Price - GAIN

Accounting for inventory

- Periodic inventory system Up to the Loss previously
- Perpetual inventory system recognized only
3. Purchase
Discounts Market price on the date of
- Trade discount purchase
- Cash discount or
whichever is
Fixed Price LOWER
Methods of recording purchases
- Gross method 4. Payment or Accounts Payable ALWAYS the Fixed Price
- Net method

INVENTORY COST FLOW

ESTIMATE IN INVENTORY VALUATION
1. First in, First out (FIFO) – Periodic
2. First in, First out (FIFO) – Perpetual
3. Weighted average 1. GROSS PROFIT METHOD
4. Moving average
The gross profit method is based on the assumption that the
rate of gross profit remains approximately the same from
LOWER OF COST AND NET REALIZABLE VALUE (LCNRV) period to period and therefore the ratio of cost of goods sold to
net sales is relatively constant from period to period.
Net Realizable Value (NRV)
- The estimated selling price in the ordinary course of For example, gross profit is 25%
business less the estimated cost of completion and
the estimated cost of disposal. On Sales On Cost
Net sales 100% Net sales 125%
Est. Selling Price Pxx COGS 75% COGS 100%
Less: Est. Cost to Complete (xx) Gross 25% Gross Profit 25%
Cost of Disposal (xx) Profit
Net Realizable Value Pxx

Net Sales (under gross profit method)

Methods of accounting for the inventory writedown  Only SALES RETURNS is deducted to get the net
a. Direct method or cost of goods sold method sales
b. Allowance method or loss method  Sales allowance and sales discounts are IGNORED
or not deducted from sales in computing net sales.
Direct Method/Cost of Goods Sold Method This is because sales allowance and sales discount
- ending inventory is recorded at the lower between do not affect the physical volume of goods sold.
Cost and Net Realizable Value and the Loss on
Writedown is NOT recognized separately
2. RETAIL INVENTORY METHOD
Allowance Method/Loss Method
 Ending inventory is recorded at COST and the Loss PAS 2, paragraph 22, provides that this method is often used in
on Writedown is recognized separately the retail industry for measuring inventory of large number of
 If required allowance increases, an additional loss is rapidly changing items with similar margin for which it is
recognized. impracticable to use other costing method.
 If required allowance decreases, a gain on reversal
of inventory writedown is recorded. However, gain The term retail simple means selling price.
is limited only to the extent of the allowance balance.
Basic formula for the retail method:
Note!!! Gain is limited only to the extent of the allowance
balance Goods available for sale at retail xx
Less: Net sales (xx)
 Loss on Inventory Writedown Ending inventory at retail xx
- Included in COGS Multiply: Cost Ratio x
Ending inventory at cost xx
 Gain on Reversal of Inventory Writedown
- Deducted from COGS Goods available for sale at cost
Cost Ratio =
Goods available for sale at retail
Whether direct method or allowance method, the cost of goods
sold must be the same.

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Net Sales (under retail method) 1. An entity reported inventory on December 31, 2023 at
 Only SALES RETURNS is deducted to get the net P6,000,000 based on a physical count of goods priced at
sales cost and before any necessary year-end adjustments relating
 Sales allowance and sales discounts are IGNORED to the following:
or not deducted from sales in computing net sales.  Included in the physical count were goods billed to a
This is because sales allowance and sales discount customer FOB shipping point on December 30, 2023.
do not affect the physical volume of goods sold. These goods had a cost of P125,000 and were picked
up by the carrier on January 15, 2024.
 Goods shipped FOB shipping point on December 31,
Treatment of Items 2023 from a vendor were received on January 15,
2024. The invoice cost was P300,000.
Goods available for sale  Goods sold to a customer on December 31, 2023
Cost Retail which are being held for the customer to call at the
Purchase discount Deducted - customer’s convenience with a cost of P200,000 were
Purchase return Deducted Deducted included in the count.
Purchase allowance Deducted - What amount should be reported as inventory on December
Freight in Addition - 31, 2023?
Departmental transfer in or Addition Addition a. 5,875,000 c. 6,175,000
debit b. 6,100,000 d. 6,300,000
Departmental transfer out or Deducted Deducted
credit 2. An entity incurred the following costs during the current year:

Cost of purchases based on invoices 5,000,000

Net Sales Trade discounts already deducted from 500,000
Retail invoices
Sales discount - Import duties 400,000
Sales allowance - Freight and insurance on purchases 600,000
Sales return Deducted Other handling costs on imports 100,000
Employee discounts Addition Commissions paid to agents for arranging 200,00
Normal shortage, shrinkage, spoilage, Addition imports
breakage Sales commission paid to sales agents 300,000
Salaries of accounting department 1,000,000
After sales warranty costs 250,000
APPROACHES IN THE USE OF RETAIL METHOD
1. Conservative / Conventional / LCNRV Approach What is the total cost of purchases?
2. Average Cost Approach / PAS 2 Approach a. 6,300,000 c. 6,100,000
3. FIFO Approach b. 5,800,000 d. 6,600,000

3. An entity included the following items in inventory at year-

end:
a. Conservative / Conventional / LCNRV Approach
Goods out on consignment at sale price, 1,400,000
Goods available for sale including 40% markup on cost
Cost Retail Goods purchased in transit, shipped FOB 1,200,000
Markup - Addition destination
Markup cancelation - Deducted Goods held on consignment by the entity 900,000

At what amount should the inventory at year-end be

b. Average Cost Approach / PAS 2 Approach reduced?
a. 1,460,000 c. 1,300,000
Goods available for sale b. 2,660,000 d. 2,500,000
Cost Retail
4. On June 1, 2023, an entity sold merchandise with a list price
Markup - Addition
of P5,000,000 to a customer. The entity allowed trade
Markup cancelation - Deducted
discounts of 20% and 10%. Credit terms were 5/10, n/30
Markdown - Deducted
and the sale was made FOB shipping point. The entity
Markdown cancelation - Addition prepaid P100,000 of delivery cost for the customer as an
accommodation. On June 11, 2023, what is the full
remittance from the customer?
c. FIFO Approach a. 3,600,000 c. 3,700,000
b. 3,420,000 d. 3,520,000
Goods available for sale
Cost Retail 5. On July 1, 2023, an entity recorded purchases of P3,000,000
Markup - Addition and P2,000,000 under credit terms of 2/15, net 30. The
Markup cancelation - Deducted payment on the P3,000,000 purchase was remitted on July
Markdown - Deducted 16. The payment on the P2,000,000 purchase was remitted
Markdown cancelation - Addition on July 31. What amount of purchases should be included in
the determination of cost of goods available for sale
- IGNORE Beginning Inventory in computing for Total
Goods Available for Sale as used in the Cost Ratio 1. Under gross method?
a. 5,000,000
b. 4,900,000
c. 4,940,000
d. 4,960,000

2. Under net method?

a. 5,000,000
b. 4,900,000
c. 4,940,000
PROBLEMS d. 4,960,000
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a. 19,000,000
6. An entity had usual sales terms of net 60 days, FOB b. 19,300,000
shipping point. Sales, net returns and allowances totaled c. 18,700,000
P2,000,000 for 2023 before year-end adjustments. d. 24,000,000
 Goods with an invoice amount of P40,000 were billed
to a customer on January 15, 2024. The goods were 9. On December 1, 2023, an entity entered into a commitment
shipped on December 31, 2023. to purchase 100,000 barrels of aviation fuel for P55 per
 On January 5, 2024, a customer notified the entity that barrel on March 31, 2024. The entity entered into this
goods billed and shipped on December 31, 2023 were purchase commitment to protect itself against the volatility
lost in transit. The invoice amount was P50,000. in the aviation fuel market. By December 31, 2023, the
 On December 31, 2023, the entity authorized a purchase price of aviation fuel had fallen to P50 per barrel.
customer to return, for full credit goods shipped and However, by March 31, 2024, when the entity took delivery
billed at P25,000 on December 15, 2023. The of the 100,000 barrels the price of aviation fuel had risen to
returned goods were received by the entity on P53 per barrel.
January 15, 2024 and P25,000 credit memo was
issued on the same date. 1. What amount should be recognized as loss on
purchase commitment in 2023?
What amount should be reported as net sales for 2023? a. 500,000
a. 1,975,000 b. 200,000
b. 2,015,000 c. 300,000
c. 1,965,000 d. 0
d. 1,990,000
2. What amount should be recognized as gain on
7. An entity provided the following information: purchase commitment for 2024?
Units Unit Total cost a. 500,000
cost b. 300,000
Jan. 1 Beginning 10,000 150 1,500,000 c. 800,000
Balance d. 0
5 Purchase 10,000 180 1,800,000
15 Sale 15,000 3. What amount should be debited to purchases on March
16 Sale return 1,000 31, 2024?
25 Purchase 4,000 200 800,000 a. 5,500,000
26 Purchase 2,000 200 400,000 b. 5,300,000
return c. 5,000,000
d. 4,700,000
1. Under FIFO, what amount should be reported as cost of
goods sold? 10. During the current year, an entity purchased a tract of land
a. 2,220,000 for P12,000,000. The entity incurred additional cost of
b. 2,620,000 P3,000,000 in preparing the land for sale. Of the tract of
c. 2,500,000 land, 70% was subdivided into residential lots and 30% was
d. 2,900,000 for road and park. The tract of land was subdivided into
residential lots as 100 Class A lots with sale price of
2. Under weighted average, what amount should be P240,000 per lot, 100 Class B lots with sale price of
reported as ending inventory? P160,000 per lot, and 200 Class C lots with sale price of
a. 1,345,440 P100,000 per lot. What amount of the costs should be
b. 1,366,640 allocated to Class A lots?
c. 1,413,360 a. 3,000,000
d. 1,432,000 b. 3,750,000
c. 6,000,000
3. Under moving average, what amount should be d. 4,200,000
reported as ending inventory?
a. 1,690,000 11. On September 30, 2023, a fire at an entity’s warehouse
b. 1,390,000 caused severe damage to the entire inventory. The entity
c. 1,790,000 has a gross profit of 30% on cost. The following data are
d. 1,600,000 available for nine months ended September 30, 2023:

4. Under moving average, the next sale of inventory Inventory – January 1 1,100,000
would be priced at what cost? Net purchases 6,000,000
a. 173.75 Net sales 7,280,000
b. 179.00
c. 200.00 A physical inventory disclosed usable damaged goods
d. 190.00 which can be sold for P100,000. What is the estimated
amount of fire loss on September 30, 2023?
8. On December 31, 2023, an entity experienced a decline in a. 1,500,000
the value of inventory resulting in a writedown from b. 1,400,000
P4,000,000 cost to P3,500,000 net realizable value. The c. 2,004,000
entity used the allowance method to record the necessary d. 1,904,000
adjustment. In 2024, market conditions have improved
dramatically. On December 31, 2024, the inventory had a 12. Caramel Company used the retail inventory method. At
cost of P5,000,000 and net realizable value of P4,800,000. year-end, the following information relating to the inventory
The entity made purchases of P20,000,000 in 2024. was gathered:
Cost Retail
1. What amount should be recognized as gain on Beginning inventory 190,000 450,000
reversal of inventory writedown in 2024? Purchases 2,990,000 4,350,000
a. 200,000 Purchase discounts 40,000
b. 300,000 Freight-in 150,000
c. 500,000 Markups 300,000
d. 0 Markdowns 400,000
Sales 4,400,000
2. What amount should be reported as cost of goods Sales return 100,000
sold in 2024? Sales discount 50,000

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Sales allowance 30,000

3. What is the gain from change in fair value due to
1. What is the estimated cost of the ending inventory price change?
using the average cost approach? a. 292
a. 280,000 b. 222
b. 260,000 c. 237
c. 245,000 d. 55
d. 292,000
4. What is the gain from change in fair value due to
2. What is the estimated cost of the ending inventory physical change?
using the FIFO approach? a. 292
a. 280,000 b. 222
b. 260,000 c. 237
c. 245,000 d. 55
d. 292,000
THEORY
3. What is the estimated cost of the ending inventory
using the conventional approach? 1. Why are inventories included in the computation of net
a. 280,000 income?
b. 260,000 a. To determine cost of goods sold.
c. 245,000 b. To determine sales revenue.
d. 292,000 c. To determine merchandise returns.
d. Inventories are not included in the computation of net
income.
13. An entity provided the following assets in a plantation
forest:
2. Entities must allocate the cost of all goods available for
Freestanding trees 5,000,000 sale between
Land under trees 600,000 a. The cost of goods on hand at the beginning and the
Roads in forests 300,000 cost of goods acquired during the period
Animals related to recreational activities 1,000,000 b. The cost of goods on hand at the end and the cost of
Bearer plants 1,500,000 goods acquired during the period.
Bearer animals 2,000,000 c. The income statement and the statement of financial
Agricultural produce growing on bearer 800,000 position
plants d. All of the choices are correct.
Agricultural produce harvested 1,200,000
Plants with dual use 1,400,000
3. When inventory is misstated, its presentation lacks
1. What total amount should be classified as biological a. Relevance
assets? b. Faithful representation
a. 7,800,000 c. Comparability
b. 7,200,000 d. All of the choices are correct
c. 8,400,000
d. 9,200,000 4. When allocating costs to inventory produced for the period,
fixed overhead should be based upon
2. What total amount should be included in property, a. The actual use of production facilities.
plant and equipment? b. The normal capacity of production facilities.
a. 4,600,000 c. The highest production levels in the last three periods.
b. 3,400,000 d. The lowest production levels in the last three periods.
c. 1,800,000
d. 4,200,000 5. How should unallocated fixed overhead costs be treated?
a. Allocated to finished goods and cost of goods sold.
14. At the beginning of the current year, Honey Company had a b. Allocated to raw material, work in process and
herd of 10 2-year old animals. One animal aged 2.5 years finished goods.
was purchased on July 1 for P108, and one animal was c. Recognized as an expense in the period when
born on July 1. No animals were sold or disposed of during incurred.
the year. d. Allocated to work in process, finished goods and cost
of goods sold.
Fair value less cost of disposal per unit
2 – year old animal on January 1 100 6. Variable production overhead is allocated to each unit of
2.5 – year old animal on July 1 108 production on the basis of
New born animal on July 1 70 a. Normal capacity of the production facilities
2 – year old animal on December 31 105 b. Actual use of the production facilities
2.5 – year old animal on December 31 111 c. Either the normal capacity or the actual use of
Newborn animal on December 31 72 production facilities, whichever is appropriate
3 – year old animal on December 31 120 d. Neither the normal capacity nor the actual use of
production facilities
0.5 – year old animal on December 31 80
7. Theoretically, cash discounts permitted on purchased raw
1. What is the fair value of the biological assets on
materials should be
December 31?
a. Added to other income, whether taken or not
a. 1,400
b. Added to other income, only if taken
b. 1,320
c. Deducted from inventory, whether taken or not
c. 1,440
d. Deducted from inventory, only if taken
d. 1,360
8. The use of a discount lost account implies that the
2. What amount of gain from change in fair value of
recorded cost of an inventory is
biological assets should be recognized in the
a. Invoice price
current year?
b. Invoice price plus the purchase discount lost
a. 222
c. Invoice price less the purchase discount taken
b. 292
d. Invoice price less the purchase discount allowable
c. 300
whether taken or not
d. 332
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9. When a portion of inventory has been pledged as security

on loan 18. Commodity broker-traders
a. The value of the portion pledged should be subtracted a. Produce or raise commodities such as rice, corn or
from the debt. precious metals.
b. An equal amount of retained earnings should be b. Hold inventory primarily to sell the commodities in the
appropriated. near term and generate a profit from price fluctuation.
c. The fact should be disclosed but the amount of c. Value inventories at LCNRV.
current assets should not be affected. d. All of the choices are correct regarding broker-traders.
d. The cost of the pledged inventory should be
transferred from current to noncurrent asset. 19. Situations in which net realizable value is used to value
inventory include
10. If a material amount of inventory has been ordered through a. Agricultural produce
a formal purchase contract at the statement of financial b. Mineral and mineral products
position date for future delivery at firm prices c. Commodities held by broker-traders
a. This fact must be disclosed. d. All of these are measured at net realizable value
b. Disclosure is required only if prices have been
declined since the date of the order. 20. When the FIFO inventory cost flow method is used, a
c. Disclosure is required only if prices have since risen perpetual inventory system would
substantially. a. Not be permitted
d. An appropriation of retained earnings is necessary. b. Result in a higher ending inventory than a periodic
inventory system
11. The credit balance that arises when loss on a purchase c. Result in the same ending inventory as a periodic
commitment is recognized should be inventory system
a. Presented as a current liability. d. Result in a lower ending inventory than a periodic
b. Subtracted from ending inventory. inventory system
c. Presented as an appropriation of retained earnings.
d. Presented in the income statement. 21. When the conventional retail inventory method is used,
markdowns are commonly ignored in the computation of
12. The cost of inventories that are not ordinarily the cost to retail ratio because
interchangeable and goods produced and segregated for a. There may be no markdowns in a given year.
specific projects shall be measured using specific b. This tends to give a better approximation of the lower
identification method. Which is the reason why the specific of cost and net realizable value.
identification method may be considered ideal? c. Markups are also ignored.
a. The potential for manipulation of income is reduced. d. This tends to result in the showing of a normal profit
b. There is no arbitrary allocation of cost. margin in a period when no markdown goods have
c. The cost flow matches the physical flow. been sold.
d. It is applicable to all types of inventory.
22. Which of the following is not a reason the retail inventory
13. In a period of rising prices, the inventory method which method is used widely?
tends to give the highest reported net income is a. As a control measure in determining inventory
a. Moving average shortages
b. First-in, first-out b. For insurance information
c. Specific identification c. To permit the computation of net income without a
d. Weighted average physical count of inventory
d. To defer income tax liability
14. The pricing issues from inventory must be deferred until
the end of the accounting period under which method of 23. The use of the gross profit method assumes
inventory valuation? a. The amount of gross profit is the same as in prior
a. Moving average years.
b. Weighted average b. Sales and cost of goods sold have not changed from
c. Specific identification previous years.
d. FIFO c. Inventory value has not increased from previous
years.
15. Why are inventories measured at lower of cost and net d. The relationship between selling price and cost of
realizable value? goods sold is similar to prior years.
a. To report a loss when there is decrease in future utility
b. To be conservative 24. How is the gross profit method used as it relates to
c. To report a loss when there is a decrease in future inventory valuation?
utility below the original cost a. To verify the accuracy of the perpetual inventory
d. To permit future profit to be recognized records.
b. To verify the accuracy of the physical inventory.
16. Which of the following statements is true about the c. To estimate cost of goods sold.
LCNRV method of measuring inventory? d. To provide an inventory value of LIFO inventories.
a. The LCNRV is always either cost or net realizable
value. 25. To produce an inventory valuation which approximates the
b. The LCNRV gives the lowest valuation if applied to lower of cost or market using the retail inventory method,
individual items of inventory. the computation of the ratio of cost to retail should
c. When the cost of goods sold method is used to record a. Include markups but not markdowns
inventory at net realizable value, the NRV is b. Include markups and markdowns
substituted for cost and the loss is buried in the cost of c. Ignore both markups and markdowns
goods sold. d. Include markdowns but not markups
d. All of these statements are true about LCNRV method
26. A markup of 25 percent on cost is equivalent to what
17. Which statement is true regarding inventory writedowns markup on selling price?
and recovery of writedown? a. 15 percent
a. Recovery of inventory writedown is prohibited under b. 20 percent
IFRS. c. 25 percent
b. IFRS requires separate reporting of reversal of d. 33 percent
inventory writedown.
c. IFRS requires entities to record writedown in a 27. Biological assets
separate loss account. a. Are found only in Biotech entities.
d. All of the choices are true.
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b. Are living animals or living plants and must be 38. Animals related to recreational activities are accounted for
disclosed as a separate line item in the statement of under what standard?
financial position a. IAS 41 – Agriculture
c. Must be valued at cost b. IAS 16 – Property, plant and equipment
d. Do not generally have future economic benefits c. IAS 40 – Investment property
d. Either IAS 41 or IAS 16
28. Agricultural activity includes all of the following, except
a. Raising livestock 39. Land that is related to agricultural activity is measured
b. Annual perennial cropping a. At fair value
c. Floriculture and aquaculture, including fishing b. At fair value in combination with the biological asset
d. Ocean fishing that is being grown on the land.
c. At the resale value separate from the biological asset
29. All of the following must be satisfied before a biological that is being grown on the land.
asset can be recognized, except d. In accordance with PAS 16 Property, plant and
a. The entity controls the asset as a result of past event. equipment or PAS 40 Investment property.
b. It is probable that future economic benefits relating to
the asset will flow to the entity.
c. An active market for the asset exists.
d. The fair value or cost of the asset can be measured
reliably.

30. Which of the following statement is true about biological

assets?
a. Biological assets are measured at fair value less cost
of disposal.
b. When fair value cannot be determined reliably, the
biological asset shall be measured at cost less
accumulated depreciation and impairment losses.
c. Where there is production cycle of more than one year
for biological asset, separate disclosure is
encouraged for physical change and price change
d. All of these statements are true about biological
assets.

31. A bearer plant is a living plant that

a. Is used in the production or supply of agricultural
produce.
b. Is used to bear produce for more than one period.
c. Has a remote likelihood of being sold as agricultural
produce, except for scrap sales.
d. Must possess all of these characteristics.

32. All of the following can be considered bearer plant, except

a. Coconut tree
b. Grape vine
c. Rubber tree
d. Tree in a forest plantation to be harvested and sold as
log or lumber

33. A living plant with a dual use is classified as

a. Bearer plant
b. Biological asset
c. Investment property
d. Inventory

34. Agricultural produce as it grows on bearer plant is

measured at the end of each reporting period prior to
harvest at
a. Fair value
b. Fair value less cost of disposal
c. Fair value plus cost of disposal
d. Fair value less cost of disposal at the point of harvest

35. Agricultural produce harvested from bearer plant is

accounted for as inventory and measured at
a. Fair value
b. Fair value less cost of disposal at the point of harvest
c. Cost
d. Fair value plus cost of disposal at the point of harvest

36. Under IFRS, bearer plants are accounted for as

a. Biological assets with disclosure
b. Biological assets without disclosure
c. Property, plant and equipment
d. Noncurrent investment
37. Under IFRS, bearer animals are accounted for as
a. Biological assets
b. Property, plant and equipment
c. Investment property
d. Agricultural produce

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