Inventories

• Inventories


  Assets which are held for sale in the ordinary course of business, in the process of production for such sale or in the form of materials or supplies to be consumed in the production process or in the rendering of services
• Inventories encompass

  • Goods purchased and held for resale
  • Land and other property held for resale by a subdivision entity and real estate developer
• Classes of Inventory

  • Inventories of a trading entity
  • Inventories of a manufacturing entity
• Trading entity


  One that buys and sells goods in the same form purchased
• Merchandise inventory


  Goods held by a trading entity
• Manufacturing entity


  One that buys goods which are converted into another form before they are made available for sale
• Inventories of a manufacturing entity

  • Finished Goods
  • Goods in process or Work in Process
  • Raw Materials
  • Factory or Manufacturing Supplies
• Finished Goods


  Completed products which are ready for sale
• Goods in process or Work in Process


  Partially completed products which require further process or work before they can be sold
• Raw Materials


  Goods that are to be used in the production process, physically incorporated in the production of other goods and can be traced directly to the end product
• Factory or Manufacturing Supplies


  Supplies similar to raw materials but their relationship to the end product is indirect, referred to as indirect materials
• As a rule, all goods to which the entity has title shall be included in the inventory, regardless of location
• Passing of title


  The point of time at which ownership changes
• Legal test


  Is the entity the owner of the goods to be inventoried?
• Legal Test: Goods included in inventory

  • Goods owned and on hand
  • Goods in transit and sold FOB destination
  • Goods in transit and purchased FOB shipping point
  • Goods out on consignment to consignee
  • Goods in the hands of salesmen or agents
  • Goods held by customers on approval or on trial
• Exception to Legal Test

  1. Installment contracts may provide for the retention of title by the seller until the selling price is fully collected
  2. In such cases, it is an accepted accounting procedure to record the installment sale as a regular sale on the part of the seller and as a regular purchase on the part of the buyer
• Exception to Legal Test

  This is a clear example of economic substance prevailing over legal form
• Consignment


  A method of marketing goods in which the owner called the consignor transfers physical possession of certain goods to an agent called consignee who sells them on the owner's behalf
• A consigned goods shall be included in the consignor's inventory and excluded from the consignee's inventory
• Freight and other handling charges on goods out on consignment are part of the Cost of Goods consigned
• The inventories shall be presented as one line item in the statement of financial position, but the details of the inventories shall be disclosed in the notes to financial statements
• For example, the note shall disclose the composition of the inventories of a manufacturing concern as finished goods, goods in process, raw materials and manufacturing supplies
• Freight Terms


  • FOB Shipping Point
  • Payee - Buyer
  • Owner during transit - Buyer
  • FOB Destination
  • Payee - Seller
  • Owner during transit - Seller
• Maritime Shipping terms


  • FAS (Free Along Side)
  • CIF (Cost, Insurance, and Freight)
  • Ex-Ship
• Accounting for Inventories


  • Periodic System
  • Perpetual System
• Periodic System


  Calls for the physical counting of goods on hand at the end of the accounting period to determine the quantities
• Perpetual System


  Requires the maintenance of records called stock cards that usually offer a running summary of the inventory inflow and outflow
• When the perpetual system is used, a physical count of the units on hand should at least happen once a year to confirm the balances appearing on the stock cards
• Purchase of merchandise on account

  1. Debit Purchases

  2. Credit Accounts Payable
• Payment of freight charges

  1. Debit Freight In

  2. Credit Cash
• Return of merchandise purchased to supplier

  1. Debit Accounts Payable

  2. Credit Purchase Return
• Sale of merchandise on account

  1. Debit Accounts Receivable

  2. Credit Sales

  3. Debit Cost of Goods Sold

  4. Credit Merchandise Inventory
• Return of merchandise sold from customer

  1. Debit Sales Return

  2. Credit Accounts Receivable

  3. Debit Merchandise Inventory

  4. Credit Cost of Goods Sold
• Adjustment of ending inventory

  1. Debit Merchandise Inventory, end

  2. Credit Income Summary
• Inventory shortage or overage


  An adjustment is necessary to recognize any inventory shortage or overage
• Adjusting entry for inventory shortage

  1. Debit Inventory Shortage

  2. Credit Merchandise Inventory
• The inventory shortage is usually closed to cost of goods sold, because this is often result of normal shrinkage and breakage in inventory
• Abnormal and material shortage shall be separately classified and presented as other expenses
• Trade discounts


  Deductions from the list or catalog price in order to arrive at the invoice price which is the amount actually charged to the buyer, not recorded
• Cash discounts

  Deductions from the invoice price when payment is made within the discount period, recorded as purchase discount by the buyer and sales discount by the seller