INVENTORIES

- Asset
- Current asset

Inventories are asset:

Held for sale in the ordinary course of business

Used in the process of production
In the form of materials or supplies used in the production or on the
rendering of services

Measurement of Inventories
An entity shall measure inventories at the lower of cost and estimated selling price
less costs to complete and sell.

An entity shall include:

costs of purchase
costs of conversion and other costs incurred in bringing the
inventories to their present location and condition.

A. Costs of purchase
The costs of purchase of inventories comprise:

purchase price,
import duties and other taxes (other than those subsequently recoverable by
the entity from the taxing authorities)
transport, handling and other costs directly attributable to the acquisition of
finished goods, materials and services.
Trade discounts, rebates and other similar items are deducted in determining
the costs of purchase.
An entity may purchase inventories on deferred settlement terms. A
difference between the purchase price for normal credit terms and the
deferred settlement amount. In these cases, the difference is recognized as
interest expense over the period of the financing and is not added to the cost
of the inventories.

Example: (Cost of Purchase)

1. A retailer buys a good priced at Php 500 per unit. However, the supplier awards
the

retailer a 20 per cent discount on orders of 100 units or more. The retailer buys 100

units in a single order.

Answer: Php 40,000

Solution:

100 units x (php 500 20%)

=php 40,000

2. On 1 November 20X1 a retailer buys 90 units of a good from a supplier for php
500

per unit on 60 days interest-free credit (normal credit terms). To encourage early

settlement the supplier awarded the retailer a 10 per cent early settlement discount

for settling within 30 days of buying the goods.

On 30 November 20X1 the retailer paid Php 40,500 to settle the amount owing for
the

90 units purchased from the supplier.

Solution:

Php 40,500

= 100 units [PHP500 list (10%(PHP500) early settlement discount)].

3. An entity acquired an item of inventory for Php2,000,000 on two-year interest-

free

credit.

An appropriate discount rate is 10 per cent per year.

Answer: The cost of the inventory is Php1,652,893

Calculation: Php2,000,000 future payment (1.1)2 or 1x1 /1.10 2

B. Cost of Conversion
The costs of conversion of inventories include:

costs directly related to the units of production, such as direct labour.

They also include a systematic allocation of fixed and variable production
overheads that are incurred in converting materials into finished goods.

Costs of conversion = direct production costs + fixed production overheads +

variable production overheads.

Example:

An entity manufactures blocks for use in the construction of residential housing. The
manufacturing process involves combining specific proportions of raw materials (ie
sand, ash, cement and water) in a mixing process. The mixture is then placed into
reusable moulds. After standing for three days the solidified blocks are removed
from the moulds. The blocks then undergo drying in a drying room for two weeks
before becoming ready for sale. The dried bricks are then stored in the finished
goods store room. For ease of access dry raw materials are stored in a space
adjacent to the production area.

The mixing process is mechanised. However, a manned front-end loader is used to

add the dry materials (ie sand, ash and cement) to the mixing machine which is
operated by a dedicated operator. Both factory workers are full-time employees of
the entity, remunerated on a fixed annual wage. Casual labourers are employed to
remove the blocks from the moulds. They are paid a fixed fee for each block
removed from its mould. There are also two managers employed by the entity. The
operations manager supervises the factory and the administration manager who is
responsible for administration, finance and sales.

The entity operates from premises leased in return for a fixed annual rental. It
financed the acquisition of its equipment with a fixed period loan that bears interest
at 8 per cent per year.

Answer: The costs of conversion include the direct costs, the fixed production
overheads and the

variable production overheads.

Solution:

Direct costs includes:

costs of raw materials (ie sand, ash, cement and water)

the costs of the casual labor that removes the blocks from the moulds.
Fixed Overhead includes:

the rental of the production area (including the area where dry raw materials
are stored and the drying room but excluding the finished goods storeroom)
the cost of the two machine operators (eg salary and benefits), the cost of
the operations manager (ie salary and benefits)
depreciation of the manufacturing equipment (ie the front-end loader, the
mixing machine and the moulds).

Allocation of production overheads

13.9 An entity shall allocate fixed production overheads to the costs of conversion
on the basis

of the normal capacity of the production facilities.

Normal capacity

fixed overhead

Variable production overheads

Example:

1. An entity incurred fixed production overheads of Php900,000 during a one-month

period in which it manufactured 250,000 units of production. When operating at
normal capacity the entity manufactures 250,000 units of production per month.

Answer: The entity allocates Php3.6 fixed overhead cost to each unit produced
during the month.

Calculation: Php900,000 fixed production overhead 250,000 units (ie normal

capacity) =

PHP3.6 per unit produced.

2. The facts are the same as in example 19. However, in this example, the entity
manufactured 200,000 units of production during the month.

Answer: Allocated fixed production overheads would be PHP 720,000

Calculation: 200,000 units produced x PHP 3.6 allocation rate based on normal
production rate (see example 1 above).

Answer: The unallocated fixed production overheads of PHP180,000 must be

recognised as an expense in the profit or loss.

Calculation: PHP900,000 incurred less PHP 720,000 allocated

to inventory.

3. The facts are the same as in example 19. However, in this example, the entity
manufactured 300,000 units during the month. This level of production is
abnormally high.

The entity allocates CU3 fixed overhead cost to each unit produced during the
month.

Calculation: PHP 900,000 300,000 units (actual production) = PHP3 per unit
produced.

Joint and By- Products

A production process may result in more than one product being produced
simultaneously. This is the case, for example, when joint products are produced or
when there is a main product and a by-product. When the costs of raw materials or
conversion of each product are not separately identifiable, an entity shall allocate
them between the products on a rational and consistent basis.

Most by-products, by their nature, are immaterial. When this is the case, the entity
shall measure them at selling price less costs to complete and sell and deduct this
amount from the cost of the main product. As a result, the carrying amount of the
main product is not materially different from its cost.

Other costs included in inventories (Other Costs)

An entity shall include other costs in the cost of inventories only to the extent that
they are incurred in bringing the inventories to their present location and condition.

Costs excluded from inventories

13.13 Examples of costs excluded from the cost of inventories and recognised as
expenses in the period in which they are incurred are:

(a) abnormal amounts of wasted materials, labour or other production costs.

(b) storage costs

(c) administrative overheads that do not contribute to bringing inventories to their

present
location and condition.

(d) selling costs.

Examples:

1. An entity manufactures cotton sheeting. Total costs in each production run are
PHP100,000 including a cost of normal wastage of PHP2,000. The weakening of
operating controls while the owner-manager was away from the plant in hospital
caused the wastage of raw materials to increase to CU7,000 per production run.

Answer: The abnormal wastage cost of PHP5,000 (PHP7,000 less PHP2,000) is not
included in the cost

of inventory but is recognized as an expense.

2. A retailer incurred staff costs of PHP10,000 for its sales personnel and PHP5,000
in advertising costs.

Answer: The salaries of the sales staff and advertising costs are selling costs. Selling
costs are not

included in the cost of inventory.

3. A retailer has four motor vehicles. Vehicle 1 is used to bring goods from the
entitys suppliers to its retail outlets. Vehicle 2 is a roadside retail outlet. Vehicle 3
delivers goods to its customers. Vehicle 4 is used by the entitys travelling salesman
to visit potential customers.

Answer: Depreciation and maintenance of Vehicle 1 are included in the cost of the
inventory that it transports from the entitys suppliers to its retail outlets.

Depreciation and maintenance on the other vehicles do not form part of the cost of
inventory. These are selling expenses.

Techniques for measuring cost, such as standard costing, retail

method and most recent purchase price

Approximate Cost
Standard costs take into account normal levels of materials and supplies, labour,
efficiency and capacity utilisation. They are regularly reviewed and, if necessary,
revised in the light of current conditions.

The retail method measures cost by reducing the sales value of the inventory by
the appropriate percentage gross margin.

Cost formulas
An entity shall measure the cost of inventories of items that are not ordinarily
interchangeable and goods or services produced and segregated for specific
projects by using specific identification of their individual costs.

Specific Identification

- specific costs are attributed to identified items of inventory.

- appropriate treatment for items that are segregated for a specific project,
regardless of whether they have been bought or produced.
- inappropriate when there are large numbers of items of inventory that are
ordinarily interchangeable.

FIFO Method or Weighted Average

LIFO

Example

1. (FIFO)
Answer:

(a) 200 units CU10 per unit

(b) (800 units CU10 per unit) + (100 units CU15 per unit)
2. The facts are the same as in example 39. However, in this example, the entity
allocates the cost of inventories by using the weighted average cost formula
calculated as each additional shipment is received.

Answer:

(a) 200 units CU10 per unit = CU2,000.

(b) CU18,000 1,400 units = CU12.86 per unit.

(c) 900 units CU12.86 = CU11,574.

Impairment of inventories
- Inventories are impaired when carrying amount is not fully recoverable.
- measured in selling price less cost to complete and sell and recognize
Impairment loss

Recognition as an expense
When inventories are sold, the entity shall recognize the carrying amount of those
inventories as an expense in the period in which the related revenue is recognized.

Examples:

1. On 14 December 20X5 a machine manufacturer sold an item of machinery it

manufactured in 20X5 to a customer for CU8,000 cash. The cost of the machine was
CU5,500. The customer took immediate delivery of the inventory.
On 14 December 20X5, when the risks and rewards of ownership of the machine
passed to the purchaser, the entity must recognise the carrying amount of the
inventory as an expense, assuming all the other conditions in paragraph 23.10 are
satisfied.

The following entries are made:

Disclosures
An entity shall disclose the following:

(a) The accounting policies adopted in measuring inventories, including the cost
formula

(b) The total carrying amount of inventories and the carrying amount in
classifications appropriate to the entity.

(c) The amount of inventories recognized as an expense during the period.

(d) Impairment losses recognized or reversed in profit or loss in accordance with

Section 27.

(e) The total carrying amount of inventories pledged as security for liabilities.
Illustration:
INVESTMENT IN ASSOCIATES
This section applies to accounting for associates in consolidated financial
statements and in the financial statements of an investor that is not a parent
but that has an investment in one or more associates.

With subsidiaries SECTION 14

- prepare consolidated financial statements are not separate financial statements.

Without subsidiaries SECTION 9

- Does not prepare consolidated financial statements

- Such an entity may then choose (or be required by the law in its jurisdiction)
to prepare separate financial statements in addition to its primary financial
statements.

Always classified as non-current asset

Associates

- An entity, including an unincorporated entity such as a partnership, over

which the investor has significant influence and that is neither a subsidiary
nor an interest in a joint venture.

Significant influence is the power to participate in the financial and operating policy
decisions of the associate but is not control or joint control over those policies.

Presumed to exists when the investor holds at least 20% of the investees
voting power
Presumed not to exists when the investor holds less than 20% of the
investees voting power.

Measurementaccounting policy election

An investor shall account for all of its investments in associates using one of the
following:

(a) the cost model in paragraph 14.5.

(b) the equity method in paragraph 14.8.

(c) the fair value model in paragraph 14.9.

COST MODEL
Transaction price + transaction cost
Not permitted to use the published price quotation
Investment in associates carried at cost is tested for impairment
Dividends and other distributions are recognized income

Example:

1.

Answer: dividend income of CU45,000

Calculation: 30% CU150,000 dividend declared by entity B in profit or loss for

the year ended 31 December 20X1.

At 31 December 20X1 entity A must report its investment in entity B (an associate)
at CU300,000 (ie cost). Entity A must also consider whether there are any indicators
that its investment is impaired and, if so, conduct an impairment test in accordance
with

Section 27 Impairment of Assets. In this case there would not be any impairment
loss because the fair value (CU425,000) less costs to sell of the investment exceeds
its carrying amount (CU300,000).

2.

Answer:without regard to whether the distributions are from Bs accumulated profits

arising before or after 1 January 20X1, recognise dividend income of CU75,000 in
profit or loss for the year ended 31 December 20X1
Calculation: 30% CU100,000 dividend declared on 2 January + 30% CU150,000
dividend declared on 31 December.

At 31 December 20X1 entity A must report its investment in entity B (an associate)
at CU300,000 (ie cost).

The payment of the dividend out of pre-acquisition profits on 2 January 20X1 could
be an impairment indicator that, in accordance with Section 27 Impairment of
Assets, could trigger an impairment test at 31 December 20X1. In this case there
would not be any impairment loss because the fair value (CU400,000) less costs to
sell of the investment exceeds its carrying amount (CU300,000).

3.

Answer: Entity A must recognise dividend income of CU45,000

Calculation: ie 30% CU150,000 dividend declared by entity B and increase in the

fair value of its investment in entity B of CU125,000 in profit or loss for the year
ended 31 December 20X1.

At 31 December 20X1 entity A must report its investment in entity B (an associate)
at CU425,000 (ie fair value).

Note: Even though entity A has elected the cost model as its accounting policy for
investments in associates it accounts for its investment in entity B using the fair
value model because entity B has a published price quotation.
EQUITY METHOD

- Initially recognized in transaction price + transaction cost

- Adjusted to reflect the investors share of the profit or loss and other
comprehensive income of the associate.
- Dividends and other distribution received are recognized as reduction of the
carrying amount
- Acquisition Cost Fair Value of the net identifiable asset= Goodwill , that is
included in the carrying amount of the investment.

Examples:

1.

Answer : Entity A must recognise income from its associate of CU120,000

Calculation: 30% CU400,000 entity Bs profit for the year in profit or loss for the
year ended 31 December 20X1.

At 31 December 20X1 entity A must report its investment in entity B (an associate)
at CU375,000

calculation: CU300,000 cost + CU120,000 share of earnings less CU45,000 dividend.

Entity A must also consider whether there are any indicators that its investment is
impaired and, if so, conduct an impairment test in accordance with Section 27
Impairment of Assets. In this case there would not be any impairment loss because
the fair value (CU425,000) less costs to sell of the investment exceeds its carrying
amount (CU375,000).

2.
Answer: Entity A must recognise income from its associate of CU120,000

Calculation: 30% CU400,000 entity Bs profit for the year in profit or loss for the
year ended 31 December 20X1.

At 31 December 20X1 entity A must report its investment in entity B (an associate)
at CU345,000

calculation: CU300,000 cost + CU120,000 share of earnings less CU30,000 dividend

less CU45,000 dividend

Entity A must also conduct an impairment test in accordance with Section 27

Impairment of Assets. The payment of the dividend out of pre-acquisition profits on
2 January 20X1 is an impairment indicator that, in accordance with Section 27,
would trigger an impairment test at 31 December 20X1 (ie at 31 December 20X1
entity A must calculate the recoverable amount of its investment in entity B and, if
the recoverable amount is lower than the carrying amount, reduce the carrying
amount to the recoverable amount). In this case there would not be any impairment
because the fair value (CU400,000) less costs to sell of the investment would
exceed its carrying amount (CU345,000).

3.

Answer: Entity A must recognise income from its associate of CU120,000

Calculation: 30% CU400,000 entity Bs profit for the year) in profit or loss for the
year ended 31 December 20X1.

At 31 December 20X1 entity A must report its investment in entity B (an associate)
at CU375,000

calculation: CU300,000 cost + CU120,000 share of earnings less CU45,000 dividend.

Entity A must also consider whether there are any indicators that its investment is
impaired and, if so, conduct an impairment test in accordance with Section 27
Impairment of Assets. In this case there would not be any impairment because the
fair value (CU425,000) less costs to sell of the investment would exceed its carrying
amount (CU375,000).
C. FAIR VALUE

- Initially measured at transaction price excludes transaction cost

- At each reporting date, an investor shall measure its investments in
associates at fair value, with changes in fair value recognised in profit or loss
- If it is impractible to measure fair value reliably without undue cost or effort,
the investment is accounted for under the cost model matter of
judgement
- Not tested for impairment

Examples:

1.

Answer:

In determining profit or loss for the year ended 31 December 20X1 entity A must:

recognise dividend income of CU45,000

Calculation: 30% CU150,000 dividend declared by entity B

recognise the increase in the fair value of its investment in entity B of CU125,000

Calculation: CU425,000 fair value at 31 December 20X1 less CU300,000 carrying

amount on 1 January

20X1.

At 31 December 20X1 entity A must report its investment in entity B (an associate)
at its fair value of CU425,000.

2.

Answer:
In determining profit or loss for the year ended 31 December 20X1 entity A must:

recognise dividend income of CU75,000

Calculation: CU30,000 from the first distribution + CU45,000 from the second
distribution

recognise the increase in fair value of CU100,000

Calculation: CU400,000 fair value at 31 December 20X1 less CU300,000 carrying

amount on 1 January 20X1).

At 31 December 20X1 entity A must report its investment in entity B (an associate)
at its fair value of CU400,000.

3.

Answer:

In determining profit or loss for the year ended 31 December 20X1 entity A must:

recognise dividend income of CU45,000

Calculation: 30% CU150,000 dividend declared by

entity B

recognise in the increase in the fair value of its investment in entity B of

CU125,000

Calculation: CU425,000 fair value at 31 December 20X1 less CU300,000 carrying

amount on 1

January 20X1.

At 31 December 20X1 entity A must report its investment in entity B (an associate)
at its fair value of CU425,000.

FINANCIAL STATEMENT PRESENTATION

- Non-current asset
DISCLOSURES
An investor in an associate shall disclose the following:

(a) its accounting policy for investments in associates.

(b) the carrying amount of investments in associates (see paragraph 4.2(j)).

(c) the fair value of investments in associates accounted for using the equity
method for which there are published price quotations.

[Refer: Section 33 for related party disclosures]

[Refer: paragraph 9.27 for disclosures in separate financial statements, if prepared]

A. Cost Model Disclosure

- disclose the amount of dividends and other distributions recognized as income.

B. Equity Model Disclosures

- An investor shall disclose separately its share of the profit or loss of such
associates and its share of any discontinued operations of such associates.
C. Fair Value Model Disclosure
AMMENDMENTS