Chapter 5

INVENTORIES
Inventories are assets:
1. In the form of materials or supplies to be consumed in the production process (examples: materials and
supplies awaiting use in the production process);

2. In the form of materials or supplies to be consumed or distributed in the rendering of services (examples:
office supplies, ammunitions, maintenance materials);

3. Held for sale or distribution in the ordinary course of operations (examples: merchandise purchased by an
entity and held for resale, or land and other property held for sale, agricultural produce); or

4. In the process of production for sale or distribution (examples: goods purchased or produced for distribution
to other parties for no charge or for a nominal charge like educational books produced by a health authority
for donation to schools).

Cost of Inventories. The cost of inventories shall comprise all costs of purchase, costs of conversion (materials,
labor and overhead) and other costs incurred in bringing the inventories to their present location and condition,
excluding abnormal amounts of wasted materials, labor, other production and selling costs, administrative
overheads that do not contribute to bringing inventories to their present location and condition. Trade
discounts, rebates, and other similar items are deducted in determining the costs of purchase.

The weighted average method shall be used for costing inventories. This method calls for the re-calculation of
the average cost of all items in stock after every purchase. Therefore, the weighted average cost is the total cost
of all units subsequent to the latest purchase, divided by their total number of units available. The Accounting
Division/Unit shall be responsible in computing the cost of inventory on a regular basis as shown in the following
sample Supplies Ledger Card (SLC)

Recognition as an Expense. When inventories are sold, exchanged, or distributed, their carrying amount shall
be recognized as an expense in the period in which the related revenue is recognized. If there is no related
revenue, the expense is recognized when the goods are distributed or the related service is rendered.

Perpetual Inventory Method. Supplies and materials purchased for inventory purpose shall be recorded using
the perpetual inventory system, resulting in a more accurate inventory records and a running total for the cost
of goods sold in each period. (method of recording)

Regular purchases shall be coursed through the inventory account and issues thereof shall be recorded as they
take place except for supplies and materials purchased out of PCF for immediate use or on emergency cases
which shall be charged directly to the appropriate expense accounts

Semi-expendable Property. Tangible items below the capitalization threshold of P15,000 shall be accounted as
semi-expendable property. The following policies apply as follows: (disposable)

a. Semi-expendable property which were recognized as PPE shall be reclassified to the affected accounts.

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b. These tangible items shall be recognized as expenses upon issue to the end-user.

Inventory Accounting System. The Inventory Accounting System consists of the system of monitoring,
controlling and recording of acquisition and disposal of inventory. The system starts with the receipt of the
purchased inventory items.

Illustrative Accounting Entries. The following are the illustrative accounting entries for transactions involving
inventories:

a. Inventory Held for Sale:

Merchandise Inventory P 1,000
Cash-MDS, Regular P 1,000
To recognize purchase of inventories for sale amounting to P 1,000

Cash-Collecting Officers P 1,200

Sales Discounts 300
Sales Revenue P 1,500
To recognize sale of merchandise for P 1,500 at 20% discount

Cost of Sales 1,000

Merchandise Inventory 1,000
To recognize sale of merchandise inventory worth P 1,000

Sales Revenue P 1,500

Revenue and Expense Sum.P 1,500
To close the Revenue accounts to Revenue and Expense Summary account

Revenue and Expense Summary P 1,300

Cost of Sales 1,000
Sales Discount 300
To close the Expense accounts to Revenue and Expense Summary account

Revenue and Expense Summary 200

ACcumulated Surplus/(Deficit) 200
To close the Revenue and Expense Summary account to Accumulated Surplus/(Deficit) account

b. Inventory Held for Distribution:

Welfare Goods for Distribution P 2,000

Accounts Payable P 2,000
To recognize the purchase of welfare goods for distribution

Accounts Payable P 2,000

Cash-MDS, Regular P 2,000
To recognize payment of welfare goods purchased

Welfare Goods Expenses P 2,000

Welfare Goods for Distribution P 2,000
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To recognize the issue/distribution of goods amounting to P 2,000

Revenue and Expense Summary P 2,000

Welfare Goods Expenses P 2,000
To close the expense account to Revenue and Expense Summary account

Accumulated Surplus/(Deficit) P 2,000

Revenue and Expense Summary P 2,000
To close the Revenue and Expense Summary account to Accumulated Surplus/(Deficit) account

C. Inventory Held for Consumption

Office Supplies Inventory P 600

Accounts Payable P 600
To recognize purchase of office supplies on account amounting to P 600

Office Supplies Expenses P 400

Office Supplies Inventory P 400
To recognize issue/consumption of office supplies amounting to P 400

Revenue and Expense Summary P 520

Office Supplies Expenses P 520
To close the expense accounts to Revenue and Expense Summary account

Accumulated Surplus/(Deficit) P 520

Revenue and Expense Summary P 520
To close the Revenue and Expense Summary account to Accumulated Surplus/(Deficit) account

D. Semi-Expendable Machinery and Equipment:

Semi-Expendable Machinery P 13,000

Cash-MDS, Regular P 13,000
To recognize purchase of air-conditioning unit amounting to P 13,000

S/E Office Equipment P 14,500

Cash-MDS, Regular P 14,500
To recognize purchase of printer amounting to P 14,500

S/E Machinery and Equipment Exp. P 27,500

Semi-Expendable Machinery P 13,000
Semi-Expendable Office Equipment 14,500
To recognize the issuance of semi-expendable machinery and office equipment to end-users

Repairs and Maintenance-Semi-

Expendable Machinery and Equipment P4,000
Cash-MDS, Regular P4,000
To recognize repair of the air-conditioning unit two years after purchase

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Revenue and Expense Summary P 31,500
Semi-Expendable Machinery
and Equipment Expenses P 27,500
Repairs and Maintenance-
Semi-Expendable Machinery
and Equipment 4,000
To close the expense account to Revenue and Expense Summary account

Accumulated Surplus/(Deficit) P 31,500

Revenue and Expense Summary P 31,500
To close the Revenue and Expense Summary account to Accumulated Surplus/(Deficit) account

E. Semi-Expendable Furniture, Fixtures and Books:

Semi-Expendable Furniture and

Fixtures P 10,000
Cash-Modified Disbursement
System (MDS), Regular P 10,000
To recognize purchase of sofa set amounting to P 10,000

Semi-Expendable Books P 12,500

Cash-MDS, Regular P 12,500
To recognize purchase of books amounting to P 12,500

Semi-Expendable Furniture,
Fixtures and Books Expenses P 22,500
Semi-Expendable Furniture
and Fixtures P 10,000
Semi-Expendable Books P 12,500
To recognize the issue of semi-expendable furniture, fixtures and books to end-users

Revenue and Expense Summary P 22,500

Semi-Expendable Furniture,
Fixtures and Books Expenses P 22,500
To close the expense account to Revenue and Expense Summary account

Accumulated Surplus/(Deficit) P 22,500

Revenue and Expense Summary P 22,500
To close the Revenue and Expense Summary account to Accumulated Surplus/(Deficit) account

PROPERTY, PLANT AND EQUIPMENT

Covers the of accounting for Property, Plant and Equipment (PPE) which includes land; land improvements;
buildings and other structures; machinery and equipment; transportation equipment; furniture, fixtures and
books; leasehold improvements; and other PPE including specialist military equipment, infrastructure assets,
and heritage assets.

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It also, covers accounting treatment, recognition, measurement, derecognition to ensure that all PPEs are
properly valued and recorded, and the disclosure requirements in reporting PPE.

Definition of Terms. When used in this Manual, the following terms shall mean:

a. Carrying Amount – is the amount at which an asset is recognized after deducting any accumulated
depreciation and accumulated impairment losses. (book value) (FV)

b. Cost – is the amount of cash or cash equivalents paid and the fair value (FV) of the other consideration given
to acquire an asset at the time of its acquisition or construction.

c. Depreciation – is the systematic allocation of the depreciable amount of an asset over its useful life.

d. Depreciable Amount – is the cost of an asset, or other amount substituted for cost, less its residual value.

e. Property, Plant and Equipment – are tangible assets that are:

1. purchased, constructed, developed or otherwise acquired;

2. held for use in the production or supply of goods or services or to produce program outputs;
3. for rental to others;
4. for administrative purposes;
5. expected to be used during more than one reporting period; and
6. not intended for resale in the ordinary course of operations.

F. Residual Value – is the equivalent to at least five percent (5%) of the cost of an asset that the entity would
currently obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset were
already of the age and in the condition expected at the end of its useful life, unless a more appropriate
percentage is determined by an entity based on their operation.

g. Useful Life – is the period over which an asset is expected to be available for use by an entity; or the number
of production or similar units expected to be obtained from the asset by an entity.

Measurement at Recognition. PPE that qualifies for recognition as an asset shall be measured at cost. However,
where the PPE is acquired through a non-exchange transaction, its cost shall be measured at its fair value as at
the date of acquisition. The cost of an item of PPE comprises:

a. Purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts
and rebates;

b. Any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable
of operating in the manner intended by management.

Examples of directly attributable costs are:

1. Costs of employee benefits arising directly from the construction or acquisition of the item of PPE;
This shall be limited to salaries and benefits of employees directly involved in the project delivery (example:
project management or construction)
2. Costs of site preparation;
3. Initial delivery and handling costs;
4. Installation and assembly costs;
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5. Costs of testing whether the asset is functioning properly, after deducting the net proceeds from selling any
items produced while bringing the asset to that location and condition (such as samples produced when testing
equipment); and
6. Professional fees.

Costs not qualified for recognition as PPE. The following are examples of costs that are expensed rather than
recognized as elements of cost of a PPE: (Par. 33, PPSAS 17)
a. Costs of opening a new facility;
b. Costs of introducing a new product or service (including costs of advertising and promotional activities);
c. Costs of conducting business in a new location or with a new class of customers (including costs of staff
training); and
d. Administration and other general overhead costs.

Example: The East Avenue Medical Center purchased medical equipment, with estimated useful life of five
years, on January 2, 2014 with the following data:
Purchase price P1,000,000
Delivery cost 15,000
Testing Fees 1,000
Cost of construction of medical equipment room 100,000

Applying the Capitalization Threshold of P15,000. The capitalization threshold of P15,000 represents the
minimum cost of an individual asset recognized as a PPE on the Statement of Financial Position.

a. Items with individual values below the threshold but which work together in the form of a group of network
asset whose total value exceeds the threshold shall be recognized as part of the primary PPE. (Example:
computer network, PABX system- private automatic branch exchange (PABX) is an automatic telephone
switching system, sewerage system).

Expenditures incurred on purchasing, developing, and operating hardware, like web servers, staging servers,
production servers and internet connections of a website is accounted for as PPE if the total value of the
primary asset (communications networks) and these items is within the threshold of P15,000 and above.

b. This threshold shall be applied on an individual asset or per item basis. Each item within the bulk acquisition
with aggregate or total value of PPE, such as library books, computer peripherals and small items of
equipment, will need to meet the capitalization threshold to be recognized as PPE.

Example: 100 Monoblock Chairs (@300/pc) = 30,000 is classified as Semi-Expendable

Modes of Acquisition of PPE

Purchase of PPE. PPE acquired through purchase are charged against appropriations/allotments or special
budget for capital outlay.

PPE can be purchased on cash basis, on account, on installment basis, with promotional items, and at a lump
sum price.

On Cash Basis. PPE acquired through cash purchase shall initially be recognized at cost which includes cash paid
plus all costs incurred in bringing the asset to the location necessary for its intended use such as delivery,

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installation costs, etc. These are recognized in the books of accounts as PPE after inspection and acceptance of
delivery.

Example: An entity purchased a photocopier with the following costs:

Total cost:
Invoice price P45,000
Delivery cost 3,000
Installation cost 1,500
Test run cost 1 ,000
Total 50,500
Less: Withholding Tax 3,140
Net Amount Paid P47,460

The accounting entries to recognize the photocopier shall be as follows:

Office Equipment P50,500

Cash-MDS, Regular P47,460
Due to BIR 3,140
To recognize cash purchase of office equipment

Say the purchase price is only P14,500 (w/tax of P500.00)

J/E is:

Upon issuance to end-user:

On Account. When an asset is acquired on account subject to a cash discount, the cost of the asset is equal to
the purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts
and rebates.

Example: An entity purchased a threshing machine on account at P200,000, with credit terms of 2/10, n/30.

Agricultural and Forestry Equipment P196,000

Accounts Payable P196,000
To recognize purchase of machinery on account

Accounts Payable P196,000

Cash-MDS, Regular P184,240
Due to BIR 11,760
To recognize payment of machinery within the discount period

Accounts Payable P196,000

Other Losses 4,000
Cash-MDS, Regular 188,240
Due to BIR 11,760
To recognize payment of machinery beyond the discount period

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Note: The cost of the asset is the invoice price minus the discount regardless of whether the discount is taken
or not. Cash discounts are generally considered as reduction of cost and not as income. If the discount is not
taken, it shall be recognized as Other Losses.

Another Example: purchased 100 books at P1,000/book (total P100,000) with credit terms of 5/10, n/30.

J/E: Semi Expendable-books 95 (100-5%)

A/P 95
To recognize purchase of books on account

Semi Expendable Exp. – Books 95

SE-Books 95
To recognize issuance to end-user

A/P 95
Cash-MDS, REg 95
To recognize payment of books within the discount period

A/P 95
Other Losses 5
Cash-MDS, REg 100
To recognize payment of books beyond the discount period

Purchase with promotional items. If promotional items are received upon purchase of the PPE, the allocation of
cost for the promo items received shall be as follows:

1. If the promotional item received is the same as the PPE purchased, the total purchase cost shall be allocated
to the total quantity purchased plus the promotional item.

Example: An entity purchased 10 units of motor vehicles at P330,000 per unit totaling P3,300,000. An additional
unit was received as promotional item.

Computation of the cost per unit is P3,300,000/11 units = P300,000.

The journal entry to recognize the motor vehicles are as follows:

Motor Vehicles P 3,300,000
Accounts Payable P 3,300,000
To recognize the purchase of 11 units of motor vehicles at P300,000/unit

Accounts Payable P3,300,000

Cash-MDS, RegularP 3,102,000
Due to BIR 198,000
To recognize the payment of 11 units of motor vehicles at P300,000/unit

If the promotional item received is different from the PPE purchased, the cost of the promo item shall be its fair
value. It shall be deducted from the total cost of the items purchased and the balance shall be allocated to the
total quantity purchased.

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Example: An entity purchased a motor vehicle at P330,000. A window-type air conditioning unit with fair value
of P20,000 was received as promotional item.

Computation of the cost of motor vehicle is P330,000 – P20,000 = P310,000. The journal entry to recognize the
motor vehicles are as follows:

Motor Vehicles P310,000

Accounts Payable P310,000
To recognize the purchase of motor vehicles at P310,000

Machinery P20,000
Accounts Payable P20,000
To recognize the receipt of window-type air conditioning unit as promo item

Accounts Payable P330,000.00

Cash-MDS, Regular P310,200
Due to BIR 19,800
To recognize the payment of accounts payable

Depreciation. PPE gradually loses its ability to provide service over the course of time. Because of this, its cost
needs to be distributed on a systematic basis over its useful life. The allocated cost is referred to as depreciation.

The depreciation charge for each period shall be recognized as expense unless it is included in the carrying
amount of another asset. For example, the depreciation of manufacturing plant and equipment is included in
the costs of conversion of inventories.

Similarly, depreciation of PPE used for development activities may be included in the cost of an intangible asset
recognized.

The following are policies regarding depreciation of PPE:

a. There are three factors an entity must consider in determining depreciation:

1. Initial cost,
2. Useful life, and
3. Expected residual value at the end of its useful life.

b. Except for land and not recognized heritage assets, all PPE shall be depreciated.
c. Depreciation of an asset begins when it is available for use such as when it is in the location and condition
necessary for it to be capable of operating in the manner intended by management.

For simplicity and to avoid proportionate computation, depreciation shall be for one month if the PPE is available
for use on or before the 15th of the month. However, if the PPE is available for use after the 15th of the month,
depreciation shall be for the succeeding month.

d. A residual value equivalent to at least five percent (5%) of the cost shall be adopted unless a more appropriate
percentage is determined by the entity based on its operation subject to the approval of COA.

e. Generally, infrastructure assets have no residual value. In case, the residual value of parts of the infrastructure
assets can be determined, the policy of at least five percent (5%) of the cost of that part shall be applied.
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f. The computation of monthly depreciation expense shall be as follows:

Depreciation Expense = (Cost – Residual Value)

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Estimated Useful Life (in months)

g. Depreciation shall be recognized as a debit to the “Depreciation Expense” account and a credit to the
“Accumulated Depreciation” account.

Accumulated Depreciation is a contra-asset account presented in the FS as deduction from the related asset
account. Depreciation expense shall be recognized on a monthly basis.

Example: On June 5, 2014, an office equipment was purchased at P22,000 and has an estimated useful life of 5
years and 5% residual value. Said equipment was available for use on June 20, 2014.

Monthly Depreciation = (P 22,000 – P 1,100) / 60 months = P348.33

The accounting entry shall be as follows:

June 30, 2014 - No depreciation expense recognized.

July 31, 2014

Depreciation Exp-Office Equipment P 348.33
A/D-Office Equipment P 348.33
To recognize depreciation for the month of July 2014

h. Each part of an item of PPE with a cost that is significant in relation to the total cost of the item shall be
recorded and depreciated separately.

The engine amounting to P15,000,000 and the passenger seats amounting to P5,000,000 are expected to be
replaced after 5 years of continuous use with 5% residual value. The remaining parts of the aircraft are estimated
to have a residual value of P2,250,000 after 20 years.

The accounting entry to recognize the depreciation is as follows:

Depreciation Expense-Transportation Equipment 494,792

A/D-Aircrafts and Aircrafts Ground Equipment 494,792
To recognize monthly depreciation

Assignment: Provide journal entries:

Jan. 2 - Purchased on account of welfare goods for distribution to indigents, P100,000.

Jan 3 - Purchased land and building in cash at a single cost of P4,400,000. The land and building have fair
values of P1,000,000 and P3,000,000, respectively, at the time of acquisition. The estimated useful life of the
building – 20 years

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Jan. 4 - Issue/distributed goods amounting to P50,000 to enlisted indigents of Sipalay City

Jan 5 - Paid welfare goods purchased on Jan 2 less w/holding tax of 5%.

Jan 6 - Purchased computer set with a printer, table, and chair at a lump sum price of P55,000. The invoice
reflected the following cost component: (estimated useful life – 5 years)

PPE Acquired Invoice Cost

Computer (CPU, Monitor, Keyboard, and Mouse) P48,000.00 (classified as ICT Equipment)
Printer 3,500.00
Computer Table 2,500.00
Computer Chair 1,000.00
Total Cost 55,000.00
Less: Withholding Tax 3,300
Net Amount Paid P 51,700

Jan 7 - purchased drugs and medicines for Health Office on account amounting to P60,000, 5/10, n/30

Jan 8 - Recognized issuance/consumption of drugs and medicines amounting to P40,000

Jan 9 –Purchased motor vehicle at P330,000. A window-type air conditioning unit with a fair value of P20,000
was received as a promotional item. (estimated life of both - 5 years)

Jan. 10 - Purchased computer printer unit amounting to P100,000 on account with credits terms; 5/10, n/20

Jan 11 - Recognized issuance of the printer to end-user (estimated useful life - 5 years)

Jan 12 - Purchased 10 units of motor vehicles at P330,000 per unit. An additional unit was received as a
promotional item. On the same day, all units were issued to end-users.

Jan. 13 - Purchased of sofa set amounting to P10,000 and books amounting to P 15,500 on account. (estimated
useful life -5 years)

Jan. 15 - Recognized issuance of sofa set and books to end-users.

Jan 20 - Purchased land at a cash price of P1,000,000. Professional fees and transfer taxes totaling P50,000 was
paid.

Jan. 21 - Received unconditional donation of a piece of land with a fair value of P2,000,000.

Jan. 22. Recognize receipt of performance bond from the contractor for construction of building project,
P112,000.

Jan 27 – Purchased office equipment costing P44,000( estimated useful life of 5 years). Said equipment was
available for use the following day.

Jan 31 – Recognized purchase and use of medical equipment, with an estimated useful life of five years and
with the following data: Purchase price P100,000, Freight Cost- P15,000, Salaries of a technician during the
first day of regular operation - P10,000.

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Jan 31 –Recognized the monthly depreciation of PPEs purchased in January. (Assume a 5% of cost as
salvage/residual/scrap value)

End of Chapter 5

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