Adigrat University Colleg of Bussiness and Economics Department of Accounting and Finanice

ADIGRAT UNIVERSITY
COLLEG OF BUSSINESS AND ECONOMICS

DEPARTMENT OF ACCOUNTING AND FINANICE
Accounting Procedures and Control Methods over Inventory
(Case Study in Addis Pharmaceutical Factory)
A Research Submitted to the Department of Accounting and Finance in Partial

Fulfillment for the requirement B.A. Degree in Accounting and Finance
Submitted by: K/mariam G/yohanns
Id NO: 764/04
Advisor: Amanuel Tesfay (MSC)
June, 2014 G.C
Adigrat, Ethiopia
I
Acknowledgement
First and for most I would like to say thank you to almighty god for his entire gifts
Secondly, my deep gratitude to my advisor” AMANUEL TESFAY” who supported me to conduct

my senior essay paper properly by giving proper advice and constructive comments
Thirdly, I would like to say thank you to the finance manager and ware house manager of Addis
pharmaceutical factory because they were supported me by giving different information
Fourthly, I would like to say thank you to all supporter and encouragement in my academic
success. the last but not the least I would to say is thank you to my family.
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Contents
CHAPTER ONE........................................................................................................1
1. Introduction...........................................................................................................1
1.1 Back ground of the study.....................................................................................1
1.3 Statement of the problem.....................................................................................2
1.4. Objectives of the study.......................................................................................3
1.4.1. General Objective............................................................................................3
1.4.2. Specific Objective...........................................................................................3
1.6 Research methodology........................................................................................4
1.6.1 Data type and Data source................................................................................4
1.6.2 Data Collection Tools.......................................................................................4
1.7 Significance of the Study.....................................................................................5
1.8 Scope of the Study...............................................................................................5
CHAPTER TWO.......................................................................................................6
2. Literature review...................................................................................................6
2.1 Over view of inventory........................................................................................6
2.1.1 Meaning and definition of inventory................................................................6
2.4. Risks and Costs of holding Inventory..............................................................12
2.5. Inventory Management.....................................................................................13
2.6. Tools and Techniques of Inventory Management and Control......................15
2.7. Concept of Internal Control..............................................................................23
2.7.1 Objective of Internal Control..........................................................................24
2.8.3. Objective of Internal Control over Inventory................................................26
2.8.5. Functions of Internal Control over Inventory..............................................28
2.8.5.2. The Receiving Function...........................................................................29
2.8.5.3. The Strong Function.................................................................................29
2.8.5.4. The Shipping Function.............................................................................29
2.8.5.5. The Production Function..........................................................................30
CHAPTER THREE.................................................................................................31
DATA ANALYSIS AND INTERPRETATION.....................................................31
Introduction.............................................................................................................31
II
3.1.1. Financial Statement Analysis........................................................................31
3.1.2 Analysis of Inventory Policy Manuals...........................................................36
3.2 Primary Data Analysis.......................................................................................39
3.2.1 Analysis of Interview with the ware house Manager.....................................39
3.2.2 Analysis of Interview with finance Manager.................................................42
CHAPTER FOUR...................................................................................................44
CONCLUSION AND RECOMMENDATION......................................................44
INTRODUCTION...................................................................................................44
4.1 Conclusion.........................................................................................................44
4.2 Recommendations.............................................................................................45
REFERANCE (BIBLOGRAPHY)..........................................................................46
Appendix 1..............................................................................................................47
Primary Source of Data...........................................................................................47
III
LIST OF TABLES
Table 3.1 interval measure……………………………………………………….32
Table 3.2 inventory turnover…………………………………………………….32
Table 3.3 Days sales in inventory………………………………………………...33
Table 3.4 profit margin…………………………………………………………...34
Table 3.5 return on asset …………………………………………………………34
Table 3.6 Return on equity………………………………………………………..34
Table 3.7 raw material inventory turnover………………………………………35
Table 3.8 work in process inventory turnover ………………………………....….35
Table 3.9 ABC system for the factory …………………………………………….36
Table 3.10 Minimum inventory policy/softy stoke……………………………….37
Table 3.11 Re order level……………………………………………………………38
Table 3.12 Maximum stoke level …………………………………………………...38
IV
V
CHAPTER ONE
1. Introduction
1.1 Back ground of the study

Inventory constitutes to be the most significant part of current assets of a large majority of
companies. It is also essential for smooth running of business operations. The manufacturing
companies hold their inventory in the form of raw materials, work in process and finished goods
(I am pandy, 1978).
A proper planning of purchasing of raw materials handling, storing and recording is to be

considered as a part of inventory management. Inventory means the process of efficiently
overseeing and management of raw materials and other related items. This inventory
management considers what to purchase, how to purchase, how much to purchase from where to
purchase, when to use to production. Control procedures are these policies and procedures that
management has established with in the control environment in order to provide reasonable
assurance that goals will be established. General control procedure can be integrated throughout
the accounting system and which apply to all enterprise in the proper manner.
Generally, the principal objective of inventory control is to accomplish the maximum profit by
making investment on inventory lowest level with efficient and effective operations (Brigham,
1976).
1.2 Back ground of the organization
APF is the largest pharmaceutical manufacturing plant in Ethiopia located in Adigrat (Tigray)
which uses stat of art technology and equipment. APF produces safe, effective and quality drug
and has annual production capacity of 1.2 billion tablets, 19 billion ampoules, 10 million vials,
500,000 capsules 4000,000 ointment tubes and 9.6 million bottles of syrup. It was established in
1992 with initial investment of birr 200,000,000.
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Currently, APF is engaged in manufacturing of analgesics, anti acid, anti biotic, anti malaria, anti
asthmatics, amoebic ides, and vitamin preparations.
Vision: Providing safe, effective affordable medicines in sufficient quantities to satisfy the
current and future prescription needs of the society there by taking care of imperative demands.
Mission: To be one of the leading and progressive pharmaceutical and health care products
manufacturing plants in Africa and to satisfy the needs of potential customers by providing
quality and effective medicine at affordable price.
Description: Addis pharmaceutical factory (APF) plc is the largest and biggest pharmaceutical
manufacturing company which is established in 1992. This company is head quartered in
Adigrat, Tigray Regional state of Ethiopia, 898 k/m from Addis. The town is 2003meter above
sea level. The plant was constructed and equipped with high production facilities.
The company has been manufacturing more than 91 high quality pharmaceutical products of
different the paregorics including anti biotic and central nervous system drugs, anti helminthes.
The company has more than nine production lines and fully equipped laboratories and utility
capable of producing tablets , capsules ,syrups, dry powders for reconstitution , inject able vials
liquid inject able ampoules ,creams ,ointments which can generally be categorized as non
lactam products. Products such as vials capsules, dry powder are lactam products. The Latham
products are manufactured in dedicated lines, where as non lactam products are in manufacturing
lines. (www.com.apf.officail web site).
1.3 Statement of the problem
In some companies’ management focus on internal control over cash and other securities, but
gives a little attention to control over inventory. However inventories require adequate and
efficient controlling methods and procedures .The performance of internal control over inventory
is important for prevention of fraud and for reduction of errors.
Good internal control is an important means of providing accurate data used to management in
price setting and decision making. In control and maintenance of inventories error in physical
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counting and recording errors are the critical problem that is not yet studied in Addis
pharmaceutical factory. This study has assessed internal control over inventories in the factory. It
has identified the internal control procedures and methods used for inventories
1.4. Objectives of the study
1.4.1. General Objective
The general objective of this study was to assess the accounting procedures and control methods
of Addis pharmaceutical factory.
1.4.2. Specific Objective
The followings are specific objectives of the study:
1. To identify the type inventory control follow by APF to manage its inventories
2. To identify the type inventory valuation in APF
3. To compare the inventory management with the performance of the factory
4. To identify the type inventory system used by APF
1.5. Research questions
The researcher has tried to answer the following research questions:
1. What type of inventory control is followed by APF to manage its inventory?

2. What type of inventory valuation does APF use?
3. Does inventory control have relationship with factories performance?
4. What type inventory system is used by APF?
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1.6 Research methodology
1.6.1 Data type and Data source
To make this study effective the researcher was used both primary and secondary source of data
as source of information. Primary source are obtained with the help of interviews, were as
secondary source of data that are obtained from written documents, books, ABC analysis
manuals, annual audited financial reports and cost of goods sold schedule.
1.6.2 Data Collection Tools
In order to obtain the sufficient information, the researcher used semi structured interview
questions. The researcher found interview to be appropriate in that the required data can be
obtained from limited people. Hence, interview questions were first prepared in English and then
translated to Amharic to make administration easy. When the researcher make interview to the
managers of the factory through face to face communication. At this time the researcher took
notes from oral speaking.
1.6.3. Sampling method and sample size
It is so difficult to study the overall population of the company due to the consumption of time
and financial recourses. So to make effective the study the researcher would use the samples that
are small number of the total population. So in Addis pharmaceutical factory there are two
departments related to inventory control method. These are warehouse and finance department.
Those departments are selected by using purposive method of sampling because they are small in
number.
1.6.4 Data Analysis and Presentation
After gathering all the required data about the procedure and control method over inventory the
researcher was analysis the data by using mathematical and statistical tools. These mathematical
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and statistical tools will analysis using percentage, table, and present in the form diagrams, bars,
charts in order to evaluate the application procedure and control method over the company.
1.7 Significance of the Study

The study would attempt to evaluate weather company follows appropriate accounting
procedures and controlling method over its inventory. It was identify the accounting procedures
and method of inventory controls in the factory. It was also identify problems in inventory
control. The out puts of this study would help the factory to improve its inventory system. It can
also be used by other researchers for further study.
1.8 Scope of the Study

This study would conduct only to study the accounting procedures and control over inventory in
the organization and most significant issues that are related to control system by referring various
sources documents.
1.9 Limitations of the Study
The researcher used only the interview questions and interviewed only to the two departments of
the factory which were the ware house and finance department managers due to lake of time. The
workers of the factory are not interested to give the full information of the factory. The research
was conducted only in Addis pharmaceutical factory it is not represent to the other factories.
1.10 Organization of the paper

The study consists of four chapters. These are introduction; background of the study,
background of the organization, statement of the problem, significance of the study, scope of the
study would under the first chapter. The second chapter also consists of the literature review only
to identify the critical factor success factors. The third chapter also deals with the data source and
data type, method of data collection tools, sampling size, sampling procedure, analysis and
presentation of data. The last chapter is conclusion and recommendation of the study.
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CHAPTER TWO
2. Literature review
2.1 Over view of inventory

Inventory occupies the most strategic position in the structure of working capital of most
business enterprise. It consists of the largest component of current asset in the most business
enterprise. The share of working capital, the efficient control of inventory has passed the most
serious problem to the cement mills because about 2/3 of current asset of mills are blocked in
inventory. The turnover of working capital is largely governed by turnover of inventory.
2.1.1 Meaning and definition of inventory

The dictionary meaning of inventory is detailed list of goods, furniture .Many understand the
word inventory bas stoke of goods, but the general accepting meaning is the stoke of finished
goods only. In manufacturing companies inventories are grouped in to:
Raw material inventory

Work in process inventory
Finished goods inventory
I) Row material inventory: are those basic inputs that are converted in to finished
products through the manufacturing process. Raw materials are inventories that are
units which have purchased and stored for future production.
II) Work in process inventory: are inventories that are semi manufactured products.
They represent products that need more work before they become finished products
for sale.
III) Finished goods inventory: are parts of inventories those completely manufactured
product which are ready for sale. Stoke of raw materials and work in process
facilitates production, while stoke of finished goods is required for smooth marketing
operations. Generally, finished goods are inventories serves as a link between the
production and consumption of goods. (Im pandey, 2010).
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2.1.2 Needs to hold Inventories
Companies may hold their inventories with various motives. There are three motives
for companies to hold inventories. These are:
 Transaction motive
 Precautionary motive
 Speculative motive
Transaction motive: emphasizes the need to maintain inventory to facilitate smooth production
and sales operation
Precautionary motive: necessities holding of inventories to guard against the risk of

unpredictable changes in demand supply forces and other factors.
Speculative motive: influences the decision to increase or decrease the level of inventory to take
advantages of price fluctuation. (IM pandy, 2010).
2.2 Methods of Inventory

There are fore methods of inventory:
 Specific identification
 Average cost method
 FIFO Method
 LIFO Method
Specific identification method: identifies cost of each item in the ending inventory. It can be
used only when it is possible to identify the units in ending inventory as coming from specific
purchases. The specific identification method may appear logical, and it can be used by the
companies that deal in high price article (Kassu etal, 2005).
Advantages of specific identification method
 The flow of recording costs marches the actual physical flow of goods
 Costs of goods sold are appropriately marched with net sales
 Realistic inventory figure is reported on the balance sheet
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Disadvantage of specific identification method
 Application may be difficult nor impossible at all

 Identifying the actual cost of units is costiy,time taking and burden same
 Susceptible to profit manipulation
Average cost method: Under this method, inventory is priced at average cost of the goods
available for sale during the accounting period. Average cost is computed by dividing the actual
cost of available for sale. This gives an average unit cost that is applied to the unit in ending
inventory. The average cost method tends to the level out the effects of cost increases and
decreases because the cost of ending inventory is influenced by the entire price paid during the
year and by the cost of beginning inventory.
Advantages of average cost method
 When there is intermingling of identical units, the average cost method

provides a realistic cost allocation approach. It is an ideal cost allocation
method for liquid items such as edible oils, petroleum’s, soft drink and
mineral water.
 In the other cost allocation methods different unit cost may be assigned for
items sold. That means it is superior for provides the same units of cost for
similar inventory item.
 It does not provide a room for profit manipulation.
Disadvantage of Average Cost Method
 Since earlier cost continuously exert their influence an inventory, value

ending inventory are smaller than current prices in the periods of inflation
and become higher in periods of deflation.
 Relative to FIFO the average cost method results in reduced in inflationary
situation.
 Does not provide a meaning full cost allocation when physically distinct
inventory units are acquired for different prices. (kassu, etal, 2005).
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First in first out (FIFO) method: The FIFO method assumes that the cost of first item
acquired should be assigned to the first item sold. The cost of goods on hand at the end period
are assumed to be from the most purchase and the costs assigned to goods that have been sold
assumed to be from the earliest purchase, any business regardless of its goods flow, can use the
FIFO method because the assumption underling it is based on the flow of costs, not the flow of
goods. Thus, the FIFO method value of ending inventory at the most recent costs and includes
earlier costs in cost of goods sold. During the period of rising price FIFO yields the highest
possible net income because cost of gods shows the earliest costs incurred, which are lower
during inflation. Another reason for this is that the business tends to raise selling price as cost
increases, in period of declining price FIFO tends to charge the order and the highest price
against revenue, thus reducing income.
Advantage of FIFO Method
 Increased income is reported in periods of rising price or inflation

 The assumption as to flow of costs normally approximates the physical
flow of goods; hence, FIFO is usually realistic cost flow assumption.
 Because ending inventory represents the latest costs, inventory balance on
the balance sheet approximates current replacement costs and realistic
inventory figure.
 There is a little opportunity for profit manipulation because FIFO assigns
costs in order of their incurrence.
Disadvantage of FIFO Method
 Increase tax payments due to increase income in periods of inflation

 Earliest cost of goods sold are matched with recent sales resulting poor
measurement of income
 Due to increase tax payments in period of general price rising firms using
FIFO suffer lesser cash flow.
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Last in first out (FIFO) Method: LIFO method assumes that the cost of last item
purchased should be assigned to the first item sold and that the cost of ending inventory should
reflect the cost of goods purchased earliest. The effect of LIFO is to value inventory at the
earliest prices and to include the cost of most recently purchased goods in the cost of goods sold.
The LIFO methods tend to show a smaller net income during inflation period and larger net
income during deflation period than other methods of inventory valuation.
Advantage of LIFO Method
 Provides tax benefit in inflationary situation due to reduced income

 Latest costs of the goods sold are matched against recent sales resulting in better
measurement of income
 The tax benefits realized in periods of rising prices result in improved cash flows
Disadvantage of LIFO Method
 Reduced income in periods of general price rises.

 Because of inventory represents earliest costs, inventory balance at year end
deviate from current replacement costs. As a result, LIFO reports unrealistic
inventory figure on the balance sheet.
 The LIFO assumes as to the flow a cost does not match with the physical
movement of goods, hence LIFO is the unrealistic cost flow assumption.
2.3 Inventory System
To assure the quantities of inventories on hand business organization may use 2 main inventory
systems:
 The periodic inventory system

 Perpetual inventory system
Periodic inventory system: as the name implies when the periodic inventory system is used, the
amount of inventory on hand is determined only periodically. As a result when periodic
inventory system is used a physical count of inventory is required, and the cost of goods sold is a
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residual amount that depend on the amount of ending inventory. Under this system the balance in
inventory account is adjusted only when the physical count is made.
Accounting Features of Periodic Inventory System
 Purchase of inventory are debited to purchase ledger account

 Transportation costs, purchase return and allowance and purchase discount
are recorded in respective separate account
 Cost of merchandise sold is recognized only at the end of fiscal year after
physical inventory are taken.
 The merchandise inventory account only shows the balance is adjusted at
the end of the period.
Perpetual inventory system: when perpetual inventory system is used there is continuous
record of changes in inventory. With the help of computer technology, however the perpetual
inventory system can also be applied for larger quantities of small unit cost items. To confirm the
inventory figure available from accounting records, physical inventory items should be taken at
least ones during the fiscal year. Hence the perpetual inventory procedure continually indicates
the balance of inventory.
Accounting features of perpetual inventory system
 Purchase of inventory are debited to inventory ledger account

 The transportation charges, purchase return and allowance and purchase
discount are recorded in inventory record account
 Cost of merchandise sold is recognized each time a sales of inventory is
made
 Inventory is controlling account that is supported by subsidiary ledger for
each individual item. Besides the inventory account is increased and
decreased by the merchandising transactions through the fiscal year.
(Kassu, etal, July 2005).
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2.4. Risks and Costs of holding Inventory
There are various risks and costs involved in the inventory holding. These are:
Capital cost: - maintaining of inventories result in blocking of the firm’s financial resources.
The funds may be arranged from own resources or from out sides, in the fore more cases there is
an opportunity cost of investment, while, in the latter case to firm has to pay interest to the out
sliders.
Storage and handling costs:-The storage cost includes rental of the go downs, insurance
charges etc.
Risk of price declines: - This may be due to the increased a market supplies consumptions or
general depreciation in the market.
Risk of obsolescence: - the inventory may become obsolete due to improved technology, change
in requirements and change in customers.
Risk of deterioration in quantity: - the quantity of material may also deteriorate while the
inventories are keeps in store.
2.5. Inventory Management

The management of inventories involves achieving the balance between holding excessive and in
sufficient amounts. Both excessive and inadequate inventories are not desirable. These are two
danger points in which the firm should avoid. So that it is necessary for every management to
give proper attention to inventory management. A proper planning of purchasing, handling
storing and accounting should from a part of inventory management. An efficient system of
inventory management will determine:-
 What to purchase
 How Mach to purchase
 From where to purchase
 Where to store.
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The objective of inventory management should be determine and maintained optimal level of
inventory investment. The optimal level of inventory will lie between the two danger points of
excessive and insufficient inventories. The firm should always avoid a situation of over
investment and under investment in inventories.
The major dangers of over investment are:
 Excessive carrying costs

 Unnecessary tie up of firms fund and loss of profit
 Risk of liquidity
The excessive level of inventory consumes funds of firm which cannot be used for any other
purpose. And thus it involves an opportunity cost. The carrying cost such as the cost of storage,
handling insurance, recording in inspection also increases in the proportion volume of the
inventory.
Excessive inventories carried for long period increase the chance of loss of liquidity. It may not
be possible to sale inventories in time and at full value. Another danger of carrying excessive
inventory is the physical deterioration of inventories while in storage. In this case certain goods
or raw materials deterioration occurs with the passage of time. (Im pandey, 1995).
2.5.1. Objective of Inventory Management
The main objectives of inventory management are operational objective and financial objectives.
Operational objective means that the materials and spares should be available in sufficient
quantity so that work is not distributed for what of inventory. Financial objective means that
investment in inventories should not remain idle and minimum working capital should be locked
on it.
In this case, an effective inventory management should have the following objectives.
 To ensure continuous supply of materials spares and finished goods so that

production should not suffer at any time and the customer demand should
also be meeting.
 To avoid both over stoking and under stoking of inventory
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 To maintain investment in inventories at optimum level as required by the
operational and sales activities.
 To keep material cost of under control so that they contribute in reducing
cost of production and overall costs.
 To eliminate duplication in ordering or replenishing stokes. This is possible
with the help of centralizing purchases.
 To minimize loss through deteriorations, wastage, and damages.
 To insure perpetual inventory control so that materials shown in stock
ledger should be actually laying in the store.
 To ensure right quality of goods at reasonable price
 To facilitate the furnishing of date for short term and long term planning
and control of inventory. (David w, 1962).
2.6. Tools and Techniques of Inventory Management and Control

The followings are the most important techniques usually adopted in different industries. These
are: Maximum stock level, Minimum stock level, Danger level, Re order level, Economic order
quantity, Average ordering quantity, ABC analysis and Material requirement planning.
A. Maximum stock level: maximum level quantity of an item should not be allowed to
increase. The maximum quantity of an item can be held in stock at any time. The following
factory should be considered while fixing the maximum stock level.
Availability of capital, Availability of floor space, Cost of capital, Possibility of fluctuation
, Risk of obsolescence, Cost of insurance, Economic order quantity, Average rate of

consumption, Seasonal nature of supply.
Maximum stock level can be calculated as follows:
Maximum stock level= re order level + re order quantity
B. Minimum stokes level:-minimum stoke level indicates the minimum quantity of material to
be maintained in stoke. Accordingly, the minimum level quantity of an item should not allow
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falling. The minimum stoke level is also known as safety stoke, Buffer stoke. This can be
calculated as follows.
Minimum stoke level = re order level-(normal consumption × normal reorder point.
C. Danger level: - is stoke level below the minimum level. This level indicates the danger point
to affect the normal production. When materials reach danger level, necessary steps should
be taken to restock the materials. The formula for determine danger level is:
Danger level =average rate of consumption × emergency supply time.
D) Reorder level: - this reorder level is termed as ordering level. It indicates when order orders
for its fresh supply. This is the stoke level between the maximum stoke level and minimum stoke
level. The reorder level is fixed on the basis of economic order quantity, lead time, and average
rate of consumption. Reorder level can be calculated as:
Reorder level=minimum level+ consumption during the time to get fresh delivery or:
Reorder level=minimum consumption × maximum reorder period.
E) Economic order quantity: - economic order quantity is one of the important techniques used
to determine the optimum quantity or number of orders to be placed from the supplier. The main
objective of EOQ is to minimize the cost ordering, cost caring materials, total cost of production.
EOQ =√ 2AB/CS where EOQ= economic order quantity

A= annual consumption
B=buying cost per order
C= cost per unit
S =storage and caring cost per annum
15
Q Maximum inventory
average inventory
Q/2
Reorder point
R
0
a b c d e f
TIME
Q= lot size
Q/2= average inventory
Ac = ce = interval between orders

ab = cd = ef = lead time
EOQ have the following assumptions:
1. Demand rate is constant, uniform, recurring and known

2. Lead time is constant and known
3. Price per unit of production is constant
4. Inventory holding cost is based on average inventory
5. Ordering and setup cost are constant
6. All demands will be satisfied (Drum, 1995).
F. Average stock level: average stock level is determines on the basis of minimum stock level
and reorder quantity. Average stock level can calculate as:
Average stock level =Minimum stock level +1/2(reorder quantity) or Average stock
level=minimum level + maximum level/2.
G) ABC Analysis: - is one of the most important techniques which is based on the items
according to importance of materials. This method is popularly known as Always better control
and this is also termed as proportional value analysis. In inventory control this technique is helps
to analyze the distribution of any characteristics by money value of importance in order to
16
determine its importance. Accordingly, materials are grouped in to three categories: those are on
the basis of money value of importance of materials. These are:-
 High value material-A

 Medium value of material-B
 Low value of material-C
One of the chief methods to practice selective inventory control is through ABC classification
scheme. In inventory it is frequently advantageous to divide inventories in to three classes: A,B,
and C. The class is high value items whose dollar volume typically accounts for 75-80% of the
value of the total inventory, while representing only 15-20% of the inventory items. It therefore
represents the most significant few. At the other extreme class C contains 5-10 of the inventory
value but 60-65% of the inventory items. These items are low value items with very little
contribution to the dollar value of inventory. In the middle is class B that contains 10-15% of the
value of the inventory, and representing 20-25% of the inventory item.
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100%
90Typical ABC
Inventory
80
model
A B C
70
60
40
20
0 20 40 60 80 100%
Advantage of ABC Analysis
 Exercise selective control is possible

 Focus high attention on high value item is possible
 It reduces clerical effort and cost
 Facilitate better planning and improve inventory turnover
 It facilitates goods stock keeping and effective material handling. (Chandra Bose, 2006).
H) Material requirement planning: - Manner at specific points in time. Therefore, although the
demand for the final product may be continues and independent, the demand for the lower level,
subordinate items composing the product tends to be discrete, derived, and dependent.
Demand should be forecasted only when it cannot be calculated. Independent demand items
should be forecasted, while dependent demand items should be calculated via a bill of materials
explosion.
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Different demand patterns call for different approaches to inventory management. For
independent demand a replenishment approach is appropriate. As the stock is used, it is
replenished in order to have materials on hand for customers. Thus an inventory begins to run
out, an order is triggered for more material and the inventory is replenished.
For dependent demand items, a requirements approach is used. The amount of stock ordered is
based on requirements for higher level items. Dependent demand items need not be forecasted
but are calculated by the MRP system from the master production schedule. Dependent demand
exhibits a lumpy, on again, off-again pattern because production is typically scheduled in lots. A
quantity of parts is required and is made available when needed, not before and not after.
Although MRP system is applicable in manufacturing, construction, merchandising, and service
giving organizations most inventory in manufacturing enterprises should be controlled by an
MRP system because their demand is dependent.
Basic elements of MRP

The three major inputs of an MRP system are the master production schedule, the inventory
status records, and the product structure records. Without these basic elements, the MRP system
cannot function. The master production schedule outlines the production plan for all end items.
The product structure records contain information on all materials, components and
subassemblies required for each end item. The inventory status records contain the on hand and
on order status of inventory items.
Master Production Schedule (MPS)
The purpose of master scheduling is to specify the output of the operations function. Master
scheduling dives the entire material planning process. The demand for end items is scheduled
over a number of time periods and recorded on a master production schedule. The master
production schedule expresses how much of each item is wanted and when it is wanted. The
planning horizon of the master production schedule should be large enough to cover the
cumulative procurement and production lead times for all components and assemblies
composing the end items. The MPS is developed from end item forecasts and customer orders.
One of the functions of master scheduling is to make sure that the final master schedule is not
inflated and reflects a realistic capacity constraint. As a result of inflated master schedule, the
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order priorities (due dates) are no longer valid. The formal MPS system then quickly breaks
down and the informal planning and control system takes over. The result is many past due
orders, expediting, and stock chasing to get the product out at the door. Therefore, the master
production schedule must project a realistic plan of production that is leveled to accommodate
the available capacity.
The Product Structure Records
The product structure records, also known as bills of materials (BOM) is an inclusive definition
of a product that includes a structured list of items, ingredients, and/or materials needed to
produce end items. The master production schedule shows how much of each end item must be
available on particular dates to satisfy the independent Some manufacturing operations are
managed in a more or less chaotic way. We might find that inventories are swollen, parts are
being expedited to get orders out on time, a pressure-cooker atmosphere prevails. It is now
possible to remedy this situation through use of a new computerized planning and control system
called Materials Requirement Planning (MRP).
Material requirement planning (MRP) is a computer based production planning and inventory
control system. It is essentially a planning system providing a precise schedule of priorities of
production and a rescheduling mechanism for revising plans as changes occur, keeping inventory
at a low level while assuring that required materials are made available only when needed.
The major objectives of MRP are to:
1. Ensure the availability of materials, components, and products for planned production
and for customer delivery.
2. Maintain the lowest possible level of inventory,
3. Plan manufacturing activities, delivery schedules and purchasing activities.S

It is the attainment of these objectives concurrently that makes MRP worthwhile.
Basically it is most suited to a large manufacturing organization which produces some

components in its own workshops, buys some components from suppliers and ultimately
20
assembles them all into a fairly complicated finished product. To mention a few, examples are
manufacture of motor cars radio, television, electricity generators.
The concept of the system is that production control and inventory management are integrated.
This is done in such a way as to ensure that raw materials and components are only made
available when they are actually required, and not before. At the same time a similar principle is
applied to work-in-progress in the production shops. Each operation in a component is managed
so that when completed, the next part of the production line will be ready to receive it and put it
though the next operation without delay and also without accumulating large quantities of work-
in-progress between operations.
A crucial distinction in inventory management is whether demand for an item is independent or

dependent. Independence means no relationship exists between the demand for an item and any
other item, such as end products. Independent demand is influenced by market conditions outside
the control of operations. Thus it tends to be continuous and fluctuates because of random
influences. Finished goods inventories and spare parts for replacement have independent
demand. In contrast, dependent demand is related to or the result of the demand for a higher level
item, and is not independently determined by the market. When products are building up from
parts, components or assemblies, the demand for these materials is dependent on the demand for
the final product. Dependent demand is not random but tends to occur in a lumpy demand. The
quantities of components required to build the end item can be derived from the bill of materials.
Information on each item, such as part number, description, quantity per assembly, unit of
measurement, next higher assembly, and quantity per end item must be available. The product
structure records contain the bills of materials for the end items in levels representing the way
they are actually manufactured: from raw materials to subassemblies to assemblies to end items.
The Inventory Status Records
The inventory status records contain information on the status of all items in inventory. All
inventory items must be uniquely identified. These records must be kept up to date, with each
receipt, disbursement, or withdrawal documented to maintain record integrity. They should also
contain information on lead times, lot sizes, or other item peculiarities. MRP will determine form
the master production schedule and the product structure records the gross component
requirements will be reduced by the available inventory (on hand plus on-order) as indicated in
21
the inventory status records. Quantities of items in inventory at the start of a planning horizon are
available for use and are referred to as "on-hand". "on-order" quantities are those that are
expected to become available during a planning horizon form open work orders or open purchase
orders. MRP takes into account both on-hand and on order quantities.
The MRP Computations
The computations and steps in the MRP process are not complicated. They involve a simple
arithmetic as shown in the following:
1) Gross requirements: the total anticipated production, Use, or withdrawals during each time
period. For end items, this quantity is obtained from the master production schedule
(independent demand items); for components (dependent demand items) it is derive from the
"planned order releases" of their parents.
3) Projected on hand: the expected quantity inventory at the end of the period, available for
demand in subsequent period 2) Scheduled receipts: material that is already ordered (from
manufacturing orders or purchase orders) that is expected to arrive (also known as on order, open
orders, or scheduled orders).
from the "scheduled receipts" and "planned order receipts" for same period as well as the
"projected on hand" form the previous period. When "safety stock" is maintained and' or units
are "allocated" to future orders, these amounts must be added to the gross requirements before
calculating the "projected on hand".
4) Net requirements: the reduction of "gross requirements" by the "scheduled receipts" in the
period plus the "projected on hand" in the previous period. Thus indicates the net number of
items that must be provided to satisfy the parent or master schedule requirements.
5) Planned order receipts: the size of the planned order (the order has not been placed yet) and
when it is needed. This appears in the same time period as the "net requirements," but its size is
modified by the appropriate lot sizing policy. It shows when the order is needed in stock. With
lot sizing planned order quantity will generally exceed the "net requirements." Any excess
beyond the "net requirements" goes into "projected on hand" inventory. With lot-for-lot ordering,
the "planned order receipts" is always the same as the "net requirements."
22
6) Planned order releases: when the order should be placed (released) so the items are available
when needed by the parent. This is the same as the "planned order receipts" offset for lead times.
"Planned order releases" at one level generate material requirements at lower levels. When the
order is placed, it is removed from the "planned order receipts" and "planned order releases"
rows and entered in the "scheduled receipts" row. "Planned order releases" show the what, how
many, and when of MRP.
2.7. Concept of Internal Control

Internal standards of auditing ISA (1999) defined internal control as comparing of internal
environment and control procedure. Horogren and Harrison (1992) define internal control as the
organization plan and all related measures adopted by entity safeguard assets ensure accurate and
reliable accounting records promote operational efficiency and encourage adherence to company
polices. Internal control includes administrative control and accounting control.
I. Administrative control: - Includes the plan of the organization methods and

procedures that help managers achieve operational efficiency and adherence to
company polices.
II. Accounting control: - Includes the methods and procedures that safeguard the asset,
authorized transaction, and ensure accuracy of financial records. This accounting
control can be classified in to two; these are :-
 Preventive control
 Detective control
Preventive control: - Is designed to prevent undesirable results before they happen. Thus they
can avoid errors and reduce costs of corrections. Preventive control includes hiring of trust
worthy and competent people. Separation of duties to prevent intentional wrong doing, proper
authorization to prevent improper use of organization resources.
Detective control: - Are designed to identify the undesirable results when they do happen. These
controls are more expensive than preventive controls, but they are very important to know the
reason.
They measure the effectiveness of preventive controls
23
Some errors cannot be effectively controlled through a system of
prevention. They must be detected when they occur.
Detective controls include reviews and comparison of documents, physical count of

inventories and analysis of variances. Therefore, internal controls are policies and procedures
established in the organization to authorize transactions in order to ensure the accuracy of
financial records and to provide the assurance that organization objectives will be achieved.
Internal control include s all policies and procedures adopted by management of an entity to
assist in achieving their objectives as far as practicable. The controls are aimed at aiding
management in charring on business in an orderly and efficient manner and showing
transparency and accountability of polices in such as stock control through professional
ethics and following routine practices. (Horngren, Herrison, 1992).
2.7.1 Objective of Internal Control

The main objectives of internal control system are to ensure that:-
 The orderly and efficiency conduct of the business

 Adherence e to management polices
 The safeguarding of the asset
 The prevent of fraud and error
 Accuracy and completeness of the accounting record
 The timely preparation of reliable financial information
Despite the emphasis on the objective of internal controls most organizations have failed to
achieve the objectives due to different hindrance like incompetent personnel, human error,
collusion and procedures being directed at routine transaction most of the time. (Saxena,
1997)
2.8. Inventory Control
Inventory control is concerned with accusation storage, handling, and use of the inventories
so as to ensure the availability of inventory when ever needed, providing adequate provision
for contingencies, diving maximum economy and minimum wastage and loses. Hence
24
inventory control is refers to a system which ensures the supply of required quantity and
quality of inventory at the required time and at the same time prevent unnecessary investment
in inventories. It is the most vital phase of inventory management. Reducing inventory
without impairing operating efficiency frees working capital that can be effectively employed
else were. Inventory control can make or break company. This examines the usual saying that
inventories are the blood life of the organization. Designing a sound inventory control system
is in large measure for balancing operations. It is a focal point of many seeming conflicting
interests and considerations both short range and long range. The aim of inventory control
system is to secure the best balance between too much and too little. Too much inventory
carries financial raises and too little react adversely continuity of productions of the size of
the inventory as whole. But to secure a scientifically determined balance between several
items that make up the inventory. The efficiency of inventory control affects the flexibility of
the firms. In sufficient procedures may result in an unbalanced inventory. Some items out of
stock, other over stock necessitating excessive investment. These inefficiencies ultimate will
have adverse effects up on profits. Turning the situation round, difference in the efficiency of
the inventory control for the given level of flexibility affects the level of investment required
in inventory. The less efficient is the inventory control, the greater the investment is required.
Excessive investment in inventories increase cost and reduces profit, thus, the effects of
inventory control of flexibility and the level of investment required. So that the chief aim of
inventory control is:
 To maintain a balanced inventory

 To ensure the smooth flow of production
 To keep the investment in inventory as low as possible.
2.8.1. Internal Control over Inventory
Internal control over inventory is important to any business. Because inventory is the life
blood of merchandiser. Horngren and Harrison (1992) argue that successful companies take
care to protect their inventories.
2. 8.2. Elements of Good Internal Control over Inventory
25
Good internal controls over inventory have the following elements:
Physically counting inventory at list once each year no matter which system is
used.
Maintaining efficiency purchasing, receiving and shipping procedures.
Limiting access to inventory to personnel who do not have access to the
accounting record
Storing inventory to protect it against theft damage and decay.
Keeping perpetual inventory records for high unit cost merchandise.
Purchasing inventory in economic quantities
Not keeping to large stock pilled, thus avoiding the expense of typing up money
in unneeded items. (Horngren, 1992)
2.8.3. Objective of Internal Control over Inventory

The objective of internal control is to provide adequate control mechanism over inventory
function (acquisition, storing and usage) in order to prevent or minimize opportunities for
fraud, loss, and wastage in handling inventory. The purpose of internal control over inventory
is to assure control over purchase, inventory and cost of usage.
Auditors objectives in the examination of inventories and cost of goods sold used are to
determine that:
 Internal control over inventories is adequate

 The recorded inventories are (existence and right)
 Inventories are recorded (completeness)
 Inventory records and supporting schedules are mathematically correct and agree
with general ledger accounts
 The revelation of inventory approximates the lower of cost or market method
 The presentation and disclosure of inventories is adequate
2.8.4. Procedures of Internal Control over Inventories
The following procedures are some of internal control over inventory items. Those are:
26
I. Proper authorization procedures
 Changes to master are be authorized
 The movement of inventory is properly authorized
 Standard costs are properly authorized
 Disposition of obsolete inventory are authorized and recorded
II. Use of adequate documents and records

 Master files are be maintained
 Adequate perpetual record are maintained
 A comprehensive chart of accounts for each activity is maintained
 The movement of inventory is captured in the accounting records.
III. Independent Verification of Employee Responsibilities

 Perpetual records are periodically reconciled to physical count
 Standard cost calculation compared to actual result
 Actual versus applied overhead is periodically reconciled and adjust.
IV) Physical Control
Access to inventory assets, document and records is strictly controlled and limited to authorized
person
V) Segregation of Duties
 Receiving, manufacturing, warehousing and delivery activities are properly segregated.
Accounting for inventory is properly segregated from handling of inventory
2.8.5. Functions of Internal Control over Inventory

Internal control procedures for inventories and cost of goods sold affect nearly all functions
involved in producing and issuing of the company’s products. Good internal control is a means
of providing accurate cost data for inventories and the cost of goods sold as well as accuracy in
27
reporting physical quantities. In adequate internal control may cause losses by primitive
erroneous cost data.
Purchasing, receiving, storing issuing processing and shipping are the physical functional
directly connected with inventories: the cost accounting system and perpetual inventory records
comprise the recording function.
function. (Meigs, etal).
2.8.5.1. The Purchasing Function
Adequate internal control over purchase requires, first of all, an organizational structure that
delegates to a separate department of the company exclusive authority to make all purchases of
materials and service. The purchasing receiving and recording functions should be clearly
separated and lodged in separate department. In small companies, this type of department
operation may not be possible, but even very small enterprise: it is usually feasible to make one
person responsible for all purchase transactions.
Serially numbered purchase order should be prepared for all purchases, and copies forwarded to
the accounting and receiving departments. The copy set receiving should have quantities
blacked out to increase the probability that receiving personal will make independent counts of
the merchandise received. Even though the buyer may actually place an order by telephone, the
formal purchase order should be prepared and forwarded. In many large organizations, purchase
order should be prepared and compliance with extensive procedures for: (1) determining the
need for the item, (2) obtained competitive bids, and (3) obtaining approval of the financial
aspect of the commitment.
2.8.5.2. The Receiving Function

All goods received by the company- without exception- should be cleared through a received
department that is in depended of purchasing, storing and shipping department. The receiving
department is responsible for (1) the determination of quantities of goods received, (2) detection
of damage of defective merchandise, (3) the preparation of a receiving report, and (4) the prompt
transmittal of goods received to the stores department.
28
2.8.5.3. The Strong Function
As goods are delivered to stores, they are counted, inspected, and receipted for. The stores
department will than notify the accounting of the amount received and place it in stock. In
performing these functions, the stores department makes an important contribution to overall
control of inventories, by signing for the goods, it fixes its own responsibility, and by notifying
the accounting department of actual goods stored, it provides verification of the receiving
departments work.
2.8.5.4. The Shipping Function
Shipment of goods should be made only after proper authorization has been received. The
authorization will normally be a sales order approved by the credit department, although the
shipping function also includes the returning of defective goods to supplier. In this latter case,
the authorization may take the font of shipping advice from a purchasing department executive.
One copy of the shipping authorization will go to the stores department: a second copy will be
retained by the shipping department as evidence of shipment: and a third copy will be enclosed
as a packing slip with the goods when they are shipped. These forms should be pre-numbered
and kept under accounting control. The control aspect of this procedure is strengthened by fact
that an outsider, the consumer will inspect the packing slip and notify the company of any
discrepancy between this list, the goods ordered, and the good actually received.
When the goods have been shipped, the shipping department will attach to a fourth copy of each
shipping order the related evidence of shipment: bills of lading, racking bills, carrier’s receipts,
freight bills, and so on. This facilities subsequent audit by grouping together the documents
showing that were probably authorized and carried out. The shipping advice, with supporting
documents attached, is then sent to the billing department, where it is used as the basic of
invoicing the customer.
2.8.5.5. The Production Function

The production department must generate scrap reports that accounting can reflect the movement
of materials in the books and determine accurate cost of production. This department is
responsible for the determination of the type and quantities of production.
29
With in various production department provision, must be made to allow for the quantities
produced, control of scrap quality controls, and physical protection of the material in process.
The system of internal control over goods in process may include regular inspection procedures
to revel defective work. From time to time, materials delivered to the factory until they are
completed and moved to a finished goods store room, designated supervisory should be control.
Control procedures should also assure that goods scrapped during the process of production and
promptly reported to the accounting depart
30
CHAPTER THREE
DATA ANALYSIS AND INTERPRETATION
Introduction
This chapter deals with data analysis and interpretation. It is divided in to two broad sections.
The first section presents analysis of secondary data and the second section is concerned with
primary data analysis. Each main section is further divided in two sub-sections. In all the cases
analysis and interpretation are made.
3.1 Secondary Data Analysis
Under this section analysis of data obtained from secondary sources is provided. Data obtained
from the audited financial statements of the company from 2010 to 2013 are analyzed first and
followed by inventory policy manuals of the company and cost of gods sold schedule.
3.1.1. Financial Statement Analysis

This financial statement analysis related to the inventory management. This section deals with
the analysis of interval measure, inventory turnover, days, of inventory holding (days sales
inventory), profit margin, return on asset (return on investment), return on equity, raw material
inventory turnover and work in process inventory turnover.
Interval Measure: measures the period of time a firm stays in operation while its cash is drying.
Interval measure = current asset – inventory/ average daily operating expense. Based on the
above formula the researcher wants to calculate the interval measure for the four years.
31
Table 3.1 interval measure
Item Year ( 2010- 2013)

Interval measure 2010 (2002) 2011(2003) 2012(2004) 2013(2005)
805 days 1375 days 1577 days 3003 days
Source (audited financial statement, 2010 – 2013)
From the above table the factory in 2010, 805 days in 2011, 1375 days in 2012, 1577 days and
in2013, 3003 days respectively. This interval measure indicates it has a sufficient liquid asset to
finance its operation. Therefore, the factory has higher interval measure in 2013 and lower
interval measure in 2010.
Inventory turnover: - measures of the rate at which inventories are sold.
Inventor turnover = cost of goods sold/inventory.
Table 3.2 inventory turnover
Item Year
Inventory turn
over 2010 2011 2012 2013
1.73 times 1.19 times 1.13 times 1.50 times
Source: Audited financial statement (2010- 2013)
This table also shows, the inventory turnover of the factory that means the inventory of the
factory is sold on average 1.73 times 1.19 times 1.13 times 1.50 times in 2010, 2011, 2012 and
2013 respectively. In 2013 the factory has the highest inventory turnover which is 1.50 times.
This indicates the factory have good inventory management in 2013 and lower inventory
management in 2012 because of lower inventory turnover which is 1.13 times.
Day’s sales in inventory (day’s inventory holding): - it is the length of time inventory retains
unsold.
Days sales in inventory = 365 days/ inventory turnover.
Table 3.3 Days sales in inventory
32
Item Year
Days sales in 2010 2011 2012 2013
211 days 307 days 323 days 243days
inventory
Source: audited financial statement (2010- 2013)
The above table is shows the length of time in which inventory of the factory is retained unsold.
This is in 2010; 211days in 2011, 307 days in 2012, 323 days and in 2013, 243days is the
inventory age period. The maximum day waits the inventory unsold is 323 days in 2012 and the
minimum day is in 2011 which is 211 days.
The researcher wants to calculate the profitability ratio in order to know the performance of the
factory.
Profitability ratio: - measures the ability of the factory to generate the profit or the net income.
1) Profit margin = net income / sales
Table 3.4 profit margin
Item Year
Profit margin 2010 2011 2012 2013
11% 10.9% 7.4% 11.5%
The above table shows that the profit margin of the factory for the four years respectively. In
2010 the factory generate 11% profit sales, in 2011 10.9% profit is generated from sales, in 2012
7.4% and 11.5%in 2013.From this the researcher concludes that in 2013 there was a higher
profit(11.5%) this shows the factory operating efficiency has been good during 2013.
Generally, the factory profit margin is decreased from year to year (2010-2012). So the operating
efficiency was not good during this year’s.
Return on Asset: it measures the efficiency of the firm ability to utilize its asset. It can be
calculated as: Return on asset = net income/ net asset, so that the researcher has calculated ROA
for four years.
Table 3.5 return on asset
33
Item Year
Return on asset 2010 2011 2012 2013
= net income
11.8% 8.66% 5.5% 10.3%
/net asset
This table shows the return on investment of the factory for four years. This is for each one
invested in total asset 11.8% are generated as profit in 2010, 8.66% in 2011, 5.5%in 2012and
10.3% 2013.
In 2010 there have a maximum return on asset generated as a profit which is 11.8%and the
minimum return on asset is in 2012 which is 5.5%.
Return on equity: measures the firm’s ability to generate net income to its shares holders for
each birr invested. The higher rate of return implies the factory can generate sufficient returns of
share holders. It is calculated as
Return on equity= net income /total equity
Table 3.6 Return on equity
Item Year
Return on 2010 2011 2012 2013
equity= net
8% 10% 9.6% 33%
income/total
equity
Source: audited financial statement (2010- 2013)
As shown from the above table the higher rate of return was registered during the year of 2013
which was 33%. This shows the total equity was less in number as compared with the other
year. In 2010 the return equity is lower due to increment of o the total equity.
Raw material inventory turnover = material consumed/average raw material inventory
Average raw material inventory = raw material begging + raw material ending/2
34
Material consumed = begging balance - ending balance
Table 3.7 raw material inventory turn over
Item Year
Raw material inventory turn 2012 2013

over 0.61 0.69
Source: Schedule of cost of goods sold 2012& 2013.
From the above table the inventory of raw material for 2012 and 2013 is 0.61 and 0.69
respectively. The factory holds 590 days (360/0.61) and 522 days (360/0.61) in 2012 and 2013
respectively. From this in 2013, the factory has better inventory management. Because the
inventory turnover is higher than in 2012.
Work in process inventory turnover =cost of production/average work in process inventory.
Cost of production=Material consumed + Manufacturing expense +beginning balance-ending

balance of work in process inventory turnover
Table 3.8 work in process inventory turnover
Item Year
Work in process inventory 2012 2013
turnover 18 26.35
Source: schedule of CGS 2012/2013
From the above table the work in process inventory turnover for 2012 were 18 and for 2013 were
26.35. This indicates the increase of work in process inventory by 8.35. From this the researcher
Can conclude there was better inventory management in 2013 than 2012.
3.1.2 Analysis of Inventory Policy Manuals

This section deals with ABC system uses for raw materials and packing material, minimum
inventory policy, maximum inventory policy, re order level policy of the factory.
Table 3.9 ABC system for the factory
35
Raw materials units Unit Annual %of Category
cost material Value commutative
required usage
qty
Amoxicillintrihydrate Kg 512.40 79,381.33 40,674,995.2 21.048 A
3
Sugar total Kg 14 842,820.03 11,799,480.4 47.098 A
0
White bees wax total Kg 1,828.9 938.84 1,714,639.52 80.405 B
0
Parecetamol total Kg 65 14,488.40 941,745.94 90.607 B
Super total Kg 604 1,080 652 320 93.476 C

Starch total Kg 14 27 175.11 380,451.56 95.755 C
Source: ABC analysis of 2012/2013
 According to the above table raw materials are grouped based on the usage value as A,B
and C categories. From this material that have 21.04% and 47.09% usage value are
classified as category A. These types of materials are required care full control, more
effort to reduce lead time, low safety stokes and consumption value. In addition to this
materials that are grouped under category B have a usage value of 80.4% and 90.6%. this
types of materials are also contains moderate control ,size of order based on usage,
moderate effort to reduce lead time, large safety stoke , average consumption value.
Materials grouped under category C; are 93.4% and 95.75% and they require maintain
lose control, lower consumption value and minimum effort, size of order based on
inventory, very large safety stoke (3 month consumption).generally the factory uses ABC
analysis as an effective tool in material management. Because it is applicable in:
 Information of items which require higher degree of control
 Stock records
 Recording strategy
 Priority treatment to different items
 Determination of safety stoke
 Stock lay out
36
By assuming the lead time four months we have exercised the following proposal for
establishing inventory policy.
Table 3.10 Minimum inventory policy/softy stoke
Types of inventory Quantity Minimum stoke level

Active pharmaceutical - 1 month consumption
ingredients
Common inactive:
a. Common in active >1 and <4products 2 months
b. Common in active >5and <10 products 2.5 months
for
c. Common in active >10 products 3 months
for
d. For ethanol and sager - 2months
For imported packing - 1 months

material
For local available packing -
materials 1 months
Source: written document 2010

From the above table the minimum stoke level for active pharmaceutical ingredients,
imported packing material and local available packing materials are equal which is 1
month.
Re order level: reorder level= softy stokes+ Lead time consumption

According to the policy of the factory the lead time for imported material is 4 months and
2 months for local purchase materials
Table 3.11 Re order level
Inventory type Reorder level

Imported packing materials 1+4 = 5 months
37
Inactive materials 2+4 = 6 months
Local available raw materials 1+3 =4 months
Local available packing materials 1+2 =3 months
As we have observed from the above table there order level of imported materials and
local purchase material is 5 months, for the in active materials and imported packing is 6
months and for local available raw material and local available local raw material are 3
and 4 months respectively.
Table 3.12 Maximum stoke level
Inventory type Quantity Maximum stock level

Active raw material <500kg 5+12 = 17 months
>500 <1000kg 5+6 = 11 months
>1000kg 5+3 = 8 months
Inactive materials < 1000 kg 12+6 = 18 months
>1000 <10000 kg 6+6 = 12 months
>10000 kg 3+6 = 9 months
Imported packing materials < 500 kg 12+6 = 18 months
>500 kg 6+6 = 12 months
Local available raw materials 3+3 = 6 months

From the above table the maximum stoke level of active materials which have quantity< 500kg,
>500kg, <1000kg and >1000kg is 17,11and 18 months respectively. For inactive raw materials with
the quantity of >1000 kg <10000kg and > 10000kg is 18, 12, and 9 months respectively. And for
imported packing materials <500kg and > 500kg quantity 18 and 12 month consumption and for
local available raw materials 6 month consumption.
3.2 Primary Data Analysis

This second major section of chapter is deals with analysis of data obtained from primary source.
This primary data was gathered through interview with the ware house manager and finance
manager. Hence, interview conducted with the ware house manager is presented first followed
38
by that of the finance manager. In both cases the questions raised are provided followed by the
responses given with the required analysis and interpreted.
3.2.1 Analysis of Interview with the ware house Manager

The first question asked to the ware house manager was "What is the reason for choosing ABC
analysis for your factory? Is that any difference among the employees who keep A, B and C
materials? By what criteria are they assigned?"
According to the ware house manager the factory chooses the ABC system of inventory
management control due to the following reasons:
Firstly ABC analysis shows more material criticality; secondly it shows the effect of the factory,
and thirdly, it shows the capital amount of the factory, Lastly It relates with the profit of the
factory,
When it is compared with the other systems ABC analysis shows all listed in the above,
where as the other systems are shows the only the movement of the company. Due to the above
reasons the factory uses the ABC system inventory control. In addition to this the manager says
that our materials are grouped as A, B and C categories. C” materials are not required store
keeper as much, B “materials are requires medium controlling and A “materials are requires
amore management control due to the following reasons;
 Material A shows more investments

 It shows the income of the factory. To this type of materials it needs a serious keeping
and controlling. To keep this type of material in previous time we use the person who
have diploma, but currently we use the person who have a degree level of education
and more honest liable to keep the materials.
The second question asked to the ware house manager was “When is takes place the
material purchase? How many times purchase the materials within one year? How much
materials are purchase on average at one time?”
The ware house manager also answered question no 2 as follows. The respondent said that
inventories are purchased quarterly that means three times within one year. But there is a
39
difference depending up on the type of inventories. Sometimes inventories are purchased at the
end of the year cumulatively and purchased semi annually. Regarding to this within one year the
average inventory purchased is approximately 40 million.
The third question asked to the ware house manager was “At the time of receiving the
inventories what are the methods and forms to be use?”
According to the ware house manager question no 3 answered as follows:
He was responded that inventories are receiving through the following forms:
 Purchase requisition: it shows the quantity and the price of the inventory
 Invoice: prepared by the supplier which includes the quantity and the price of the
inventory
 Packing list:
 Purchase order
 Certificate of analysis: shows list of inventories and their amount
 Goods acknowledgement(internal document )
 Quality purchase control
 Goods received: it shows the list of inventories and have passed and rejected. If it is
rejected the supplier con not allowed to pay any payment of amount.
The 4th question asked to the ware house manager was “What is the method to be use when
inventory is goes to the production process and what are the forms to be use?
This question is also answered by the ware house manager. He said that firstly, the production
department writes a letter to the ware house department about the amount and the requirement of
the inventories. Then after, the production department and the ware house department exchanges
the following forms store requisition, work order requisition and work order and by using the
FIFO method which is the computerized system the inventories are goes to the production
process.
40
The 5th question asked to the ware house manager was “when the counting of inventory is
takes place? How much persons are parts pated in the counting?”
According to the ware house manager the physical counting of the inventory is at the end of the
period. This indicates the factory uses the periodic inventory system. After counting the
inventories the amount that is count by the employees is reconciled with the finance record. If
any error is occurred it must be reason out at the end.
The 6th question asked to the ware house was “Does the factory have shortage of raw
materials during the production process? How many times?”
As the researcher obtained information from the manager there is a shortage of raw materials
during the time of production process due to the following reasons
 Our materials are comes from the foreign countries

 Lake of experienced management
 Due to the external factors like gimruck, foreign exchange and banks
 Lake of smooth supply
Due to all reasons the factory has shortage of materials during the production process.
The 7th question asked to the ware house manager was “Does the factory occurs any
obsolesce of materials? How many times?”
According to the opinion of the ware house manager of the factory material obsolesce in
finished goods is small, but large in raw materials due to the following reasons
 The existence of bad planning

 The fluctuation of demand / market
 At the time sipping
Due to the above reasons materials are deteriorated, but it is not known the specific amount the
materials
The 8th question asked to the ware house manager was “Does your factory is uses the EOQ
system?”
41
The respondent says that EOQ is not applicable in our factory. Because it only allows the
required material at the required time only. So that our factory uses material requirement
planning (MRP) rather than economic order quantity because it is more computerized system.
But our lead time is estimated lead time.
The last question asked to the ware house manager was” Does the store room for raw
materials and finished products are different? Is that enough store for this materials?”
The answer related to this question is given by the ware house manager. He said that it is not
allowed to put different materials in one ware house /store/ and he says that we have different
stores. Those stores are contains their own separate materials.
3.2.2 Analysis of Interview with finance Manager

The 1st question asked to the finance manager was “What is the inventory valuation used
by the factory?” This question is answered by the finance manager of the factory. He said that
in previous our factory uses FIFO method but it is too difficult to separate the income of the
factory. Rather our factory currently uses the average cost method due to the simplicity of
implementation it is simple to work.
The second question asked to the finance manager was “Does the internal control over
inventory is effective?”
According to the finance manager of the factory the internal control over inventory is effective
by the following methods: periodic counting of inventory, due to the auditing process and
reconcile at the end of the period with other records.
The 3rd question asked to the finance manager was “What is the system of inventory
applied by your factory?”
As the researcher obtained the information from the interviewee the factory uses more perpetual
inventory system. Because this method is helps for soft ware, for inventory up dating, for
knowing of cost goods sold easily. So that the researchers conclude that the factory uses more
perpetual inventory system.
42
The 4th question asked to the finance manager was “What are the procedures applied by
the factory to control its inventory?”
The finance manager said that we use different procedures to control our inventory like that of
separation of duties among the departments like finance, production, etc, record and
documentation reconciles each other documents.
The 5th question asked to the finance manager was “What are the necessary actions under
taken by the management of the factory when inventories are expired on the store?”
The manager also gives the answer for this question as he said that sometimes inventories are
expired but not always. At the time of inventory expired the management is the responsibility to
protect of materials from deterioration. Unless if the inventories are expired they are rejected.
The last question asked to the finance manager was “What type of transportation
agreement is applied by the factory?”
According to the finance manager the factory our factory uses both FOB destinations and FOB
shipping method of agreements. Fob destination is used when the inventories are exported to the
other countries; at the time of this the payment is made after the goods are delivered at the
specific place. Before that payment is not made. Fob shipping is also applied by our factory at
the time of imported goods from other countries. During this time the supplier of the inventory is
responsible until the goods are reached to inside countries.
CHAPTER FOUR
CONCLUSION AND RECOMMENDATION
INTRODUCTION
This chapter deals with the conclusion and recommendation. In order to meet the objective of the
study tried to asses all possible and available information through reading different manuals and
written documents and polices used in the factory.
43
4.1 Conclusion
From the discussion and analysis the researcher tries to conclude about the accounting
procedures and control methods over inventory in Addis pharmaceutical factory. Hence the
following conclusions are made.
 The factory uses ABC system of inventory management because of its suitability for
material criticality of the factory and the factory purchases raw materials on quarterly
basis.
 Addis pharmaceutical factory uses documents and forms at the time of receiving
materials from the supplier. Those forms are purchase requisition, invoice, packing lists,
purchase order, quality purchase control and goods received.
 The factory uses periodic inventory system to count and record its inventory.
 Addis pharmaceutical factory uses inventory valuation which is average cost method for
identifying the cost of goods sold and ending inventory on hand during the selling of
inventories.
 It also uses the FIFO method inventory valuation during the raw materials goes to the
production process.
 The factory does not use the economic order quantity (EOQ) of the material rater it uses
the material requirement planning (MRP) because it has a computerized method of
inventory management and also uses the estimated lead time.
 In Addis pharmaceutical factory there was shortage of raw materials during the time of
production process due to: Delaying of raw materials from foreign country, Lake of
experienced management ,Due to the external factors such as bank, foreign exchange
 The factory occurs obsolesce of materials due to: the existence of bad planning,
fluctuation of the market and at the time of shipping materials
 The internal control over inventory also effective in Addis pharmaceutical factory
because the factory uses different procedures like, physical counting of inventory,
separation of duties among the employee and record and documentation.
 The researcher also concludes that the operating efficiency of the factory was not much
good especially 2011 and 2012 when it compares with 2010 and 2013.
44
4.2 Recommendations
As the researcher concluded in the conclusion part he also recommended the following
points.
 To improve shortage of materials during the production process by: prompt
receipts of materials from other country, announcement of experienced
management and creating smooth supply.
 To avoid the obsolesce in the material by making: good planning in inventory
and sustainable market.
 To improve the poor inventory turn over to the future by creating good inventory
management on the factory
 To improve the poor profit margin by decreasing operating expenses and
outstanding expenses and by enhancing effective control over the expenses
 To improve the week return on investment by making efficient management
control over its expenses
 To improve return on equity by using long term loans rather than short term
loans and through retaining earning benefit of the share holders as well as by
issuing new share.
 To increase the operating efficiency by increasing the poor inventory control in
the factory.
REFERANCE (BIBLOGRAPHY)
 Impandy financial management 9th edition

 Brigham financial management 13th edition
 Www.com.apf.offical website (retrieved on December 12,2006)
 Principle of accounting 1st imprecation in July 2005
 Intermediate financial accounting 15th edition
 Impandy financial management 19th edition
 Contemporary accounting 17th edition
 Material management hand out
45
 Operations and supplies management 12th edition
 Horongren and Harison internal standards of auditing(1991)
 Principles and practices of auditing: R.g Saxena
Appendix 1
Primary Source of Data

I. Interview Questions to the ware house Manager
1). what is the reason for choosing ABC analysis for your factory? Is that any difference among
the employees who keep A, B and C materials? By what criteria are they assigned?"
2). When is takes place the material purchase? How many times purchase the materials within
one year? How much materials are purchase on average at one time?”
46
3). at the time of receiving the inventories what are the methods and forms to be use?”
4). What is the method to be use when inventory is goes to the production process and what are
the forms to be use?
5). When the counting of inventory is takes place? How much persons are parts pated in the
counting?
6). Does the factory have shortage of raw materials during the production process? How many
times?”
7). Does the factory occurs any obsolesce of materials? How many times?”
8). Does your factory is uses the EOQ system?
9). Does the store room for raw materials and finished products are different? Is that enough
store for this materials?”
II. Interview Questions to the Finance Manager
1). what is the inventory valuation used by the factory?
2). Does the internal control over inventory is effective?”
3). what is the system of inventory applied by your factory?”
4). what are the procedures applied by the factory to control its inventory?”
5).what is the necessary action under taken by the management of the factory when inventories
are expired on the store?”
6).what type of transportation agreement is applied by the factory?”
47

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ADIGRAT UNIVERSITY

COLLEG OF BUSSINESS AND ECONOMICS

(Case Study in Addis Pharmaceutical Factory)

A Research Submitted to the Department of Accounting and Finance in Partial

Submitted by: K/mariam G/yohanns

Advisor: Amanuel Tesfay (MSC)

June, 2014 G.C

Secondly, my deep gratitude to my advisor” AMANUEL TESFAY” who supported me to conduct

Table 3.1 interval measure……………………………………………………….32

Table 3.2 inventory turnover…………………………………………………….32

Table 3.3 Days sales in inventory………………………………………………...33

Table 3.4 profit margin…………………………………………………………...34

Table 3.5 return on asset …………………………………………………………34

Table 3.6 Return on equity………………………………………………………..34

Table 3.7 raw material inventory turnover………………………………………35

Table 3.8 work in process inventory turnover ………………………………....….35

Table 3.9 ABC system for the factory …………………………………………….36

Table 3.10 Minimum inventory policy/softy stoke……………………………….37

Table 3.11 Re order level……………………………………………………………38

Table 3.12 Maximum stoke level …………………………………………………...38

1.1 Back ground of the study

A proper planning of purchasing of raw materials handling, storing and recording is to be

1.2 Back ground of the organization

1.3 Statement of the problem

1.4. Objectives of the study

1.4.1. General Objective

1.4.2. Specific Objective

The followings are specific objectives of the study:

2. To identify the type inventory valuation in APF

3. To compare the inventory management with the performance of the factory

4. To identify the type inventory system used by APF

1.5. Research questions

The researcher has tried to answer the following research questions:

1. What type of inventory control is followed by APF to manage its inventory?

1.6.1 Data type and Data source

1.6.2 Data Collection Tools

1.6.3. Sampling method and sample size

1.6.4 Data Analysis and Presentation

1.7 Significance of the Study

1.8 Scope of the Study

1.9 Limitations of the Study

1.10 Organization of the paper

2.1 Over view of inventory

2.1.1 Meaning and definition of inventory

Raw material inventory

Precautionary motive: necessities holding of inventories to guard against the risk of

2.2 Methods of Inventory

Advantages of specific identification method

 Application may be difficult nor impossible at all

Advantages of average cost method

 When there is intermingling of identical units, the average cost method

Disadvantage of Average Cost Method

 Since earlier cost continuously exert their influence an inventory, value

Advantage of FIFO Method

 Increased income is reported in periods of rising price or inflation

Disadvantage of FIFO Method

 Increase tax payments due to increase income in periods of inflation

Advantage of LIFO Method

 Provides tax benefit in inflationary situation due to reduced income