RIFT VALLEY UNIVERSITY ABICHU CAMPUS

DEPARTMENT OF ACCOUNT & BUDGET SUPPORT

LEVEL-IV

Unit of Competence: -MAINTAIN INVENTORY

RECORD
Module Title:- MAINTAINING INVENTORY RECORD .
LG Code: BUF ACB4 14 0812
TTLM Code: BUF ACB4M 14 0812
BY MEGERSA HIRPHA
01/25/2021 BY Instructor Megersa H. 1
 Accounting for Inventory
Definition of inventories
As an itemized list of goods that are on hand
Consist of good owned by a business and held either for use of in
the manufacture of product, or as goods for resale to customer
Classification of inventories
Inventories may be classified according to the nature of operations of
the company
There are three forms of organization namely service,
merchandizing and manufacturing
1.Manufacturing Inventories
A. Row Material Inventory
This represents tangible goods purchased or obtained in other way
and on hand for direct use in the manufacture of goods for sale
E.g. Cotton, wheat,
01/25/2021 BY Instructor Megersa H. 2
B. Work – In- Process Inventory
Represent goods partially processed and requiring
further processing before completion and sale
Include cost of raw materials, direct labor
allocating and manufacturing overheads costs
incurred to date.
C. Finished Goods Inventory
Represents goods completed and held for sale
E.g.- Flour inventory held by flour factory
- Garment inventory held by textile factory
01/25/2021 BY Instructor Megersa H. 3
2.Merchandise inventories
This represent goods on hand purchased by the
retailer or a trading company fore resale to
customers
The trading company buys and sells these goods
without changing their physical forms
E.g.-Goods held by super markets
-Medicines held by drug stores

01/25/2021 BY Instructor Megersa H. 4

 Inventory Systems
There are two principle system of inventory accounting
1. Periodic Inventory System
Is a method of accounting that records the cost of inventory purchased but
does not track the quantity on hand or sold to customers under this
method the record are up date at the end of each period to reflect the
result of physical counts of the items on hand.
No journal entry is made at the time of sale to record the cost of
merchandise that has been sold
In other word, the cost of goods sold is not recorded as each sale occurs
instead; the total cost of goods sold during the period is inputted of the end
of the period using the following formula.
Beginning inventory + Net purchases = cost of merchandise available for
sale
Cost of good sold = cost of merchandise available for sale - Ending
inventory
 
01/25/2021 BY Instructor Megersa H. 5
 2. Perpetual inventory system
Is a method of inventory accounting that
maintains continuous records of the cost of
inventory on hand and cost of goods sold under
perpetual inventory systems, the records
continuously disclose the amounts of inventory.
For each type of merchandise, a separate account
is maintained in the subsidiary ledger.
Under a perpetual inventory system, each
purchase, return and allowance, purchase
discount and transportation in transaction is
recorded in the merchandise inventory account
01/25/2021 BY Instructor Megersa H. 6
 The effects of inventory on the financial statement
In correct determination of the cost of ending
inventory affects both balance sheet and income
statement.
A. If ending inventory amount is understated in the
income statement
Cost of Goods sold is over stated in the income
statement
Gross profit is under stated in the income statement
Net income is under stated in the balance sheet
Total Asset is under stated in the balance sheet
Owners Equity is under stated in the balance sheet
01/25/2021 BY Instructor Megersa H. 7
B. on the other hand if the inventory amount is overstated
in the current period
Cost of Goods sold is under stated in the income
statement
Gross profit is over stated in the income statement
Net income is over stated in the balance sheet
Total Asset is over stated in the balance sheet
Owner equity is over stated in the balance sheet
From the above analysis, we can conclude that
There is direct relationship between ending inventory and
cost of good sold.
There is direct relationship b/n ending inventory and gross
profit net income total assets and owner’s equity
01/25/2021 BY Instructor Megersa H. 8
To illustration: consider the following data for Bacha Merchandising firm
for the ended Dec. 31, 2002
Net sales = 60,000
Cost of merchandize available for sale = 50,000
Operating expense = 18,000
Other assets = 90,000
Liabilities = 20, 000
Based on the above data and the following assumptions show the effect of
wrong inventory on the financial statement of year 2002
Assumption 1: Ending inventory is correctly stated at Br. 15000
Assumption 2: Ending inventory is incorrectly stated at Br.
19000
Assumption 3: Ending inventory is incorrectly stated at Br
12000
Assumption 1 Ending inventory ……….15, 000
01/25/2021 BY Instructor Megersa H. 9
Income statement
Bacha Company
Income statement
For the year ended, Dec 31, 2002
Net sales ……………………………………………60,000
Less (cost of goods sold) 50,000-15000)
…………..35,000
Goss profit on sale ………………………………….25, 000
Less expense ………………………………………...18,000
Net in come …………………………………………..7000

01/25/2021 BY Instructor Megersa H. 10

Balance sheet
Bacha Company
Balance sheet
Dec 31, 2002
Bacha inventory ……………………………… ,..15,000
Assets ……………………………………………..90000
Total …………………………………………….. 105,000
Liabilities ……………………………………....... 20,000
Owner equity (105,000-20,000)…………………...
85,000
Total ……………………………………………….105,000
01/25/2021 BY Instructor Megersa H. 11
Assumption2. Ending inventory ……………...19,000
Income statement
Bacha Company
Income statement
For the year ended Dc. 31, 2002
Net sales ……………………………………………60,000
Less: cost of goods sold (50,000-19000) …………
31,000
Gross profit on sale …………………………………29, 000
Less: - expense ………………………………………18,000
Net income …………………………………………11,000
01/25/2021 BY Instructor Megersa H. 12
Balance sheet
Bacha Company
Balance sheet
Dec 31,2002
Merchandise Inventory …………………………..19,000
Other assets ……………………………………….90, 000
Total ………………………………………………109,000
Liabilities ………………………………………… 20,000
Owner’s equity (10900-20,000) ………………… 89000
Total ………………………………………………109,000

01/25/2021 BY Instructor Megersa H. 13

Assumption 3, Ending inventory …………12,000
Income statement
Bacha Company
Income statement
For the year ended Dc. 31, 2002
Net sales ……………………………………………60,000
Less: cost of goods sold (50,000-12000) ……………
38,000
Gross profit on sale ………………………………….22, 000
Less: - expense ……………………………………….18,000
Net income ……………………………………………4,000
01/25/2021 BY Instructor Megersa H. 14
Balance sheet
Bacha Company
Balance sheet
Dec. 31, 2002
Merchandise inventory …………………………….12,000
Other assets …………………………………………90,000
Total ……………………………………………… 102,000
Liabilities …………………………………………… 20,000
Owners equity (102,000-20,000) …………………..
82,000
Total …………………………………………………102,000
01/25/2021 BY Instructor Megersa H. 15
 Determine the Value of Inventory using Appropriate Valuation
Rule
1.Inventory Costing Methods
A. Period System B. Perpetual System

1.FIFO (First in First Out) 1. FIFO (First in First Out)

2.LIFO (Last in First Out) 2. LIFO (Last in First Out )
3.Weighted Average Method 3.Moving Average Method
2. Valuation of inventory other than Cost
Lower cost (Market) method LCM
Net Realizable value
3. Estimating inventory cost
Retail methods
Gross profit methods
01/25/2021 BY Instructor Megersa H. 16
1. Inventory Costing Methods
A. Periodic inventory System
One of the most important problems in determining
inventory costs comes when identically units of a certain
commodity have been a cost flow assumption must be
made the three most widely used inventory costing
methods
i. FIFO (first in first out )
FIFO method of costing inventory is based on the
assumption that cost should be charged against revenue
in the order in which they were incurred.
Hence the inventory remaining assumed to be made up of
the most recent costs.
01/25/2021 BY Instructor Megersa H. 17
The FIFO methods illustration the following data for
commodity
A. One of the Grace Company inventory items
Jan 1 Inventory300 units at Br 5.00 = Br 1500
May 7 Purchased 500 units at Br 6.00 = 3000
Sep 12 purchased 400 units at Br 8.00 = 3200
Oct 27 purchased 600 units at Br 9.00 = 5400
Nov 30 purchased 200 units at Br 10.00 = 2000
Available for sale during the year 2000 unit Br
15100
Physical count on Dec 31 shoes that 400 units of commodity
on hand under FIFO periodic system, the cost of ending
inventory and cost of goods sold are computed as follows.
01/25/2021 BY Instructor Megersa H. 18
Cost of ending inventory
 Nov 30 purchase 200 units birr 10.00 ……………..Br 200
 Oct 27 purchase 200 units Birr 9.00……………..Br 1800
Ending inventory 400 units Br 3800
Cost of Goods Sold = Cost of Merchandise Available for Sale –
Ending inventory
11,300 = 15100 – 3800
Cost of Good Sold
 Oldest purchase (Jan 1) ………300 units birr 5.00 --------------1500
 Next oldest purchase (May 7) …..500 units birr 6.00 ---------3000
 Next oldest purchase (Sep 12) ……400units birr 8.00 --------3200
 Next oldest purchase (Oct. 27400 units birr 9 -----------------3600
Cost of Good sold 1600 unit Br11300
01/25/2021 BY Instructor Megersa H. 19
LIFO (last in first out)
LIFO methods is the method of assigning cost to inventory under the
assumption that most items purchase are first and their costs are
charged to costs of good sold.
Under LIFO method the costs of earliest (oldest) purchases are
assigned to inventory based on data above (commodity A) the costs
of good sold and the cost ending inventory are computed as follows.
Cost of ending inventory
Oldest purchase (Jan inventory ……300 units at Br 5.00 -----1500
Next older purchase (May 7) ……100 units at Br 6.00--------- 600
Ending inventory 400 units Br2100
Cost of goods sold
Cost of Goods Sold = Merchandise available for sale - Ending
Inventory
13,000= 15100 -2100
01/25/2021 BY Instructor Megersa H. 20
 Other methods
Most recent purchase (Nov30) …………………..200 units at 10.00 -----2000
Next most recent purchase (Oct27) ……………. 600 units at 9.00 -------5400
Next most recent purchase (sep12) ……………...400units at 8.00 -------3200
Next most recent purchase (May 7) ……………..400units at 6.00 --------2400
1600units Br13000
3. Weighted average method (Average cost Method)
The weighted average method is the method of assigning cost of inventory in which
costs of ending inventory and cost of goods sold are determined using average costs
Average cost method determine that dividing the total costs of the identical unit
available for sell by related no of unit of the commodity
 
Average Cost =Cost of Good Available for Sale
Quantities of Good Available for Sale

= 15100 =7.55
2000

01/25/2021 BY Instructor Megersa H. 21

 Ending inventory =physical count x Average cost
= 400x7.55
=3020
Cost of Goods Sold = Quantity of goods sold x
Average cost
= 1600x7.55
Br 12080
Or Cost of Good Sold =Merchandise Available for
Sale –Ending Inventory
= 15100 – 3020
= 12080
01/25/2021 BY Instructor Megersa H. 22
 Comparison of inventory costing methods
Cost of good sold and ending inventory for each of the
three methods (FIFO.LIFO and Average cost)
 
Cost of goods sold Ending inventory
FIFO 11,300 3800
Average cost 12080 3020
LIFO 13,000 2100
To show the effect of each method on gross profit and
net income assume that net sales and operating
expenses are 20,000 birr and 5000 birr respectively the
effect of each method is shown below
01/25/2021 BY Instructor Megersa H. 23
 FIFO LIFO
Net sales ----------------- 20,000 Net sales ----------------20,000
Less: Cost of good sold ------11,300 Less: Cost of goods sold ---13,000
Grass profit --------------- 8,700 Grass profit ---------7000
Less: Operating Expenses ----5000 Less: Operating expense ------ 5000
Operating income 3700Operating income -----------2000
 

AVERAGE COSTS
Net sales ---------------------20,000
Less: cost of good sold------12,080
Gross profit--------------------7920
Less operating expenses ---5000
Operating income ------------2920
01/25/2021 BY Instructor Megersa H. 24
 FIFO LIFO
Net sales ----------------- 20,000 Net sales ----------------20,000
Less: Cost of good sold ------11,300 Less: Cost of goods sold ---13,000
Grass profit --------------- 8,700 Grass profit ---------7000
Less: Operating Expenses ----5000 Less: Operating expense ------ 5000
Operating income 3700Operating income -----------2000
 

AVERAGE COSTS
Net sales ---------------------20,000
Less: cost of good sold------12,080
Gross profit--------------------7920
Less operating expenses ---5000
Operating income ------------2920
01/25/2021 BY Instructor Megersa H. 25
Inventory costing methods under a perpetual system
Merchandise is a mixed mass of goods details of the cost each type of
merchandise purchased and sold together with such related
transaction are maintained in subsidiary inventory ledger with a
separate account for each type.
 Illustration
The following for merchandise identified as commodity 127 B
Unit quantity cost
Jan 1 Inventory ………………..10 @20 birr.
4 Sale …………………….……7
10 purchase …………..…….8 @21birr
22 Sale …………………..…… 4
28 Sale …………………..…….2
30 purchase …………...….10 22birr
Commodity 172 B under FIFO
01/25/2021 BY Instructor Megersa H. 26
Date Purchase Cost of Merchandise Sold Inventory

Quanti Unit Total Quanti Unit Total Quanti Unit Total

ty Cost Cost ty Cost Cost ty Cost Cost
Jan 1 10 20 200

4 7 20 140 3 20 60

10 8 21 168 3 20 60
8 21 168
22 3 20 60 147
1 21 21
28 2 21 42 5 21 105

30 10 22 220 5 21 105
10 22 220

Cost of Good sold = 140 + 60 + 21 + 42 =263

Ending inventory = 105+220 = 325

01/25/2021 BY Instructor Megersa H. 27

LIFO method
When the last in first out method is used in a
perpetual inventory system the cost of units sold
is the cost of the most recent purchase.
To illustrate, the ledger account for commodity
127 B, prepared on a LIFO is as follows.

Commodity 127B

01/25/2021 BY Instructor Megersa H. 28

Date Purchase Cost of goods sold Inventory
Quanti Unit Total Quanti Unit Total Quanti Unit Total
ty cost cost ty cost cost ty cost cost

Tan 1 10 20 200

4 7 20 140 3 20 60

10 8 21 168 3 20 60
8 21 168
22 4 21 84 3 20 60
4 21
28 2 21 42 3 20
2 21
30 10 22 220 3 20 60
2 21 42
10 22 220

Cost of Goods Sold = 140 + 42 = 266

Ending inventory = 60+42+220 =322

01/25/2021 BY Instructor Megersa H. 29

Moving average cost method
Under a periodic system average cost is computed
at the end of the period to determine the cost of
ending inventory and cost of merchandise sold
using average cost methods.
However, when the average cost method is used
in a perpetual inventory system, an average unit
cost is computed each time a purchase is made,
rather than the end of period.
This unit has is then used to determine the cost of
each sale unit another purchase is made and me
is average cost is computed.
From the Given Illustration commodity 127 B
01/25/2021 BY Instructor Megersa H. 30
Date Purchase Cost of goods sold Inventory

Quanti Unit Total Quanti Unit Total Quanti Unit Total

ty cost cost ty cost cost ty cost cost

Jan 1 10 20 200

4 7 20 140 3 20 60

10 8 21 168 11 20.72 228

22 4 20.72 82.88 7 20.72 145.04

28 2 20.72 41.44 5 20.72 103.6

30 10 22 220 15 21.58 323.6

Ending inventory = 323.6

Cost of fund sold = 140+82.88+41.44=264.32
01/25/2021 BY Instructor Megersa H. 31
 O U
K Y !!
N !
A ND
T H E
HE
T

01/25/2021 BY Instructor Megersa H. 32