East-Africa TVET College

Occupational Standard: Accounts and Budget Service

Level IV

Learning Guide
Unit of Competence: Maintain Inventory Record
Module Title: Maintaining Inventory Record
TTLM Code: BUF ACBS4 12 04 20

Information Sheet 1 Process Inventory Purchases

1.1 Recording purchase of inventory From appropriate
documentation in subsidiary ledger
What is inventory process?

Inventory process: any business process that involves goods going in or coming out of a firm’s
inventory. It generally includes receiving, temporary storage, withdrawal issues, and movement
of the item through work in process routine.

Purchase requisition – For commonly used direct materials, organizations have a reorder level,
which is the minimum amount of stock that can be on hand at any given time before another
purchase is made to meet the lead time demand. The reason for maintaining such a minimum
stock level is to hedge against the risk of stock shortages due to reasons like unexpected heavy
usage, delays and other reason that results in stock out situations. When the stock level reaches
such a point, the storeroom clerk fills a purchase requisition, a form requesting the purchase of
the needed material. After the form is duly filled, it will be sent to the purchasing department.

Purchase order – the purchasing department following purchase requisitions from the
storeroom clerk will prepare a purchase order. A purchase order is a document that authorizes the
supplier to ship the specified merchandise ordered.

Receiving report – when the ordered materials are received, the receiving department prepares a
receiving report, which lists the description, and quantities of goods received. A copy of the
document will be sent to the storeroom clerk along with the materials. The receiving report,
together with the invoice of the supplier forms the basis for recording the purchase of the
materials.

What an invoice?

Invoices are also an essential part of the purchasing process. Invoices are the documents that
request payment for any goods /services/ hat have been delivered or rendered.

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.Raw 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,
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
2. Merchandise inventories
This represents goods on hand purchased by the retailer or a trading company for 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
3. Miscellaneous inventory:. Includes item such as office, janitorial, and shipping supplies.
Inventories of this types are typically used in the near future and are usually recorded as selling
or general expenses when purchased.
1.2 maintaining periodic and perpetual record of inventory
Inventory Systems
There are two principle system of inventory accounting
1. Periodic Inventory System
The periodic system relies on physical count of goods on hand as the basis for control,
management decisions and financial accounting. Although these procedures may give accurate
results on a specific date, there is no continuing record of the inventory.
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 goods sold = cost of merchandise available for sale - Ending inventory
Note that there is no cost of merchandise sold account in the ledger of a merchandising enterprise
that uses periodic inventory system, a physical inventory at the end of an accounting period.
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.
The balance of each inventories of items on hand are shown on the account after each
transaction. These balances are called book inventories.
The merchandise inventory account is updated after each purchase and each sale.the cost of
merchandise sold account also is updated after each sale so that during the period. the account
balance reflects the periods total cost of merchandise sold to date then the records are compared
with the actual quantities on hand any d/f are corrected through adjusting journal entry.
Periodic inventory system is more appropriate for retail enterprises that sell May kinds of low
unit cost merchandises. Such enterprise include hard ware drug stores, groceries super markets
and the like
In case of perpetual inventory system is more appropriate for enterprise selling a relatively small
number of high unit cost items such as office equipment. Automobile dealers, machinery dealers.
Timing Error in the recording of the inventory
An error and determination of the inventory amount at the end of the period will cause an equal
misstatement of gross profit and net income and the amount reported for both assets and owner‘s
equity in the balance sheet will be incorrect by the same amount.
Illustration
To illustrate the effect of error in determining of the ending inventory assume the following data
at the end of the fiscal period before closing.
Beg inventory……………………………30,000
End inventory……………………………25,000
Other Assets……………………………...80,000
Liabilities…………………………………30,000
Owner equity……………………………..65,000
Net sales………………………………….200,000
Purchases………………………………...125, 000
Expenses…………………………………..60,000
Required
Show the effect of each assumption on net income, asset and owner equity if ending inventory is
incorrectly stated by the amount of 20,000 and 30,000.
Solution
 1 2 3
Net sales……………….200,000 Net sales……………..200,000 Net sales……………….200,000
Beg inv……..30,000 Beg inv……..30,000 Beg inv……..30,000
Plus purch…125,000 Plus purch…125,000 Plus purch…125,000
C.G.A.S……155,000 C.G.A.S……155,000 C.G.A.S……155,000
Less End inv.25,000 Less End inv.20,000 Less End inv. 30,000
C.G.S…………………..130,000 C.G.S………………….135,000 C.G.S…………………..125,000
Gross profit……………70,000 Gross profit……………65,000 Gross profit……………75,000
Less Expenses…………60,000 Less Expenses…………60,000 Less Expenses…………60,000
Net income…………….10,000 Net income…………….5,000 Net income…………….15,000
Owner’s equity Owner’s equity Owner’s equity
65,000+10,000=75,000 65,000+5,000=70,000 65,000+15,000=80,000
Balance Sheet Balance Sheet Balance Sheet
Liabilities………………30,000 Liabilities………………30,000 Liabilities………………30,000
O.equity………………..75,000 O.equity………………..70,000 O.equity………………..80,000
Total assets……………105,000 Total assets……………100,000 Total assets……………110,000
OR OR OR
End Inv…………………25,000 End Inv…………………20,000 End Inv…………………30,000
Other Assets…………….80,000 Other assets…………….80,000 Other Assets…………….80,000
Total assets…………….105,000 Total asset ………….100,000 Total assets…………….110,000

1. When an ending inventories Decreases from the correct stated amount.

2. When an ending inventories increases from the correct stated amount.
Ending Cost of Gross profit Net income Asset Owner’s
inventory goods sold equity
Decrease from overstated understated understated Understated understated
the correct
stated
Increase from understated overstated Overstated Overstated overstated
the correct
stated
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
B. on the other hand if the inventory amount is overstated in thecurrent 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
1. There is direct relationship between ending inventory and cost of goods sold.
2. There is direct relationship b/n ending inventory and gross profit net income total assets
and owner’s equity.

Information Sheet 2 Record Inventory Flow

2.1Applying Inventory flow Assumption
Determine the cost of inventory
There are four commonly used in assigning costs to inventory and cost of merchandise sold.
These are:
1. Specific Identification Method
2. FIFO (First in First Out)
3. LIFO (Last in first out)
4. Weighted average Method
Inventory costing Method under Periodic inventory System
One of the most important decisions in accounting for inventory is determining the per unit costs
assigned to inventory items. When all units are purchased at the same unit cost, this process is
simple the same unit cost is applied to determine the cost of goods sold and ending inventory.
But when identical items are purchased at different costs, a questions arises as to what amounts
are included in the cost of merchandise sold and what amounts remain in inventory.
1. Specific Identification Method
When each item in inventory can be directly identified with a specific purchase and its invoices,
we can use specific identification (also called specific invoice pricing) to assign costs. This
method is appropriate when the variety of merchandise carried in stock is small and the volume
of sales is relatively small. We can specifically identify the items sold and the items on hand.
Example
A. One of the Grace Company inventory items
Jan 1 Inventory 300 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 shows that 400 units of commodity on hand, 100 each of the last
purchases.So,the items on hand are specifically known from which purchases they are:
Cost of ending inventories under specific identification method
Br10.00 x100 units = Br1000.00
Br 9.00 x100 units = Br 900.00
Br 8.00 x 100 units = Br 800.00
Br6.00x 100 units = Br 600.00
400 units Br 3300.00
Cost of ending inventory = 3300.00
The cost of merchandise sold = cost of goods available for sale_ Ending inventory
=Br 15100_Br 3300.00
= Br 11800.00
2. FIFO (first in first out )
This method of assigning cost to inventory and the goods sold assumes inventory items are sold
in the order acquired. This means the cost flow is in the order in which the expenditures were
made. So to determine the cost of ending inventory, we have to start from the most recent
purchase and continue to the next recent. Because the first purchased items (old purchases) are
the first to be sold they are used(included) in the computation of cost goods sold.
For example, easily spoiled goods such as fruits, vegetables etc., must be sold near the time of
their acquisition. So, the inventory on hand will be from the recent purchases.
The FIFO methods illustration the following data for commodity
. Cost of ending inventory
Nov 30 purchase 200 units birr 10.00 …………….Br 2000
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
Other methods
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.27)400 units birr 9.00 -------------- 3600
Cost of Goods sold 1600 unit Br11300
3. LIFO (last in first out)
LIFO methods is the method of assigning cost to inventory under the assumption that most
recent purchases are sold first.Thier costs are charged to cost of goods sold, and the costs of the
earliest purchases are assigned to inventory based on data above (commodity A) the costs of
goods sold and the cost ending inventory are computed as follows.
Cost of ending inventory
Oldest purchase (Jan1 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 = Merchandise available for sale - Ending Inventory
13,000 = 15100 -2100
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
4. 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.
To calculate the cost of ending inventory, we will calculate first the cost per unit of goods
available for sale
Average Cost per unit = Cost of Good Available for Sale
Total units available for sale
= 15100 =7.55
2000
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 Goods Sold =Merchandise Available for Sale –Ending Inventory
= 15100 – 3020
= 12080
Comparison of inventory costing methods
Cost of goods 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
FIFO LIFO
Net sales ---------------------- 20,000 Net sales ----------------- 20,000
Less cost of goods sold ------11,300 less cost of goods sold ------13,000
Gross profit ------------------- 8,700 Gross profits -------------7000
Less: Operating Expenses ----5000 Less Operating expense ------ 5000
Operating income 3700 Operating income ----------- 2000

Average Costs
Net sales ---------------------20,000
Less cost of goods sold------12,080
Gross profit--------------------7920
Less operating expenses ---5000
Operating income ------------2920
Inventory costing methods under a perpetual system
Under perpetual inventory systems we will apply the inventory costing methods each times sales
of merchandise is made. We calculate the cost of goods (merchandise) sold and inventory on
hand at the time of each sales. This means the merchandise inventory account is continually
updated to reflect purchase and sales.
Illustration
The following for merchandise identified as commodity 127 B
Unit cost
Jan 1 Inventory …………………..10 20 .00
4 Sale …………………………7 25.00
10 purchase …………………….8 21.00
22 Sale ………………………… 4 23.00
28 Sale ………………………….2 23.00
30 purchase …………………….10 22.00
Commodity 127 B under FIFO
Date Purchase Cost of Merchandise Sold Inventory
Quantity Unit Total Quantity Unit Total Quantity Unit Total
Cost Cost Cost Cost 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 7 21 147
1 21 21
28 2 21 42 5 21 105
30 10 22 220 5 21 105
10 22 220
Cost of Goods sold = 140 + 60 + 21 + 42 =263
Ending inventory = 105+220 = 325
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
Date Purchase Cost of march sold Inventory
Quantity Unit Total Quantity Unit Total Quantity Unit Total
cost Cost cost Cost 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 4 21 84 3 20 60
4 21 84
28 2 21 42 3 20 60
2 21 42
30 10 22 220 3 20 60
2 21 42
10 22 220
Cost of Goods Sold = 140 + 84+42 = 266
Ending inventory = 60+42+220 =322
Weighted average cost method (moving average)
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.
. From the Given Illustration commodity 127 B
Purchase Cost of Goods sold Inventory A.Cost
Date Quant. Unit Cost Total Quant. Unit Total Quant. Unit Cost Total
Cost
Jan 1 10 20 200
4 7 20 140 3 20 60
10 8 21 168 11 20.72 228 20.72
22 4 20.7 82.88 7 20.72 145.04
2
28 2 20.7 41.44 5 20.72 103.6
2
30 10 22 220 15 21.57 323.6 21.57
Ending inventory = 323.6
Cost of goods sold = 140+82.88+41.44=264.32

2.2 Valuing inventory using appropriate valuation rule

Valuation of inventory at other than cost
We used costs of merchandise purchase to determine the cost of ending an inventory b/c cost is
considered to the primary basis for inventory valuation.
However, there are certain circumstances under which we values inventory at other amount than
cost. Two of these circumstances are:-
1. When the replacement cost of inventory items is below recorded cost in which cases
however of cost or market method is used.
2. Might be inventory is not salable at a normal sale prices. The cause might be
imperfection shop wear, obsolesce or other causes for this of inventory items. The most
common method is what we call it net realizable value( NRV).

1. Lower cost ( market ) method

If the cost of replacing an item in inventory is lower than the original purchase cost, the lower-
of-cost-or-market (LCM) method is used to value the inventory. Market, as used in lower of
cost or market, is the cost to replace the merchandise on the inventory date. This market value is
based on quantities normally purchased from the usual source of supply. In businesses where
inflation is the norm, market prices rarely decline. In businesses where technology changes
rapidly (e.g., microcomputers and televisions), market declines are common. The primary
advantage of the lower-of-cost-or-market method is that gross profit (and net income) is reduced
in the period in which the market decline occurred.
In applying the lower-of-cost-or-market method, the cost and replacement cost can be
determined in one of three ways. Cost and replacement cost can be determined for
(1) Each item in the inventory,
(2) Major classes or categories of inventory, or
(3) The inventory as a whole. In practice, the cost and replacement cost of each item are
Usually determined.
To illustrate let’s consider the following data for Kassa Company
Illustrates a method of organizing inventory data and applying the lowerof-cost-or-market
method to each inventory item. The amount of the market decline, $380 ($3120 - $2740), may be
reported as a separate item on the income statement. The amount of the market decline, $270
($3120 - $2850), may be reported as a whole item on the income statement.
 Items Units Unit Unit Total
cost market Cost Market Lower of Cost or Market
price price Inventory Inventory as
each item a whole
A 100 5 4 500 400 400
B 80 9 7 720 560 560
C 110 14 15 1540 1650 1540
D 120 3 2 360 240 240
Total 3120 2850 2740 2850

2, Net realizable value

Obsolete, spoiled or damaged merchandise and other merchandise that can be sold only of prices
below cost should be valued at net realizable value.
For these purpose, net realized value is the estimated selling prices less any direct cost of
disposition. Such as sales commission
E.g. assume the damaged merchandise that had a cost of 1,000 can be sold for only $ 800, and
direct selling expenses are estimated at 150, the inventory would value at 650 (800-150).
Estimating inventory cost
Three reasons force us to estimate inventory cost these are
1. Preparation of interim financial state prepared for a period of less than a year
2. To verify the accuracy of the record or physical inventory
3. The damage or destruction of inventory by fire, flood, earth quake or other causalities.
Two method of estimating inventory cost
1. Retail methods
Estimating cost of goods sold and ending inventory to prepare interim financial statement. and
annual financial statement.
Retail price refers to price at which goods are marked to sell.
In order to estimate inventory by the retail method you need to have the following data
1. Beginning inventory by the retail method
2. Beginning inventory at retail price
3. Net purchase of cost and retail price
4. Net sales
Step in computing retail method
Step 1Compute merchandizing available for sale and merchandise available for sale at retail
Step 2, compute cost % or cost to retail ratio
Cost % = Merchandise available for sale at cost
Merchandise available for sale at retail
Step 3 Compute ending inventory at retail
Ending inventory at retail = Merchandise available for sale at retail - Net sale
Step 4, estimated ending inventory at cost = Ending inventory at retail x cost percentage
E.g. To illustrate assume that grace merchandising companies records show the following data as
of November 30, 2003
Cost Retail
Beginning inventory 20,000 30,000
Net purchase 40,000 70,000
Net sale during the month 80,00
Solution
Step 1, Merchandise available for sale at cost = Beg, inventory at cost + Net purchase at cost
= 20,000 + 4000 = 60,000
Merchandise available For sale at retail = Beg . Inventory at retail + net purchase at retail
= 30,000 + 70,000 = 100,000
Step 2 Cost percentage = 60.000 = 60%
100.000
Step 3 Ending inventory at retail = 100.000-80,000 = 20,000
Step 4 Estimating ending inventory at cost= 20,000 x 60%= 12,000
Exercise: At the end of year 4 the following information for April Company. Department store
was obtained
Cost Retail
Beginning inventory $20,460 $ 31,000
Purchase 207,735 337,271
Purchase return and allowance 7,329 12,021
Sales 316,148
Sales return 3198

Required: compute April Company’s ending inventory at cost using the retail inventory method

2 Gross Profit Methods

The gross profit methods estimates inventory by applying a gross profit rate to net sales
In order to estimate inventory by the gross profit method we need to have the following data
1. Net sales
2. Beginning inventory at cost
3. Net purchase of cost
4. Gross profit rate explains a percentage of net sales
Step 1 Estimated Gross Profit = Net Sales x Gross Profit
Step 2 Estimated Cost of Goods Sold = Net Sales – Estimated Gross Profit
Step 3 Cost of Merchandise Available For Sale = Beg. Inventory + Net Purchase
Step 4 Estimated Cost of Ending Inventory = Cost ofMerch. Avail. for Sale - Estimated CGS
E.g. Assume Top Merchandising Company wishes to prepare financial statement for the month
of November 30, 2003 .The records of the company show the following
Net sales ----------------------------------------- 60.000
Beg inventory ---------------------------- ------ 10.000
Net purchase ----------------------------------- 40,000
Gross profit rate of % -------------------------- 30%of sales
Based on the above data, the cost of ending inventory can be estimated by the gross profit
method as follows
Step 1 Estimated Gross Profit = Net Sale x Gross Profit %
= 60.000x 30% = 18,000
Step 2 Estimated Cost of Goods Sold = Net Sale –Estimated Gross Profit
= 60,000- 18000 = 42,000
Step 3 Cost of Merchandise available for sale = Beg. Inventory +net purchase
= 10,000 + 40,000 = 50,000
Step 4 Estimated Cost of Ending Inventory = Cost of Merch. Avail. ForSale – Estimated CGS
=50,000 – 42,000= 8000
Exercise: Y Company uses the gross profit method to estimate month
inventories. in recent months gross profit has average 35% of net sales. The
following data are available for the month of January, year 5

Inventories January, year 5 Br 26580

Purchase 120,000
Purchase return 5000
Freight in 6000
Gross sales 165000
Sales return and allowance 10,000
Required: compute the estimated cost of Y- Company’s on January 31, year

The END