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ADMAS UNIVERSITY BISHOFTU CAMPUS

Course Title - Maintain Inventory Records

GROUP ASSIGNMENT 1
GROUP MEMBERS
S.No NAME ID SECTION YEAR DEPT.
rd
1 Asefa Birhanu 107/10 1 3 Accounting
2 Adanech Tariku 785/10 1 3rd Accounting
3 Binyam Debaba 636/10 1 3rd Accounting
4 Tayitu Sime 154/10 1 3rd Accounting

Submitted to Instructor: Tilahun G

June 03, 2020 G.C.

INSTRUCTIONS
NB: Read duly the following instructions and act as per requirements.
o This is a group assignment. Thus, copy and paste from other groups will result in zero values.
o You must use either MS-word or PDF format for your answers. Other forms may not to be
welcomed. In particular images using cell phone be considered at your risk.
o You must send your work using telegram via cell phone: : 09-25-28-20-70only using private
telegram account for telegram users are welcomed. You cannot send via your (students) group
telegram.
o Otherwise non- telegram user may submit in person using hardcopy to your respective department.
Those who are willing to submit with hardcopy should make sure that their handwriting is legible.
Please any other way of submission is not welcomed.
o Your final submission date is on June 11/06/2020. You can submit before the due date. I highly value
your punctuality as part of your assignment. Thus, late submission may result in 1% punishment per
delay for each day. But the submission date by no means extends beyond June 12/06/2020.
o Neatness and clarity have its own value!

Stay Safe!

QUESTIONS:
1. Define what does it mean by inventory
  Inventories are asset items held for sale in the ordinary course of business or goods that will be
used or consumed in the production of goods to be sold.
They are mainly divided into two major:
 Inventories of merchandising businesses
 Inventories of manufacturing businesses

i. Inventories of merchandising businesses are merchandise purchased for resale in the normal
course of business. These types of inventories are called merchandise inventories.
ii. Inventories of manufacturing businesses are businesses that produce physical output. They
normally have three types of inventories. These are:

 Raw material inventory

 Work in process inventory
 Finished goods inventory

2. List and explain inventory cost flow assumption

 Inventory cost is measured by the total cash equivalents outlay made to acquire the goods
and to prepare them for sale. These costs include the purchase cost and incidental costs
incurred until the goods are ready for sale to the customer such costs include transportation
cost, insurance cost during transit, custom duties, unloading cost and handling costs
3. Demonstrate the difference between periodic and perpetual inventory system
 There are two principal systems of inventory accounting periodic and perpetual.
 Periodic inventory system
Under this system there is no continuous record of merchandise inventory account. The inventory balance
remains the same throughout the accounting period, i.e. the beginning inventory balance. This is because
when goods are purchased, they are debited to the purchases account rather than merchandise inventory
account.

In a periodic inventory system, no effort is made to keep up – to – date records of either the inventory or
the cost of goods sold. Instead these amounts are determined only periodically, usually at the end of each
year. In periodic inventory system when merchandise is purchased, its cost is debited to an account
entitled purchases. When merchandise is sold, an entry is made to recognize the sales revenue, but no
entry is made to record the cost of goods sold or to reduce the balance of the inventory account. As the
inventory records are not updated as transactions occur, there is no inventory subsidiary ledger.
The revenue from sales is recorded each time a sale is made. No entry is made for the cost of goods sold.
So, physical inventory must be taken periodically to determine the cost of inventory on hand and goods
sold.

The periodic inventory system is less costly to maintain than the perpetual inventory system, but it gives
management less information about the current status of merchandise.

This system is often used by retail enterprises that sell many kinds of low unit cost merchandise such as
groceries, drugstores, hardware etc.

 Perpetual inventory system

In a perpetual inventory system, merchandising transactions are recorded as they occur. The system draws
its name from the fact that the accounting records are kept perpetually up-to-date. Purchases of
merchandise are recorded by debiting an asset account entitled inventory. When merchandise is sold, two
entries are necessary to recognize the revenue earned and the second to recognize the related cost of goods
sold. This second entry also reduces the balance of the Inventory account to reflect the sale of some of the
company’s inventory.
Under this system the accounting record continuously disclose the amount of inventory. We can determine
the cost of ending inventory as well as goods sold from the accounting record. No need of physical
counting to determine their costs. A perpetual inventory system includes an inventory subsidiary ledger.
This ledger provides company personnel with up-to-date information about each type of product that the
company sells, including the per- unit cost and the number of units purchased, sold, and currently on hand.

Companies that sell items of high unit value, such as appliances or automobiles, tended to use the
perpetual inventory system.

Given the number and diversity of items contained in the merchandise inventory of most businesses, the
perpetual inventory system is usually more effective for keeping track of quantities and ensuring optimal
customer service. Management must choose the system or combination of systems that is best for
achieving the company's goal.

 No adjusting entry or closing entry for merchandise inventory is needed at the end of each
accounting period.
4. What are the Effects of Inventory Errors on the Financial Statements
 The value for cost of the goods available for sale is dependent on accurate beginning and ending
inventory numbers. Because of the interrelationship between inventory values and cost of goods
sold, when the inventory values are incorrect, the associated income statement and balance sheet
accounts are also incorrect.

Inventory errors at the beginning of a reporting period affect only the income statement.
Overstatements of beginning inventory result in overstated cost of goods sold and understated net
income. Conversely, understatements of beginning inventory result in understated cost of goods
sold and overstated net income.

Inventory errors at the end of a reporting period affect both the income statement and the balance
sheet. Overstatements of ending inventory result in understated cost of goods sold overstated net
income, overstated assets, and overstated equity. Conversely, understatements of ending inventory
result in overstated cost of goods sold understated net income, understated assets, and understated
equity.

5. Demonstrate clearly the retail and gross method of estimating inventory cost
 Retail method of inventory costing
This method is mostly used by retail business. The estimate is made based on the relationship between the
cost and the retail price of merchandise available for sale.

The steps to be followed are:

(1) Calculate the cost to retail ratio = CGAFS at cost
CGAFS at retail

(2) Calculate the EI at retail price = CGAFS at retail– Sales

(3) Calculate the estimated cost of ending inventory

Estimated cost of EI = Cost to retail ration X Ending inventory at retail
 Gross profit method
The gross profit method is simple technique for estimating the cost of goods sold and the amount of
inventory on hand. In using this method, it is assumed that the rate of gross profit earned in the preceding
year will remain the same for the current year. When the gross profit rate is known, the ending inventory
can be estimated by the following procedures:

1. Determine the cost of goods available for sale from the general ledger records of
beginning inventory and net purchases
2. Estimate the cost of goods sold by multiplying the net sales by the cost ratio. Cost ratio
is determined by deducting the gross profit rate from 100%
3. Deduct the cost of goods sold from the cost of goods available for sale to find the
estimated ending inventory.