NORTH SOUTH UNIVERSITY

School of Business & Economics

Midterm - 2

Submitted to
Dr. Samina Rahman
Assistant Professor
Department of Accounting & Finance

Submitted by
Khalid Mohammed Zubair
ID: 1221076030

Sanjida Khandoker
ID : 2011579030

Jarif Jalal
ID: 1712385630

Ishtiaque Sarowar Utsho

ID: 1912681630
 Table of Content

Contents
1. INTRODUCTION..........................................................................................................................................1
2. CLASSIFYING INVENTORIES & SYSTEM TO ACCOUNT FOR INVENTORIES................................................................2
3. INVENTORY COST FLOW METHOD.................................................................................................................3
4. EFFECTS IN FINANCIAL STATEMENT................................................................................................................6
5. STATEMENT PRESENTATION.........................................................................................................................7
6. REFERENCE...............................................................................................................................................8

Word count: 1651

1. INTRODUCTION:

‘Tees’ is a partnership online business that manufactures quality t-shirt for youngsters. Two
young entrepreneurs set up the business in January 2020 in Brooklyn, New York. Since it is a
merchandise-manufacture-oriented business, we have tried to relate some inventory accounting
theories and application..

Since Tees is a merchandise-manufacture oriented business, it follows and applies inventory

management. Inventory management is a systematic approach to sourcing, storing, and selling
inventory both raw materials (components) and finished goods (products). In business terms,
inventory management means the right stock, at the right levels, in the right place, at the right
time and at the right cost as well as price.

As a part of supply chain, inventory management includes aspects such as controlling and
overseeing purchases from suppliers as well as customers maintaining the storage of stock,
controlling the amount of product for sale, and order fulfillment.

As Tees belongs to small-to-medium businesses (SMBs), it uses Excel, Google Sheets, or other
manual tools to keep track of inventory databases and make decisions about ordering as the part
of accounting information system (AIS). With these systems, the procedures of inventory
management extend beyond basic reordering and stock monitoring to encompass everything
from end-to-end production and business management to lead time and demand forecasting to
metrics, reports, and even accounting.

More precisely, Tees maintains retail inventory management. Retail is the broadest catch-all term
to describe business-to-consumer (B2C) selling. There are essentially two types of retail
separated by how and where a sale takes place.

 First, online retail (e-commerce) where the purchase takes place digitally.
 Second, offline retail where the purchase is physical through a brick-and-mortar
storefront or a salesperson.

As Tees is an online based business, it follows the first type retail to operate its business.

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2. CLASSIFYING INVENTORIES:
Since we mentioned before that Tees is a merchandise-manufacture oriented business, it
classifies its inventory in three types. The three types of inventories are described below:

1. Raw Material: Raw materials are the basic materials that a manufacturing company buys
from its suppliers and that is used by the former to convert them into the final products by
applying a set of manufacturing processes. As produces t-shirts, it purchases raw
materials such as fabrics, cottons, neck rib, neck tape, colors, trimmers, labels etc. from
local suppliers. records all the transactions while purchasing raw materials from
suppliers in the particular accounting period.
2. Work in Progress Inventory: Work in progress inventory can also be called semi-
finished goods which are not ready for sale. They are the raw materials that have been
taken out of the raw materials store and are now undergoing the process of their
conversion into the final products. These are the partly processed raw materials lying on
the production floor. And they have also not reached the stage where they have been
converted into the final product. For instance, the uncut trimmed t-shirts with no main
label, size label and wash & care label fall under work in progress inventory.
3. Finished Good: Finished goods are indeed the final products obtained after the
application of the manufacturing processes on the raw materials and the semi-finished
goods. They are saleable, and their sale contributes fully to the revenue from the core
operations of the company. For instance, the final packaged ironed t-shirts with main
label, size, wash & care label and price tag are the finished good ready to sell to
customers.

SYSTEM TO ACCOUNT FOR INVENTORIES:

Tees use perpetual inventory system to record its inventory, puchases and sales. The reason
behind using perpetual inventory system is, as Tees produce a large number of products, it needs
to record its inventories accurately. Moreover, through perpetual system, Tees can maintain
detailed records of of cost of each inventory purchase and sale. This record continuously shows
inventory that should be on hand for every item. Tees can determine cost of goods sold each time
a sale occurs.

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3. INVENTORY COST FLOW METHOD:
To maintain the inventory management, follows First in First out (FIFO) method to record its
inventory amount, purchases and sales and to analyze cost, profit and loss as the inventory cost
flow method. considers First in First out method to analyze inventory cost flow because of its
advantages. As we know that a major advantage of FIFO method is that in a period of inflation,
costs allocated to ending inventory will approximate their current cost. Both inventory and net
income are higher when companies use FIFO in a period of inflation. Moreover, the reasons
behind using FIFO method are:

Generating a higher gross profit: One of the trade-offs between FIFO and LIFO is gross profit
versus potential tax liability. While LIFO will generally enable a lower tax liability, FIFO fosters
a higher gross income as the cost of goods sold (COGS) is usually lower. This is good news for
current and potential investors and is arguably a more accurate picture of business profitability
and growth.

Simple and logical: As the cycle and flow of goods under FIFO runs logically oldest to newest,
it is reasonably easy to use for most businesses. The cost flow layers involved are also simpler
than LIFO, making it a stable and user-friendly accounting method. Another plus is that financial
and income statements are harder to manipulate under the FIFO method.

Matching inventory costs to the current market value: Because FIFO accounts for the sale of
the oldest stock first, the value of on-hand inventory is determined using the most recently
acquired items. This provides a more accurate match of inventory cost to current market value
and gives a better idea of inventory value and replacement costs.

Matching costs to inflation: As the newest stock is sold last, there is more opportunity to match
inventory costs to inflation. Recently acquired stock can be sold at a level that better reflects
market value so our business can effectively keep pace, absorbing the worst effects of inflation.

Less chance of obsolete and spoiled stock: Businesses using FIFO as an inventory management
technique are able to minimize losses caused by obsolete and perishable stock. With the oldest
stock sold first it becomes easier to create a more intuitive flow of goods.

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Here we have analyzed inventory cost flow in three different methods- FIFO, LIFO and Average
cost method to show a comparison and difference in cost of goods sold and ending inventories.

Date Explanation Units Unit Cost Total Cost Balance in Unit

February Beginning Inventory 100 10 1000 100
March Purchase 200 11 2200 300
April Purchase 300 12 3600 600
May Sale 550 50
June Purchase 400 13 5200 450
July Sale 350 100
August Purchase 200 13.5 2700 300
14700

The table above is a detailed summary about inventories, purchase and sales in the accounting
period. T-shirt is a summer oriented apperal. So Tees has decided to operate their business from
February to August including production and purchase. As we can see that sales occurred in May
and July and their last purchase/production occurred in August.

Now we are showing the application of three inventory cost flow methods below:

First in First out (FIFO):

Date Purchase Cost of Good Sold Balance

February (100*10) $1000
March (200*$11) $2200 3200
April ($300*12) 3600 6800
(100*$10) $1000
(200*11) 2200
May
(250*12) 3000
6200 (50*12) 600
June (400*13) 5200 5800
(50*12) 600
July (300*13) 3900 (100*13) 1300
4500
August (200*13.50) 2700 4000

Ending Inventory $4,000

COGS 6200 + 4500 = $10700

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Last in First out (LIFO):

Average Cost Method:

Date Purchase Cost of Good Sold Balance

February (100*10) $1000
March (200*$11) $2200 3200
April (300*12) 3600 6800
May (550*11.33) 6231 (50*11.33) 567
June (400*13) 5200 5767
July (350*12.82) 4487 (100*12.82) 1282
August (200*13.50) 2700 3982

Ending Inventory $3,982

COGS 6231 + 4487 = $10718

As we can see that the cost of goods sold (COGS) and the ending inventories are fluctuating in
three different inventory cost flow methods. The highest COGS is found in LIFO method and the
highest ending inventories is found in FIFO method. On the other hand, the lowest COGS is
found in FIFO method and the lowest ending inventory is found in LIFO method. As we know,
Gross profit = Sales Revenue-COGS, for this reason, gross profit will be higher in FIFO

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method and so the net income. So, we can say that, FIFO method is effective and beneficial to
for analyzing inventory cost flow.

4. EFFECTS IN FINANCIAL STATEMENT:

As we have analyzed inventory cash flow in three different methods, now we will see the effects
in financial statement by applying data from FIFO, LIFO and average cost method.

Here is the income statement of of their accounting period-

FIFO LIFO Average Cost

Sales Revenue $22,500 $22,500 $22,500
Beginning Inventory 1000 1000 1000
(+)Purchases 13700 13700 13700
Cost of goods available for sale
14700 14700 14700
(-)Ending Inventory 4000 3850 3982
Cost of good sold 10700 10850 10718
Gross Profit 11800 11650 11782
(-)Operating expense 6000 6000 6000
Income before income taxes 5800 5650 5782
(-)Income tax expense (30%) 1740 1695 1735
Net Income 4060 3955 4047
Gross Profit Rate 52.44% 51.78% 52.36%

We determined that the selling price of each t-shirt is $25 and total 900 t-shirts were sold in two
different times in the period. So the sales revenue of is $22,500. Due to the fluctuated ending
inventory, we have got three different COGS in three different inventory cash flow methods and
as we know, Gross profit = Sales Revenue-COGS, for this reason, gross profit is higher in
FIFO method. As a consequence, after applying 30% tax on income, the income tax is higher in
FIFO and so the net income is $4060 and the lowest net income found in LIFO $3955. In
addition, the gross profit rate is higher in FIFO 52.44%. So we can claim that applying FIFO
method is most effective for the business to generate more profit and this is how the ending
inventory and COGS affect the income statement.

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5. STATEMENT PRESENTATION:

As 300 t-shirts are left in inventory stock at end of the accounting period, we need to disclose
inventory account by determining a replacement cost of inventory. As t-shirt is a summer
oriented apparel, so we are assuming that the value of t-shirt can be decreased after August as
winter is the upcoming season.

As we follow FIFO method to analyze inventory cash flow, we have found 300 t-shirts are left in
stock which cost $4000. So we have determined a current market value for july month’s t-shirts
is price $9 per unit and for august month $10 per unit.

Lower-of-Cost-or-Net
Item Unit Cost per Unit Market Value Market Value

July 100 $13 $9 (100*$9) $900

August 200 13.5 10 (200*$10) $2000
Total Inventory $2,900

INVENTORY ANALYSIS:

Note: Average Inventory = (Beginning Inventory + Ending Inventory) / 2

Inventory turnover shows how many times a company has sold and replaced inventory during a
given period. So here, our company has sold and replaced inventory 4.28 times during a given
period. Also, our company will turnover its inventory 4.28 times within a year. This will help our
businesses to make better decisions on pricing, manufacturing, marketing, and purchasing new
inventory. It is a very important part of data to maximize the efficiency of sale. Our company
will take 85.3 days for inventory to turn it into sales.

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6. REFERENCE:

1. (n.d.). TradeGecko. Types of inventory management. Retrieved December 16, 2020,

from https://www.tradegecko.com/
2. (n.d.). WallStreetMojo. Types of Inventory. Retrieved December 16, 2020, from
https://www.wallstreetmojo.com/
3. (n.d.). Lumen Learning. Effects of Choosing Different Inventory Methods. Retrieved
December 17, 2020, from https://courses.lumenlearning.com/
4. (n.d.). Scott Partners. THE BASICS AND BENEFITS OF FIFO INVENTORY
ACCOUNTING. Retrieved December 17, 2020, from https://scottpartners.com.au/
5. (n.d.). Analyst Forum. Net realizeable value (NRV) and replacement value. Retrieved
December 17, 2020, from https://www.analystforum.com/
6. (n.d.). IEduNote. Lower of Cost or Market Rule (LCM Definition, Examples, Formula).
Retrieved December 17, 2020, from https://www.iedunote.com/
7. HARGRAVE, M. (2020, April 28). Investopedia. Inventory Turnover. Retrieved
December 17, 2020, from https://www.investopedia.com/

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