Ifa Ii CH 1

RIFT VALLEY UNIVERSITY
SENDEFA CAMPUS
DEPARTMENT OF CCOUNTING & FINANCE
INTERMEDIATE FINANCIAL ACCOUNTING-II
Course Instructor: Benol Mekonnen (BSC, BA and MBA)
Chapter One
Inventories and Special valuation of inventory
Contents
 Definition of Inventories
 Inventory cost flow assumptions
 Inventory costing methods under a perpetual and
periodic inventory system
 Special Valuation of inventory
January 24 BENOL.M 2
Definition of Inventory
International Accounting Standard 2 Inventories
 The following terms are used in this Standard with the
meanings specified:
 Inventories are assets:
 Held for sale in the ordinary course of business
 In the process of production for such sale; or
 In the form of materials or supplies to be consumed in the
production process or in the rendering of services.
Inventory Classification
They are mainly divided into two major categories:
 Inventories of merchandising businesses and
 Inventories of manufacturing businesses
CONT,
Inventories of merchandising businesses
 Are merchandise purchased for resale in the normal course
of business.
Inventories of manufacturing business
 Manufacturing businesses are businesses that produce
physical output.
 They normally have three types of inventories. These are:
 Raw material inventory – are the basic goods that will be
used in production but have not yet been placed into
production. Example, wood to make a chair or other office
furniture’s, the steel to make a car etc.
CONT,
 Work in process inventory-is that portion of
manufactured inventory that has been placed into
the production process but is not yet complete.
 Finished goods inventory – manufactured items
that are completed and ready for sale.
 In this unit, only the determination of the
inventory of merchandise purchased for resale
commonly called merchandise inventory will be
discussed.
Inventory Cost Flow Assumptions
There are two methods systems of inventory accounting.
 Periodic inventory system
 Perpetual inventory system
 Periodic inventory system:- Under this system the

amount appearing in the Inventory account is not
updated when purchases of merchandise are made from
suppliers.
An accounting method that requires a physical inventory count at
specific intervals, counts of inventory may be executed monthly,
quarterly,annully,rather than regularly or after each sale.
Cont.…
 Under the periodic inventory system, purchases of

merchandise are recorded in one or
more Purchases accounts.
 At the end of the year the Purchases account(s) are
closed and the Inventory account is adjusted to equal the
cost of the merchandise actually on hand at the end of
the year.
 Under the periodic system there is no Cost of Goods
Sold account to be updated when a sale of merchandise
occurs.
 In short, under the periodic inventory system there is no
way to tell from the general ledger accounts the amount
of inventory or BENOL.M
January 24
the cost of goods sold. 7
Perpetual inventory system
• Under this system the Inventory account is continuously

updated.
• The Inventory account is increased with the cost of
merchandise purchased from suppliers and it is reduced by
the cost of merchandise that has been sold to customers.
(The Purchases account(s) do not exist.)
Under the perpetual system there is a Cost of Goods Sold
account that is debited at the time of each sale for the cost of
the merchandise that was sold.
• Under the perpetual system a sale of merchandise will result
in two journal entries: one to record the sale and the cash or
accounts receivable, and one to reduce inventory and to
increase
January 24
cost of goods
BENOL.M
sold. 8
Cont.…
 There are three most widely used inventory costing
methods or assumptions of cost flows:-
1. First In, First Out (FIFO)
2. Last In, First Out (LIFO)
3. Average (weight)Method
Inventory Costing Under Periodic Systems
1. First In, First Out (FIFO) Method
• Earliest goods purchased are the first to be sold.
• Under the FIFO cost flow assumption, the first (oldest) costs are the
first ones to leave inventory and become the cost of goods sold on the
income statement. The last (or recent) costs will be reported as
inventory on the balance sheet.
• Example:- calculate cost of inventory based on the data below
Date Item Unit Unit price Total
Jan 1 Inventory 200 9 1,800
March 10 Purchase 300 10 3,000
September 21 Purchase 400 11 4,400
November 18 Purchase 100 12 1,200
Units available for the Year 1,000 10,400
• The physical count on Dec, 31 shows that 300 units on hand then
determine the cost of inventory
Cont…
 Solution
Most recent costs; Nov, 18 100units @ $12 1,200
Next recent costs; Sept 21 200units @ 11 2,200
Inventory cost of Dec.31 300unit $3,400
• Eg 2 Stewart Inc beginning inventory and purchases during the fiscal
year ended March 31, 2014 were as follows:
April 1, 2013 Inventory 1,000 50 50,000
April 10, 2013 Purchase 1,200 52.50 63,000
May 30, 2013 Purchase 800 55 44,000
August 26, 2013 Purchase 2,000 56 112,000
October 15, 2013 Purchase 1,500 57 85,500
December 31, 2013 Purchase 700 58 40,600
January 18, 2014 Purchase 1,350 60 81,000
March 21, 2014 Purchase 450 62 27,900
Cont.…
Stewart Inc uses the periodic inventory system and there are
3,200 units of inventory on hand on March 31,2014
Instructions: Determine the cost of inventory on March 31,
2014.
Solution
450 units@62 27,900
1,350 units@60 81,000
700 units@58 40,600
700 units@57 39,900
3,200 unit 189,400
Cont.…
2. Last In, First Out (LIFO) Method

• Under the LIFO cost flow assumption, the last (or recent) costs are the
first ones to leave inventory and become the cost of goods sold on the
income statement.
• The first (or oldest) costs will be reported as inventory on the balance
sheet.
BENOL.M 13
January 24
 Solution Cont…
Earliest costs; Jan, 1 200units @ $9 1,800

 Next earliest costs; Mar 10 100units @ 10 1,000
Inventory cost of Dec.31 300unit $2,800
• Eg 2 Bontu Inc beginning inventory and purchases during the fiscal
April 1, 2013 Inventory 1,000 50 50,000
April 10, 2013 Purchase 1,200 52.50 63,000
May 30, 2013 Purchase 800 55 44,000
August 26, 2013 Purchase 2,000 56 112,000
March 21, 2014 Purchase 450 62 27,900
Cont.…
Stewart Inc uses the periodic inventory system and there are
2014.
Solution
1,000 units@50 50,000
1,200 units@52.50 63,000
800 units@55 44,600
200 units@56 11,200
3,200 unit 168,200
Cont…
3. Average Cost Method (Weighted Average)

• average cost is calculated using the total goods available for sale
(cost from the beginning inventory plus the costs of all subsequent
purchases made during the entire year).
Cont.…
 Solution
Average unit cost = Total Cost/Total Unit
= 10,400/1000 = 10.40
 Inventory cost of Dec.31 300unit@ 10.40 $3,120
• Eg 2 Bontu Inc beginning inventory and purchases during the fiscal
April 1, 2013 Inventory 1,000 50 50,000
April 10, 2013 Purchase 1,200 52.50 63,000
May 30, 2013 Purchase 800 55 44,000
August 26, 2013 Purchase 2,000 56 112,000
March 21, 2014 Purchase 450 62 27,900
Units available for the
January 24 Year
BENOL.M 9,000 504,000
17
Cont.…
Bontu Inc uses the periodic inventory system and there are
2014.
Solution
Average cost per unit = Total Cost/Total Unit
= 504,000/9,000units = 56
Inventory cost 3,200 unit @ 56 $179,200
Cont.…
• Eg 3 The following data relate to Tulema Company which uses the
Periodic inventory system:

Jan 1, 2013 Inventory 8,000 50 50,000
Jan 10, 2013 Purchase 20,000 52.50 63,000
Jan 20, 2013 Purchase 30,000 55 44,000
Jan 30, 2013 Purchase 10,000 56 112,000
Jan 31, 2013 Sold 56,000
• Determine the cost of ending inventory by the following methods:-
1. FIFO
2. LIFO
3. Average Weighted Method
Inventory Costing Under Perpetual Systems
 Under this system, an entity continually updates its
inventory records in real time.
 When a retailer purchases merchandise, the retailer debits
its Inventory account for the cost; when the retailer sells the
merchandise to its customers its Inventory account is
credited and its Cost of Goods Sold account is debited for
the cost of the goods sold.
 The perpetual system ensures that the balance sheet and
income statement are correct at all times.
Cont.…
 Rather than staying dormant as it does with the periodic
method, the Inventory account balance is continuously
updated.
 Under the perpetual system, two transactions are recorded
when merchandise is sold:
a.The sales amount is debited to Accounts
Receivable or Cash and is credited to Sales, and
b.The cost of the merchandise sold is debited to Cost of Goods
Sold and is credited to Inventory.
(Note: Under the periodic system the second entry is not made.)
Cont.…
1. First In, First Out (FIFO) Method

– With perpetual FIFO, the first (or oldest) costs are the first
moved from the Inventory account and debited to the Cost
of Goods Sold account.
– The end result under perpetual FIFO is the same as under
periodic FIFO.
– In other words, the first costs are the same whether you
move the cost out of inventory with each sale (perpetual)
or whether you wait until the year is over (periodic).
Cont.…
 Exercise 1: based on the following data calculate the
Inventory cost using FIFO Method
Date Item Units Unit Price

Jan 1 Inventory 10 $20
Jan 4 Sale 7
Jan 10 Purchase 8 21
Jan 22 Sale 4
Jan 28 Sale 2
Cont.…
2. Last In, First Out (LIFO) Method

– The last costs available at the time of the sale are the first
to be removed from the Inventory account and debited to
the Cost of Goods Sold account.
– Since this is the perpetual system we cannot wait until the
end of the year to determine the last cost-an entry must be
recorded at the time of the sale in order to reduce the
Inventory account and to increase the Cost of Goods Sold
account.
– The cost of the units sold is the cost of the most recent
purchases.
Cont.…
 Exercise 1: based on the following data calculate the
Inventory cost using LIFO Method

Jan 4 Sale 7
Jan 22 Sale 4
Jan 28 Sale 2
Cont.…
3. Average Cost Method

– The average cost of the items in inventory as of the date of
the sale.
– This average cost is multiplied by the number of units sold
and is removed from the Inventory account and debited to
the Cost of Goods Sold account.
– We use the average as of the time of the sale because this is
a perpetual method.
Cont.…
 Exercise 1: beginning Inventory, purchase and sales data for commodity
D45 are as follows:
Jan 5 Sold 5
Jan 17 Sold 12
Jan 22 Sold 3
 The enterprise maintains a perpetual inventory system;

a. Determine the cost of the merchandise sold in each sale and cost of inventory balance after each sale,
by using FIFO, LIFO and Average cost Method.
SPECIAL VALUATION OF INVENTORY
1. Net Realizable Value
 Estimated selling price in the normal course of business
less
 estimated costs to complete and
 estimated costs to make a sale.
2. Retail Method of Inventory Costing

 is widely used by retail businesses, particularly department
stores.
 is based on the relationship of the cost of the merchandise
available for sale to the retail price of the same
merchandise.
CONT..
Retail Method of Inventory Costing Formula
Step 1:Goods available for –net sales =Ending inventory at retail
sale at retail
Step 2:Goods available for sale at cost / Goods available for sale at
retail =Cost to retail ratio
Step 3:Ending inventory at retail x Cost to retail ratio =
Estimated cost of ending inventory.
CONT.…
3. Gross Profit Method of Estimating Inventories
 It uses an estimate of the gross profit realized during the
period to estimate the inventory at the end of the period.
 By using the rate of gross profit, the dollar amount of sales
for a period can be divided in to its two components:
1. Gross profit
2. Cost of merchandise sold
The latter may then be deducted from the cost merchandise

available for sale to yield the estimated inventory of
merchandise on hand.
CONT.…
Gross Profit Method of Estimating Inventories Formula
Step 1:Net sales – Estimated gross profit=Estimated cost of

goods sold
Step 2:Cost of Goods available for sale –Estimated cost of

goods sold =Ending cost of ending inventory
Cost of Goods available for sale = Beginning inventory +

cost of goods purchased
Thank you !!!

Ifa Ii CH 1

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RIFT VALLEY UNIVERSITY

 Periodic inventory system:- Under this system the

 Under the periodic inventory system, purchases of

• Under this system the Inventory account is continuously

2. Last In, First Out (LIFO)

2. Last In, First Out (LIFO) Method

Earliest costs; Jan, 1 200units @ $9 1,800

3. Average Cost Method (Weighted Average)

Date Item Unit Unit price Total

1. First In, First Out (FIFO) Method

Date Item Units Unit Price

2. Last In, First Out (LIFO) Method

Date Item Units Unit Price

3. Average Cost Method

 The enterprise maintains a perpetual inventory system;

 estimated costs to make a sale.

2. Retail Method of Inventory Costing

Step 3:Ending inventory at retail x Cost to retail ratio =

Estimated cost of ending inventory.

2. Cost of merchandise sold

The latter may then be deducted from the cost merchandise

Step 1:Net sales – Estimated gross profit=Estimated cost of

Step 2:Cost of Goods available for sale –Estimated cost of

Cost of Goods available for sale = Beginning inventory +

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