CHAPTER ONE

INVENTORIES
1.1 Nature of Inventories:
Inventory is used to indicate;
(1) Asset items held for sale in the ordinary course of business,
(2) Merchandise held for resale purpose in the normal operation of business and
(3) Materials in the process of production or held for production. They are mainly divided into two
major;
(A) Inventories of merchandising businesses: are merchandise purchased for resale in the normal
course of business. These types of inventories are called merchandise inventories.
(B) Inventories of manufacturing businesses: manufacturing businesses are businesses that produce
physical output. They normally have three types of inventories. These are; raw material inventory,
work in process inventory and finished goods inventory
Note: In this chapter, we focus primarily on inventory of merchandise purchased for resale.
1.2 Internal Control of Inventories:
The cost of inventory is a significant item in many businesses’ financial statements. Not only must the cost
inventory be determined, but good internal control over inventory must also be maintained. Two primary
objectives of internal control over inventory are;
(1) Safeguarding the inventory and
(2) Properly reporting it in the financial statement (Balance sheet).
These internal controls can be either preventive or detective in nature. A preventive control is designed to
prevent errors or misstatements from occurring. A detective control is designed to detect an error or
misstatement after it has occurred.

Controls for safeguarding inventory begin as soon as the inventory is ordered. The following documents
are often used for inventory control; purchase order, receiving report and vendor’s invoice.

A physical inventory or count of inventory should be taken near year-end to make sure that the quantity
of inventory reported in the financial statements is accurate. After the quantity of inventory on hand is
determined, the cost of the inventory is assigned for reporting in the financial statements. Most companies
assign costs to inventory using one of three inventory cost flow assumptions.

1.3 Effect of Inventory Errors on Financial Statements:

Any errors in the inventory count will affect both the balance sheet and the income statement. For
example, an error in the physical inventory will misstate the ending inventory, current assets, and total
assets on the balance sheet. This is because the physical inventory is the basis for recording the adjusting
entry for inventory shrinkage. Also, an error in taking the physical inventory misstates the cost of goods
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sold, gross profit, and net income on the income statement. In addition, because net income is closed to the
owner’s equity at the end of the period, owner’s equity will also be misstated on the balance sheet. This
misstatement of owner’s equity will equal the misstatement of the ending inventory, current assets, and
total assets.
Summary of Inventory Errors on Financial Statements
If inventory is: CGS is GP & NI are Ending owner’s equity is
Overstated Understated Overstated Overstated
Understated Overstated Understated Understated
Any errors in merchandise inventory will affect the balance sheet and income statement. Some reasons that
inventory errors may occur include the following:
(1) Physical inventory on hand was miscounted.
(2) Costs were incorrectly assigned to inventory. For example, the FIFO or average cost method was
incorrectly applied.
(3) Inventory in transit was incorrectly included or excluded from inventory.
(4) Consigned inventory was incorrectly included or excluded from inventory.
Example-1: Assume that in taking the physical inventory on December 31, 2001, Yahoo Company
incorrectly recorded its physical inventory as Birr 115,000 instead of Birr 125,000. What should be the
effect of misstatement of the inventory on Dcecember-31, 2001 financial statements?
Solution: The Effect of Inventory Error on the Financial Statements Will;
Balance sheet:
Merchandise Inventory understated (Birr 10,000)
Current assets understated (10,000)
Total assets understated (10,000)
Owner’s equity understated (10,000)
Income Statement:
Cost of merchandise sold overstated Birr 10,000
Gross profit understated (10,000)
Net income understated (10,000)
As a result, the merchandise inventory, current assets, and total assets reported on the December 31, 2001
balance sheet would be understated by Birr 10,000 (125,000 - 115,000). Because the ending physical
inventory is understated, the inventory shrinkage and the cost of merchandise sold will be overstated by
Birr 10,000. Thus, the gross profit and the net income for the year will be understated by Birr 10,000.
Since the net income is closed to owner’s equity at the end of the period, the owner’s equity on the
December 31, 2001 balance sheet will also be understated by Birr 10,000.
Example-2: Assume ABC Company incorrectly counted its December 31, 2002, inventory as Birr
250,000 instead of the correct amount of Birr 220,000. What should be the effect of the misstatement on
ABC’s December 31, 2002, balance sheet and income statement for the year ended December 31, 2002?

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Example-3: Assume on December-31, 2003, the physical ending inventory of Macha Company was
overstated by Birr 25,000. What is the effect of this error on the financial statements?

1.4 Inventory Systems and Inventory Cost Flow Assumptions:

There are two principal inventory systems. These are; periodic and perpetual.
(A) Periodic inventory system;
Purchases of merchandise are debited to Purchases.
Ending Inventory determined by physical count.
At the time of sale no need of recording CGS.
Calculation of Cost of Goods Sold;
Beginning Inventory Birr 100,000
Add: Cost of Purchase (Net) 800,000
Goods Available for Sale Birr 900,000
Less: Ending Inventory (125,000)
Cost of Goods Sold Birr 775,000
(B) Perpetual inventory system;
Provides a continuous record of Inventory and Cost of Goods Sold to disclose the amount of the
inventory.
Purchases of merchandise and Freight-in should be debited to Inventory.
Purchase returns and allowances and purchase discounts are credited to Inventory.
Cost of goods sold is debited and Inventory is credited for each sale.
Subsidiary records show quantity and cost of each type of inventory on hand.
The cost of merchandise sold will be recorded each time a sale is made.
Physical inventory is taken to compare the records with the actual quantities on hand.
Journal entries to be prepared are;
Date Explanation Debit Credit
(1) At the time of purchase of Merchandise inventory XX
merchandise (at cost); A/P (Cash) XX
(2) At the time of sale of A/R (Cash) XX
merchandise (at retail price); Sales XX
Cost of Goods Sold
Merchandise inventory
(3) To record purchase returns and A/P (Cash) XX
allowances; Merchandise inventory XX
(4) No adjusting entry or closing entry for merchandise inventory is needed at the end of
each accounting period.
There are three cost flow assumptions. These are;
(1) Specific Identification Method
(2) FIFO Method, and
(3) Weighted Average Method.
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(1) Specific Identification Method: A major accounting issue arises when identical units of merchandise
are acquired at different unit costs during a period. In such cases, when an item is sold, it is necessary to
determine its unit cost so that the proper accounting entry can be recorded. The specific identification
method is not practical unless each unit can be identified accurately. An automobile dealer, for
example, may be able to use this method, since each automobile has a unique serial number. For many
businesses, however, identical units cannot be separately identified, and a cost flow must be assumed.
That is, which units have been sold and which units are still in inventory must be assumed.
(2) FIFO Method: This method of costing inventory is based on the assumption that costs should be
charged against revenue in the order in which they were incurred. Hence, the inventory remain is
assumed to be made up of the most recent costs and the cost of inventory sold is made up of the earliest
costs.
(3) Average Cost Method: The average cost method is sometimes called the weighted average method.
When this meted is used, costs are matched against revenue according to an average of the unit cost of
goods sold. The same weighted average unit cost are used in determine the cost of the merchandise
inventory at the end various purchase of identical items, the average method approximates physical
flow of goods. The weighted average unit cost is determined by dividing the total cost of the units of
each item available for sale during the period by the related number of units of that item. The weighted
average unit cost is then multiplied with the units on hand to determine the cost of the ending inventory.
Average unit cost will be determined as follows;
Average Unit Cost Calculation Formula;

Example-4: Assume three identical units of item X are purchased during May 2004, as shown below and
assume one unit is sold on May 30 for Birr 20. Using the identification method, what should be the cost of
goods sold, gross profit and cost of ending inventory, if the item sold is from May-10, May-18 or May-24?
Date Item-X Units Cost per Unit Total Cost
May-10 Purchase 1 Birr 9 Birr 9
May-18 Purchase 1 13 13
May - 24 Purchase 1 14 14
Total 3 Birr 36
Average Cost Per Unit (36/3) Birr 12

Solution: Using Specific Identification Method;

Items May-10 May-18 May-24
Sales Birr 20 Birr 20 Birr 20
Cost of Goods Sold ( 9) (13) (14)
Gross Profit Birr 11 Birr 7 Birr 6
Ending Inventory Birr 27 (13 +14) Birr 23 (9 +14) Birr 22 (13 +9)
Solution: Using First In First Out (FIFO) Method; Solution: Using Average Cost Method;
Sales Birr 20 Sales Birr 20
Cost of Goods Sold (9) Cost of Goods Sold (12)
Gross Profit Birr 11 Gross Profit Birr 8
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 Ending Inventory Birr 27 (13 +14) Ending Inventory Birr 24

Note: There are two common cost flow assumptions used in business; that the FIFO and averages cost
method and each of these assumptions is identified with an inventory costing method, as shown below;
Cost Flow Assumptions and Costing Methods;

Note: When the first-in, first-out (FIFO) method is used, the ending inventory is made up of the most
recent costs. When the average cost method is used, the cost of the units in inventory is an average of the
purchase costs.

1.5 Inventory Costing Methods Under a Periodic Inventory System:

When the periodic inventory system is used, only revenue is recorded each time a sale is made. No entry is
made at the time of the sale to record the cost of the merchandise sold. At the end of the accounting period,
a physical inventory is taken to determine the cost of the inventory and the cost of the merchandise sold.
Example-5: Assume the following information for ABC Merchandise Company; a physical count on
December 31, 2005 reveals that 450 inventory.
Date Explanation Units Total Cost
January-1 Beginning Inventory 100 Units at Birr 10 Birr 1,000
March-15 Purchase 200 Units at Birr 11 2,200
September-24 Purchase 300 Units at Birr 12 3,600
November-27 Purchase 400 Units at Birr 13 5,200
Available for sale during the year 1,000 Units Birr 12,000
Required: Compute Cost of Goods Sold and Cost of Ending Inventory; using FIFO and Average cost
methods.
Solution: Using First In First Out (FIFO) Method;
Most Recent Costs – November-27, 2005 400 Units at Birr 13 Birr 5,200
Next Most Recent Costs – September-24, 2005 50 Units at Birr 12 Birr 600
Cost of Inventory, December-31, 2005, 450 Units Birr 5,800

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 Cost of Goods Sold (Birr 12,000-5,800) Birr 6,200
Solution: Using Weighted Average Cost Method;
Average Unit Cost (12,000/1,000) Birr 12 Per Unit
Cost of Inventory, December-31, 2005 (Birr 12 X 450 Units) Birr 5,400
Cost of Goods Sold (Birr 12 X 550 Units) Birr 6,600
Example-6: Assume the following data for Printing Press Company for the period of December-31, 2006;
physical counting shows that 150 units were on hand at end of the period.
Date Item Units Total Cost
September-10, 2006 Beginning inventory 100 Units at Birr 20 Birr 2,000
September-16, 2006 Purchase 80 Units at Birr 21 1,680
September-20, 2006 Purchase 100 Units at Birr 22 2,200
Total 280 Units Birr 5,880
Required: Determine Cost of Goods Sold and Cost of Ending Inventory, using FIFO and Average cost
methods.
Example-7: Assume the following information for Techno Company; those 16 units of the item in the
physical inventory at December-31, 2007 reveals on hand.
Date Item Units Total Cost
January-1, 2007 Beginning inventory 6 Units at Birr 50 Birr 300
March-20, 2007 Purchase 14 Units at Birr 55 770
Octeber-30, 2007 Purchase 20 Units at Birr 62 1,240
Total 40 Units Birr 2,310
Required: Determine Cost of Goods Sold and Cost of Ending Inventory, using FIFO and Average cost
methods.
Example-8: Assume three identical units of Item WH4 are purchased during June, 2008 by Jaffe
Company as shown below;
Date Item Units Total Cost
June-3, 2008 Purchase 1 Unit at Birr 30 Birr 30
June-3, 2008 Purchase 1 Unit at Birr 36 36
June-3, 2008 Purchase 1 Unit at Birr 42 Birr 42
Total 3 Units Birr 108
Required: Determine Cost of Goods Sold and Cost of Ending Inventory, using FIFO and Average cost
methods; if one unit is sold on June-23, 2008 for Birr 53, on June-30, 2008.

1.6 Inventory Costing Method Under Perpetual System:

In a perpetual inventory system, all merchandise increases and decreases are recorded in a manner similar to
recording increases and decreases in cash. The merchandise inventory account at the beginning of an
accounting period indicates the merchandise in stock on that date. Purchases are recorded by debiting
Merchandise Inventory and crediting Cash or Accounts Payable. On the date of each sale, the cost of the
merchandise sold is recorded by debiting Cost of Merchandise Sold and crediting Merchandise
Inventory. Like the periodic inventory system, a cost flow assumption must be made when identical units
are acquired at different unit costs during a period. In such cases, the FIFO, or Average method is used.
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Example-9: Assume the following information for XYZ merchandise Company for the month of
January, 2009:
Date Items Units Unit Costs
January-1, 2009 Beginning inventory 20 Units Birr 20
January-4, 2009 Sales 14 Units 30
January-10, 2009 Purchase 16 Units 12
January-22, 2009 Sales 8 Units 20
January-28, 2009 Sales 4 Units 16
January-30, 2009 Purchase 20 Units Birr 22
Required: Determine Cost of Goods Sold and Cost of Ending Inventory, using FIFO and Average cost
methods.
Solution: Using First In First Out (FIFO) Method;
Date Purchase Cost of Goods Sold Balance
Jan-1 20 Units at Birr 20 Birr 400
Jan-4 14 Units at Birr 20 Birr 280 6 Units at Birr 20 Birr 120
Jan-10 16 Units at Birr 12 Birr 192 6 Units at Birr 20
16 Units at Birr 12 Birr 312
Jan-22 6 Units at Birr 20 Birr 120
2 Units at Birr 12 14 Units at Birr 12
Birr 24 Birr 168
Jan-28 4 Units at Birr 12 Birr 48
10 Units at Birr 12 Birr 120
Jan-30 20 Units at Birr 22 Birr 440 10 Units at Birr 12
20 Units at Birr 22 Birr 560
Total 36 Units Birr 632 26 Units Birr 472 30 Units Birr 560
Solution: Using Weighted Average Cost Method;
Date Purchase Cost of Goods Sold Balance
Jan-1 20 Units at Birr 20 Birr 400
Jan-4 14 Units at Birr 20 Birr 280 6 Units at Birr 20 Birr 120
Jan-10 16 Units at Birr 12 Birr 192 6 Units at Birr 20 Birr 120
16 Units at Birr 12 Birr 192
22 Units at Birr 14.2 Birr 312
Jan-22 8 Units at Birr 14.2 Birr 113.6 14 Units at Birr 14.2 Birr 198.8
Jan-28 4 Units at Birr 14.2 Birr 56.8 10 Units at Birr 14.2 Birr 142
Jan-30 20 Units at Birr 22 Birr 440 10 Units at Birr 14.2 Birr 142
20 Units at Birr 22
Birr 440
30 Units at Birr 19.4
Birr 582
Total 36 Units 26 Units Birr 450.4 30 Units Birr 582
Example-10: Assume the following information for XYZ Merchandise Company for the month of
November, 2010;
Date Items Units
November-1, 2010 Beginning inventory 40 Units at Birr 5
November-5, 2010 Sales 32 Units at Birr 8
November-11, 2010 Purchase 60 Units at Birr 7
November-21, 2010 Sales 45 Units at Birr 9

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Required: Determine Cost of Goods Sold and Cost of Ending Inventory, using FIFO and Average cost
methods.
Example-11: Assume information regarding the beginning inventory, purchases, and sales for Item
CJ10 for Yardstick Company for the period of April 2011 are as follows;
Date Item Units
April-1, 2011 Beginning inventory 300 Units at Birr 70
April-8, 2011 Sales 185 Units at Birr 80
April-15, 2011 Purchase 25 Units at Birr 72
April-24, 2011 Sales 135 Units at Birr 85
Required: Determine Cost of Goods Sold and Cost of Ending Inventory, using FIFO and Average cost
methods.
Example-12: Assume the following information for FDF Merchandise Company for the year of 2012;
Date Items Units Unit Costs
January-1, 2012 Beginning inventory 1,000 Units Birr 50
March-10, 2012 Purchase 1,200 Units 52.5
June-25, 2012 Sales 800 Units 60
August-30, 2012 Purchase 800 Units 55
Octeber-5, 2012 Sales 1,500 Units 65
November-26, 2012 Purchase 2,000 Units 58
Deemberc-31, 2012 Sales 1,000 Units 66.5
Required: Determine Cost of Goods Sold and Cost of Ending Inventory, using FIFO and Average methods.

1.7 Inventory Valuation Methods:

Goods sold (used) during an accounting period seldom correspond exactly to the goods bought (produced)
during that period. As a result, inventories either increase or decrease during the period. Companies must
then allocate the cost of all the goods available for sale (use) between the goods that were sold or used and
those that are still on hand. The cost of goods available for sale or use is the sum of; (1) the cost of the
goods on hand at the beginning of the period, and (2) the cost of the goods acquired or produced during the
period. The cost of goods sold is the difference between; (1) the cost of goods available for sale during the
period, and (2) the cost of goods on hand at the end of the period. The following table shows these
calculations;
Beginning Inventory Birr 100,000
Add: Cost of Goods Purchased (Produced) 800,000
Cost of Goods Available for Sale Birr 900,000
Less: Ending Inventory (200,000)
Cost of Goods Sold Birr 700,000
Cost is the primary basis for valuing inventories. In some cases, however, inventory is valued at other than
cost. Two such cases arise when;
(A) The cost of replacing items in inventory is below the recorded cost and
(B) The inventory is not salable at normal sales prices and this case may be due to imperfections,
shop wear, style changes, or other causes. Thus, inventory can be valued;
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(1) Net Realizable Value: The term net realizable value (NRV) refers to the net amount that a company
expects to realize from the sale of inventory. Specifically, net realizable value is the difference between
estimated selling price in the normal course of business and estimated costs to complete and estimated
costs to make a sale. NRV is the estimated selling price less any direct cost of disposals such as sales
commissions.
(2) Lower-of-Cost-or-Net Realizable Value (LCNRV): Inventories are recorded at their cost. However,
if inventory declines in value below its original cost, a major departure from the historical cost principle
occurs. Whatever the reason for a decline - obsolescence, price-level changes, or damaged goods a
company should write down the inventory to net realizable value to report this loss. A company
abandons the historical cost principle when the future utility (revenue-producing ability) of the asset
drops below its original cost. Cost and replacement cost can be determined for; (1) each item in the
inventory; (2) major classes or categories of inventory; and (3) the inventory as a whole.
Example-13: Assume that ABC Company’s damaged merchandise costing Birr 1,000 can be sold for only
Birr 800 during July-10, 2013, and direct selling expenses are estimated to be Birr 150. What should be the
value of inventory, using NRV?
Value of Inventory Using NRV;

Estimated sales price of inventory Birr 800

Less: Estimated direct selling expenses (150)
Net Realizable Value Birr 650
Example-14: Assume ABC Company’s damaged merchandise costing Birr 1,500 can be sold for only Birr
1,250 as of August-21, 2014, and direct selling expenses are estimated to be Birr 175. What should be the
accurate value of the inventory?
Example-15: Assume the following data of inventory of ABC Company on May-31, 2015;
Inventory Items (A) Cost NRV
X Birr 750,000 Birr 700,000
Y Birr 180,000 Birr 190,000
Inventory Items (B) Cost NRV
W Birr 100,000 Birr 112,000
Z Birr 96,000 Birr 87,000
Required: What should be the accurate value of the inventory, using lower of cost or net realizable value
(LCNRV) method; under (1) each item in the inventory; (2) major classes or categories of inventory; and
(3) the inventory as a whole.?
Solution: Inventory Valuation Based on LCNRV Under 3 Sections;
Inventory Value by LCNRV;
Inventory Items (A) Cost NRV Individual Major Groups Total Inventory
Items
X Birr 750,000 Birr 700,000 Birr 700,000
Y Birr 180,000 Birr 190,000 Birr 180,000
Total Items (A) Birr 930,000 Birr 890,000 Birr 890,000
Inventory Items (B)
W Birr 100,000 Birr 112,000 Birr 100,000
Z Birr 96,000 Birr 87,000 Birr 87,000
Total Items (B) Birr 196,000 Birr 199,000 Birr 196,000
Total Items (A&B) Birr 1,126,000 Birr 1,089,000 Birr 1,067,000 Birr 1,086,000 Birr 1,089,000
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 1.8 Estimating Methods of Inventory Costs:
A business may need to estimate the amount of inventory for the following reasons: (1) Perpetual inventory
records are not maintained; (2) a disaster such as a fire or flood has destroyed the inventory records and the
inventory; and (3) monthly or quarterly financial statements are needed, but a physical inventory is taken
only once a year. It may be necessary for a business to know the amount of inventory when perpetual
inventory records are not maintained and it is impractical to take a physical inventory. There are methods of
estimating inventory that; (1) gross profit method, and (2) retail method.
(1) Gross Profit Method: Companies take a physical inventory to verify the accuracy of the perpetual
inventory records or, if no records exist, to arrive at an inventory amount. Sometimes, however, taking
a physical inventory is impractical. In such cases, companies use substitute measures to approximate
inventory on hand. The gross profit method relies on three assumptions;
(A) The beginning inventory plus purchases equal total goods to be accounted for.
(B) Goods not sold must be on hand.
(C) The sales, reduced to cost, deducted from the sum of the opening inventory plus purchases, equal
ending inventory.
The gross profit method is applied as follows; (1) Determine the merchandise available for sale at cost; (2)
Determine the estimated gross profit by multiplying the net sales by the gross profit percentage; (3)
Determine the estimated cost of merchandise sold by deducting the estimated gross profit from the net
sales; and (4) Estimate the ending inventory cost by deducting the estimated cost of merchandise sold from
the merchandise available for sale. The formula should be as follow;
1) Merchandise Available for Sale at Cost = Beginning Inventory (at Cost) + Purchases (at Cost)
2) Estimated Gross Profit = Estimated Gross Profit Percent X Net Sales
3) Estimated Cost of Merchandise Sold = Net Sales - Estimated Gross Profit
4) Estimate the ending inventory cost = Merchandise available for sale at cost - Estimated CGS
Example -16: Assume that Central Company has a beginning inventory of Birr 60,000 and purchases of
Birr 200,000, both at cost on December-31, 2016. Sales at selling price amount to Birr 280,000. The gross
profit on selling price is 30 percent. What should be the cost of ending inventory; using gross profit
method?
Solution: Determining Estimated Ending Inventory Cost;
Beginning inventory (at cost) Birr 60,000
Add: Purchases (at cost) 200,000
Goods available (at cost) Birr 260,000
Sales (at selling price) Birr 280,000
Less: Gross profit (30% X 280,000) (84,000)
Less: Sales (at cost) (Birr 196,000)
Approximate inventory (at cost) Birr 64,000
Example-17: Assume the merchandise inventory of XYZ Company was destroyed by fire on October-20,
2017 and the following data were obtained from the accounting records; and based on the following data
determine the estimated cost of ending inventory;
Date Items Amounts
January-1, 2017 Merchandise Inventory Birr 160,000

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 January-1, 2017 - October-20, 2017 Purchase (net) Birr 850,000
January-1, 2017 - October-20, 2017 Sales (net) Birr 1,080,000
Estimated Gross Profit 36%
Solution: Determining Estimated Ending Inventory Cost;
Beginning Merchandise Inventory Birr 160,000
Add: Purchase (net) Birr 850,000
Merchandise Available for Sale Birr 1,010,000
Less: CGS (Birr 1,080,000 X 64%) (Birr 691,200)
Estimated Ending Merchandise Inventory Birr 318,800
Example-18: Assume the merchandise inventory of Yoon Company was destroyed by earth quake on
June- 27, 2018 and the following data were obtained from the accounting records; and based on the data
determine the estimated ending inventory cost; using gross profit method;
Date Items Amounts
January-1, 2018 Merchandise Inventory Birr 57,000
January-1, 2018 – June-27, 2018 Purchase (net) Birr 180,000
January-1, 2018 – June-27, 2018 Sales (net) Birr 250,000
Estimated Gross Profit 30%
(2) Retail Method: The retail inventory method of estimating inventory cost requires costs and retail prices
to be maintained for the merchandise available for sale. A ratio of cost to retail price is then used to
convert ending inventory at retail to estimate the ending inventory cost. The retail inventory method is a
pplied as follows;
(1) Step-1: Determine the total merchandise available for sale at cost and retail.
(2) Step-2: Determine the ratio of the cost to retail of the merchandise available for sale.
(3) Step-3: Determine the ending inventory at retail by deducting the net sales from the
merchandise available for sale at retail.
(4) Step-4: Estimate the ending inventory cost by multiplying the ending inventory at retail by the
cost to retail ratio.
1) Merchandise available for sale Beginning inventory + Purchases (net)
2) Cost to Retail Ratio Merchandise available for sale at cost/at retail
3) Ending inventory at retail Merchandise available for sale at retail – Sales (net)
4) Ending inventory at cost Cost to Retail Ratio X Ending inventory at Retail
Example-19: Assume the following information of Yonatan Company for June-30, 2018; and compute the
estimated ending Inventory.
Date Item Cost Retail Price
June-1 Inventory Birr 428,300 Birr 670,500
June 1-30 Purchases (net) Birr 608,500 Birr 949,500
June 1-30 Sales (net) Birr 1,140,000
Solution: Estimated Cost of Ending Inventory Determination;
1 Merchandise Available for Sale Birr 1,036,000 Birr 1,620,000
Less: Sales (Birr 1,140,000)
2 Ending inventory at Retail Birr 480,000
3 Cost Retail Ratio (Birr 1,036,000/1,620,000) 64%
4 Estimated Ending Inventory (Birr 480,000 X 64%) Birr 307,200
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Example-20: Assume in June, 2018, XYZ Company has the following information from its record; and
determines the ending inventory using the retail method.
Date Items Cost Retail Price
June-1 Inventory Birr 19,400 Birr 36,000
June 1-30 Purchases (net) Birr 42,600 Birr 64,000
June 1-30 Sales (net) Birr 70,000
Solution: Estimated Cost of Ending Inventory Determination;
Merchandise inventory, January 1 Birr 19,400 Birr 36,000
Add: Purchases in January (net) Birr 42,600 Birr 64,000
Merchandise available for sale Birr 62,000 Birr 100,000
Cost to Retail Ratio (62,000/100,000) 62%
Merchandise available for sale Birr 100,000
Less: Sales (net) (70,000)
Merchandise inventory, January-31, at retail Birr 30,000
Estimated Ending inventory cost (Birr 30,000 X 62%) Birr 18,600
Example-21: Assume the following data of Delta Company, and estimate the cost of the merchandise
inventory at April-30, 2018, by the retail method;
Date Items Cost Retail Price
April -1 Merchandise inventory Birr 180,000 Birr 300,000
April- 1-30 Purchases (net) Birr 1,200,000 Birr 2,000,000
April- 1-30 Sales (net) Birr 2,025,000
1.9 Presentation of Merchandise Inventory on Balance Sheet:
Merchandise inventory is usually presented in the current asset section of the balance sheet, following
receivables. In addition to this amount, the following are reported:
(1) The method of determining the cost of the inventory (FIFO, or average)
(2) The method of valuing the inventory (cost, or the lower of cost or net realizable value)
Both the method of determining the cost of inventory (FIFO, or average) and the method of valuing the
inventory (cost or the lower of cost or market) should be show. The details may be disclosed in parentheses
on the balance sheet or in a foot note to the financial statements. The company may change its inventory
costing methods for valid reason. In such cases, the effect of the change and the reason for the change should
be disclosed in the financial statements for period in which the change occurred.
Example-22: Assume ABC Company presented its Balance Sheet as follow;
ABC Company, Balance Sheet, End year Dec-31, 2004;
Current Assets: Amounts Net Amounts
Cash Birr 235,000
Trading Investment (at cost) Birr 240,000
Add: Valuation Allowance on Investments Birr 45,000 Birr 285,000
Accounts Receivable Birr 305,000
Less: Allowance for Doubt full Birr 12,300 Birr 292,700
Merchandise inventory at LCNRV (FIFO) Birr 120,000

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