Prepare and maintain accounting records related to inventories (using different stock-taking systems (perpetual and periodic) and using different inventory valuation methods (FIFO, LIFO and weighted average))

Inventory Record-Keeping and Valuation

The core idea: Businesses must keep accurate records of their inventory (stock) and value that inventory using systematic methods to determine the true cost of goods sold and the true value of closing inventory reported in financial statements.

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1. Stock-Taking Systems

A business needs to know how much inventory it has at any time. There are two main systems for tracking inventory:

Periodic Inventory System

• Inventory is counted only at specific intervals (monthly, quarterly, or annually).
• The business does not know the exact quantity of inventory on hand between counts.
• Suitable for businesses with many low-value items, such as supermarkets and small shops.
• Journal entry for purchases: Debit Purchases, Credit Cash/Creditors.
• Cost of sales is calculated at the end of the period: Opening Inventory + Purchases − Closing Inventory.

Perpetual Inventory System

• Inventory is continuously updated after every transaction (every purchase and every sale).
• A subsidiary ledger (inventory record card) shows the running balance of each item.
• Suitable for businesses with fewer, high-value items, such as car dealerships and electronics stores.
• Journal entries:
  • Purchase: Debit Inventory, Credit Cash/Creditors
  • Sale: Debit Cost of Sales, Credit Inventory

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2. Inventory Valuation Methods

When identical items are purchased at different prices over time, the business must decide which costs to assign to goods sold and which to closing inventory. The three standard methods are:

First In, First Out (FIFO)

• Assumes the first items purchased are the first items sold.
• Closing inventory consists of the most recently purchased items.
• This matches the natural flow of most businesses.

Last In, First Out (LIFO)

• Assumes the most recent items purchased are the first items sold.
• Closing inventory consists of the oldest items purchased.
• Note: IAS 2 does not permit LIFO for financial reporting in Tanzania.

Weighted Average Cost (WAM)

• Calculates an average cost per unit by dividing total cost of available inventory by total units available.
• Formula: $\text{Weighted Average Cost} = \frac{\text{Total Cost of Available Inventory}}{\text{Total Units Available}}$
• This smooths out price fluctuations.

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3. Worked Example: Periodic System

Mzee Juma trades in rice. The following transactions occurred during January 2024:

Date	Transaction	Units	Unit Cost (TZS)
Jan 1	Opening inventory	100	2,000
Jan 10	Purchased	200	2,200
Jan 20	Sold	150	—
Jan 25	Purchased	100	2,400

Required: Calculate the value of closing inventory and cost of sales using FIFO, LIFO, and WAM (Periodic system).

Solution:

Units available for sale = 100 + 200 + 100 = 400 units Units sold = 150 units Closing inventory = 400 − 150 = 250 units

FIFO (Periodic): Closing inventory consists of the most recent purchases:

• 100 units × TZS 2,400 = TZS 240,000
• 150 units × TZS 2,200 = TZS 330,000
• Total closing inventory = TZS 570,000

Cost of goods sold = Total purchases (100×2,000 + 200×2,200 + 100×2,400) − Closing inventory = (200,000 + 440,000 + 240,000) − 570,000 = TZS 310,000

LIFO (Periodic): Closing inventory consists of the oldest purchases:

• 100 units × TZS 2,000 = TZS 200,000
• 150 units × TZS 2,200 = TZS 330,000
• Total closing inventory = TZS 530,000

Cost of goods sold = 880,000 − 530,000 = TZS 350,000

WAM (Periodic): Total cost = (100×2,000) + (200×2,200) + (100×2,400) = TZS 880,000 Weighted average cost = TZS 880,000 ÷ 400 = TZS 2,200 per unit Closing inventory = 250 × 2,200 = TZS 550,000 Cost of goods sold = 880,000 − 550,000 = TZS 330,000

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4. Summary Comparison

Method	Closing Inventory (TZS)	Cost of Sales (TZS)
FIFO	570,000	310,000
LIFO	530,000	350,000
WAM	550,000	330,000

During periods of rising prices:

• FIFO reports the highest profit (lower cost of sales, higher inventory value).
• LIFO reports the lowest profit (higher cost of sales, lower inventory value).
• WAM falls in between.

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Real-life application

A Form 5 student running a small shop (duka) in Morogoro or Arusha can apply this knowledge when pricing their products. If they buy maize flour in small batches at rising prices throughout the month, using FIFO will show a higher profit at month-end because the closing inventory is valued at the most recent (higher) prices, helping them understand how their choice of valuation method affects the money they actually make.