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FAR OCAMPO/OCAMPO
FAR.03-Estimating Inventories

LECTURE NOTES
Reference Retail Inventory Method

PAS 2 – Inventories The retail method is often used in the retail industry for
measuring inventories of large numbers of rapidly
changing items with similar margins for which it is
Techniques to Estimate Cost of Inventories impracticable to use other costing methods. This method
is based upon an observable pattern between cost and
• Gross profit method sales price that exists in most retail concerns.
• Retail inventory method
• Standard cost method Under this method, an entity must keep a record of the
following:
Although commonly used to estimate the cost of • total cost and retail value of goods purchased;
inventories, the gross profit method is not normally • total cost and retail value of the goods available for
acceptable for year-end financial reporting purposes. sale; and
• sales for the period.
PAS 2 allows the use of standard cost and retail methods
for the measurement of cost, provided that the results Computation of ending inventory at retail:
approximate actual cost.
Total goods available for sale (at retail) Pxx
Net deduction from GAS (at retail) ( xx)
Estimated ending inventory (at retail) Pxx
Gross Profit Method
Computation of net deduction from GAS:
The gross profit method assumes that the gross profit
rate (also known as gross profit percentage or gross Gross Net
margin ratio) is known and the relationship between Sales Sales
gross profit and sales remains stable over time. This Sales returns (xx) -
method also assumes the following: Sales allowances - xx
• The beginning inventory plus purchases equal total Sales discounts - xx
goods to be accounted for. Employee discounts xx xx
• If sales, reduced to cost, are deducted from the Normal shortages xx xx
sum of the opening inventory plus purchases, the
Abnormal shortages - -
result is the ending inventory.
Net deduction from GAS xx xx
• Goods not sold must be on hand.
Computation of ending inventory at cost:
The gross profit method is useful when:
• Interim financial statements are prepared. Estimated ending inventory (at retail) Pxx
• Inventory is destroyed by fire or flashfloods. x Cost-to-retail ratio x%
• Testing of the validity of an inventory cost Estimated ending inventory (at cost) Pxx
determined under either periodic or perpetual
system. Computation of cost-to-retail ratio:

Computation of estimated ending inventory: Goods available for sale (at cost) Pxx
/ Goods available for sale (at retail) Pxx
Beginning inventory Pxx Cost-to-retail ratio %
Purchases, net xx
Total goods available for sale xx Retail inventory methods and their differences in
Cost of sales ( xx) computing goods available for sale:
Estimated ending inventory Pxx
Beg.
Computation of cost of sales: Method Markdown Inventory

If the GPR is based on sales: Conventional Exclude Include

Average Include (Deduct) Include

Cost of sales = Net sales x Cost ratio
Cost ratio = 1 – GPR FIFO Include (Deduct) Exclude
GPR = Gross profit/Net sales

If the GPR is based on cost: To yield an estimate that approximates cost, PAS 2
requires that the percentage used takes into
Cost of sales = Net sales/ (1 + GPR) consideration inventory that has been marked down to
GPR = Gross profit/Cost of sales below its original selling price. Therefore, the
conventional retail inventory method is no longer
allowed.

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The beginning inventory is excluded in the computation Cost Retail

under FIFO retail method and the entity computes the Departmental transfer in xx xx
cost-to-retail ratio for the current period purchases only. Departmental transfer out (xx) (xx)
The beginning inventory is included in the computation Markupsb - xx
under average retail method. Therefore, the cost-to- Markup cancellations - (xx)
retail ratio is the same under both methods if there is no Markdownsc - (xx)
beginning inventory. Markdown cancellations - xx
Normal shortagesd - -
Assuming no beginning inventory, the treatment of the
Abnormal shortages (xx) (xx)
items in computing cost-to-retail ratio under both FIFO
Goods available for sale xx xx
and average retail method is summarized as follows:
a
Cost Retail Original selling price (Purchases at cost + Initial markup)
b
Purchases xx xxa Increase in original selling price
c
Decrease in original selling price
Purchase returns (xx) (xx) d
Breakage, damage, theft or shrinkage
Purchase allowances (xx) -
Purchase discounts (xx) -
Freight in xx - - done -

DISCUSSION PROBLEMS
1. Techniques for the measurement of the cost of 5. On May 6 of the current year, a flash flood caused
inventories may be used for convenience if the results damage to the merchandise stored in the warehouse of
approximate cost. Examples of techniques to estimate Cabanatuan Co. You were asked to submit an estimate
cost of inventories mentioned in PAS 2 include of the merchandise destroyed in the warehouse. The
following data were established:
I. Gross profit method
a. Net sales for the prior year were P800,000,
II. Retail inventory method
matched against cost of P560,000.
III. Standard cost method
b. Merchandise inventory at Jan. 1 was P200,000,
IV. Most recent purchase price method
90% of which was in the warehouse and 10% in
downtown showrooms.
a. I, II, III and IV c. I and II only
c. For Jan. 1 to date of flood, you ascertained invoice
b. II, III and IV only d. II and III only
value of purchases (all stored in the warehouse),
P100,000; freight inward, P4,000; purchases
2. The gross profit method is useful
returned, P6,000.
a. When interim financial statements are prepared.
d. Cost of merchandise transferred from the
b. When inventory is destroyed by fire or flashfloods.
warehouse to show-rooms was P8,000, and net
c. When testing of the validity of an inventory cost
sales from Jan. 1 to May 6 (all warehouse stock)
determined under either periodic or perpetual
were P320,000.
system.
d. In all of these. Assuming gross profit rate in the current year to be the
same as in the previous year, the estimated
3. The use of the gross profit method assumes merchandise destroyed by the flood was
a. The amount of gross profit is the same as in prior a. P80,000 c. P50,000
years. b. P66,000 d. P46,000
b. Sales and cost of goods sold have not changed
from previous years. 6. The Bayambang Corp. was organized on Jan. 1 of the
c. Inventory values have not increased from prior year. On Dec. 31 of the current year, the entity
previous years. lost most of its inventory in a warehouse fire just
d. The relationship between gross profit and sales before the year-end count of inventory was to take
remains stable over time. place. Data from the records disclosed the following:
Prior year Current year
4. The gross profit method assumes Goods available for sale 4,069,400 4,157,000
a. The beginning inventory plus purchases equal total Sales 3,940,000 4,180,000
goods to be accounted for. Sales returns and
b. Goods not sold must be on hand. allowances 80,000 100,000
c. If sales, reduced to cost, are deducted from the Gross profit rate 21% ?
sum of the opening inventory plus purchases, the
result is the ending inventory. On Jan. 1 of the current year, the entity’s pricing policy
d. All of these. was changed so that the gross profit rate would be
three percentage points higher than the one earned in
prior year.
Salvaged undamaged merchandise was marked to sell
at P120,000 while damaged merchandise was marked
to sell at P80,000 had an estimated realizable value of
P18,000.
How much is the inventory loss due to fire?
a. P918,200 c. P856,200
b. P947,000 d. P824,600

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7. Luna Manufacturing began operations 5 years ago. On 9. Which statement is incorrect regarding the retail
Aug. 13 of the current year, a fire broke out in the inventory method?
warehouse destroying all inventory and many a. The retail method is often used in the retail
accounting records relating to the inventory. The industry for measuring inventories of large
information available is presented below. All sales and numbers of rapidly changing items with similar
purchases are on account. margins for which it is impracticable to use other
Jan. 1 Aug. 13 costing methods.
Inventory P143,850 ? b. The cost of the inventory is determined by
Accounts Receivable 130,590 P128,890 reducing the sales value of the inventory by the
Accounts Payable 88,140 122,850 appropriate percentage gross margin.
c. The percentage used takes into consideration
Jan. 1 Aug. 13 inventory that has been marked down to below its
Collections on accounts rec., original selling price.
Jan. 1- Aug. 13 753,800 d. A percentage computed using the conventional
Payments to suppliers, retail is required for each retail department.
Jan. 1- Aug. 13 487,500
Goods out on consignment
at Aug. 13, at cost 52,900 Use the following information for the next four questions.
Summary on previous years’ sales: Pugo uses the retail inventory method. The following
Three-year Two-year information is available for the current year:
prior prior Prior year Cost Retail
Sales P626,000 P705,000 P680,000 Beginning inventory P 1,300,000 P 2,600,000
Gross Profit 187,800 183,300 231,200 Purchases 18,000,000 29,200,000
GPR 30% 26% 34% Freight in 400,000
Determine the inventory loss suffered as a result of the Purchase returns 600,000 1,000,000
fire. Purchase allowances 300,000
a. P139,590 c. P86,690 Departmental transfer in 400,000 600,000
b. P102,560 d. P86,310 Net markups 600,000
Net markdowns 2,000,000
8. The work-in-process inventory of Burp Corp. were Sales 24,700,000
completely destroyed by fire on June 1 of the current Sales returns 350,000
year. You were able to establish physical inventory Sales discounts 200,000
figures as follows: Employee discounts 600,000
Loss from breakage 50,000
Jan. 1 June 1
Raw materials P 60,000 P120,000 10. The estimated cost of inventory at the end of the
Work-in-process 200,000 - current year using the conventional (lower of cost or
Finished goods 280,000 240,000 market) retail inventory method is
Sales from Jan. 1 to May 31, were P546,750. a. P3,200,000 c. P3,250,000
Purchases of raw materials were P200,000 and freight b. P3,000,000 d. P3,360,000
on purchases, P30,000. Direct labor during the period
was P160,000. It was agreed with insurance adjusters 11. The estimated cost of inventory at the end of the
that an average gross profit rate of 35% based on cost current year using the average retail inventory method
be used and that direct labor cost was 160% of factory is
overhead. a. P3,200,000 c. P3,250,000
b. P3,000,000 d. P3,584,000
The work in process inventory destroyed by fire is
a. P366,000 c. P265,000 12. The estimated cost of inventory at the end of the
b. P314,612 d. P185,000 current year using the FIFO retail inventory method is
a. P3,200,000 c. P3,250,000
SOLUTION GUIDE: b. P3,000,000 d. P3,658,480
Raw materials, 1/1 P 60,000
Purchases 200,000 13. Which method results in highest cost of sales?
Freight in 30,000 a. Conventional
RM available for use 290,000 b. Average
Raw materials, 6/1 ( 120,000) c. FIFO
Raw materials used 170,000 d. Cannot be determined from the information given
Direct labor 160,000
Factory overhead ? SOLUTION GUIDE:
Total manufacturing costs ? Conventional Average FIFO
WIP, 1/1 200,000
Total costs placed in process ? GAS at cost
WIP, 6/1 ?
Cost of goods manufactured ? GAS at retail
Finished goods, 1/1 280,000
Cost ratio
TGAS ?
Finished goods, 6/1 (240,000) EI at cost
COGS P ?

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14. In calculating the cost-to-retail percentage for the 18. Yumul Company provided the following data:
retail method, the cost column will include: Cost Retail
a. Markup cancellations Beginning inventory P 160,000 P 400,000
b. Markdown cancellations Purchases 2,800,000 3,200,000
c. Sales returns Freight in 40,000
d. Purchase allowances Markup 300,000
Markup cancellation 30,000
15. In calculating the cost-to-retail percentage for the Markdown 160,000
retail method, the retail column will include: Markdown
a. Sales discounts cancellation 40,000
b. Employee discounts Sales 3,000,000
c. Sales allowances Physical inventory at
d. Purchase returns year end 500,000
Estimated normal
16. In calculating the cost-to-retail percentage for the shrinkage is 4% of
retail method, the retail column will not include: sales
a. Purchases
b. Purchase returns Assuming the company uses the average retail
c. Abnormal shortages inventory method, the estimated inventory shortage is
d. Freight-in a. P104,000 c. P200,000
b. P130,000 d. P 4,000
17. The records of Binmaley’s Department Store report the
following data for the month of January: 19. The retail inventory method is characterized by
a. The recording of sales at cost.
Beginning inventory at cost P 440,000
b. The reporting of year-end inventory at retail in
Beginning inventory at sales price 800,000
the financial statements.
Purchases at cost 4,500,000
c. The recording of markups at retail and
Initial markup on purchases 2,900,000
markdowns at cost.
Purchase returns at cost 240,000
d. The recording of purchases at selling price.
Purchase returns at sales price 350,000
Freight on purchases 100,000
J - end of FAR.03 - J
Additional markup 250,000
Markup cancellations 100,000
Markdown 600,000
Markdown cancellations 100,000
Net sales 6,500,000
Sales allowances 100,000
Sales returns 500,000
Employee discounts 200,000
Theft and other losses 100,000
Using the average retail inventory method, Binmaley’s
ending inventory at cost is
a. P360,000 c. P420,000
b. P384,000 d. P448,000

SOLUTION GUIDE:
Cost Retail
Beginning inventory
Purchases
Purchase returns
Freight in
Additional mark up
Mark up cancellations
Mark down
Mark down cancellations
GAS

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