Unit of Competence : Maintain Inventory Records

Summary of Learning Outcomes

After completing this learning guide, you should be able to:

.
Lo1:- . Process inventory purchase

Lo2:- . Record inventory flows

Lo3:- . Reconcile inventory records to general ledgers

Lo4:- Prepare inventory schedules and ad hoc reports

Lo1:- . Process inventory purchase

INTRODUCTION

What is inventory?

Inventory is an asset that is intended to be sold in the ordinary course of business. Inventory may not be
immediately ready for sale. Inventory are usually the largest current asset of business.proper
measurement of them is necessary to ensure accurate financial statement.if inventory is not properly
measured expense and revenue cannot be properly matched. When ending inventory is incorrect the
following balance of balance sheet will also be incorrect as asset.merchandise inventory,total asset ,and
owner's equity.when ending inventory is incorrect the cost of merchandise sold and net income will also
be incorrect on the income statement.Inventory refers to all the items, goods, merchandise,and
materials held by a business for selling in the market to earn a profit. Example: If a newspaper vendor
uses avehicle to deliver newspapers to the customers, only thenewspaper will be considered inventory .
The vehicle willbe treated as an asset.Accounting for InventoriesAs we say before, There are three basic
types of inventory:

1. Raw Materials —raw materials inventory is made up of goods that will be used in the production of
finished products, e.g., nuts, bolts, flour, sugar.

2. Work in Process —work in process inventory, or WIP, consists of materials entered into the
production process but not yet completed,

e.g., subassemblies.
3. Finished Goods —finished goods inventory includes 2completed products waiting to be sold, e.g., bar
stools, bread, cookies.2

Cost of good sold = Begining inventory + purchase __Ending inventory

Gross profit = sales __ CGS

INVENTORY SYSTEM

Inventory system is through which we can determine the cost of merchandise sold and cost of
merchandise on hand.There are two types of inventory system.

1. Periodic inventory system

2. Perpetual inventory system

1. Periodic inventory system :- is a form of inventory valuation where the inventory account is updated
at the end of an accounting period rather than after every sale and purchase . The method allows a
business to track its beginning inventory and ending inventory within an accounting period.is only
revenue from sales is accounted but inventory is not updated.

*. Physical inventory must be taken at the end of the year to determine the cost of goods sold.

*. Regardless of what inventory accounting system is usedits good practice to perform physical
inventory at least once a year.A periodic inventory system only updates the ending inventory balance in
the general ledger when a physical inventory count is conducted. Since physical inventory counts are
time-consuming, few companies do them more than once a quarter or year. In the meantime, the
inventory account in the accounting system continues to show the cost of the inventory that was
recorded as of the last physical inventory count. Under the periodic inventory system, all purchases
made between physical inventory counts are recorded in a

purchases account. When a physical inventory count is done, the balance in the purchases account is
then shifted into the inventory account, which in turn is adjusted to match the cost of the ending
inventory.

The calculation of the cost of goods sold under the

periodic inventory system is:

Beginning inventory + Purchases = Cost of goods

available for sale

Cost of goods available for sale – Ending inventory =Cost of goods sold

For example, Milagro Corporation has beginning inventory of $100,000, has paid $170,000 for
purchases,and its physical inventory count reveals an endinginventory cost of $80,000.
The calculation of its :-

cost of goods sold is:=$100,000 Beginning inventory + $170,000 Purchases -$80,000 Ending inventory

CGS. = $190,000

Periodic Inventory Accounting

Under a periodic inventory system, inventory purchases

made by a company are initially stored in a purchases

(asset) account with the following journal entry:

2. Perpetual inventory system:- is a program that continuously estimates your inventory based on your
electronic records, not a physical inventory. This system starts with the baseline from a physical count
and updates based on purchases made in and shipments made out.

*. is show the amount of of inventory on hand at all times.

*. It maintain aseparete account to record for both cost of good sold and merchandise inventory on
hand.the account is updated each time aquantity is added or taken out.

The difference between periodic and perpetual inventory system

PERIODIC. PERPETUAL

*. Inventory report annual base. *. Inventory report less than a year

*. Inventory is not report after sales and purchase. *. Inventory known after sales and purchase

*. CGS report annual base. *. CGS reports every sales.

INVENTORY COSTING METHOD _ PERIODIC INVENTORY SYSTEM

The periodic system record only revenue each time as sales is made.in order to determine the cost of
goods sold physical inventory must be taken. The most commonly used inventory costing method under
periodic system are :-There are three main valuation methods retail companies use for inventory
accounting:

1. First In, First Out (FIFO).

2. Last In, First Out (LIFO).

3. Average Cost Method.

You'll just need to stipulate which one is being used when submitting financial records and

accounts.
 1) FIFO

FIFO is a useful inventory management technique to actually use in the handling of stock in your
warehouse. But it's also a method of valuing unsold inventory.It assumes inventory that was purchased
first, is also the first to be sold. So the oldest on-hand inventory available is what will be used to fufill an
order.There are a number of benefits to the FIFO method. Primarily, companies selling perishable goods
(food and drinks) face less risk of their products spoiling or crossing best-before sale date. They can
establish a smooth supply chain and ensure their clients receive the freshest items in their inventory.All
products received and sold must be recorded individually when using the FIFO accounting method. It’s
possible that the FIFO system can lead businesses to under or overestimate the value of inventory in the
future, due to market changes down the line.

2) LIFO

The LIFO helps in reducing the inventory profits by matching the most recent costs against

revenues. It results in reduction of understatement of cost of goods sold (COGS) and

overstatement of profit. Therefore the quality andreliability of earnings are improved under LIFO.

The LIFO approach works on the assumption that the most recent products added to your inventory are
the first ones to be sold first.This system works well for retail businesses specializing in non-perishable
goods or those with a low risk of obsolescence. It can also increase COGS and lessen net profit
(therefore reducing annual tax liability) if more recently purchased goods are more expensive.Note: LIFO
is an acceptable inventory accounting method in the US only.

3) Average Cost

Average Cost (or weighted-average) inventory accounting method is totally different to the previous
two.

4 1. FIFO(first in first out):-This method assumed early purchase goods must sold and the late one
will be ending inventory .this method used by company sold of following types of goods.

Goods most fashionable

Different foods and beverage itemss

Medicines

Under the FIFO cost flow assumption, a company includes the earliest cost
incurred in the cost of goods sold, and includes the most recent cost in the ending
inventory.The units in the opening stock of materials are treated as if they are
issued first, the units from the first purchase issued next, and so on until the units
left in the closing stock of materials are valued at the latest cost of purchases. This
method is most suitable in times of falling prices because the issue price of
materials to jobs or work order will be high while the cost of replacement of
materials will be low. But in case of rising prices this method is not suitable
because the issue price of materials to production will be low while the cost of
replacement of materials will be high.5
high.5

Advantages:

(i) Since materials issued for production are at the original cost, the inventory
reflects the current market price,

(ii) Profit and Loss Account and the Balance Sheet satisfactorily represent the
actual conditions,

(iii) When the price level is declining, the FIFO method shows a lower profit for
income tax implications,

(iv) Next to the Average Cost Method, FIFO is the most commonly accepted basis
of valuation of issue, and

(v) The method simplifies computation of the values of issues.

Demerits:

(i) When there are price-fluctuations FIFO method makes the cost of production
fluctuating from period to period,

ii) At the time of increasing price-level this method shows profit and inventory at
higher figures which have unfavourable income tax implications.
6

Earliest Costs cost of goods sold Income statement

FIFO

Latest costs ending inventory Balance sheet

In other words the first costs incurred are the first transferred to cost of goods
sold (in a merchandising company) or goods in process and then to finished goods
and costs of goods sold (in a manufacturers company).

Consequently the ending inventory consists of the most recent costs incurred.
There fore in periods of rising costs, FIFO produces a lower costs of goods sold
figure in dollar (Birr), whereas ending inventory is based on the most recent and
higher costs.

1. LIFO COST FLOW ASSUMPTION

*. Inventory on hand assumed the most recent cost

*. Inventory sold assumed the oldest or earliest cost .This method is suitable in
times of rising prices because material will be issued from the latest consignment
at a price which is closely related to the current price levels. Valuing material
issues at the price of the latest available consignment will help the management
in fixing the competitive selling prices of the products.

Advantages:

This method claims a few advantages:

(a) The issue will be priced at the market rate prevailing, more or less, near the
date of issue. This has the advantage of ascertaining the cost at 7about the
prevailing market price and the cost thus ascertained will enable the prices to be
fixed on competitive basis.

(b) The principle of costing the goods at cost has not been given up.

(c) In case of rising prices the method has the advantage of showing a lower profit
which may help in saving tax to some extent. It is not without reason that this
method has come into use only when prices have been steadily rising.

Disadvantages:

(i) The disadvantages of this method are the same as those of the FIFO method,
namely, excessive clerical labour and differing costs of similar jobs using similar
materials.

(ii) Under this method the inventory is shown at the oldest market price and so
does not reflect the current conditions,

(iii) Since the inventory value at the end of a period is out of date, large
adjustment may be necessary, if the cost or market rule is applied.7
applied.7

ILLUSTRATION 1.
1. YOU are given the following data for BB Electronics for the year
2012 for one of its item called CD- RW
Date Item Quantity Unit cost Total cost

January 1 Inventory 500 units Br 10.50 5250

March 31 Sold 300 units

Appril 1 Purchase 1800 unite Br 12 21600

June 30 Sold 600 units

July 1 Purchase 500 units Br 12.50 6250

September 30 Sold 700 units

October 1 Purchase 200units Br 13 2600

December 31 Sold 800 unit

Required for the CD - RW of BB electronic computer the cost of inventory on hand

as of December 31 2012 and cost of goods sold under the following three cost
flow assumption.

FIFO costing method LIFO costing method and AVERAGE costing method.under
method.under
periodic inventory system.

Ending inventory = (£purchase + inventory _£ sales) =3000_2400=600

=3000_2400=600 units

Cost of ending inventory (COEI)

200units *Br 13-------------------------------------------------Br 2600

400 units * Br 12.5--------------------------------------------Br 500

COEI------------------------------------------------------------------BR 7600
 Cost of Goods sold (CGS)

500 units *Br 10.50----------------------------------------------------------------------------------Br 5,250

1800units *Br 12-----------------------------------------------------------------------------------------Br 21,600

100 unit*Br 12.5-------------------------------------------------------------------------------------------Br 1,250

CGS---------------------------------------------------------------------------------------------------------------Br 28,100

2.. LIFO cost flow assumption

*. The ending inventory assumed the oldest purchase or earliest cost

*. The cost of merchandise sold assumed the most recent cost.

COST OF ENDING INVENTORY

500units * Br 10.50 -----------------------------------------------Br 5250

100 units *Br 12-----------------------------------------------------Brv1200

COEI--------------------------------------------------------------------------Br 6450

COST OF GOOD SOLD (COGS)

200units *Br 13----------------------------------------------------------------------------------------Br 2600

500 units *Br 12.5-------------------------------------------------------------------------------------Br 6250

1700units *Br 12-------------------------------------------------------------------------------------------Br 20,400

COGS--------------------------------------------------------------------------------------------------------------Br 29,250

3. THE AVERAGE METHOD COSTING METHOD

This cost flow is an average of the expenditure . It charges cost against revenue applying the weighted
average unit cost of the goods available for sales.In this method, price is calculated by dividing the total
of the prices of the materials in the stock from which the material to be priced could be drawn by the
number of the prices used in that total. This method may lead to over-recovery or under-recovery of
cost of materials from production because quantity purchased in each lot is ignored.

Advantages:

(a) It is simple to work out & apply.

(b) Issue price cannot be affected considerably by the fluctuations in prices of purchase.

(c) Average cost method is suitable for the condition when different lots of purchases get mixed up so
that the identification is not possible.

(d) Where the quantity of each purchase is stable but the prices fluctuate, average cost method suits the
condition.

Disadvantages:

(a) Profit or loss in material arises as total cost incurred usually does not become equal to the total
charges.

(b) Frequent calculations of rates will be necessary in case of frequent purchases, thereby involving
much clerical work. Average rate may have to be revised due to exhaustion of an existing stock even if
no new10purchase comes.10

(c) Too much profit or loss on materials may be resulted from the method, when lots of purchases vary
much in quantities.

(d) Due to fact that the identity of the materials disappeared in the store, the verification of closing stock
figures becomes difficult.

(e) Absurd figures may be shown by the closing stock. The closing stock account may even show credit
balance, in times of inflationary spiraling.The simple average method can work well where:

(a) in each lot, there is standard quantity of purchase

(b) there is very mild fluctuation in prices.

10Weighted average unit cost = purchase * price /total purchase

Weig average unit cost = 500*10.5 +1800*12+500*12.5 + 200*13/500+1800+500+200=Br 11.90

COST OF ENDING INVENTORY

COEI= BR 11.90 *600 units = Br 7,140

COST OF GOODS SOLD

COGS = BR 11.90 * 2400 units = 28,560

COMPARISON OF THE THREE METHOD

Costing method FIFO LIFO AVERAGE

COGAFS 35700 35700 35700

COEI 7600 6450 7140

COGS 28100 29250 28560

INVENTORY COSTING METHOD UNDER PERPETUAL INVENTORY SYSTEM

1. FIFO COST FLOW ASSUMPTION

Date Purchase SOLD Invetory

Qty UC TC Qty UC TC Qty UC TC

Jan 1 500 10.50 5250

March 31 300 10.50 3150 200 10.50 2100

April 1 1800 12 21600 200 10.50 2100

1800 12 21600

June 30 200 10.50 2100

400 12 2800 1400 12 16800

July 1 500 12.5 6250 1400 12 16800

500 12.5 6250

Sept 30 700 12 8400 700 12 8400

500 12.5 6250

Oct 1 200 13 2600 700 12 8400

500 12.5 6250

200 13 2600

Dec 31 700 12 8400 400 12.5 500

100 12.5 1250 200 13 2600

Total Br Br 7600
28100

2. LIFO COST FLOW ASSUMPTION

Date Purchase SOLD INVENTORY

Qty UC TC QTY UC TC Qty UC TC

Jan 1 500 10.50 5250

March 31 300 10.5 3150 200 10.50 2100

Appril 1 1800 12 21600 200 10.50 2100

1800 12 21600

June 30 600 12 7200 200 10.50 2100

1200 12 14400

July 1 500 12.50 6250 200 10.50 2100

1200 12 14400

500 12.5 6250

Sept 30 500 12.50 6250 200 10.50 2100

200 12 2400 1000 12 12000

Oct 1 200 13 2600 200 10.5 2100

1000 12 12000

200 13 2600

Dec 31 200 13 2600 200 10.50 2100

600 12 7200 400 12 4800

Total Br Br 6900
28800

Inni3. AVERAGE ( MOVING AVERAGE COST)

Each time purchase is made anew average cost will be computed and sales after that that are made at
this new average unit cost.

Date Purc SOLD INVEN

hase TORY

Qty UC TC Qty UC TC Qty UC TC

Jan 1 500 10.50 5250

March 300 10.5 3150 200 10.50 2100

31 0

Appril 1 1800 12 21,600 2000 11.85 23700

June 30 600 11.8 7110 1400 11.85 16590

5

July 1 500 12.5 6250 1900 12.02 22,840

Sept 39 700 12.0 8414 1200 12.02 14426

2

Oct 1 200 13 2600 1400 12.16 17026

Dec 31 800 12.1 9728 600 12.16 7298

6

Total Br 28402 Br 7298

Weighted average unit cost = Total cost of inventory +Total cost of

purchase/Inventory Quantity

Example . 11.85 = 2100+21600/2000.

12.02 = 16590+6250/1900

12.16= 14426+2600/1400

Illustration 7-4 Inventory inflows and out flows for ABC Company

Inventory, April 1 --------------------- 100 units at $10 per unit -------------- $ 1,000

Purchases, April 10 ------------------- 80 units at $11 per unit ------------------ $ 880

Purchases, April 20 ------------------- 70 units at $12 per unit ------------------ $ 840

Goods available for sale --------------250 units --------------------------------- $ 2,720

Sales, April 18 ---------------------------- (90) units

140 units

Sales, April 27 ---------------------------- (50) units

Inventory, April 30 --------------------110 units

FIFO cost flow assumption

Periodic inventory system)

Ending inventory (110 units)

40 units at $ 11 --------------------------------------------------$440

70 units at $ 12 --------------------------------------------------$840
--------------------------------------------------$840

Total ------------------------------------------------------------$1,280

Cost of goods sold (140 units)• Impact of LIFO and FIFO in periods of rising prices

Beginning inventory +Purchases - ending inventory = Cost of goods sold

$ 1000 +$1,720 - $1,280 =$1440

If ABC Company uses perpetual inventory system (for cost as well as physical
quantities) it calculates the cost of goods sold of $1,440 and the end inventory of
$1,280 as shown below:
 FIFO cost flow assumption

(Periodic inventory system)

Cost of goods sold (140 units):

April 18:90 units at $10 -------------------------------------------- $900

April 27: 50 units: 10 units at $10 --------------------------------- 100

: 40 units at $ 11 ------------------------------- 440

Total ---------------------------------------------------------$1,440

Ending inventory (110 units)

40 units at $11=$440

70 units at $12= 840

Total-------------------- $1,280

Note that the ending inventory and the cost of goods sold under both the
perpetual and the periodic systems are equal this always is true for the FIFO cost
flow assumption because the most recent costs incurred are included in the
ending inventory.

2. LIFO(Last in last out):- This method assumed last purchase goods must be sold first the early
purchase will be ending inventory. Company used those method

Land,Gold ,House

In this method of costing is based on the assumption that the most recent
cost incurred should be charged against revenue. Hence the inventory
remaining is assumed to be composed of the earliest costs.

LIFO cost flow assumption

 (Periodic inventory system)

Cost of goods sold (140 units):

April 20:70 units at $12 -------------------------------------------- $ 840

20 units at $ 11 ----------------------------------------------- 220

April 27: 50 units at $11 --------------------------------------------- 550

Total --------------------------------------------------------- $ 1,610

Ending inventory (110 units)

100 units at $10=$1000

10 units at $11 = 110

Total------------------- $1,110

Inventory: Cost Measurement and Flow Assumption

Inventories: is especially significant because the acquisition manufacture and sale

of products are important to the profitability of many companies the cost
(carrying value) of the inventory usually has a material impact on a company’s
balance sheet since the ending inventory of one period is the beginning inventory
of the next period the cost of the inventory on the balance sheet will have an
impact on the next periods cost of goods sold and net income. In this chapter we
shall discuss. The determinations of inventory quantities and costs and alternative
inventory cost flow assumptions.

Average cost Flow Assumption

Under the average cost flow assumption, a company considers all the costs and
units to be commingled so that no individual units or costs are identified. When
the periodic inventory system is used the average cost method is known as the
weighted average method.
method. The cost of the units for the period is calculated on
the basis of the cost of the beginning inventory and the average cost of the unit’s
purchased or manufactured, weighted accounting to the number of units at each
cost. In other words under the weighted average method, the average cost per
unit for the period is the cost of goods available for sale divided by the number of
units available. This average cost is used for both the ending inventory and the
cost of goods sold.When a company uses the average cost method under a
perpetual inventory system (for costs as well as physical units) the same principle
are applied, but it is known as a moving average method because a new
weighted average cost must be calculated after each purchase. The new weighted
average is computed in the same way as in the weighted average method. That is
under the moving average method, the average cost per unit is the cost of the
units available for sale after the purchase divided by the number of units available
for sale at that time.

This available cost is used to determine the cost each sale made until the next
purchase, at which time a new average cost must be calculated. The illustration
for both systems as follows:

Weighted Average cost flow Assumption

(Periodic Inventory system)

Cost of goods available for sale ($1000 + $1,720) ------------------------$ 2,720

Units available for sale ------------------------------------------------------------- 250

Average cost (cost number of units) ---------------------------------------$ 10.88

Ending inventory (110 units at $10.88) ---------------------------------------$ 1,197

Beginning + purchases - Ending = Cost of goods

Inventory Inventory Sold

$1000 + $ 1,720 - $1,297 = $1,423

Moving Average cost flow assumption

(Perpetual inventory System)

April 1, Beginning Inventory --------------------- 100 units at $10 ------$1000

April 10, Purchases --------------------------------- 80 units at $11 ----------$880

April 10, Balance ---------------------------------- 180 units at $10.44 -----$1,880

April 18, Sales --------------------------------- (90) units at $10.44 ---------$(940)

April 18, Balance ---------------------------------- 90 units at $10.44 ---------$940

April 20, Purchases --------------------------------- 70 units at $12.00 -------$840

April 20, Purchases --------------------------------- 160 units at $11.125 --$1,780

April 27, Sales -------------------------------------- (50) units at $11.125 ----$(556)

April 30, Balance ------------------------------ ---- 110 units at $11.125 ----$1,224

Cost of goods sold (140 units at $11.125) ----------------------------------- $1,224

 Lo2:- . Record inventory flows
Accounting for and reporting inventory under a perpetual system

In perpetual inventory system, all merchandise increase and decrease are

recorded in manner similar to the recording of increase and decrease in cash. The
merchandise inventories account at the beginning of an accounting period
indicated the merchandise in stock on that date. Purchase is recorded by debiting
merchandise inventory and crediting cash or account payable, on the data of each
sale. The cost of merchandise sold is recorded by debiting cost of merchandise
sold and crediting merchandise inventory.

Example:-The following units of item K are available for sale

Item K units cost

Jan.1 Inventory 20 $ 20

4 Sale 14

10 Purchas. 16 21

22 Sale 8

28 Sale 4

30 Purchase 20 22
The firm used a perpetual inventory system, and there are 30 units of one item on
hand at end of the year. What is the total cost of goods sold and ending inventory
according to:-

A.FIFO B.LIFO C. average cost method.

FIFO method

Using cost, costs are included in the merchandise sold in the order in which they
were incurred.
 Purchase Cost of merchandise Inventory
sold

Date Quan Unit Total Quanti Unit Total Quantit Unit Total
tity cost cost ty cost cost y cost cost

1 20 20 400

4 14 20 280 6 20 120

10 16 21 336 6 20 120

16 21 336

22 6 20 120 14 21 294

2 21 42

28 4 21 84 10 21 210

30 20 22 440 10 21 210

20 22 440

Total 26 $526 30 $650

Thus cost of merchandise sold= $526 cost of ending inventory=$650

LIFO method

When the LIFO method is used in a perpetual inventory system the cost of the
units sold is the cost of the most recent purchase.

Purchase Cost of merchandise Inventory

sold

Date Quan Unit Total Quanti Unit Total Quanti Unit Total
1 20 20 400

4 14 20 280 6 20 120

10 16 21 336 6 20 120

22 8 21 168 6 20 120

28 4 21 84 6 20 120

30 20 22 440 6 20 120

4 21 84

20 22 440

Total 26 $532 30 $644

Thus cost of merchandise sold= $532 cost of ending inventory=$644

Average cost method

When the average cost method used in a perpetual inventory system an average
unit cost for each type of item is computed each time a purchase is made. This
unit cost is then used to determine the cost of each sale until another purchase is
made and a new average is computed .these average techniques called a moving
Average.

Purchase Cost of merchandise Inventory

sold

Date Quan Unit Total Quanti Unit Total Quanti Unit Total
1 20 20 400

4 14 20 280 6 20 120

10 16 21 336 22 20.7 456

22 8 20.7 166 14 20.7 290
28 4 20.7 83 10 20.7 207
30 20 22 440 30 21.56 647
Total 26 $529 30 $647

Thus cost of merchandise sold= $529 cost of ending inventory=$647

Lo3:- . Reconcile inventory records to general

ledgers
Estimating Inventory cost

In practical an inventory amount may be need in order to prepare an income

statement when it is impractical or impossible to take a physical inventory or to
maintain perpetual inventory records the amount of inventory on hand can be
estimated.

The two commonly used methods of estimating inventory cost are:-

1. The retail method

2. The gross profit method

1. Retail Methods

The retail method of estimating the cost of inventories is used primary by retailing
enterprises. Under the periodic inventory system, the cost of the ending
inventory is subtracted from the total cost of goods available for sale to compute
the cost of goods sold. Under the retail method, a record of goods available for
sale at selling prices is kept separate at selling prices. The ending inventories
valued at selling prices then are reduced to estimated cost by multiplying the
inventories at selling price by the cost percentage computed for the accounting
period.

1. RETAIL METHOD

It is used by retailers to estimate the cost of inventory on hand under this method
.

*. Record are kept for goods available for sale at both selling price and at cost .
* Sales are recorded and total sales for accounting period are deducted from the
total value of goods available for sale to determine the ending inventory at the
selling price .

The

ILLUSTRATION .2 The Following data was extracted from MM corporation for the
month of July

Item Cost Selling price

Begining inventory Br 60,000 Br 100,000

Net purchase Br 96,000 Br 160,000

MAS Br 156,000 Br 260,000

Sales 180,000

Instruction Estimate the cost of Ending inventory by the retail method

*. Cost of retail ratio = MAS/sailing price= 156000/260000= 60%

Begining inventory -------------------------------------------------------Br 100,000

Net purchase ---------------------------------------------------------------Br 160,000

RPMAS-------------------------------------------------------------------------Br 260,000

Less sales--------------------------------------------------------------------Br (180,000)

Ending inventory seling price-----------------------------------------Br 80,000

Ending inventory cost = 60% * 80,000-------------------------------------------------Br 48,000

2. THE GROSS PROFIT METHOD

When gross profit rate are known the ending inventory can be estimated by the following procedures

*. Determine the CMAS from the accounting period

*. Estimate the gross profit by multiply in the net sales by the gross profit rate

*. Determine CMS by deducting the gross profit from the net sale

*. Determine the Estimated Ending inventory by deducting CMS from the CMAS

ILLUSTRATION. The following data is taken from MM corporation as to one of its inventory .

Begining inventory ------------------------------------------------------------------------------------------------------Br

20,000

Net purchase--------------------------------------------------------------------------------------------------------------Br
80,000

Sales ---------------------------------------------------------------------------------------------------------------------------Br
90,000

Estimated gross profit rate -----------------------------------------------------------------------------------------Br 25%

INSTRUCTION Determine Estimated Ending inventory

Begining Inventory -------------------------------------------------------------Br 20,000

 Net purchase ---------------------------------------------------------------------Br 80,000

CMAS -----------------------------------------------------------------------Br 100,000

Less cost of good sold = sales _estimated gross profit rate

(90,000_25%*90,000(67500)

Estimated cost of ending inventory -----------------------------------------Br 32500

Illustration of Retail Method

The retail method of estimating inventories (at average cost) is illustrated by the
following simplified example for ABC Company.

ABC Company

Estimate of Inventories by Retail Method

End of current year

Cost Retail

Beginning inventories ---------------------------- $ 40,000 $50,000

Net Purchases -------------------------------------- $ 150,000 200,000

Goods available for sale ------------------------- $ 190,000 250,000

Cost percentage ($190,000 $250, 00) -------- $ 76%

Less: Sales and normal shrinkage --------------------------------------------- 220,000

Ending inventories at retail--------------------------------------------------- $30,000

Ending inventories at Cost ($30,000x0.76) ----------------------------------

---------------------------------- $22,800
2. Gross profit method

The gross profit method is useful for several purposes.

To control and verify the validity of inventories cost.

To estimate interim inventory valuations between physical counts, and

To estimate the inventory cost when necessary information normally used is lost
or unavailable.

The procedure involved is one of reducing sales to a cost basis; that is cost of
goods sold is estimate. The estimated cost of goods sold then is subtracted from
the cost goods available for sale to compute the estimated cost of the ending
inventories.

In the events that both merchandise and inventory records are destroyed by fire.
The inventory cost may be estimated by use of gross profit method. The gross
profit and cost of good sold percentage are obtained from prior year’s financial
statements, which presumably are available.

Lo4:- Prepare inventory schedules and ad hoc reports

Gross profit Method is really a “Cost percentage” Method

The key step in the application of the gross profit method is the development of
an accurate cost percentage, obtained by deduction of the gross profit rate from
100%. Frequently the best available measure is an average of the cost
percentages for recent years adjusted for any changes in costs and selling prices
that have been taken place in the current year.

Illustration

The following data are given for ABC Company for the year ended Dec 31, year 3.

Beginning inventories ------------------------------------------- $ 40,000

Net Purchases ----------------------------------------------------- 200,000

Net sales ------------------------------------------------------------- 225,000

Average cost percentage for the past two years ----------- 80%

Then by assuming that the cost percentage for year 4 remained at 80% the cost of
the inventories on Dec 31, year 3 is estimated as follows

ABC Corporation

Estimate of cost of inventories by gross profit method

December 31, year 3

Beginning inventories, at cost ------------------------------------ $ 40,000

Add: Net purchases ------------------------------------------------- 200,000

Cost of goods available for sale ---------------------------------- $240,000

Less: Estimated cost of goods sold:

Net sales ---------------------------------------- $225,000

Cost percentage ------------------------------- 0.80 180.000

Estimated ending inventories at cost --------------------- $60,000

Some times the gross profit percentage is stated as a percentage of cost. In such
situations the gross profit percentage must be restated to a percentage of net
sales to compute the cost percentage (based on sales).

Illustration

The gross profit is stated as 25% of cost, and then computes the cost percentage
in terms of sales.

Solution

25% =1/4 gross profit based on cost.

Add: Numerator of fraction to denominator to make 1/5

1/5 = 20% of gross profit based on net sales.

Or

Let x=cost as percentage of net sales 0.25x=gross profit percentage (based

on co