Week 1 october 5 ,7,9-2020(prelims)

 
Inventory Valuation
 
 
What is Inventory Valuation?
Inventory valuation method is the total cost that you associate with your current inventory. In other
words, it is the total amount of money you’ve spent on acquiring the inventory. It is imperative that you
place a value on your inventory because it is the basis of your Cost Of Goods Sold (COGS) or Cost of
Goods Manufactured calculation in your income statement. What’s more, if you ever seek a loan with
your inventory as the collateral guarantee, you need to know the value of your inventory so you can get
the right loan amount.
 
Inventories are assets:
(a) held for sale in the ordinary course of business;
(b) in the process of production for such sale; or
(c) in the form of materials or supplies to be consumed in the production process or in the rendering of
services.
 
Any and all costs you incur to get the product ready for sale can be included. However, you cannot
include selling costs, such as the cost of advertising your products, in this calculation.
 
Why are there different Inventory Valuation Methods?
For one, accounting principles across the globe are quite varied. Businesses registered in the United
States follow the Generally Accepted Accounting Principles (GAAP) while those in most other countries
follow the International Financial Reporting Standards or IFRS for short.
 
Now, the IFRS does not accept the LIFO method. Based on where your  business is registered, you may
need to follow a specific set of principles. That’s just the tip of the iceberg- there are also differences in
how inventory is valued according to these principles.
( PAS 2-Par.25 The cost of inventories, other than those dealt with in paragraph 23, shall be assigned by
using the first-in, first-out (FIFO) or weighted average cost formula. An entity shall use the same cost
formula for all inventories having a similar nature and use to the entity. For inventories with a different
nature or use, different cost formulas may be justified.)
 
Moreover, different valuation methods give you different results. The FIFO method  gives you the lowest
Cost Of Goods Sold and the highest net income while LIFO does the exact opposite. However, neither of
these may be the most accurate picture of your inventory value, which is where WAC  comes in.
 
What are the different Inventory Valuation Methods?
 
There are three most common methods that retailers use:
 
First-In-First-Out (FIFO)
Last-In-First-Out (LIFO)
Weighted Average Cost (WAC)
 
Each of these methods has some distinct benefits and even more powerful pitfalls. The method you
choose for your business depends on which method most accurately reflects the current state of your
business. A well-versed accounting can give you advice on which inventory valuation method to use.
 
Also, bear in mind that you cannot switch between inventory valuation methods. Once you choose a
method, you stick with it for all financial reports at all times.
 
Let us now look into each inventory valuation method and the implications of using it for your business.
 
FIRST-IN-FIRST-OUT METHOD (FIFO)
 
In this method, you assume that the first products to enter the inventory are also the first ones to be
sold. You always sell your oldest inventory first. The obvious benefit of this method is that it accurately
reflects how most retailers do business.
 
OCTOBER 5, 2020
 
FIFO Example(merchandising)
 
ABC Company had 1500 units of product X on hand at January 1 costing P5.00 each.  Purchases of
product X during the Month of January were as follows:
 
                       Date                           Units                    Unit cost
January 5                          2,000                       6.00
January 15                          2,500                       7.00
January 25                          1,000                       8.00
 
A physical count on January 31 shows 2500 units of product X on hand
 
To compute for inventory cost on January 31 under FIFO method
(Short method)
             Date          Units       Unit cost      Total cost
January 15         1,500       7.00        10,500.00
January 25         1,000       8.00          8,000.00
January 31         2,500          18,500.00
   
                                                                                                                         
(Long method)
Ending
  Uni Ending
 Dat Total                 uni Inventor  Purchase
  Units t     Sales Balance Inventor
e ts y s
cost y cost
Units
    7,500.0
Jan 1 1,500  1,500   5.00      
0
  (1,500        0   5.00   (  7,500.0            0.0  
 ) 0) 0
 12,000.0   12,000.0
Jan 5 2,000  2,000   6.00    
0 0
( 2,00 (12,000.0             0.0
        0   6.00    
0) 0) 0
Jan1   2,50  17,500.0   17,500.0
2,500   7.00    
5 0 0 0
(1,000   10,500.0 10,500.0
   1,500    1,500 7.00   (7,000.00)
) 0 0
Jan2   1,00   8,000.0   18,500.0   8,000.0
 1,000    1,000 8.00  
5 0 0 0 0
Jan3 18,500.0
       2,500        
1 0
                 
OCTOBER 7, 2020
 
LAST-IN-FIRST-OUT METHOD (LIFO)
 
In this method, the end result of calculations is the exact opposite of what it is in FIFO. You assume that
the last products to enter your inventory are the first ones to be sold.
 
LIFO Example
ABC Company had 1500 units of product X on hand at January 1 costing P5.00 each.  Purchases of
product X during the Month of January were as follows:
 
                       Date                           Units                    Unit cost
January 5                          2,000                       6.00
January 15                          2,500                       7.00
January 25                          1,000                       8.00
 
A physical count on January 31 shows 2500 units of product X on hand
 
To compute for inventory cost on January 31 under LIFO method
(Short method)
             Date          Units       Unit cost      Total cost
January 5         1,500       5.00        7,500.00
January 1         1,000       6.00        6,000.00
January 31         2,500        13,500.00
        

        
                                                                                                             
(Long method)
Ending
  Uni Ending
 Dat Total                 un Inventor  Purchas
  Units t     Sales Balance Inventor
e its y es
cost y cost
Units
    7,500.0
Jan 1 1,500  1,500  1,500 5.00     7,500.00
0
 12,000.0   12,000.0
Jan 5 2,000  2,000   6.00    
0 0
(  1,00 ( 6,000.00     6,000.0
   1,000  1,000 6.00   6,000.00
0) ) 0
Jan1  17,500.0   17,500.0
  2,500 2,500   7.00    
5 0 0
 (2,500 (17,500.0            0.0
      0   7.00    
) 0) 0
 Jan2   8,000.0     8,000.0
  1,000  1,000   8.00    
5 0 0
            0.0
  (1,000)      0   8.00   (8,000.00)  
0
Jan3 13,500.0
     2,500        
1 0

OCTOBER 9, 2020
 
WEIGHTED AVERAGE COST (WAC)
 
Because both FIFO and LIFO deal with extreme case scenarios, it is important to have a system that
balances out the pitfalls of both. Enter, Weighted Average Cost or WAC. This method is useful if your
business does not have too much variation in inventory levels.
 
Weighted Average Cost Example
 
ABC Company had 1500 units of product X on hand at January 1 costing P5.00 each.  Purchases of
product X during the Month of January were as follows:
 
                       Date                           Units                    Unit cost
January 5                          2,000                       6.00
January 15                          2,500                       7.00
January 25                          1,000                       8.00
 
A physical count on January 31 shows 2500 units of product X on hand
 
To compute for inventory cost on January 31 under WAC method
             Date          Units       Unit cost      Total cost
January 1         1,500       5.00         7,500.00
January 5       2,000       6.00      12,000.00
January 15         2,500       7.00      17,500.00
January 25         1,000       8.00        8,000.00
         7,000    45,000.00
To compute for the average cost per unit, divide total cost of inventory( beginning inventory plus
purchases) by the total number of units:
 
                     45,00000/7, 000 = 6.43
                                                     =====
To compute for the cost of ending inventory as of January 31, multiply the ending inventory the average
cost per unit:
                     
                       2,500 x 6.45= 16,075
                       ====================
 Week 2- OCTOBER/12-16/2020
 
PERPETUAL INVENTORY SYSTEM
 

1.      .  Perpetual inventory systems track the sale of products immediately through the use of point-
of-sale systems. 
2.      .   The perpetual inventory method does not attempt to maintain counts of physical products
3. 3.  Perpetual  inventory systems are in contrast to periodic inventory systems, in which
reoccurring counts of products are utilized in record-keeping.
 
Understanding Perpetual Inventory
A perpetual inventory system is superior to the older periodic inventory system because it allows for immediate
tracking of sales and inventory levels for individual items, which helps to prevent stockouts. A perpetual inventory
does not need to be adjusted manually by the company's accountants, except to the extent it disagrees with the
physical inventory count due to loss, breakage or theft.
 
How Perpetual Inventory Systems Work
A point-of-sale system drives changes in inventory levels when inventory is decreased, and cost of sales, an
expense account, is increased whenever a sale is made. Inventory reports are accessed online at any time, which
makes it easier to manage inventory levels and the cash needed to purchase additional inventory.
 
PERPETUAL INVENTORY SYSTEM EXAMPLE:
 
ABC Company had 1500 units of product X on hand at January 1 costing P5.00 each.  Purchases of product X during
the Month of January were as follows:
                       Date         Transaction                           Units                Unit cost
January 5 Purchases                          2,000                       6.00
January 10 Sale                            1,000  
January 15 Purchases                          2,500                       7.00
January 20 Sale                            2,000  
January 25 Purchases                          1,000                       8.00
January 27 Sale                            1,500  
 
If ABC Company uses FIFO Perpetual system, what is the ending inventory on January 31
 
Explaination:
Jan 1 sales
 Jan 1 Beginning balance                            1,500 units. @5.00
 Less Jan 10 sales                                       (1,000 units)
Balance from Jan 1 Beginning balance     500 units @5.00
Jan 20 sales
Balance from Jan 1 Beginning balance     500 units @5.00
Less jan 20 sales.                                      (2,000 units)                                                                    
Balance from jan 20 sales                       (1,500 units)
Jan 5 purchases.                                        2,000 units @6.00
Balance from jan 5 Purchases…………….  500 units @ 6.00
Jan 27 sales
Balance from jan 5 Purchases.                 500 units @6.00
Less Jan 27 sales.                                       (1,500 units)
Balance from Jan 27 Purchase.                (1,000units)
Jan 15 purchases.                                        2,500 units @ 7.00
Balance from jan 15 purchases.                1,500 units @ 7.00
 
Balance from Jan 15 Purchases.                1,500 units @ 7.00 = 10,500.00
Jan 25 Purchases.                                         1,000 units @ 8.00 =   8,000.00
Ending inventory as of Jan 31.                   2,500 units.                 18,500.00
                                                                               ==========================
 
Further illustration
 
PERIODIC  INVENTORY SYSTEM
 
What Is Periodic Inventory?
The periodic inventory system is a method of inventory valuation for financial reporting purposes in which a
physical count of the inventory is performed at specific intervals. This accounting method takes inventory at the
beginning of a period, adds new inventory purchases during the period and deducts ending inventory to derive the
cost of goods sold (COGS).
 
Understanding Periodic Inventory
Under the periodic inventory system, a company will not know its unit inventory levels nor COGS until the physical
count process is complete. This system may be acceptable for a business with a low number of SKUs (stock keeping
unit or barcode)in a slow-moving market, but for all others, the perpetual inventory system is considered superior
for the following main reasons:
 
1. The perpetual system continuously updates the inventory asset ledger in a company's database system,
giving management an instant view of inventory; the periodic system is time-consuming and can produce stale
numbers that are less useful to management.
2. The perpetual system keeps updated COGS as movements of inventory occur; the periodic system cannot
give accurate COGS figures between counting periods.
3. The perpetual system tracks individual inventory items so that in case there are defective items—for
example, the source of the problem can quickly be identified; the periodic system would most likely not allow for
prompt resolution.
4. The perpetual system is tech-based and data can be backed-up, organized and manipulated to generate
informative reports; the periodic system is manual and more prone to human error, and data can be misplaced or
lost.
 
Special Considerations: COGS
The cost of goods sold, commonly referred to as COGS, is a fundamental income statement account, but a
company using a periodic inventory system will not know the amount for its accounting records until the physical
count is completed.
 
PERIODIC INVENTORY SYSTEM EXAMPLE:
 
ABC Company had 1500 units of product X on hand at January 1 costing P5.00 each.  Purchases of product X during
the Month of January were as follows:
                       Date         Transaction                           Units                Unit cost
January 5 Purchases                          2,000                       6.00
January 10 Sale                            1,000  
January 15 Purchases                          2,500                       7.00
January 20 Sale                            2,000  
January 25 Purchases                          1,000                       8.00
January 27 Sale                            1,500  
 
If ABC Company uses FIFO Periodic system, what is the ending inventory on January 31
Step by step computation:
1.Total inventory available for sale
Beginning balance jan 1                        1,500 units
Purchases                  jan 5.                     2,000 units
                                 Jan 15.                    2,500 units
                                 Jan 25.                    1,000 units
Inventory available for sale                      7,000 units
 
2.Total number of units sold Jan 6           1,000 units
                                            Jan 10.          2,000 units
                                             Jan 30.          1,500 units
Total number of units sold.                        4,500 units
 
 3.  Ending inventory as of Jan 31 (in units)
Total inventory available for sale                7,000 units
Total number of units sold                           4,500 units
Ending inventory as of Jan 31                    2,500 units
 
4.Compute for the cost of ending inventory as of jan 31
Balance from Jan 15 purchases.                1,500 units @ 7.00 = 10,500.00
Jan 25 purchases.                                      1,000 units @ 8.00 =.  8,000.00
Ending inventory as of Jan 31.                   2,500 units.                 18,500.00
                                                             =============================
Explaination:
Jan 1 sales
 Jan 1 Beginning balance                            1,500 units. @5.00
 Less Jan 10 sales                                       (1,000 units)
Balance from Jan 1 Beginning balance     U units @5.00
 
Jan 20 sales
Balance from Jan 1 Beginning balance     500 units @5.00
Less jan 20 sales.                                      (2,000 units)                                                                    
Balance from jan 20 sales                       (1,500 units)
Jan 5 purchases.                                        2,000 units @6.00
Balance from jan 5 Purchases…………….  500 units @ 6.00
 
Jan 27 sales
Balance from jan 5 Purchases.                 500 units @6.00
Less Jan 27 sales.                                       (1,500 units)
Balance from Jan 27 Purchase.                (1,000units)
Jan 15 purchases.                                        2,500 units @ 7.00
Balance from jan 15 purchases.                1,500 units @ 7.00
 
Balance from Jan 15 Purchases.                1,500 units @ 7.00 = 10,500.00
Jan 25 Purchases.                                       1,000 units @ 8.00 =   8,000.00
Ending inventory as of Jan 31.                   2,500 units.                 18,500.00
                                                                               ==========================
Same explaination with Perpetual system, the only difference is that in the perpetual system, inventory
monitoring is done continously or everytime there is a transaction, while in periodic system of inventory is
done at the end of every period(monthly,quarterly,annually)
 
Whether Perpetual or Periodic system, the FIFO inventory is the same
 
 10/19/2020(discussion starts here)
MOVING AVERAGE METHOD
 
It is a method for inventory valuation or delivery cost calculation, by which the unit cost is calculated every time
inventory goods are accepted instead of calculating the cost at the inventory clearance of the end of month or
accounting period.
 
A company may choose to use a moving average inventory when it's possible to maintain a perpetual inventory
tracking system. This allows the business to adjust the values of the inventory items based on information from the
last purchase.
 
Effectively, this helps compare inventory averages across multiple time periods by converting all pricing to the
current market standard. This makes it similar to adjusting historical data based on the rate of inflation for more
stable market items. It allows simpler comparisons on items that experience high levels of volatility.
 
ABC Company had 1500 units of product X on hand at January 1 costing P5.00 each.  Purchases of product X during
the Month of January were as follows:
                       Date         Transaction                           Units                Unit cost
January 5 Purchases                          2,000                       6.00
January 10 Sale                            1,000  
January 15 Purchases                          2,500                       7.00
 January 20 Sale                            2,000  
January 25 Purchases                          1,000                       8.00
January 27 Sale                            1,500  
 
Compute for the ending inventory as of Jan 31 using  Moving Average Method
00:00
Date Transaction Units Unit cost Total cost
Jan 1 Beginning balance 1,500     5.00   7,500.00
Jan 5 Purchases 2,000     6.00 12,000.00
  (19,500.00/3,500 units = 5.5714 or 5.57) 3,500     5.57 19,500.00
Jan (1,000
Sales     5.57  (5,570.00)
10 )
  2,500     5.57 13,930.00
Jan
Purchases 2,500     7.00 17,500.00
15
  (31,430.00/5,000 units = 6.286 or 6.29) 5,000     6.29 31,430.00
Jan (2,000
Sales     6.29 (12,580.00)
20 )
    3,000     6.29 18,850.00
Jan25 Purchases 1,000     8.00   8,000.00
  (26,850.00/4,000 units = 6.7125 or 6.71) 4,000     6.71 26,850.00
Jan (1,500
Sales     6.71 (10,065.00)
27 )
Jan
Ending inventory 2,500     6.71 16,785.00
31
 
Moving average unit cost changes every  time there is a new purchase or a purchase return, the moving average
unit cost is not affected by a sale or sales return. 

Week 3 10/19-23/2020
PERIODIC INVENTORY AVERAGE COST METHOD
 
In periodic inventory system, weighted average cost per unit is calculated for the entire class of inventory. It is then
multiplied with number of units sold and number of units in ending inventory to arrive at cost of goods sold and
value of ending inventory respectively. In perpetual inventory system, we have to calculate the weighted average
cost per unit before each sale transaction.
 
ABC Company had 1500 units of product X on hand at January 1 costing P5.00 each.  Purchases of product X during
the Month of January were as follows:
                       Date         Transaction                           Units                Unit cost
January 5 Purchases                          2,000                       6.00
January 10 Sale                            1,000  
January 15 Purchases                          2,500                       7.00
January 20 Sale                            2,000  
January 25 Purchases                          1,000                       8.00
January 27 Sale                            1,500  
 
If ABC Company uses the periodic average cost method to account for inventory, what is the ending inventory for
Jan 31
 
1.Compute for goods available for sale
00:00
             Date    Transaction        Units    Unit cost     Total cost
Jan 1    Beginning Balance       1,500       5.00     7,500.00
 Jan 5    Purchase       2,000       6.00   12,000.00
 Jan 15    Purchase       2,500       7.00   17,500.00
 Jan 25    Purchase       1,000       8.00     8,000.00
   Goods available for         
Jan31
sale(45,000.00/7,000=6.4285)        7,000       6.43   45,000.00
 
Less : Sales Jan 10                  1,000 units
          Jan 20                              2,000 units
          Jan 27                              1,500 units
Total sales                                 4,500 units                                        (4,500)                         6.43                        28,935.00
(COGS)
Ending inventory sa of Jan 31                                                            
2,500.                        6.43                         16,075.00                                                                                                                      
                                                                                                             =====                       ====                      ========
  
RELATIVE SALES VALUE METHOD
 
One method of allocating joint costs is to allocate costs based on the benefits received from the expense. Revenue
is a benefit received from incurring joint costs.  This method will also result in a relatively uniform gross profit
percentage on each product sold. This method is also referred to this as the market-based approach.
 
How to Calculate Joint Costs Using Relative Sales Value Method
 
1.Get the joint-production costs, which are normally available internally.
2.Acquire the sales price and volume of the products resulting from the joint-production process.
3.Divide the sales value of each product by the total sales to determine the relative sales value of each product
4.Calculate the joint costs for each product using the relative sales values.
 
Relative sales value method example:
The production In the soap company example, if you assume that the batch production cost of soap A,B,C costs
2,000.00.   the company produces 300 pcs of soap A,  200 pcs of soap B  and 100 pcs soap C  per batch and sells
them at  P10.00(soap A), P8.00(soap B) and P6.00(soap C). 
00:00
      RELATIVE SALES    Cost per
         soap Units produced     Selling Price Total sales
VALUE per             product
A            300         10.00    3,000.00   3.0000.00/5,200.00 1,153.84
B            200           8.00    1,600.00     1,600.00/5,200.00    615.38
C            100           6.00       600.00       600.00/5,200.00    230.78
             600 pcs      5,200.00   2,000.00
 
 
MEASUREMENT AT LOWER OF COST OR NET REALIZABLE
VALUE
(LCNRV
 
What Is Net Realizable Value?
 
Net realizable value (NRV) is the value of an asset that can be realized upon the sale of the asset, less a reasonable
estimate of the costs associated with the eventual sale or disposal of the asset. NRV is a common method used to
evaluate an asset's value for inventory accounting.
 
Net realizable value (NRV) is a conservative method for valuing assets because it estimates the true amount the
seller would receive net of costs if the asset were to be sold.
 
NRV is the estimated selling price in the ordinary course of business less the estimated cost of completion and the
estimated cost necessary to make the sale. 
 
The practice of writing inventories down below cost to net realizable value is consistent with the view that assets
shall not be carried in excess of amounts expected to be realized from their sale or use.
 
 
LCNRV EXAMPLE:
 
#1.Based on a physical inventory taken on Dec. 31, ABC Manufacturing Company determined its goods in process
inventory on FIFO basis at  P 18,500.00, It is estimated that after further processing cost of P2,500.00, finished
goods could be sold at P22,000.00.
 
Using the measurement at lower of cost or net realisable value, what amount should ABC Manufacturing Company
report as ending inventory on Dec. 31?
00:00
Estimated sales price                      P22,000.00
Less additional processing cost.     (2,500.00)
Net realisable value                        P19,500.00
                                                                ==========
P18,500.00 is the inventory valuation on Dec 31 because it is lower than the net realizable value.
 
#2. ABC Company provided the following data for the current year:
 
Inventory – January 1
                                    Cost                                                P7,500.00
                                    NRV                                                 6,500.00
Net Purchases                                                                    37,500.00
Inventory – December 31                                         
                                    Cost                                                18,500.00                 
                                    NRV                                                15,500.00
 
Compute for the Cost of Goods Sold
Inventory january 1( at cost)                                                   P7,500.00
Add net purchases                                                                 37,500.00
Goods available for sale                                                        45,000.00
Less inventory December 31(at cost).                                 (18,500.00)
Cost of goods sold before inventory writedown.                   26,500.00
Loss on inventory writedown                                                   2,000.00
Cost of goods sold after inventory writedown                        28,500.00
                                                                                              ========
Inventory writedown           
Required allowance December 31
                  18,500.00-15,500.00.                  =                        3,000.00
Allowance for inventory writedown January 1
                    7,500.00-  6,500.00                    =.                       1,000.00
Loss on inventory writedown                                                    2,000.00
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 discussion starts here on      10/28/2020
#3. The inventory record show the following data on Dec 31
  Units Unit cost NRV
     RAW MATERIALS      
                  1                   1,000                   11.00                   10.00
                  2                   2,000                   23.00                   25.00
                  3                   3,000                   30.00 32.00
    GOODS IN PROCESS      
                  X                   5,000                   40.00                   38.00
                  Y                   3,000                   50.00                   52.00
      FINISHED GOODS      
                  A                   2,000                   75.00                   73.00
                  B                   2,000                   73.00                   83.00
 
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  TOTAL COST NRV LOWER
       RAW MATERIALS      
                  1                   11,000.00 10,000.00                   10,000.00
                  2                   46,000.00                   50,000.00                   46,000.00
                  3                   90,000.00                   96,000.00                   90,000.00
 
                  X               200,000.00              190,000.00               190,000.00
                  Y               150,000.00              156,000.00               150,000.00
      FINISHED GOODS      
                  A               150,000.00              146,000.00               146,000.00
                  B               146,000.00              166,000.00               146,000.00
              793,000.00               778,000.00
                  TOTAL  
             =========               =========
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ACCOUNTING FOR INVENTORY WRITEDOWN
1.If the cost is lower than NRV, there is no accounting problem because the inventory is stated at cost and the
increase in value is not recognized.
2.If NRV is lower than cost, the inventory is measured at NRV. In this case the problem is the proper treatment of
the write-down of the inventory to NRV.
 
2 METHODS OF ACCOUNTING FOR INVENTORY WRITE-DOWN:        
1.  DIRECT METHOD – The inventory is recorded at the lower of cost or NRV, any loss on inventory write-down is
not accounted for separately but “buried” in the cost of goods sold.
2.  ALLOWANCEMETHOD- Theinventoryisrecordedatcostandanylossoninventorywrite-
downisaccountedforseparately
 
DIRECT METHOD
 
The inventory is recorded at lower of cost or NRV, thus the entry on Dec. 31,  is
Dr. Inventory – December 31                                                 778,000.00
Cr. Income Summary                                                       778,000.00
 The loss on inventory write-down of P15, 000.00 is not accounted for separately. The entry will have the effect of
increasing cost of goods sold because the net realizable value is lower than the cost.
 
ALLOWANCE METHOD
 
Dr. Inventory – December 31,                                                793,000.00
Cr. Income Summary                                                        793,000.00
Dr. Loss on inventory write-down                                            15,000.00
Cr. Allowance for inventory write-down                             15,000.00
Note: the loss on inventory write-down is accounted for separately,

WEEK 4 10/26-30/2020
GROSS PROFIT METHOD (discussion starts here on 11/04/2020 +
pc narrative)
 
The gross profit method estimates the amount of ending inventory in a reporting period. This is of use in the
following situations:
 
For interim periods between physical inventory counts.
When inventory was destroyed and you need to estimate the ending inventory balance for the purpose of filing a
claim for insurance reimbursement
 
Follow these steps to estimate ending inventory using the gross profit method:
 
Add together the cost of beginning inventory and the cost of purchases during the period to arrive at the cost of
goods available for sale.
Step#1. Multiply  the expected gross profit percentage by sales during the period to arrive at the estimated cost of
goods sold.
Step#2.Subtract the estimated cost of goods sold from the cost of goods available for sale (step #1) to arrive at the
ending inventory.
 
In addition, it is useful to compare the resulting cost of goods sold as a percentage of sales to the recent trend line
for the same percentage, to see if the outcome is reasonable.
 
The gross profit method is not an acceptable method for determining the year-end inventory balance, since it only
estimates what the ending inventory balance may be. It is not sufficiently precise to be reliable for audited
financial statements.
 
Gross Profit Method Example
1.ABC Company sells its merchandise at a gross profit of 30%. On January 31 all of ABC’s inventory was destroyed
by fire
 
The following figures pertains to ABC’s operation for the month of January:
 
Net Sales                               34,450.00
Beginning inventory                7,500.00
Net purchases                       37,500.00
 
Required: Compute for the estimated cost (mark up on based cost)of destroyed inventory.
Beginning inventory                                                  7,500.00
Add net purchases                                                  37,500.00
Goods available for sale                                          45,000.00
Less cost of sales(34,450.00*70%).                        24,115.00
Ending inventory based on gross profit at cost      20,885.00
                                                                               ============
in the absence of any contrary statement, the gross profit rate is based on sales, thus if the gross profit
rate is 30%, the cost of sales is 70%
Required: Compute for the cost percentage (mark up on  retail price)             
                                                                            
Formula   30%/(100%+30%)=.230769 or 23.08%(Gross profit on retail percentage)
            
 
Problems with the Gross Profit Method
 
 There are several issues with the gross profit method that make it unreliable as the sole method for determining
the value of inventory over the long term, which are:
 
Historical basis. The gross profit percentage is a key component of the calculation, but the percentage is based on
a company's historical experience. If the current situation yields a different percentage (as may be caused by a
special sale at reduced prices), then the gross profit percentage used in the calculation will be incorrect.
 
Inventory losses. The calculation assumes that the long-term rate of losses due to theft, obsolescence, and other
causes is included in the historical gross profit percentage. If not, or if these losses have not previously been
recognized, then the calculation will likely result in an inaccurate estimated ending inventory (and probably one
that is too high).
 
Applicability. The calculation is most useful in retail situations where a company is simply buying and reselling
merchandise. If a company is instead manufacturing goods, then the components of inventory must also include
labor and overhead, which make the gross profit method too simplistic to yield reliable results.
 
RETAIL METHOD
 
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 impracticable to use other costing methods. The cost of the
inventory is determined by reducing the sales value of the inventory by the appropriate percentage gross margin.
The percentage used takes into consideration inventory that has been marked down to below its original selling
price. An average percentage for each retail department is often used.
 
What Is the Retail Inventory Method?
 
The retail inventory method is an accounting method used to estimate the value of a store's merchandise. The
retail method provides the ending inventory balance for a store by measuring the cost of inventory relative to the
price of the merchandise. Along with sales and inventory for a period, the retail inventory method uses the cost-to-
retail ratio. Also, called the cost-to-retail percentage, the measurement provides how much a good's retail price is
made up of costs.
 
However, the retail method of valuing inventory only provides an approximation of inventory value since some
items in a retail store will most likely have been shoplifted, broken, or misplaced. It's important for retail stores to
perform a physical inventory valuation periodically to ensure the accuracy of inventory estimates
 
Understanding the Retail Inventory Method
The retail inventory method calculates the ending inventory value by totaling the value of goods that are available
for sale, which includes beginning inventory and any new purchases of inventory. Total sales for the period are
subtracted from goods available for sale. The difference is multiplied by the cost-to-retail ratio (or the percentage
by which goods are marked up from their wholesale purchase price to their retail sales price).
 
The retail inventory method should only be used when there is a clear relationship between the price at which
merchandise is purchased from a wholesaler and the price at which it is sold to customers. For example, if a
clothing store marks up every item it sells by 100% of the wholesale price, it could accurately use the retail
inventory method, but if it marks up some items by 20%, some by 35%, and some by 67%, it can be difficult to
apply this method with accuracy.
 
 The retail method uses the historical markup percentage for a companies goods. However, when markups change,
such as during the holiday season, the method is inaccurate.
 
Example of the Retail Inventory Method
 
1.Conventional( conservative retail approach)
On December 31, the following information was available from ABC company
 
                                                                                                                Cost                            Retail
Inventory January 1                                                                                 7,500.00                  10,350.00
Purchases                                                                                              37,500.00                  51,750.00
Additional markups                                                                          -                                        2,100.00
Sales                                                                                                                                        35,000.00
Sales return                                                                                                                                  450.00
Sales discount                                                                                                                             900.00
Sales allowance                                                                                                                           700.00
Estimated losses due to shoplifting                                                                                             600.00
Markdowns                                                                                                                               1,300.00
 
Required: compute for the ending inventory on December 31,2011.
 
                                                                                                            Cost                            Retail
Inventory January 1                                                                          7,500.00                10,350.00  
Add:  Purchases                                                                              37,500.00               51,750.00
Additional Markups                                                                                                          2,100.00
Goods available for sale(conventional method)                               45,000.00              64,200.00
Cost to retail ratio(45,000.00/64,200.00=70%)
Less:  Markdowns                                                                                                        (   1,300.00)
Goods available for sale(cost method ).                                                                        62,900.00                                              
(45,000.00/62,900.00=71.54%) cost to retail ratio
Net sales(35,000.00-450.00)                                                                                      (34,550.00)
Estimated losses due to shoplifting                                                                                (600.00)                  
Ending inventory  at retail.                                                                                           27,750.00        
Conservative cost ratio(45,000.00/64,200.00)                                                                 70%(c/r percentage)
Ending Inventory at  cost                                                                                              19,425.00
                                                                                                                              =============
Note: sales discount and sales allowance are ignored in determining the net sales
 
2. cost method(same data from example#1)
Ending inventory  at retail                                                                                   27,750.00
Multiplied by the c/r ratio.         (Cost method ratio)                                              71.54%
Ending inventory at cost –                                                                                 19,852.35
                                                                                                                             ==========‘
 
Drawbacks of the Retail Inventory Method
 
 
The retail inventory method's primary advantage is ease of calculation, but some of the drawbacks include:
The retail inventory method is only an estimate. Results can never compete with a physical inventory count.
The retail inventory method only works if you have a consistent markup across all products sold.
The method assumes that the historical basis for the markup percentage continues into the current period. If the
markup was different (as may be caused by an after-holiday sale), then the results of the calculation will be
inaccurate.
The method does not work if an acquisition has been made, and the acquiree holds large amounts of inventory at a
significantly different markup percentage from the rate used by the acquirer.
 

note:  all example for inventory valuation was based on pactical accouning one  by
conrado t. valix and christian aris m. valix