1
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7
Inventories
1
2
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After studying this chapter, you should
be able to:
1. Describe the importance of control
over inventory.
2. Describe three inventory cost flow
assumptions and how they impact the
income statement and balance sheet.
2
3
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After studying this chapter, you should
be able to:
3. Determine the cost of inventory under the
perpetual system, using the FIFO, LIFO, and
average cost methods.
4. Determine the cost of inventory under the
periodic system, using the FIFO, LIFO, and
average cost methods.
5. Compare and contrast the use of the three
inventory costing methods.
3
4
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After studying this chapter, you should
be able to:
6. Describe and illustrate the reporting of
merchandise inventory in the financial
statement.
7. Estimate the cost of inventory using the
retail method and the gross profit
method.
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5
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7-1
Objective 1
Describe the importance of
control over inventory.
5
6
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7-1
Two primary objectives of control
over inventory are:
1) Safeguarding the inventory, and
2) Properly reporting it in the
financial statements.
6
7
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7-1
Controls over inventory
include developing and using
security measures to prevent
inventory damage or customer
or employee theft.
7
8
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7-1
To ensure the accuracy of the
amount of inventory reported in
the financial statements, a
merchandising business should
take a physical inventory.
8
9
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7-2
Objective 2
Describe three inventory cost
flow assumptions and how they
impact the income statement
and balance sheet.
9
10
Inventory Costing Methods
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7-2
10
10
11
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7-2
(Continued)
11
11
12
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7-2
(Continued)
12
12
13
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(Concluded)
7-2
13
13
14
Inventory Costing Methods
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400
7-2
371
299
300
Number of firms 200
(> $1B Sales)
130
100
0
FIFO
LIFO Average cost
14
14
15
7-2
Example Exercise 7-1
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The three identical units of Item QBM are purchased during
February, as shown below.
Item QBM
Units
Feb. 8
Purchase
1
15 Purchase
1
26 Purchase
1
Total
3
Average cost per unit
Cost
$ 45
48
51
$144
$48 ($144 ÷ 3 units)
Assume that one unit is sold on February 27 for $70.
Determine the gross profit for February and ending inventory on
February 28 using (a) first-in, first-out (FIFO); (b) last-in, first-out
(LIFO); and (c) average cost methods.
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16
7-2
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Follow My Example 7-1
Gross Profit
Ending Inventory
(a) First-in, first-out (FIFO):
$25 ($70 – $45)
$99 ($48 – $51)
(b) Last-in, first-out (LIFO):
$19 ($70 – $51)
$93 ($45 + $48)
(c) Average cost:
$22 ($70 – $48)
$96 ($48 x 2)
$144/3 units
For Practice: PE 7-1A, PE 7-1B
16
16
17
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Objective 3
7-3
Determine the cost of
inventory under the perpetual
inventory system, using
FIFO, LIFO, and average
cost methods.
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18
FIFO Perpetual
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7-3
On January 1, the firm had 100 units
of Item 127B that cost $20 per unit.
Item 127B
Jan.
1
Inventory
Units
Cost
100
$20
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18
19
FIFO Perpetual
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7-3
On January 4, the firm sold 70 units
of 127B at $30 each.
Item 127B
Jan.
1
4
Inventory
Sale
Units
Cost
100
70
$20
19
19
20
FIFO Perpetual
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7-3
On January 4, the firm sold 70 units
of 127B at $30 each.
4 Accounts Receivable
Sales
2 100 00
2 100 00
On4 January
22, the
firm sold1 twenty
Cost of Merchandise
Sold
400 00
1 400 00
units atMerchandise
$30. Inventory
20
20
21
FIFO Perpetual
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7-3
Item 127B
Purchases
Date
Jan. 1
4
Qty.
Unit
Cost
Total
Cost
Cost of Mdse. Sold
Inventory Balance
Unit
Cost
Total
Cost
2,000
600
Qty.
70
20
Total
Cost
Qty.
Unit
Cost
1,400
100
30
20
20
21
21
22
FIFO Perpetual
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7-3
On January 10, the firm purchased
80 units at $21 each.
Item 127B
Jan.
1
4
10
Inventory
Sale
Purchase
Units
Cost
100
70
80
$20
21
22
22
23
FIFO Perpetual
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7-3
On January 10, the firm purchased
80 units at $21 each.
10 Merchandise Inventory
Accounts Payable
1 680 00
1 680 00
23
23
24
FIFO Perpetual
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7-3
Item 127B
Purchases
Date
Jan. 1
4
10
Qty.
Unit
Cost
Total
Cost
Cost of Mdse. Sold
Inventory Balance
Unit
Cost
Qty.
Unit
Cost
Total
Cost
100
30
30
80
20
20
20
21
2,000
600
600
1,680
Qty.
70
80
21
1,680
20
Total
Cost
1,400
24
24
25
FIFO Perpetual
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7-3
On January 22, the firm sold 40 units
for $30 each.
Item 127B
Jan.
1
4
10
22
Inventory
Sale
Purchase
Sale
Units
Cost
100
70
80
40
$20
21
25
25
26
FIFO Perpetual
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7-3
On January 22, the firm sold 40 units
for $30 each.
22 Accounts Receivable
Sales
1 200 00
1 200 00
On
22, theSoldfirm sold twenty
22 January
Cost of Merchandise
810 00
units atMerchandise
$30. Inventory
810 00
26
26
27
FIFO Perpetual
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7-3
Item 127B
Purchases
Date
Jan. 1
4
10
22
Qty.
80
Unit
Cost
21
Total
Cost
Cost of Mdse. Sold
Inventory Balance
Unit
Cost
Qty.
Unit
Cost
Total
Cost
100
30
30
80
20
20
20
21
2,000
600
600
1,680
70
21
1,470
Qty.
Total
Cost
70
20
1,400
30
10
20
21
600
210
1,680
Of the forty sold, thirty are considered to be from
those acquired at $20 each. The other ten are
considered to be from the January 10 purchase.
27
27
28
FIFO Perpetual
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7-3
On January 28, the firm sold 20
units at $30 each.
Item 127B
Jan.
1
4
10
22
28
Inventory
Sale
Purchase
Sale
Sale
Units
Cost
100
70
80
40
20
$20
21
28
28
29
7-3
FIFO Perpetual
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On January 28, the firm sold 20
units at $30 each.
28 Accounts Receivable
Sales
600 00
28 Cost of Merchandise Sold
Merchandise Inventory
420 00
600 00
420 00
29
29
30
FIFO Perpetual
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7-3
Item 127B
Purchases
Date
Jan. 1
4
10
22
28
Qty.
80
Unit
Cost
21
Total
Cost
Cost of Mdse. Sold
Inventory Balance
Unit
Cost
Qty.
Unit
Cost
Total
Cost
100
30
30
80
20
20
20
21
2,000
600
600
1,680
70
50
21
21
1,470
1,050
Qty.
Total
Cost
70
20
1,400
30
10
20
20
21
21
600
210
420
1,680
30
30
31
FIFO Perpetual
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7-3
On January 30, purchased ten additional
units of Item 127B at $22 each.
Item 127B
Jan.
1
4
10
22
28
30
Inventory
Sale
Purchase
Sale
Sale
Purchase
Units
Cost
100
70
80
40
20
100
$20
21
22
31
31
32
7-3
FIFO Perpetual
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On January 30, purchased ten additional
units of Item 127B at $22 each.
30 Merchandise Inventory
Accounts Payable
2 200 00
2 200 00
32
32
33
FIFO Perpetual
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7-3
Item 127B
Purchases
Date
Jan. 1
4
10
Qty.
80
Unit
Cost
21
Total
Cost
22
Inventory Balance
Unit
Cost
Qty.
Unit
Cost
Total
Cost
100
30
30
80
20
20
20
21
2,000
600
600
1,680
70
50
50
100
21
21
21
22
1,470
1,050
1,050
2,200
Qty.
Total
Cost
70
20
1,400
30
10
20
20
21
21
600
210
420
1,680
22
28
30 100
Cost of Mdse. Sold
2,200
33
33
34
FIFO Perpetual
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7-3
Item 127B
Purchases
Date
Jan. 1
4
10
Qty.
80
Unit
Cost
21
Total
Cost
22
Inventory Balance
Unit
Cost
Qty.
Unit
Cost
Total
Cost
100
30
30
80
20
20
20
21
2,000
600
600
1,680
70
50
50
100
21
21
21
22
1,470
1,050
1,050
2,200
Qty.
Total
Cost
70
20
1,400
30
10
20
20
21
21
600
210
420
1,680
22
28
30 100
Cost of Mdse. Sold
2,200
Cost of merchandise sold for
January is $2,630.
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34
35
FIFO Perpetual
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7-3
Item 127B
Purchases
Date
Jan. 1
4
10
Qty.
80
Unit
Cost
21
Total
Cost
22
Inventory Balance
Unit
Cost
Qty.
Unit
Cost
Total
Cost
100
30
30
80
20
20
20
21
2,000
600
600
1,680
70
50
50
100
21
21
21
22
1,470
1,050
1,050
2,200
Qty.
Total
Cost
70
20
1,400
30
10
20
20
21
21
600
210
420
1,680
22
28
30 100
Cost of Mdse. Sold
2,200
January 31, inventory is
$3,250 ($1,050 + $2,200)
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35
36
7-3
-
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Example Exercise 7-2
Beginning inventory, purchases, and sales for Item ER27
are as follows:
Nov. 1 Inventory 40 units at $5
5 Sale
32 units
11 Purchase 60 units at $7
21 Sale
45 units
Assuming a perpetual inventory system and the first-in,
first-out (FIFO) method, determine (a) the cost of the
merchandise sold for the November 21 sale and (b) the
inventory on November 30.
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36
37
7-3
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Follow My Example 7-2
a) Cost of merchandise sold:
8 units @ $5
$40
37 units @ $7
259
45 units
$299
b) Inventory, November 30:
$161 = (23 units x $7)
For Practice: PE 7-2A, PE 7-2B
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37
38
LIFO Perpetual
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7-3
On January 1, the firm had 100 units
of Item 127B that cost $20 per unit.
Item 127B
Jan.
1
Inventory
Units
Cost
100
$20
38
38
39
LIFO Perpetual
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7-3
On January 4, the firm sold 70 units
of 127B at $30 each.
Item 127B
Jan.
1
4
Inventory
Sale
Units
Cost
100
70
$20
39
39
40
LIFO Perpetual
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7-3
On January 4, the firm sold 70 units
of 127B at $30 each.
4 Accounts Receivable
Sales
2 100 00
2 100 00
On4 January
22, theSoldfirm sold1twenty
Cost of Merchandise
400 00
1 400 00
units atMerchandise
$30. Inventory
40
40
41
LIFO Perpetual
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7-3
Item 127B
Purchases
Date
Jan. 1
4
Qty.
Unit
Cost
Total
Cost
Cost of Mdse. Sold
Inventory Balance
Unit
Cost
Total
Cost
2,000
600
Qty.
70
20
Total
Cost
Qty.
Unit
Cost
1,400
100
30
20
20
41
41
42
LIFO Perpetual
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7-3
On January 10, the firm purchased
80 units at $21 each.
Item 127B
Jan.
1
4
10
Inventory
Sale
Purchase
Units
Cost
100
70
80
$20
21
42
42
43
LIFO Perpetual
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7-3
On January 10, the firm purchased
80 units at $21 each.
10 Merchandise Inventory
Accounts Payable
1 680 00
1 680 00
43
43
44
LIFO Perpetual
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7-3
Item 127B
Purchases
Date
Jan. 1
4
10
Qty.
Unit
Cost
Total
Cost
Cost of Mdse. Sold
Inventory Balance
Unit
Cost
Qty.
Unit
Cost
Total
Cost
100
30
30
80
20
20
20
21
2,000
600
600
1,680
Qty.
70
80
21
1,680
20
Total
Cost
1,400
44
44
45
LIFO Perpetual
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7-3
On January 22, the firm sold 40 units
for $30 each.
Item 127B
Jan.
1
4
10
22
Inventory
Sale
Purchase
Sale
Units
Cost
100
70
80
40
$20
21
45
45
46
LIFO Perpetual
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7-3
On January 22, the firm sold 40 units
for $30 each.
22 Accounts Receivable
Sales
1 200 00
1 200 00
On
22, theSoldfirm sold twenty
22 January
Cost of Merchandise
840 00
units atMerchandise
$30. Inventory
840 00
46
46
47
LIFO Perpetual
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7-3
Item 127B
Purchases
Date
Jan. 1
4
10
22
Qty.
80
Unit
Cost
21
Total
Cost
Cost of Mdse. Sold
Inventory Balance
Unit
Cost
Qty.
Unit
Cost
Total
Cost
100
30
30
80
30
40
20
20
20
21
20
21
2,000
600
600
1,680
600
840
Qty.
Total
Cost
70
20
1,400
40
21
840
1,680
All of the 40 sold are considered to be from
the January 10 purchase.
47
47
48
LIFO Perpetual
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7-3
On January 28, the firm sold 20
units at $30 each.
Item 127B
Jan.
1
4
10
22
28
Inventory
Sale
Purchase
Sale
Sale
Units
Cost
100
70
80
40
20
$20
21
48
48
49
7-3
LIFO Perpetual
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On January 28, the firm sold 20
units at $30 each.
28 Accounts Receivable
Sales
600 00
28 Cost of Merchandise Sold
Merchandise Inventory
420 00
600 00
420 00
49
49
50
LIFO Perpetual
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7-3
Item 127B
Purchases
Date
Jan. 1
4
10
Qty.
Unit
Cost
Total
Cost
Cost of Mdse. Sold
Inventory Balance
Unit
Cost
Qty.
Unit
Cost
Total
Cost
100
30
30
80
30
40
30
20
20
20
20
21
20
21
20
21
2,000
600
600
1,680
600
840
600
420
Qty.
Total
Cost
70
20
1,400
22
40
21
840
28
20
21
420
80
21
1,680
All of the 20 sold are considered to be from
the January 22 purchase.
50
50
51
LIFO Perpetual
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7-3
On January 30, the firm purchased one hundred
additional units of Item 127B at $22 each.
Item 127B
Jan.
1
4
10
22
28
30
Inventory
Sale
Purchase
Sale
Sale
Purchase
Units
Cost
100
70
80
40
20
100
$20
21
22
51
51
52
7-3
LIFO Perpetual
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On January 30, the firm purchased one hundred
additional units of Item 127B at $22 each.
30 Merchandise Inventory
Accounts Payable
2 200 00
2 200 00
52
52
53
LIFO Perpetual
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7-3
Item 127B
Purchases
Date
Jan. 1
4
10
Qty.
Unit
Cost
Total
Cost
Cost of Mdse. Sold
Inventory Balance
Unit
Cost
Qty.
Unit
Cost
Total
Cost
100
30
30
80
30
40
30
20
30
20
100
20
20
20
21
20
21
20
21
20
21
22
2,000
600
600
1,680
600
840
600
420
600
420
2,200
Qty.
Total
Cost
70
20
1,400
22
40
21
840
28
20
21
420
80
30 100
21
22
1,680
2,200
53
53
33
54
LIFO Perpetual
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7-3
Item 127B
Purchases
Date
Jan. 1
4
10
Qty.
Unit
Cost
Total
Cost
Cost of Mdse. Sold
Inventory Balance
Unit
Cost
Qty.
Unit
Cost
Total
Cost
100
30
30
80
30
40
30
20
30
20
100
20
20
20
21
20
21
20
21
20
21
22
2,000
600
600
1,680
600
840
600
420
600
420
2,200
Qty.
Total
Cost
70
20
1,400
22
40
21
840
28
20
21
420
80
30 100
21
22
1,680
2,200
Cost of merchandise sold
$2,660
54
54
33
55
LIFO Perpetual
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7-3
Item 127B
Purchases
Date
Jan. 1
4
10
Qty.
Unit
Cost
Total
Cost
Cost of Mdse. Sold
Inventory Balance
Unit
Cost
Qty.
Unit
Cost
Total
Cost
100
30
30
80
30
40
30
20
30
20
100
20
20
20
21
20
21
20
21
20
21
22
2,000
600
600
1,680
600
840
600
420
600
420
2,200
Qty.
Total
Cost
70
20
1,400
22
40
21
840
28
20
21
420
80
30 100
21
22
1,680
2,200
January 31, inventory….. $3,220
55
55
33
56
7-3
-
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Example Exercise 7-3
Beginning inventory, purchases, and sales for Item ER27
are as follows:
Nov. 1 Inventory 40 units at $5
5 Sale
32 units
11 Purchase 60 units at $7
21 Sale
45 units
Assuming a perpetual inventory system and the last-in,
first-out (LIFO) method, determine (a) the cost of the
merchandise sold for the November 21 sale and (b) the
inventory on November 30.
56
56
57
7-3
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to
edit
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title
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Follow My Example 7-3
a) Cost of merchandise sold:
$315 = (45 units x $7)
b) Inventory, November 30:
8 units @ $5
15 units @ $7
23
$ 40
105
$145
For Practice: PE 7-3A, PE 7-3B
57
57
58
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Objective 4
7-4
Determine the cost of inventory
under the periodic inventory
system, using FIFO, LIFO, and
average cost methods.
58
59
FIFO Periodic
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7-4
Using FIFO, the earliest
batch purchased is
considered the first batch
of merchandise sold. The
physical flow does not
have to match the
accounting method chosen.
59
60
FIFO Periodic
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Jan. 1
100 units @ $20
= $2,000
Jan. 10
80 units @ $21
=
1,680
Jan. 30
100 units @ $22
=
2,200
7-4
$5,880
280 units available
for sale during
year
Cost of merchandise
available for sale
60
60
61
FIFO Periodic
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7-4
The physical count on January 31 shows that 150
units are on hand (conclusion: 130 units were
sold). What is the cost of the ending inventory?
Jan. 1
100Sold
unitsthese
@ $20
Sold 30 of these
=
$ 0
Jan. 10
80 units @ $21
50 units @ $21
=
1,050
Jan. 30
100 units @ $22
=
2,200
Ending inventory
$3,250
61
61
62
FIFO Periodic
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7-4
Now we can calculate the cost of goods
sold as follows:
Beginning inventory, January 1 (Slide 60)
Purchases ($1,680 + $2,200)
Cost of merchandise available for sale
Ending inventory, January 31(Slide 61)
Cost of merchandise sold
$2,000
3,880
$5,880
3,250
$2,630
62
62
63
7-4
LIFO Periodic
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Using LIFO, the most recent batch
purchased is considered the first batch of
merchandise sold. The actual flow of goods
does not have to be LIFO. For example, a
store selling fresh fish would want to sell the
oldest fish first (which is FIFO) even though
LIFO is used for accounting purposes.
63
64
LIFO Periodic
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Jan. 1
100 units @ $20
= $2,000
Jan. 10
80 units @ $21
=
1,680
Jan. 30
100 units @ $22
=
2,200
7-4
280 units available
$5,880
for sale during
year
Cost of merchandise
available for sale
64
64
65
LIFO Periodic
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7-4
Assume again that the physical count on January
31 is 150 units (and that 130 units were sold).
What is the cost of the ending inventory?
Jan. 1
100 units @ $20
=
$2,000
Jan. 10
50
80 units
units @
@ $21
$21
=
1,050
1,
680
Jan. 30
100Sold
unitsthese
@ $22
=
2,200
0
$3,050
Sold 30 of these
Ending inventory
65
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66
LIFO Periodic
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7-4
Now we can calculate the cost of goods
sold as follows:
Beginning inventory, January 1 (Slide 64)
Purchases ($1,680 + $2,200)
Cost of merchandise available for sale
Ending inventory, January 31(Slide 65)
Cost of merchandise sold
$2,000
3,880
$5,880
3,050
$2,830
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Average Cost
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7-4
The weighted average unit cost
method is based on the average
cost of identical units. The total
cost of merchandise available
for sale is divided by the related
number of units of that item.
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Average Cost
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Jan. 1
100 units @ $20
= $2,000
Jan. 10
80 units @ $21
=
1,680
Jan. 30
100 units @ $22
=
2,200
280
7-4
$5,880
Average unit cost: $5,880 ÷ 280 = $21
Cost of merchandise sold: 130 units at $21 = $2,730
Ending merchandise inventory: 150 units at $21= $3,150
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Average Cost
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7-4
Now we can calculate the cost of goods
sold as follows:
Beginning inventory, January 1 (Slide 68)
Purchases ($1,680 + $2,200)
Cost of merchandise available for sale
Ending inventory, January 31(Slide 68)
Cost of merchandise sold
$2,000
3,880
$5,880
3,150
$2,730
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7-4
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Example Exercise 7-4
The units of an item available for sale during the year were as
follows:
Jan. 1 Inventory
Mar. 20 Purchase
Oct. 30 Purchase
Available for sale
6 units @ $50
14 units @ $55
20 units @ $62
40 units
$ 300
770
1,240
$2,310
There are 16 units of the item in the physical inventory at
December 31. The periodic inventory system is used.
Determine the inventory cost by (a) the first-in, first-out
(FIFO) method, (b) the last-in, first-out (LIFO) method, and
(c) the average cost method.
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7-4
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Follow My Example 7-4
a) First-in, first-out (FIFO) method: $992 (16 units x
$62)
b) Last-in, first-out (LIFO) method: $850 (6 units x $50)
+ (10 units x $55)
c) Average method: $924 (16 units x $57.75) where
average cost = $57.75 ($2,310 ÷ 40 units)
For Practice: PE 7-4A, PE 7-4B
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7-5
Objective 5
Compare and contrast the
use of the three inventory
costing methods.
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Partial Income Statements
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7-5
First-In, First-Out
Net sales
$3,900
Cost of merchandise sold:
Beginning inventory
$2,000
Purchases
3,880
Merchandise available for sale $5,880
Less ending inventory
3,250
Cost of merchandise sold
2,630
Gross profit
$1,270
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Partial Income Statements
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7-5
Average Cost
Net sales
$3,900
Cost of merchandise sold:
Beginning inventory
$2,000
Purchases
3,880
Merchandise available for sale $5,880
Less ending inventory
3,150
Cost of merchandise sold
2,730
Gross profit
$1,170
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Partial Income Statements
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7-5
Last-In, First-Out
Net sales
$3,900
Cost of merchandise sold:
Beginning inventory
$2,000
Purchases
3,880
Merchandise available for sale $5,880
Less ending inventory
3,050
Cost of merchandise sold
2,830
Gross profit
$1,070
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7-5
Recap
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Weighted
FIFO LIFO Average
Ending inventory
$3,250 $3,150 $3,050
Cost of merchandise sold
$2,630 $2,730 $2,830
Gross profit
$1,270 $1,170 $1,070
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7-6
Objective 6
Describe and illustrate the
reporting of merchandise
inventory in the financial
statements.
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Lower-of-Cost-or-Market Method
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7-6
If the cost of replacing an
item in inventory is lower
than the original purchase
cost, the lower-of-cost-ormarket (LCM) method is
used to value the inventory.
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7-6
Market, as used in lower
of cost or market, is the
cost to replace the
merchandise on the
inventory date.
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7-6
Cost and replacement cost can be
determined for—
1) each item in the inventory,
2) major classes or categories of
inventory, or
3) the inventory as a whole.
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Determining Inventory at
Lower-of-Cost-or-Market
Method
7-6
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7-6
Merchandise that is out of date,
spoiled, or damaged should be
written down to its net realizable
value. This is the estimated
selling price less any direct cost
of disposal, such as sales
commissions.
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Merchandise Inventory on the
Balance Sheet
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7-6
Merchandise inventory is usually
presented in the Current Assets
section of the balance sheet,
following receivables.
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7-6
The method of
determining the cost of
inventory (FIFO, LIFO,
or weighted average)
should be shown.
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7-6
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Example Exercise 7-5
On the basis of the following data, determine the value
of the inventory at the lower of cost or market. Apply
lower of cost or market to each inventory item as shown
in Exhibit 7.
Inventory
Unit
Unit
Commodity Quantity Cost Price Market Price
C17Y
10
$ 39
$40
B563
7
110
98
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7-6
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Follow My Example 7-5
Unit
Unit
Commodity Qty Cost Price Market Price Cost
C17Y
B563
Total
10
7
$ 39
110
$40
98
For Practice: PE 7-5A, PE 7-5B
$ 390
770
$1,160
Lower of
Market C or M
$ 400
686
$1,086
$ 390
686
$1,076
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7-6
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Example Exercise 7-6
Zula Repair Shop incorrectly counted its December
31, 2008 inventory as $250,000 instead of the
correct amount of $220,000. Indicate the effect of
the misstatement on Zula’s December 31, 2008
balance sheet and income statement for the year
ended December 31, 2008.
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7-6
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Follow My Example 7-6
Amount of Misstatement
Overstatement (Understatement)
Balance Sheet:
Merchandise inventory overstated
Current assets overstated
Total assets overstated
Owner’s equity overstated
Income Statement:
Cost of merchandise sold understated
Gross profit overstated
Net income overstated
For Practice: PE 7-6A, PE 7-6B
$30,000
30,000
30,000
30,000
$(30,000)
30,000
30,000
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7-7
Objective 7
Estimate the cost of
inventory, using the retail
method and the gross profit
method.
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Retail Inventory Method
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7-7
The retail inventory method
of estimating inventory
cost is based on the
relationship of the cost of
merchandise available for
sale to the retail price of the
same merchandise.
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Determining Inventory by
the Retail Method
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7-7
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7-7
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Example Exercise 7-7
A business using the retail method of inventory costing
determines that merchandise inventory at retail is
$900,000. If the ratio of cost to retail price is 70%, what
is the amount of inventory to be reported on the
financial statements?
Follow My Example 7-7
$630,000 ($900,000 x 70%)
For Practice: PE 7-7A, PE 7-7B
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Gross Profit Method
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7-7
The gross profit method uses
the estimated gross profit for the
period to estimate the inventory
at the end of the period.
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Estimating Inventory by
Gross Profit Method
7-7
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7-7
The gross profit method is useful for
estimating inventories for monthly or
quarterly financial statements in a
periodic inventory system.
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7-7
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Example Exercise 7-8
Based on the following data, estimate the cost of ending
merchandise inventory:
Sales (net)
Estimated gross profit rate
Beginning merchandise inventory
Purchases (net)
Merchandise available for sale
$1,250,000
40%
$100,000
800,000
$900,000
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7-7
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Follow My Example 7-8
Merchandise available for sale
Less cost of merchandise sold
[$1,250,000 x (100% – 40%)]
Estimated ending merchandise inventory
For Practice: PE 7-8A, PE 7-8B
$900,000
750,000
$150,000
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7-7
Inventory turnover measures the
relationship between the volume of goods
(merchandise) sold and the amount of
inventory carried during the period.
Cost of merchandise sold
Inventory turnover =
Average inventory
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7-7
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SUPERVALU
Cost of merchandise sold
Inventories:
Beginning of year
End of year
Average
Inventory turnover
Zale
$16,681,472,000
$1,157,226,000
$1,078,343,000
$1,032,034,000
$1,055,188,500
$826,824,000
$853,580,000
$840,202,000
15.8 times
1.4 times
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100
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7-7
Generally, the larger the
inventory turnover, the more
efficient and effective the
management of inventory.
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7-7
The number of days’ sales in
inventory is a rough measure of the
length of time it takes to acquire,
sell, and replace the inventory.
Number of days’
sales in inventory
=
Average inventory
Average daily cost of
merchandise sold
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7-7
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SUPERVALU
Average daily cost of
merchandise sold:
$16,681,472,000/365
$1,157,226,000/365
Average inventory
Number of days’ sales
in inventory
Zale
$45,702,663
$1,055,188,500
$3,170,482
$840,202,000
23.1 days
265.0 days
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