CHAPTER1

INVENTORIES

8-1
 Concepts of inventory
 Inventory refers to the goods and materials that a
business holds for the purpose of resale, production, or
utilization.
 It is a critical asset for any company, as it directly
impacts revenue generation and operational efficiency.
 Items held for sale, or
 Goods to be used in the production of goods to be sold

8-2
 Types of Inventory

 Raw Materials: Basic materials used to produce

goods.
 Work-in-Progress (WIP): Items that are in the
process of being manufactured but are not yet
complete.
 Finished Goods: Completed products ready for
sale.
 Goods for Resale: items that have been
returned and ready to be sold again

8-3
 Purpose of Inventory:
 Buffer Against Uncertainties: Helps manage
fluctuations in demand and supply.
 Smooth Production Process: Ensures that
production can continue without delays due to
material shortages.
 Meeting customer demand: allows businesses
to fulfill customer order promptly

8-4
 Internal control
 Internal control refers to the processes,
mechanisms, and procedures implemented by
an organization to ensure the integrity of
financial and accounting information, promote
accountability, and prevent fraud.
 A system designed to provide reasonable
assurance regarding the achievement of
objectives in operational effectiveness and
efficiency, reliable financial reporting, and
compliance with laws and regulations

8-5
 Components of Internal Control
 Control Environment: Sets the tone for the organization,
influencing the control consciousness of its people. It
includes the integrity, ethical values, and competence of
the entity’s people.
 Risk Assessment: Involves identifying and analyzing
risks to achieving the organization’s objectives, forming a
basis for determining how the risks should be managed2.
 Control Activities: These are the policies and
procedures that help ensure management directives are
carried out. They include approvals, authorizations,
verifications, reconciliations, and reviews of operating
performance

8-6
 Cont’d…
 Information and Communication: Systems or
processes that support the identification,
capture, and exchange of information in a form
and time frame that enable people to carry out
their responsibilities.
 Monitoring: Processes used to assess the
quality of internal control performance over time.
This includes regular management and
supervisory activities, as well as internal audit
activities

8-7
 Types of Internal Controls

 Preventive Controls: Designed to prevent

errors or fraud from occurring in the first place
(e.g., segregation of duties, authorization of
transactions).
 Detective Controls: Designed to detect errors
or fraud that have already occurred (e.g.,
reconciliations, audits).
 Corrective Controls: Designed to correct errors
or irregularities that have been detected (e.g.,
backup procedures, error correction processes

8-8
 Importance of Internal Controls

1. Help ensure the accuracy and reliability of

financial reporting.
2. Promote operational efficiency by ensuring that
policies and procedures are followed.
3. Enabling companies complying with laws and
regulations, thereby avoiding legal penalties.
4. It protects the organization’s resources from
loss, theft, or misuse

8-9
 Internal control over inventory

 Internal control over inventory involves a set of

procedures and mechanisms designed to
ensure the accuracy and integrity of inventory
records, safeguard assets, and enhance
operational efficiency

8-10
 Components of Internal control over
inventory
1. Segregation of Duties: Different employees
should handle different aspects of inventory
management, such as ordering, receiving, and
recording inventory. This reduces the risk of
errors and fraud.
2. Authorization and Approval: All inventory
transactions should be authorized and
approved by designated personnel. This
includes purchase orders, receiving reports,
and inventory adjustments

8-11
 Cont’d…

3. Physical Controls: Regular physical counts of inventory

should be conducted to verify the accuracy of inventory
records. Discrepancies between physical counts and
recorded amounts should be investigated and resolved.
4. Documentation and Record-Keeping: Maintain
accurate and up-to-date records of all inventory
transactions, including purchases, sales, returns, and
adjustments. This helps in tracking inventory movements
and identifying discrepancies
5. Periodic Reconciliation: Regularly reconcile inventory
records with physical counts and investigate any
discrepancies

8-12
 Cont’d…

6. Inventory Management Systems: Implement

inventory management software to automate tracking
and recording of inventory transactions

8-13
 Importance of Internal control over
inventory
a) Accuracy: Ensures that inventory records are accurate
and up-to-date, which is crucial for financial reporting
and decision-making1.
b) Prevention of Fraud and Theft: Protects inventory
from theft, fraud, and misuse by implementing security
measures and regular monitoring.
c) Operational Efficiency: Helps in maintaining optimal
inventory levels, reducing excess stock, and avoiding
stock outs, thereby improving operational efficiency.
d) Compliance: Ensures compliance with company
policies, industry standards, and regulatory
requirements

8-14
 Inventory Systems
 An inventory system is designed to monitor and control
the flow of goods from purchasing to production to end
sales.
 It ensures that a company knows exactly what items are
available, their quantities, and their locations

8-15
 Elements of inventory system

Tracking: Keeps detailed records of inventory levels,

orders, sales, and deliveries. This can be done manually
or through automated systems.
Ordering: Manages the process of ordering new stock,
including determining reorder points and quantities.
Storage: Organizes the storage of inventory in
warehouses or other facilities, ensuring items are stored
efficiently and safely
Sales: Tracks the sale of inventory items, updating
records to reflect changes in stock levels

8-16
 Types of inventory systems

1. Perpetual Inventory System: Continuously updates

inventory records with each transaction, providing real-
time data on inventory levels.
2. Periodic Inventory System: Updates inventory
records at specific intervals, such as monthly or
annually, based on physical counts

8-17
 Inventory
Inventory Cost
Cost Flow
Flow

Perpetual System
1. Purchases of merchandise are debited to Inventory.
2. Freight-in is debited to Inventory. Purchase returns and
allowances and purchase discounts are credited to Inventory.
3. Cost of goods sold is debited and Inventory is credited for each
sale.
4. Subsidiary records show quantity and cost of each type of
inventory on hand.

The perpetual inventory system provides a continuous

record of Inventory and Cost of Goods Sold.

8-18
 Inventory
Inventory Cost
Cost Flow
Flow

Periodic System

1. Purchases of merchandise are debited to Purchases.

2. Ending Inventory determined by physical count.
3. Calculation of Cost of Goods Sold:

Beginning inventory

$ 100,000
Purchases, net

800,000
8-19
Goods available for sale
 Inventory
Inventory Cost
Cost Flow
Flow

Illustration: Fesmire Company had the following transactions

during the current year.

Record these transactions using the Perpetual and Periodic

systems.

8-20
 Inventory
Inventory Issues
Issues

Basic Issues in Inventory Valuation

Companies must allocate the cost of all the goods available
for sale (or use) between the goods that were sold or used
and those that are still on hand.
Illustration 6-5

8-21
 Costs
Costs Included
Included in
in Inventory
Inventory

Product Costs - costs directly connected with

bringing the goods to the buyer’s place of business
and converting such goods to a salable condition.

Period Costs – generally selling, general, and

administrative expenses.

Treatment of Purchase Discounts – Gross vs.

Net Method

8-22
 Which
Which Cost
Cost Flow
Flow Assumption
Assumption to
to Adopt?
Adopt?

Specific Identification --- Average Cost --- FIFO

Cost
CostFlow
Flow Assumption
AssumptionAdopted
Adopted
does
doesnot
notneed
needto
toequal
equal
Physical
Physical Movement
Movementof
ofGoods
Goods

Method adopted should be one that most clearly reflects periodic income.

8-23
 Cost
Cost Flow
Flow Assumptions
Assumptions

Example
Young & Crazy Company makes the following purchases:
1. One item on 2/2/11 for $10
2. One item on 2/15/11 for $15
3. One item on 2/25/11 for $20
Young & Crazy Company sells one item on 2/28/11 for $90.
What would be the balance of ending inventory and cost of
goods sold for the month ended February 2011, assuming
the company used the FIFO, Average Cost, and Specific
Identification cost flow assumptions? Assume a tax rate of
30%.
8-24
 Cost
Cost Flow
Flow Assumptions
Assumptions
“First-In-First-Out (FIFO)”
Inventory Balance Young & Crazy Company
Income Statement
= $ 45 For the Month of Feb. 2011

Sales $ 90
Purchase on Cost of goods sold 0
2/25/11 for $20 Gross profit 90
Expenses:
Administrative 14
Purchase on Selling 12
2/15/11 for $15 Interest 7
Total expenses 33
Income before tax 57
Purchase on Taxes 17
2/2/11 for $10 Net Income $ 40

8-25
 Cost
Cost Flow
Flow Assumptions
Assumptions
“First-In-First-Out (FIFO)”
Inventory Balance Young & Crazy Company
Income Statement
= $ 35 For the Month of Feb. 2011

Sales $ 90
Purchase on Cost of goods sold 10
2/25/11 for $20 Gross profit 80
Expenses:
Administrative 14
Purchase on Selling 12
2/15/11 for $15 Interest 7
Total expenses 33
Income before tax 47
Purchase on Taxes 14
2/2/11 for $10 Net Income $ 33

8-26
 Cost
Cost Flow
Flow Assumptions
Assumptions
“Average Cost”
Inventory Balance Young & Crazy Company
Income Statement
= $ 45 For the Month of Feb. 2011

Sales $ 90
Purchase on Cost of goods sold 0
2/25/11 for $20 Gross profit 90
Expenses:
Administrative 14
Purchase on Selling 12
2/15/11 for $15 Interest 7
Total expenses 33
Income before tax 57
Purchase on Taxes 17
2/2/11 for $10 Net Income $ 40

8-27
 Cost
Cost Flow
Flow Assumptions
Assumptions
“Average Cost”
Inventory Balance Young & Crazy Company
Income Statement
= $ 30 For the Month of Feb. 2011

Sales $ 90
Purchase on Cost of goods sold 15
2/25/11 for $20 Gross profit 75
Expenses:
Administrative 14
Purchase on Selling 12
2/15/11 for $15 Interest 7
Total expenses 33
Income before tax 42
Purchase on Taxes 12
2/2/11 for $10 Net Income $ 30

8-28
 Cost
Cost Flow
Flow Assumptions
Assumptions
“Specific Identification”
Inventory Balance Young & Crazy Company
Income Statement
= $ 45 For the Month of Feb. 2011

Sales $ 90
Purchase on Cost of goods sold 0
2/25/11 for $20 Gross profit 90
Expenses:
Administrative 14
Purchase on Selling 12
2/15/11 for $15 Interest 7
Total expenses 33
Income before tax 57
Purchase on Taxes 17
2/2/11 for $10 Net Income $ 40

8-29
 Cost
Cost Flow
Flow Assumptions
Assumptions
“Specific Identification”
Inventory Balance Young & Crazy Company
Income Statement
= $ 45
Depends which
For the Month of one is sold
Feb. 2011

Sales $ 90
Purchase on Cost of goods sold 0
2/25/11 for $20 Gross profit 90
Expenses:
Administrative 14
Purchase on Selling 12
2/15/11 for $15 Interest 7
Total expenses 33
Income before tax 57
Purchase on Taxes 17
2/2/11 for $10 Net Income $ 40

8-30
 Cost
Cost Flow
Flow Assumptions
Assumptions
Financial Statement Summary
FIFO Average
Sales $ 90 $ 90
Cost of goods sold 10 15
Gross profit 80 75
Operating expenses:
Administrative 14 14
Selling 12 12
Interest 7 7
Total expenses 33 33
Income before taxes 47 42
Income tax expense 14 12
Net income $ 33 $ 30

Inventory Balance 35 30
8-31
 Cost
Cost Flow
Flow Assumptions
Assumptions

Illustration: Call-Mart Inc. had the following transactions in

its first month of operations.

Calculate Goods Available for Sale

Beginning inventory (2,000 x $4)

$ 8,000
Purchases:
6,000 x $4.40

8-32 26,400
 Average
Average Cost
Cost
Weighted-Average Illustration 6-9

8-33
 Average
Average Cost
Cost

Moving-Average
Illustration 6-10

In this method, Call-Mart computes a new average unit

cost each time it makes a purchase.

8-34
 First-In,
First-In, First-Out
First-Out (FIFO)
(FIFO)

Periodic Method Illustration 6-11

Determine cost of ending inventory by taking the cost of the most recent
purchase and working back until it accounts for all units in the inventory.

8-35
 First-In,
First-In, First-Out
First-Out (FIFO)
(FIFO)

Perpetual Method
Illustration 6-12

In all cases where FIFO is used, the inventory and cost of goods sold would
be the same at the end of the month whether a perpetual or periodic system is
used.

8-36
 Inventory
Inventory Valuation
Valuation Methods
Methods -- Summary
Summary
Illustration 6-13

8-37
 Inventories:
Inventories: Additional
Additional Valuation
Valuation Issues
Issues

Lower-of-Cost-or-Net
Gross Profit Retail Inventory
Realizable Value Valuation Bases
Method Method
(LCNRV)

Net realizable Special Gross profit Concepts

value valuation percentage Conventional
situations Evaluation of method
Illustration of
LCNRV Relative sales method Special items
value
Application of Evaluation of
LCNRV method
Recording net
realizable
value
Recovery of
inventory loss

8-38
 Lower-of-Cost-or-Net
Lower-of-Cost-or-Net Realizable
Realizable Value
Value

LCNRV
A company abandons the historical cost principle
when the future utility (revenue-producing ability)
of the asset drops below its original cost.

8-39
 Lower-of-Cost-or-Net
Lower-of-Cost-or-Net Realizable
Realizable Value
Value

Net Realizable Value

Estimated selling price in the normal course of
business less estimated costs to complete and
estimated costs to make a sale.
Illustration 6-14

8-40
 Lower-of-Cost-or-Net
Lower-of-Cost-or-Net Realizable
Realizable Value
Value

Net Realizable Value Illustration 6-15

LCNRV Disclosures

8-41
 Lower-of-Cost-or-Net
Lower-of-Cost-or-Net Realizable
Realizable Value
Value

8-42
 Lower-of-Cost-or-Net
Lower-of-Cost-or-Net Realizable
Realizable Value
Value

Methods of Applying LCNRV

8-43
 Lower-of-Cost-or-Net
Lower-of-Cost-or-Net Realizable
Realizable Value
Value

Methods of Applying LCNRV

► In most situations, companies price inventory on an
item-by-item basis.

► Tax rules in some countries require that companies use

an individual-item basis.

► Individual-item approach gives the lowest valuation for

statement of financial position purposes.

► Method should be applied consistently from one period

to another.

8-44
 Lower-of-Cost-or-Net
Lower-of-Cost-or-Net Realizable
Realizable Value
Value
Recording Net Realizable Value Instead of Cost

Cost of goods sold (before adj. to NRV) $ 108,000

Ending inventory (cost) 82,000
Ending inventory (at NRV) 70,000
1. Direct inventory reduction method
Loss
Loss Loss due to decline to NRV 12,000
Method
Method Inventory

12,000
COGS
COGS Cost of goods sold 12,000
Method
Method Inventory

8-45 12,000
 Lower-of-Cost-or-Net
Lower-of-Cost-or-Net Realizable
Realizable Value
Value

Statement of Financial Position Presentation

Partial Statement COGS Loss
Method Method
Current assets:
Inventory $ 70,000 $ 70,000
Prepaids 20,000 20,000
Accounts receivable 350,000 350,000
Cash 100,000 100,000
Total current assets 540,000 540,000

8-46
 Lower-of-Cost-or-Net
Lower-of-Cost-or-Net Realizable
Realizable Value
Value
Income Statement Presentation Loss COGS
Method Method
Sales $ 200,000 $ 200,000
Cost of goods sold 108,000 120,000
Gross profit 92,000 80,000
Operating expenses:
Selling 45,000 45,000
General and administrative 20,000 20,000
Total operating expenses 65,000 65,000
Other income and expense:
Loss due to NRV on inventory 12,000 -
Interest income 5,000 5,000
Total other (7,000) 5,000
Income from operations 20,000 20,000
Income tax expense 6,000 6,000
Net income $ 14,000 $ 14,000
8-47
 Lower-of-Cost-or-Net
Lower-of-Cost-or-Net Realizable
Realizable Value
Value

2. Allowance Method
Instead of crediting the Inventory account for net realizable
value adjustments, companies generally use an
allowance account.

Loss
Loss Loss due to decline to NRV 12,000
Method
Method Allowance to reduce
inventory to NRV

COGS
COGS Cost12,000
of goods sold 12,000
Method
Method Allowance to reduce
inventory to NRV
8-48
 Lower-of-Cost-or-Net
Lower-of-Cost-or-Net Realizable
Realizable Value
Value

Statement of Financial Position Presentation

Partial Statement Inventory reduction Allowance
Method Method
Current assets:
Inventory $ 70,000 $ 82,000
Allowance to reduce inventory (12,000)
Inventory at NRV 70,000
Prepaids 20,000 20,000
Accounts receivable 350,000 350,000
Cash 100,000 100,000
Total current assets 540,000 540,000

8-49
 Lower-of-Cost-or-Net
Lower-of-Cost-or-Net Realizable
Realizable Value
Value

Recovery of Inventory Loss

►Amount of write-down is reversed.

►Reversal limited to amount of original write-down.

Continuing the Ricardo example, assume the net realizable

value increases to $74,000 (an increase of $4,000). Ricardo
makes the following entry, using the loss method.
Allowance
Allowance Allowance to reduce inventory to NRV
Method
Method Recovery of inventory loss
4,000
Inventory 4,000
Inv. reduction 4,000
Inv. reduction
method
method Recovery of inventory loss
8-50
 Lower-of-Cost-or-Net
Lower-of-Cost-or-Net Realizable
Realizable Value
Value
Exercise: Remmers Company manufactures desks. Most of the
company’s desks are standard models and are sold on the basis of
catalog prices. At December 31, 2010, the following finished desks
appear in the company’s inventory.

Finished Desks A B C D
FIFO cost inventory at 12/31/10 $ 470 $ 450 $ 830 $ 960
Est. cost to complete and sell 50 110 260 200
Catalog selling price 500 540 900 1,200

Instructions: At what amount should the desks appear in the company’s

December 31, 2010, inventory, assuming that the company has
adopted a lower-of-FIFO-cost-or-net realizable value approach for
valuation of inventories on an individual-item basis?
8-51
 Lower-of-Cost-or-Net
Lower-of-Cost-or-Net Realizable
Realizable Value
Value
Exercise: Remmers Company manufactures desks. Most of the
company’s desks are standard models and are sold on the basis of
catalog prices. At December 31, 2010, the following finished desks
appear in the company’s inventory.

Finished Desks A B C D
FIFO cost inventory at 12/31/10 $ 470 $ 450 $ 830 $ 960
Est. cost to complete and sell 50 110 260 200
Catalog selling price 500 540 900 1,200

Net realizable value 450 430 640 1,000

Lower-of-cost-or-NRV 450 430 640 960

8-52
 Valuation
Valuation Bases
Bases

Special Valuation Situations

Departure from LCNRV rule may be justified in situations when
► cost is difficult to determine,

► items are readily marketable at quoted market prices, and

► units of product are interchangeable.

Two common situations in which NRV is the general rule:

► Agricultural assets

► Commodities held by broker-traders.

8-53
 Valuation
Valuation Bases
Bases
Agricultural Inventory NRV
Biological asset (classified as a non-current asset) is a living
animal or plant, such as sheep, cows, fruit trees, etc

► Biological assets except bearer plants are measured on

initial recognition and at the end of each reporting
period at fair value less costs to sell (NRV).

► Companies record gain or loss due to changes in NRV

of biological assets in income when it arises.

► Bearer plants (coffee trees, Mango trees, etc) are

measured at cost model or revaluation model.
8-54
 Valuation
Valuation Bases
Bases

Agricultural Inventory NRV

Agricultural produce is the harvested product of a biological
asset, such as wool from a sheep, milk from a dairy cow,
picked fruit from a fruit tree, or cotton from a cotton plant.

► Agricultural produce are measured at fair value less

costs to sell (NRV) at the point of harvest.

► Once harvested, the NRV becomes cost.

8-55
 Valuation
Valuation Bases
Bases
Illustration: Bancroft Dairy produces milk for sale to local cheese-
makers. Bancroft began operations on January 1, 2011, by
purchasing 420 milking cows for €460,000. Bancroft provides the
following information related to the milking cows.

8-56
 Valuation
Valuation Bases
Bases

Bancroft makes the following entry to record the change in

carrying value of the milking cows.
Biological Asset—Milking Cows 33,800

Unrealized Holding Gain or Loss—Income 33,800

8-57
 Valuation
Valuation Bases
Bases

Biological Asset—Milking Cows 33,800

Unrealized Holding Gain or Loss—Income

33,800
Reported in statement of financial position reports the
Biological Asset—Milking Cows as a non-current asset at fair
value less costs to sell (net realizable value).

Reported as “Other income and expense” on the income

statement.

8-58
 Valuation
Valuation Bases
Bases
Illustration: Bancroft makes the following summary entry to record the
milk harvested for the month of January.

Milk Inventory 36,000

Unrealized Holding Gain or Loss—Income 36,000

Assuming the milk harvested in January was sold to a local cheese-

maker for €38,500, Bancroft records the sale as follows.

Cash 38,500
Sales 38,500

Cost of Goods Sold 36,000

Milk Inventory 36,000
8-59
 Valuation
Valuation Bases
Bases

Commodity Broker-Traders NRV

Generally measure their inventories at fair value less costs to
sell (NRV), with changes in NRV recognized in income in the
period of the change.

► Buy or sell commodities (such as harvested corn, wheat,

precious metals, heating oil).

► Primary purpose is to sell the commodities in the near

term and generate a profit from fluctuations in price.

8-60
 Valuation
Valuation Bases
Bases

Valuation Using Relative Sales Value

Permitted by GAAP under the following conditions:
(1) a controlled market with a quoted price applicable to all
quantities, and
(2) no significant costs of disposal (rare metals and
agricultural products)

or
(3) too difficult to obtain cost figures (meatpacking).

8-61
 Valuation
Valuation Bases
Bases
Valuation Using Relative Sales Value
Used when buying varying units in a single lump-sum purchase.

Exercise: Larsen Realty Corporation purchased a tract of unimproved land

for $55,000. This land was improved and subdivided into building lots at
an additional cost of $30,000. These building lots were all of the same size
but owing to differences in location were offered for sale at different prices
as follows. Operating expenses allocated to this project total $18,200.

Instructions: Calculate the

No. of Price Lots Unsold
net income realized on this
Group Lots per Lot at Year-End
operation to date.
1 9 $ 3,000 5
2 15 4,000 7
3 19 2,000 2

8-62
 Valuation
Valuation Bases
Bases

Exercise (Relative Sales Value Method):

No. of
x Price =
Selling Relative
x Total
=
Cost Cost
Group Lots per Lot Price Sales Price Cost Allocated Per Lot
1 9 $ 3,000 $ 27,000 $27,000/125,000 $ 85,000 $ 18,360 $ 2,040
2 15 4,000 60,000 60,000/125,000 85,000 40,800 2,720
3 19 2,000 38,000 38,000/125,000 85,000 25,840 1,360
$ 125,000 $ 85,000

Lots Price Total Cost Total Cost Calculation of Net Income

x = Sales
Group Sold per Lot Per Lot of Goods Sales $ 78,000
1 4 $ 3,000 $ 12,000 $ 2,040 $ 8,160 Cost of good sold 53,040
2 8 4,000 32,000 2,720 21,760 Gross profit 24,960
3 17 2,000 34,000 1,360 23,120 Expenses 18,200
$ 78,000 $ 53,040 Net income $ 6,760

8-63
 Gross
Gross Profit
Profit Method
Method of
of Estimating
Estimating Inventory
Inventory

Substitute Measure to Approximate Inventory

Relies on Three Assumptions:

(1) Beginning inventory plus purchases equal total goods to

be accounted for.

(2) Goods not sold must be on hand.

(3) The sales, reduced to cost, deducted from the sum of the
opening inventory plus purchases, equal ending
inventory.

8-64
 Gross
Gross Profit
Profit Method
Method

Illustration: Cetus Corp. has a beginning inventory of €60,000

and purchases of €200,000, both at cost. Sales at selling price
amount to €280,000. The gross profit on selling price is 30
percent. Cetus applies the gross margin method as follows.

Illustration 6-20

8-65
 Gross
Gross Profit
Profit Method
Method

Computation of Gross Profit Percentage

Illustration 6-21

8-66
 Gross
Gross Profit
Profit Method
Method
Exercise: Astaire Company uses the gross profit method to
estimate inventory for monthly reporting purposes. Presented
below is information for the month of May.

Inventory, May 1 € 160,000

Purchases (gross) 640,000
Freight-in 30,000
Sales 1,000,000
Sales returns 70,000
Purchase discounts 12,000
Instructions:
(a) Compute the estimated inventory at May 31, assuming that the
gross profit is 25% of sales.
(b) Compute the estimated inventory at May 31, assuming that the
gross profit is 25% of cost.
8-67
 Gross
Gross Profit
Profit Method
Method
(Solution):
(a) Compute the estimated inventory assuming gross profit is 25% of sales.

Inventory, May 1 (at cost) € 160,000

Purchases (gross) (at cost) 640,000
Purchase discounts (12,000)
Freight-in 30,000
Goods available (at cost) 818,000
Sales (at selling price) € 1,000,000
Sales returns (at selling price) (70,000)
Net sales (at selling price) 930,000
Less gross profit (25% of €930,000) 232,500
Sales (at cost) 697,500
Approximate inventory, May 31 (at cost) € 120,500

8-68
 Gross
Gross Profit
Profit Method
Method
(Solution):
(b) Compute the estimated inventory assuming gross profit is 25% of cost.

Inventory, May 1 (at cost) € 160,000

Purchases (gross) (at cost) 25% 640,000
= 20% of sales
Purchase discounts 100% + 25% (12,000)
Freight-in 30,000
Goods available (at cost) 818,000
Sales (at selling price) € 1,000,000
Sales returns (at selling price) (70,000)
Net sales (at selling price) 930,000
Less gross profit (20% of €930,000) 186,000
Sales (at cost) 744,000
Approximate inventory, May 31 (at cost) € 74,000

8-69
 Gross
Gross Profit
Profit Method
Method

Evaluation
Disadvantages:

(1) Provides an estimate of ending inventory.

(2) Uses past percentages in calculation.

(3) A blanket gross profit rate may not be representative.

(4) Normally unacceptable for financial reporting purposes.

IFRS requires a physical inventory as additional
verification.

8-70
 Retail
Retail Inventory
Inventory Method
Method

A method used by retailers, to value inventory without a

physical count, by converting retail prices to cost.

Requires retailers to keep:

(1) Total cost and retail value of goods purchased.
(2) Total cost and retail value of the goods available for sale.
(3) Sales for the period.

Conventional Method or Cost Method

(based on
LCNRV)
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 Retail
Retail Inventory
Inventory Method
Method
Exercise: Fuque Inc. uses the retail inventory method to
estimate ending inventory for its monthly financial statements.
The following data pertain to a single department for the month
of October 2011.
Instructions:
COST RETAIL
Beg. inventory, Oct. 1 $ 52,000 $ 78,000 Prepare a schedule
Purchases 272,000 423,000 computing estimate
Freight in 16,600
retail inventory using
Purchase returns 5,600 8,000
Additional markups 9,000 the following
Markup cancellations 2,000 methods:
Markdowns (net) 3,600
(1) Conventional
Normal spoilage 10,000
Sales 390,000 (2) Cost

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 Retail
Retail Inventory
Inventory Method
Method
Solution - CONVENTIONAL Method:
Cost to
COST RETAIL Retail %
Beg. inventory $ 52,000 $ 78,000
Purchases 272,000 423,000
Freight in 16,600
Purchase returns (5,600) (8,000)
Markups, net 7,000
Current year additions 283,000 422,000
Goods available for sale 335,000 500,000 67.00%
Markdowns, net / (3,600)
=
Normal spoilage (10,000)
Sales (390,000)
Ending inventory at retail $ 96,400

Ending inventory at Cost:

$ 96,400 x 67.00% = $ 64,588

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 Retail
Retail Inventory
Inventory Method
Method
Solution - Cost Method Cost to
COST RETAIL Retail %
Beg. inventory $ 52,000 $ 78,000
Purchases 272,000 423,000
Freight in 16,600
Purchase returns (5,600) (8,000)
Markdowns, net (3,600)
Markups, net 7,000
Current year additions 283,000 418,400
Goods available for sale 335,000 / 496,400 = 67.49%
Normal spoilage (10,000)
Sales (390,000)
Ending inventory at retail $ 96,400

Ending inventory at Cost:

$ 96,400 x 67.49% = $ 65,056

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 Retail
Retail Inventory
Inventory Method
Method

Special Items
 Freight costs
 Purchase returns
 Purchase discounts and allowances
 Transfers-in
 Normal spoilage
 Abnormal shortages
 Employee discounts
 Sales returns & allowances
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 Sales discounts
 Retail
Retail Inventory
Inventory Method
Method

Special
Items

Illustration 6-28

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 Retail
Retail Inventory
Inventory Method
Method

Evaluation
Widely used for the following reasons:
(1) To permit the computation of net income without a
physical count of inventory.
(2) Control measure in determining inventory shortages.
(3) Regulating quantities of merchandise on hand.
(4) Insurance information.
Some companies refine the retail method by computing
inventory separately by departments or class of
merchandise with similar gross profits.
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