Inventory is merchandise purchased by merchandisers (retailers, wholesalers, distributors) for the purpose of being sold to customers. The cost of the merchandise purchased but not yet sold is reported in the account Inventory or Merchandise Inventory.
Inventory
is reported as a current asset on the company's balance sheet. Inventory is a
significant asset that needs to be monitored closely. Too much inventory can
result in cash flow problems, additional expenses (e.g., storage, insurance),
and losses if the items become obsolete. Too little inventory can result in
lost sales and lost customers.
Because
of the cost principle, inventory is reported on the balance sheet at the amount
paid to obtain (purchase) the merchandise, not at its selling price.
Inventory
is also a significant asset of manufacturers. However, in order to simplify our
explanation, we will focus on a retailer.
Cost
of Goods Sold
Cost
of goods sold is the cost of the merchandise that was sold to customers. The
cost of goods sold is reported on the income statement when the sales revenues
of the goods sold are reported.
A
retailer's cost of goods sold includes the cost from its supplier plus any
additional costs necessary to get the merchandise into inventory and ready for
sale. For example, let's assume that Corner Shelf Bookstore purchases a college
textbook from a publisher. If Corner Shelf's cost from the publisher is $80 for
the textbook plus $5 in shipping costs, Corner Shelf reports $85 in its
Inventory account until the book is sold. When the book is sold, the $85 is
removed from inventory and is reported as cost of goods sold on the income
statement.
When
Costs Change
If
the publisher increases the selling prices of its books, the bookstore will
have a higher cost for the next book it purchases from the publisher. Any books
in the bookstore's inventory will continue to be reported at their cost when
purchased. For example, if the Corner Shelf Bookstore has on its shelf a book
that had a cost of $85, Corner Shelf will continue to report the cost of that
one book at its actual cost of $85 even if the same book now has a cost of $90.
The cost principle will not allow an amount higher than cost to be included in
inventory.
Let's
assume the Corner Shelf Bookstore had one book in inventory at the start of the
year 2010 and at different times during 2010 purchased four identical books.
During the year 2010 the cost of these books increased due to a paper shortage.
The following chart shows the costs of the five books that have to be accounted
for. It also assumes that none of the books has been sold as of December 31,
2010.
Number of Books Cost per Book Total Cost
Inventory
at Dec. 31, 2009 1 @ $85 = $ 85
First
purchase (January 2010) 1 @ 87 = 87
Second
purchase (June 2010) 2 @ 89 = 178
Third
purchase (December 2010) 1 @ 90 = 90
Total
goods available for sale 5 $440
Less:
Inventory at Dec. 31, 2010 5 440
Cost
of goods sold 0 $ 0
Cost
Flow Assumptions
If
the Corner Shelf Bookstore sells only one of the five books, which cost should
Corner Shelf report as the cost of goods sold? Should it select $85, $87, $89,
$89, $90, or an average of the five amounts? A related question is which cost
should Corner Shelf report as inventory on its balance sheet for the four books
that have not been sold?
Accounting
rules allow the bookstore to move the cost from inventory to the cost of goods
sold by using one of three cost flows:
1. First In, First Out (FIFO)
2. Last In, First Out (LIFO)
3. Average
Note
that these are cost flow assumptions. This means that the order in which costs
are removed from inventory can be different from the order in which the goods
are physically removed from inventory. In other words, Corner Shelf could sell
the book that was on hand at December 31, 2009 but could remove from inventory
the $90 cost of the book purchased in December 2010 (if it elects the LIFO cost
flow assumption).
Inventory
Systems
Each
of the three cost flow assumptions listed above can be used in either of two
systems (or methods) of inventory:
A. Periodic
B. Perpetual
A. Periodic inventory system. Under this system
the amount appearing in the Inventory account is not updated when purchases of
merchandise are made from suppliers. Rather, the Inventory account is commonly
updated or adjusted only once—at the end of the year. During the year the
Inventory account will likely show only the cost of inventory at the end of the
previous year.
Under
the periodic inventory system, purchases of merchandise are recorded in one or
more Purchases accounts. At the end of the year the Purchases account(s) are
closed and the Inventory account is adjusted to equal the cost of the
merchandise actually on hand at the end of the year. Under the periodic system
there is no Cost of Goods Sold account to be updated when a sale of merchandise
occurs.
In
short, under the periodic inventory system there is no way to tell from the
general ledger accounts the amount of inventory or the cost of goods sold.
B. Perpetual inventory system. Under this system
the Inventory account is continuously updated. The Inventory account is
increased with the cost of merchandise purchased from suppliers and it is
reduced by the cost of merchandise that has been sold to customers. (The
Purchases account(s) do not exist.)
Under
the perpetual system there is a Cost of Goods Sold account that is debited at
the time of each sale for the cost of the merchandise that was sold. Under the
perpetual system a sale of merchandise will result in two journal entries: one
to record the sale and the cash or accounts receivable, and one to reduce
inventory and to increase cost of goods sold.
Inventory
Systems and Cost Flows Combined
The
combination of the three cost flow assumptions and the two inventory systems
results in six available options when accounting for the cost of inventory and
calculating the cost of goods sold:
A1. Periodic FIFO
A2. Periodic LIFO
A3. Periodic Average
B1. Perpetual FIFO
B2. Perpetual LIFO
B3. Perpetual Average
A1.
Periodic FIFO
"Periodic"
means that the Inventory account is not routinely updated during the accounting
period. Instead, the cost of merchandise purchased from suppliers is debited to
an account called Purchases. At the end of the accounting year the Inventory
account is adjusted to equal the cost of the merchandise that has not been
sold. The cost of goods sold that will be reported on the income statement will
be computed by taking the cost of the goods purchased and subtracting the
increase in inventory (or adding the decrease in inventory).
"FIFO"
is an acronym for First In, First Out. Under the FIFO cost flow assumption, the
first (oldest) costs are the first ones to leave inventory and become the cost
of goods sold on the income statement. The last (or recent) costs will be
reported as inventory on the balance sheet.
Remember
that the costs can flow differently than the goods. If the Corner Shelf
Bookstore uses FIFO, the owner may sell the newest book to a customer, but is
allowed to report the cost of goods sold as $85 (the first, oldest cost).
Let's
illustrate periodic FIFO with the amounts from the Corner Shelf Bookstore:
Number of Books Cost per Book Total Cost
Inventory
at Dec. 31, 2009 1 @ $85 = $ 85
First
purchase (January 2010) 1 @ 87 = 87
Second
purchase (June 2010) 2 @ 89 = 178
Third
purchase (December 2010) 1 @ 90 = 90
Total
goods available for sale 5 $440
Less:
Inventory at Dec. 31, 2010 4 -
355
Cost
of goods sold 1 @ $85 $ 85
As
before, we need to account for the total goods available for sale (5 books at a
cost of $440). Under FIFO we assign the first cost of $85 to the one book that
was sold. The remaining $355 ($440 - $85) is assigned to inventory. The $355 of
inventory costs consists of $87 + $89 + $89 + $90. The $85 cost assigned to the
book sold is permanently gone from inventory.
If
Corner Shelf Bookstore sells the textbook for $110, its gross profit under
periodic FIFO will be $25 ($110 - $85). If the costs of textbooks continue to
increase, FIFO will always result in more profit than other cost flows, because
the first cost is always lower.
A2.
Periodic LIFO
"Periodic"
means that the Inventory account is not updated during the accounting period.
Instead, the cost of merchandise purchased from suppliers is debited to an
account called Purchases. At the end of the accounting year the Inventory
account is adjusted to equal the cost of the merchandise that is unsold. The
other costs of goods will be reported on the income statement as the cost of
goods sold.
"LIFO"
is an acronym for Last In, First Out. Under the LIFO cost flow assumption, the
last (or recent) costs are the first ones to leave inventory and become the
cost of goods sold on the income statement. The first (or oldest) costs will be
reported as inventory on the balance sheet.
Remember
that the costs can flow differently than the goods. In other words, if Corner
Shelf Bookstore uses LIFO, the owner may sell the oldest (first) book to a
customer, but can report the cost of goods sold of $90 (the last cost).
It's
important to note that under LIFO periodic (not LIFO perpetual) we wait until
the entire year is over before assigning the costs. Then we flow the year's
last costs first, even if those goods arrived after the last sale of the year.
For example, assume the last sale of the year at the Corner Shelf Bookstore
occurred on December 27. Also assume that the store's last purchase of the year
arrived on December 31. Under LIFO periodic, the cost of the book purchased on
December 31 is sent to the cost of goods sold first, even though it's
physically impossible for that book to be the one sold on December 27. (This
reinforces our previous statement that the flow of costs does not have to
correspond with the physical flow of units.)
Let's
illustrate periodic LIFO by using the data for the Corner Shelf Bookstore:
Number of Books Cost per Book Total Cost
Inventory
at Dec. 31, 2009 1 @ $85 = $ 85
First
purchase (January 2010) 1 @ 87 = 87
Second
purchase (June 2010) 2 @ 89 = 178
Third
purchase (December 2010) 1 @ 90 = 90
Total
goods available for sale 5 $440
Less:
Inventory at Dec. 31, 2010 4 -
350
Cost
of goods sold 1 @ $90 $ 90
As
before we need to account for the total goods available for sale: 5 books at a
cost of $440. Under periodic LIFO we assign the last cost of $90 to the one
book that was sold. (If two books were sold, $90 would be assigned to the first
book and $89 to the second book.) The remaining $350 ($440 - $90) is assigned
to inventory. The $350 of inventory cost consists of $85 + $87 + $89 + $89. The
$90 assigned to the book that was sold is permanently gone from inventory.
If
the bookstore sold the textbook for $110, its gross profit under periodic LIFO
will be $20 ($110 - $90). If the costs of textbooks continue to increase, LIFO
will always result in the least amount of profit. (The reason is that the last
costs will always be higher than the first costs. Higher costs result in less
profits and usually lower income taxes.)
A3.
Periodic Average
Under
"periodic" the Inventory account is not updated and purchases of
merchandise are recorded in an account called Purchases. Under this cost flow
assumption an average cost is calculated using the total goods available for
sale (cost from the beginning inventory plus the costs of all subsequent
purchases made during the entire year). In other words, the periodic average
cost is calculated after the year is over—after all the puchases of the year
have occurred. This average cost is then applied to the units sold during the
year as well as to the units in inventory at the end of the year.
As
you can see, our facts remain the same—there are 5 books available for sale for
the year 2010 and the cost of the goods available is $440. The weighted average
cost of the books is $88 ($440 of cost of goods available ÷ 5 books available)
and it is used for both the cost of goods sold and for the cost of the books in
inventory.
Number of Books Cost per Book Total Cost
Inventory
at Dec. 31, 2009 1 @ $85 = $ 85
First
purchase (January 2010) 1 @ 87 = 87
Second
purchase (June 2010) 2 @ 89 = 178
Third
purchase (December 2010) 1 @ 90 = 90
Total
goods available for sale 5 $440
Less:
Inventory at Dec. 31, 2010 4 @ $88 - 352
Cost
of goods sold 1 @ $88 $ 88
Since
the bookstore sold only one book, the cost of goods sold is $88 (1 x $88). The
four books still on hand are reported at $352 (4 x $88) of cost in the
Inventory account. The total of the cost of goods sold plus the cost of the
inventory should equal the total cost of goods available ($88 + $352 = $440).
If
Corner Shelf Bookstore sells the textbook for $110, its gross profit under the
periodic average method will be $22 ($110 - $88). This gross profit is between
the $25 computed under periodic FIFO and the $20 computed under periodic LIFO.
B1.
Perpetual FIFO
Under
the perpetual system the Inventory account is constantly (or perpetually)
changing. When a retailer purchases merchandise, the retailer debits its
Inventory account for the cost; when the retailer sells the merchandise to its
customers its Inventory account is credited and its Cost of Goods Sold account
is debited for the cost of the goods sold. Rather than staying dormant as it
does with the periodic method, the Inventory account balance is continuously
updated.
Under
the perpetual system, two transactions are recorded when merchandise is sold:
(1) the sales amount is debited to Accounts Receivable or Cash and is credited
to Sales, and (2) the cost of the merchandise sold is debited to Cost of Goods
Sold and is credited to Inventory. (Note: Under the periodic system the second
entry is not made.)
With
perpetual FIFO, the first (or oldest) costs are the first moved from the
Inventory account and debited to the Cost of Goods Sold account. The end result
under perpetual FIFO is the same as under periodic FIFO. In other words, the
first costs are the same whether you move the cost out of inventory with each
sale (perpetual) or whether you wait until the year is over (periodic).
B2.
Perpetual LIFO
Under
the perpetual system the Inventory account is constantly (or perpetually)
changing. When a retailer purchases merchandise, the retailer debits its
Inventory account for the cost of the merchandise. When the retailer sells the
merchandise to its customers, the retailer credits its Inventory account for
the cost of the goods that were sold and debits its Cost of Goods Sold account
for their cost. Rather than staying dormant as it does with the periodic
method, the Inventory account balance is continuously updated.
Under
the perpetual system, two transactions are recorded at the time that the merchandise
is sold: (1) the sales amount is debited to Accounts Receivable or Cash and is
credited to Sales, and (2) the cost of the merchandise sold is debited to Cost
of Goods Sold and is credited to Inventory. (Note: Under the periodic system
the second entry is not made.)
With
perpetual LIFO, the last costs available at the time of the sale are the first
to be removed from the Inventory account and debited to the Cost of Goods Sold
account. Since this is the perpetual system we cannot wait until the end of the
year to determine the last cost—an entry must be recorded at the time of the
sale in order to reduce the Inventory account and to increase the Cost of Goods
Sold account.
If
costs continue to rise throughout the entire year, perpetual LIFO will yield a
lower cost of goods sold and a higher net income than periodic LIFO. Generally
this means that periodic LIFO will result in less income taxes than perpetual
LIFO. (If you wish to minimize the amount paid in income taxes during periods
of inflation, you should discuss LIFO with your tax adviser.)
Once
again we'll use our example for the Corner Shelf Bookstore:
Number of Books Cost per Book Total Cost
Inventory
at Dec. 31, 2009 1 @ $85 = $ 85
First
purchase (January 2010) 1 @ 87 = 87
Second
purchase (June 2010) 2 @ 89 = 178
Third
purchase (December 2010) 1 @ 90 = 90
Total
goods available for sale 5 $440
Less:
Inventory at Dec. 31, 2010 4 -
351
Cost
of goods sold 1 @ $89 $ 89
Let's
assume that after Corner Shelf makes its second purchase in June 2010, Corner
Shelf sells one book. This means the last cost at the time of the sale was $89.
Under perpetual LIFO the following entry must be made at the time of the sale:
$89 will be credited to Inventory and $89 will be debited to Cost of Goods
Sold. If that was the only book sold during the year, at the end of the year
the Cost of Goods Sold account will have a balance of $89 and the cost in the
Inventory account will be $351 ($85 + $87 + $89 + $90).
If
the bookstore sells the textbook for $110, its gross profit under perpetual
LIFO will be $21 ($110 - $89). Note that this is different than the gross
profit of $20 under periodic LIFO.
B3.
Perpetual Average
Under
the perpetual system the Inventory account is constantly (or perpetually)
changing. When a retailer purchases merchandise, the costs are debited to its
Inventory account; when the retailer sells the merchandise to its customers the
Inventory account is credited and the Cost of Goods Sold account is debited for
the cost of the goods sold. Rather than staying dormant as it does with the
periodic method, the Inventory account balance under the perpetual average is
changing whenever a purchase or sale occurs.
Under
the perpetual system, two sets of entries are made whenever merchandise is
sold: (1) the sales amount is debited to Accounts Receivable or Cash and is
credited to Sales, and (2) the cost of the merchandise sold is debited to Cost
of Goods Sold and is credited to Inventory. (Note: Under the periodic system
the second entry is not made.)
Under
the perpetual system, "average" means the average cost of the items
in inventory as of the date of the sale. This average cost is multiplied by the
number of units sold and is removed from the Inventory account and debited to
the Cost of Goods Sold account. We use the average as of the time of the sale
because this is a perpetual method. (Note: Under the periodic system we wait
until the year is over before computing the average cost.)
Let's
use the same example again for the Corner Shelf Bookstore:
Number of Books Cost per Book Total Cost
Inventory
at Dec. 31, 2009 1 @ $85 = $ 85
First
purchase (January 2010) 1 @ 87 = 87
Second
purchase (June 2010) 2 @ 89 = 178
Third
purchase (December 2010) 1 @ 90 = 90
Total
goods available for sale 5 $440.00
Less:
Inventory at Dec. 31, 2010 4 @ $88.125 - 352.50
Cost
of goods sold 1 @ $87.50 $
87.50
Let's
assume that after Corner Shelf makes its second purchase, Corner Shelf sells
one book. This means the average cost at the time of the sale was $87.50 ([$85
+ $87 + $89 + $89] ÷ 4]). Because this is a perpetual average, a journal entry
must be made at the time of the sale for $87.50. The $87.50 (the average cost
at the time of the sale) is credited to Inventory and is debited to Cost of
Goods Sold. After the sale of one unit, three units remain in inventory and the
balance in the Inventory account will be $262.50 (3 books at an average cost of
$87.50).
After
Corner Shelf makes its third purchase, the average cost per unit will change to
$88.125 ([$262.50 + $90] ÷ 4). As you can see, the average cost moved from
$87.50 to $88.125—this is why the perpetual average method is sometimes
referred to as the moving average method. The Inventory balance is $352.50 (4
books with an average cost of $88.125 each).
Comparison
of Cost Flow Assumptions
Below
is a recap of the varying amounts for the cost of goods sold, gross profit, and
ending inventory that were calculated above.
Periodic Perpetual
FIFO LIFO Avg. FIFO LIFO Avg.
Sales
$110 $110 $110 $110 $110 $110.00
Cost
of Goods Sold
– 85
– 90 – 88 – 85 – 89 – 87.50
Gross Profit
$ 25 $ 20 $ 22 $ 25 $ 21 $ 22.50
Ending
Inventory $355 $350 $352 $355 $351 $352.50
The
example assumes that costs were continually increasing. The results would be
different if costs were decreasing or increasing at a slower rate. Consult with
your tax advisor concerning the election of cost flow assumption.
Specific
Identification
In
addition to the six cost flow assumptions presented in Parts 1 – 4, businesses
have another option: expense to the cost of goods sold the specific cost of the
specific item sold. For example, Gold Dealer, Inc. has an inventory of gold and
each nugget has an identification number and the cost of the nugget. When Gold
Dealer sells a nugget, it can expense to the cost of goods sold the exact cost
of the specific nugget sold. The cost of the other nuggets will remain in
inventory. (Alternatively, Gold Dealer could use one of the other six cost flow
assumptions described in Parts 1 – 4.)
LIFO
Benefits without Tracking Units
In
Part 1 and Part 2 you saw that during the periods of increasing costs, LIFO
will result in less profits. In the U.S. this can mean less income taxes paid
by the company. Most companies view lower taxes as a significant benefit.
However, the process of tracking costs and then assigning those costs to the
units sold and the units on hand could be too expensive for the amount of
income tax savings. To gain the benefit of LIFO without the tracking of costs,
there is a method known as dollar value LIFO. This topic is discussed in
intermediate accounting textbooks. The Internal Revenue Service also allows
companies to use dollar value LIFO by applying price indexes. (You should seek
the advice of an accounting and/or tax professional to assess the cost and
benefit of these techniques.)
Inventory
Management
Over
the past few decades sophisticated companies have made great strides in
reducing their levels of inventory. Rather than carry large inventories, they
ask their suppliers to deliver goods "just in time." Suppliers and
merchandisers have learned to coordinate their purchases and sales so that
orders and shipments occur automatically.
A
company will realize significant benefits if it can keep its inventory levels
down without losing sales or production (if the company is a manufacturer). For
example, Dell Computers has greatly reduced its inventory in relationship to
its sales. Since computer components have been dropping in costs as new
technologies emerge, it benefits Dell to keep only a very small inventory of
components on hand. It would be a financial hardship if Dell had a large
quantity of parts that became obsolete or decreased in value.
Financial
Ratios
Keeping
track of inventory is important. There are two common financial ratios for
monitoring inventory levels: (1) the Inventory Turnover Ratio, and (2) the
Days' Sales in Inventory. (These are discussed and illustrated in the
Explanation of Financial Ratios.)
Estimating
Ending Inventory
It
is very time-consuming for a company to physically count the merchandise units
in its inventory. In fact, it is not unusual for companies to shut down their
operations near the end of their accounting year just to perform inventory
counts. The company may assign one set of employees to count and tag the items
and another set to verify the counts. If a company has outside auditors, they
will be there to observe the process. (Even if the company's computers keep
track of inventory, accountants require that the computer records be verified
by actually counting the goods.)
If
a company counts its inventory only once per year it must estimate its
inventory at the end of each month in order to prepare meaningful monthly
financial statements. In fact, a company may need to estimate its inventory for
other reasons as well. For example, if a company suffers a loss due to a disaster
such as a tornado or a fire, it will need to file a claim for the approximate
cost of the inventory that was lost. (An insurance adjuster will also compute
this amount independently so that the company is not paid too much or too
little for its loss.)
Methods
of Estimating Inventory
There
are two methods for estimating ending inventory:
1. Gross Profit Method
2. Retail Method
1. Gross Profit Method. The gross profit method
for estimating inventory uses the information contained in the top portion of a
merchandiser's multiple-step income statement:
ABC
Company
Income
Statement (partial)
For
the Year Ended Dec. 31, 2009
Sales $100,000 100.0%
Cost
of Goods Sold
Beginning Inventory $ 22,000
Purchases - net
83,000
Cost of Goods Available 105,000
Less: Ending Inventory
25,000
Cost of Goods Sold 80,000 80.0%
Gross
Profit $ 20,000
20.0%
Let's
assume that we need to estimate the cost of inventory on hand on June 30, 2010.
From the 2009 income statement shown above we can see that the company's gross
profit is 20% of the sales and that the cost of goods sold is 80% of the sales.
If those percentages are reasonable for the current year, we can use those
percentages to help us estimate the cost of the inventory on hand as of June
30, 2010.
While
an algebraic equation could be constructed to determine the estimated amount of
ending inventory, we prefer to simply use the income statement format. We
prepare a partial income statement for the period beginning after the date when
inventory was last physically counted, and ending with the date for which we
need the estimated inventory cost. In this case, the income statement will go
from January 1, 2010 until June 30, 2010.
Some
of the numbers that we need are easily obtained from sales records, customers,
suppliers, earlier financial statements, etc. For example, sales for the first
half of the year 2010 are taken from the company's records. The beginning
inventory amount is the ending inventory reported on the December 31, 2009
balance sheet. The purchases information for the first half of 2010 is
available from the company's records or its suppliers. The amounts that we have
available are written in italics in the following partial income statement:
ABC
Company
Income
Statement (partial)
For
the Six Months Ended June 30, 2010
Sales $ 56,000 100.0%
Cost
of Goods Sold
Beginning Inventory $ 25,000
Purchases - net 46,000
Cost of Goods Available
Less: Ending Inventory
Cost of Goods Sold 80.0%
Gross
Profit 20.0%
We
will fill in the rest of the statement with the answers to the following
calculations. The amounts in italics come from the statement above. The bold
amount is the answer or result of the calculation.
Step
1. Cost of Goods Available = Beginning
Inventory + Net Purchases
Cost of Goods Available = $25,000 + $46,000
Cost of Goods Available = $71,000
Step
2. Gross Profit = Gross Profit
Percentage (or Gross Margin) x Sales
Gross Profit = 20% x $56,000
Gross Profit = $11,200
Step
3. Cost of Goods Sold = Sales – Gross Profit
Cost of Goods Sold = $56,000 – $11,200
(from Step 2.)
Cost of Goods Sold = $44,800
This can also be calculated as
80% x
Sales of $56,000 =
$44,800.
Inserting
this information into the income statement yields the following:
ABC
Company
Income
Statement (partial)
For
the Six Months Ended June 30, 2010
Sales $56,000 100.0%
Cost
of Goods Sold
Beginning Inventory $25,000
Purchases - net
46,000
Cost of Goods Available 71,000
Less: Ending Inventory ?
Cost of Goods Sold
44,800 80.0%
Gross
Profit $11,200 20.0%
As
you can see, the ending inventory amount is not yet shown. We compute this
amount by subtracting cost of goods sold from the cost of goods available:
Ending
Inventory = Cost of Goods Available – Cost of Goods Sold
Ending
Inventory = $71,000 – $44,800
Ending
Inventory = $26,200
Below
is the completed partial income statement with the estimated amount of ending
inventory at $26,200. (Note: It is always a good idea to recheck the math on
the income statement to be certain you computed the amounts correctly.)
ABC
Company
Income
Statement (partial)
For
the Six Months Ended June 30, 2010
Sales $56,000 100.0%
Cost
of Goods Sold
Beginning Inventory $25,000
Purchases - net
46,000
Cost of Goods Available 71,000
Less: Ending Inventory
26,200
Cost of Goods Sold
44,800 80.0%
Gross
Profit $11,200 20.0%
2. Retail Method. The retail method can be used
by retailers who have their merchandise records in both cost and retail selling
prices. A very simple illustration for using the retail method to estimate
inventory is shown here:
Cost Retail
Beginning
Inventory $ 11,000 $ 15,000
Purchases
- net + 69,000 + 85,000
Goods Avail. & Cost Ratio 80,000 100,000
Less:
Sales at retail - 90,000
Est.
ending inventory at retail 10,000
Est.
ending inventory at cost $ 8,000
As
you can see, the cost amounts are arranged into one column. The retail amounts
are listed in a separate column. The Goods Available amounts are used to
compute the cost-to-retail ratio. In this case the cost of goods available of
$80,000 is divided by the retail amount of goods available ($100,000). This
results in a cost-to-retail ratio, or cost ratio, of 80%.
To
arrive at the estimated ending inventory at cost, we multiply the estimated
ending inventory at retail ($10,000) times the cost ratio of 80% to arrive at
$8,000.
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