FAR 6815 – GROSS PROFIT METHOD FAR 6816 – RETAIL INVENTORY METHOD

Inventory estimation is used when: - Other method of estimating the value of

1. Interim FS are prepared
2. Inventory is destroyed by catastrophes
3. Testing the validity of inventory counts
Two methods of estimating inventory valuation
1. Gross profit method – assumes the
relationship of GP and Sales remains stable
over time
2. Retail inventory method – estimated the cost
of inventory using cost-to-retail ratio
GROSS PROFIT METHOD
Sales xx
Less: Cost of goods sold xx
Gross profit xx
GP ratio on sales = Gross profit / Sales
GP ratio on cost = GP / COGS
Converting:
GP ratio on sales / COGS = GP on cost
GP ratio on cost / Sales = GP ratio on sales
inventory
- Commonly used by grocery stores wherein
there are various products
Use of the retail inventory method requires:
1. Beginning inventory at cost and at retail price
2. Purchases dure the period at cost and retail
price
3. Adjustments to the original retail price such as
additional markup, markup cancelation,
markdown and markdown cancelation
4. Other adjustments such as departmental
transfer, breakage, shrinkage, theft, damaged
goods and employee discount
BASIC FORMULA
- Similar to GP method but Ending Inventory is
expressed in terms of selling price
GAS at retail or SP xx
Less: Net sales (Gross sales – returns) xx
Ending inventory at SP xx
Multiply by cost ratio xx
Ending inventory at cost xx

Goods available for sale xx Cost ratio = Goods available for sale at cost
Less: Ending inventory xx Goods available for sale at SP
Cost of goods sold xx
APPROACHES IN THE USE OF RETAIL METHOD
COGS is computed as follows: 1. Conservative or conventional or LCNRV –
1. Net sales x cost ratio exclude markdowns
- This formula is used when the GP rate is 2. Average cost approach – include all items
based on sales 3. FIFO approach – exclude beginning inventory
2. Net sales divided by sales ratio
- This formula is used when the GP rate is CONSERVATIVE AND AVERAGE COST APPROACH
based on cost Cost Retail
*Sales allowance and sales discount are disregarded Beginning inventory xx xx
Net purchases xx xx
Deductions on ending inventory: Additional markup xx xx
a. Inventory counted on physical count to Markup cancelation xx xx
determine missing inventory GAS – conservative xx xx
b. Inventory on consignment based on cost to Markdown xx xx
determine missing inventory Markdown cancelation xx xx
c. Amount of inventory covered by insurance GAS – average xx xx
d. NRV of partially damaged inventory Less: Sales xx
Sales return (xx)
Employee discount xx
Spoilage & breakage xx xx
Ending inventory at retail xx
Conservative cost ratio x EI at retail xx
Average cost ratio x EI at retail xx

FIFO RETAIL
- current cost ratio is determined every year
considering only the net purchases of the year

Cost Retail
Sales xx xx
Purchases xx xx
Net markup xx xx
Net markdown xx (xx)
Net purchases xx xx
FIFO – cost ratio
Goods available for sale xx xx
Less: Net sales xx
Ending inventory at retail xx

FIFO cost ratio x EI at retail xx

Cost Retail
Beginning inventory xx xx
Purchases xx xx
Purchase discount (xx)
Purchase return (xx) (xx)
Purchase allowance (xx) -
Freight in xx -
Departmental transfer in or debit xx xx
Departmental transfer out or credit (xx) (xx)
Total xx xx
Less: Sales (xx)
Sales discount and allowances -
Sales return xx
Employee discount (xx)
Normal shortage, shrinkage, etc. (xx)
Abnormal shortage, shrinkage, etc. (xx) (xx)