Inventory Estimation Methods

Inventories have high inherent risk. It may be lost due to embezzlement or catastrophic events.

Estimation method- used to give a reliable measurement to inventory.

1. Gross Profit Method – usually used when there are catastrophies.

Example: To know the number of goods damaged, the amount of loss or even how
much is embezzled.

2. Cost-to-Retail Method – usually used to estimate amount of inventory of retail businesses.

Example: Used in malls or stores. Instead of physically counting the goods, they estimate
the amount of inventory.

*Estimation happens when physical count alone is not enough to give a reliable measurement of the
inventory. *

GROSS PROFIT METHOD

Remember: When estimating inventories, you do not consider sales discount and sales allowances.

Exception: If sales returns and allowances are together. (If not, sales allowances are ignored).

Gross Profit Method uses the COGS Method of accounting for ending inventory and Cost of
Goods Sold:

Note: Net Purchases = Purchases

Beginning Inventory – Returns – Allowances -
Discounts
Net Purchases +Freight In
-
Goods Available for Sale
(Estimated COGS)
Estimated Ending Inventory
How to estimate the COGS?

By getting the relationship between the Sales

and COGS. Example:

SALES 100 SALES 125%

(COGS) 75% (COGS) 100%

GROSS PROFIT 25% GROSS PROFIT 25%

(GP based on sales) (GP based on cost)

 *Sales discounts and allowances are IGNORED because they DO NOT have physical transfer of
goods. This helps preserve the Gross Profit ratio and Cost ratio.*

If there is a Shortage due to Theft / Embezzlement

Estimated Ending Inventory Example: You have an estimated inventory of 100.

-Inventory Per Count During the inventory count, you only have 90.
-Goods not in Possession You purchased goods from a supplier with
Inventory Shortage terms FOB shipping point worth 5.

Estimated Ending Inventory 100

-Inventory Per Count 90

-Goods not in Possession 5

Inventory Shortage 5

Note: Goods not in possession can either be Goods in transit or Goods in Consignment.

If there is a Loss due to Catastrophe on hand goods

Estimated Ending Inventory

-Undamaged goods @cost including in transit goods in transit

- Partially damaged goods @LCNRV

Inventory Loss goods on consignment

Exercises:

Computation:

How to get the Ending Inventory:

Beginning Inventory P550,000

Total purchases 3,000,000
Freight In 60,000
Credit Memo (200,000)
Purchase Discount (80,000)
Goods In Transit (FOB shipping) 120,000
Cost of Goods Available for Sale 3,450,000
COGS (2,618,000)
Ending Inventory P832,000
 How to get the estimated Cost of Goods Sold:

Total sales delivered and recorded P3,600,000

Unrecorded sales 300,000
Sales returns (160,000)
Net Sales P3,740,000 (100%)
COGS (2,618,000) (70%)
Gross Profit P1,122,000 (30%)

How to get the Inventory loss:

Ending Inventory P832,000

Undamaged Goods – goods in transit (120,000)
Partially damaged goods (50,000)
Inventory Loss P662,000

Answer : B

Computation:

How to get the Ending Inventory:

Jan 1, inventory P1,000,000

Purchases 800,000
Freight In 20,000
Cost of Goods Available for Sale 1,820,000
Cost of Goods Sold 1,477,000
Ending Inventory P 343,000
How to get the estimated Cost of Goods Sold:

Sales P2,200,000
Sales return (50,000)
Sales return (in transit) (40,000)
Net Sales 2,110,000 (100%)
COGS (1,477,000) (70%)
Gross Profit P633,000 (30%)

How to get the Inventory Shortage:

Ending Inventory P343,000

Inventory Per Count (160,000)
Goods not in Possesion @ cost (28,000) - 70% of 40,000
Inventory shortage P155,000

Answer: C