INVENTORY ESTIMATION

Immediate information about inventory is sometimes needed where an immediate physical count is
deemed to be impossible due to some circumstances. To estimate inventory value, the entity can either
use:

1. Gross Profit Method or

2. Retail Inventory Method

Use of Inventory Value Estimates

1. Interim Financial Statements

2. Inventory Reasonableness
3. Catastrophe and Other Extraordinary Circumstances

A. Gross Profit Method – allows expressing and using a gross profit percentage based on either
cost of goods sold or net sales to estimate inventory value.
a. Gross Profit Rate Based on Sales
b. Gross Profit Rate Based on Cost

B. Retail Inventory Method – is an inventory estimation method that applies retail (sales price)
information to determine its relationship with costs (cost ratio) and ultimately, the estimated
ending inventory.
The retail inventory method is applicable for industries that has numerous product
offers and variety of goods that monitoring of costs would be burdensome like groceries and
department stores.

Formula:
Beginning Inventory at Retail Price xxx
Add: Net Purchases at Retail Price xxx
Cost of Goods Available for Sale Retail Price xxx
Less: Net Sales (xxx)
Estimated Ending Inventory at Retail Price xxx
Multiply - Cost to Retail Ratio xxx
Estimated Ending Inventory at Cost xxx

Methods of Retail Inventory Estimation

1. Conservative Method – consider all effects of price markups but not consider price
markdowns.
2. Average Method – considers both price markups and price markdowns
3. FIFO Method – cost to retail ratio is only based on current period purchases which excludes
beginning inventory based on the claim that markups and markdowns are applied only to
purchases during the period and not on beginning inventory.
Sample Problem

The following information was made available by Catecoin Company:

Cost Retail
Beginning inventory 965,000 1,227,000
Net purchase 2,598,657 3,300,296
Additional markup 113,5000
Markup cancellation 32,667
Markdown 89,750
Markdown cancellation 13,974
Sales 2,896,745
Sales return 125,697
Sales allowance 33,255
Sale discount 12,576

Conservative
Cost Retail
Beginning inventory 965,000.00 1,227,650.00
Net purchases 2,598,657.00 3,300,296.00
Additional markup 113,500.00
Markup cancellation 32,667.00
Conservative goods available for sale 3,563,657.00 4,608,779.00

Conservative cost-to-retail ratio 77.3232%

Conservative goods available for sale 3,563,657.00 4,608,799.00

Markdown 89,750.00
Markdown cancellation 13,974.00
Goods available for sale for estimation 3,563,657.00 4,533,003.00
Less: Net sales
2,896,745-125,897 2,771,048.00
Ending inventory at retail price 1,761,955.00
Multiply by cost-to-retail ratio 77,332%
Ending inventory at cost 1,362,400.60
Average
Cost Retail
Beginning inventory 965,000.00 1,227,650.00
Net purchases 2,598,657.00 3,300,296.00
Additional markup 113,500.00
Markup cancellation - 32,667.00
Markdown - 89,750.00
Markdown cancellation 13,974.00
Goods available for sale 3,563,657.00 4,553,003.00

Average- cost- to- retail ratio 78.6158%

Goods available for sale 3,563,657.00 4,533,003.00
Less: Net sales
2.896,745-125,697 - 2,711,048.00
Ending inventory at retail price 1,761,955.00
Multiply by cost-to-retail ratio 78.618%
Ending inventory at cost 1,385,175.19

FIF0
Cost Retail
Net purchases 2,598,657.00 3,300,296.00
Additional markup 113,500.00
Markup cancellation - 32,667,00
Markdown - 89,750.00
Markdown cancellation 13,974.00
Purchases during the period 2,598,657.00 3,305,353.00

FIFO cost-to-retail-ratio 78.619%

Purchases during the period 2,598,657.00 3,305,353.00
Beginning inventory 965,000.00 1,227,650.00
Goods available for sale 3,563,657.00 4,533,033.00
Less: Net sales
2,896,745-125,697 - 2,771,048.00
Ending inventory at retail 1,761,955.00
Multiply by cost-to-retail-ratio 78.6197%
Ending inventory at cost 1,385,242.88