Introduction

There are instances when the value of inventories must be estimated such as

in the preparation of interim financial statements wherein physical count of inventory is

not practicable. Another instances also is when inventory records is not complete and

the inventories must be approximated.

A ctivity

Assume you have a small sari-sari store at home. Unfortunately, a sudden

flashflood wiped your store. How are you going to value the cost of inventory that were

damaged or even carried by the flood? Another example, if you are the accountant and

you were asked to prepare a financial statement needed for loan application as soon as

possible, how would you determine the cost of inventory?

A nalysis

The above-mentioned occurrence will lead the business to make estimates on

their inventories. Other cases may include robbery, fire and other circumstances

that conducting physical count is impractical.

A bstraction

There were two methods that can be used in estimating inventory. These are the

following:

1. Gross profit method

a. GPR based on sales

b. GPR based on cost

2. Retail method

a. Average cost method

b. FIFO cost method

A. GROSS PROFIT METHOD

➢ Gross profit rate based on sales is computed by dividing gross profit by

the net sales.

➢ Gross profit rate based on cost is computed by dividing gross profit by the

cost of goods sold.

COST RATIO

• GPR based on sales

Example: GPR based on sales is 25%.

Cost ratio = (100% - 25%) = 75%

• GPR based on cost

Example: GPR based on cost is 25%.

Cost ratio = (100% ÷ 125%) = 80%

B. RETAIL METHOD

• The cost ratio is computed directly without regard to the gross profit rate,

unlike in gross profit method.

• Net mark-ups and net mark-downs are considered.

DEFINITION OF TERMS

• Net markups (markups less markup cancellations) are net increases

above the original retail price, which are generally caused by changes in

supply and demand.

• Markup refers to increase above the original retail price.

• Original retail price refers to the selling price at which the goods are first

offered for sale.

• Markup cancellation refers to decrease in selling price that does not

reduce the selling price below the original retail price.

• Net markdowns (markdowns less markdown cancellations) are net

decreases below the original retail price.

• Mark-down refers to the decrease below the original retail price.

• Markdown cancellation refers to increase in selling price that does not

raise the selling price above the original retail price.

APPLICATIONS OF THE RETAIL METHOD

1. Average cost method

2. FIFO cost method

ILLUSTRATIONS

1. An entity had net sales of P600,000 and cost of sales of P400,000. What are the (a) gross

profit rate based on sales and (b) gorss profit rate based on cost?

Net sales 600,000

Less: COGS 400,000 (200K ÷ 600K) (200K ÷ 400K)

Gross profit 33.33% 50%

Solutions:

GPR based on sales GPR based on cost

2. If the gross profit rate based in sales is 40%, what is the gross profit rate based on cost?

Solution: (40% ÷ 60%) = 66.67%

3. If the mark-up based in cost is 50%, whar is the mark-up based on sales?

Solution: (50% mark-up based on cost ÷ (100% cost + 50% mark-up) = 33 1/3%

4. If the gross profit rate based on cost is 42.86%, what is the cost ratio? Solution:

(100% ÷ 142.86%) = 70%

5. On November 29, 2021, a meterorite struck the warehouse of Unlucky Co. and destroyed the

inventories contained therein. The following information was determined:

Beginning inventory 80,000

Accounts payable, Jan. 1 30,000

Accounts Payable, Nov. 29 60,000

Payments to suppliers 480,000

Purchase returns 3,000

Purchase Discounts 4,000

Freight-In 5,000

200,000

Sales from Jan. to Nov. 585,000

Sales Returns 15,000

Sales Discounts 117,000

Gross profit rate based on sales 25%

Goods in transit, purchased FOB shipping point, from a vendor on November 29,2021 were

P28,000, while goods held by consignees were P32,000. The goods salvaged from the fire can

be sold at a scrap value of P2,500. How much is the inventory loss?

Solution:

Accounts payable

30,000

480,000

510,000

60,000
beg.

Payments Net purchases (squeeze)

end.

Inventory

80,000

510,000

5,000

427,500

167,500

(28,000)

(32,000)

(2,500)

105,000

beg.

Net purchases COGS (585K - 15K) x 75%

Freight-in

end.

goods in-transit

consigned goods

salvage value

Inventory loss
6. On December 1, 2021, aliens invaded Earth and destroyed the warehouse of Unlucky Too Co. Th

following information was determined:

Beginning inventory 80,000

Gross purchases 517,000

Freight-In 5,000

Purchase returns 3,000

Purchase discounts 4,000

Sales from Jan. to Nov. 585,000

Sales Returns 15,000

Sales Discounts 117,000

Gross profit rate based in cost 33 13%

Twenty percent of the inventory contained in the warehouse has been salvaged from the

destruction, while half is partially damaged. The aliens agreed to buy the partially damaged goods at

thirty percent of the cost as peace offering. How much is the inventory loss?

Solution:

Inventory

80,000

517,000

3,000

5,000
4,000

427,500

167,500

(33,500)

beg.

Gross purchases Purchase returns

Freight-in Purchase discounts

COGS

(585K - 15K) x 100%/133 1/3%

end.

Undamaged (20% x 167.5K)

Salvage value

(50% x 167.5K x 30%)

Inventory loss

7. The invading aliens in the preceding problem put up a department store to sell alien stuff to the

alien settlers. The alien accountant determined the following information:

Cost Retail

Inventory, beg. 300,000 375,000

Purchases 1,180,000 1,500,000

Freight-In 30,000 -

Purchase discounts 150,000 -

Purchase Returns 4,000 5,000

Departmental Transfers-in 2,000 3,000

Mark-ups 20,000

Mark-up cancellation 2,000

Markdowns 6,000

Markdown cancellation 1,000

Abnormal spoilage 8,000 11,000

Normal Spoilage 400

Sales 1,428,000

Sales Returns 56,000

Sales Discounts 2,000

Employee discounts 2,600

Requirements:

Compute for the (1) ending inventory and (2) cost of goods sold under wach of the following

methods:(a) Average cost method and (b) FIFO method

Solutions:

Cost Retail

Inventory, beg. 300,000 375,000

Net purchases (a) 1,056,000 1,495,000

(25,125)

108,875

Departmental Transfers-In 2,000 3,000

Net mark-ups (20,000 – 2,000) 18,000

Net mark-downs (6,000 – 1,000) (5,000)

Abnormal spoilage (8,000) (11,000)

TGAS 1,350,000 1,875,000

Net sales (b)

(1,375,000)

EI @ retail

(a) @ cost: 1,180,000 + 30,000 - 150,000 - 4,000 = 1,056,000;

@ retail: 1,500,000 – 5,000 = 1,495,000

(b)

Normal spoilage 400

Sales 1,428,000

Sales returns (56,000)

Employee discounts 2,600

Net sales

1,375 ,000

Cost ratios:

Total goods avail. for sale at cost

Cost ratio

(Average cost)

Total goods avail. for sale at sales price

Average cost ratio = (1,350,000 ÷ 1,875,000) = 72.00%

TGAS at cost less beg. inventory at cost

Cost ratio

(FIFO)

TGAS at retail less beg. inventory at retail

FIFO cost ratio = [(1,350,000 – 300,000) ÷ (1,875,000 – 375,000)] = 70.00%

Average FIFO

Cost ratios 72.00% 70.00%

Multiply by: EI @ retail 500,000 500,000

Ending inventory @ cost 360,000 350,000

Average FIFO

500 ,000

TGAS @ cost 1,350,000 1,350,000

Ending inventory @ cost (360,000) (350,000)

Cost of goods sold 990,000 1,000,000