Pamantasan ng Lungsod ng Valenzuela

College of Business and Accountancy

Department of Accountancy

Financial Accounting and Reporting (FAR 1)

Accounting for Inventories

USE OF ESTIMATE IN INVENTORY VALUATION

Most common reasons for making an estimate of the cost of goods on hand are:
a. Inventory is destroyed by fire and other catastrophe, or theft of merchandise has occurred, and the amount of inventory is
required for insurance purposes.
b. A physical count of the goods on hand is made and it is necessary to prove the correctness or reasonableness of such count by
making an estimate.
c. Interim financial statements are prepared and a physical count of the goods on hand is not necessary because it may take time to
do the same.

Methods in approximating inventories:

1. GROSS PROFIT METHOD – based on the assumption that the rate of the gross profit remains approximately the same from
period to period and therefore the ratio of cost of goods sold to net sales is relatively constant from period to period.

Problem 1:
ABC Company has the following inventory data as of December 31, 2021:

Beginning inventory P 100,000

Net Purchases 600,000
Net Sales 500,000
Gross profit rate 40%

Compute for the ending inventory and gross profit using the following assumptions:
a. Gross profit rate is based on sales.
b. Gross profit rate is based on cost.

Note:
o If the gross profit rate is based on sales, the cost ratio is computed as 100% minus gross profit rate on sales.
o If the gross profit rate is based on cost, the sales ratio is computed by adding 100% to the gross profit rate.

Problem 2:
Lorenzo Enterprise has the following data as of December 31, 2021:

Net Sales P 600,000

Cost of Goods Sold 400,000
Gross Profit 200,000

Look for the following:

a. Gross profit rate on sales.
b. Gross profit rate on cost.

Problem 3:
Anabelle Company has the following data during the period:

Inventory – January 1 P 500,000

Purchases 1,000,000
Purchase return 20,000
Purchase allowance 5,000
Purchase discount 15,000
Freight in 60,000
Sales 1,260,000
Sales Return 50,000
Sales Allowance 5,000
Sales Discount 5,000

Compute for the ending inventory using the following assumptions:

a. Gross profit rate is 30% on sales.
b. Gross profit rate is 30% on cost.

Note:
Sales allowances and sales discounts are ignored in computing net sales since it does not affect the physical volume of the
goods sold.

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Accounting for Trade and Other Receivables FAR 3

2. RETAIL INVENTORY METHOD – often used in the retail industry for measuring inventory in large number of rapidly changing
items with similar margin for which it is impracticable to use other costing method.

Problem 4:
Alona Company has the following data as January 31, 2021:

Cost Retail
Beginning
inventory 100,000.00 150,000.00
Purchases 140,000.00 230,000.00
Freight in 5,000.00
Purchase return 20,000.00 30,000.00
Purchase allowance 8,000.00
Purchase Discount 7,000.00
Sales 300,000.00
Sales return 10,000.00

Compute for the cost of ending inventory using retail inventory method.

Treatment of items:
a. Purchase discount – deducted from purchase at cost only.
b. Purchase return – deducted at purchases at cost and in retail.
c. Purchase Allowance – deduct from purchases at cost only.
d. Freight in – addition to purchases at cost only.
e. Departmental transfer in or debit – addition to purchases at cost and at retail.
f. Departmental transfer out or credit – deduction from purchases at cost or retail.
g. Sales discount and sales allowances – disregarded, not deducted from sales.
h. Sales return - deducted from sales.
i. Employee discount – shall be added back to sales.
j. Normal shortage, shrinkage, spoilage, breakage – deducted from goods available for sale at retail.
k. Abnormal shortage, shrinkage, spoilage, breakage – deducted from goods available for sale of both at cost and retail so
as to not distort the cost ratio. Separately reported as loss.

Items related to retail method:

a. Initial mark-up – original mark up on the cost of goods.
b. Original retail – sales price at which the goods are first offered for sale.
c. Additional mark-up – increase in sales price above the original sales price.
d. Mark-up cancellation – decrease in sales price but not below the original sales price.
e. Net additional mark-up or net mark-up – mark-up minus mark-up cancellation.
f. Markdown – decrease in sales price below the original sales price.
g. Markdown cancellation – increase in sales price but not above the original price.
h. Net Markdown – markdown minus markdown cancellation.
i. Maintained mark-up (mark-on) – difference between cost and sales price after adjustments for all of the above items.

Problem 5
Provide the missing data on the table below.

Cost 1,000.00
Initial Markup 500.00
Original retail Price ?
Additional Mark up 200.00
New sales Price ?
Markup cancellation 150.00
New sales Price (not below original SP) ?
Net Markup ?
New sales price 1,300.00
Markup cancellation ?
Markdown ?
New sales price ?
Markdown cancellation 150.00
New sales price ?
Net markdown ?
Maintained markup ?

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Accounting for Trade and Other Receivables FAR 3

Approaches in the use of retail method:

a. Conservative or conventional or lower of cost and net realizable value approach - includes net markup and excludes net
markdown in determining the cost ratio in order to arrive a conservative cost.
b. Average cost approach – includes both net markup and net markdown in determining the cost ratio to arrive at an inventory
that will approximate or equal historical cost.
c. FIFO Approach – assume that markup and markdown applies only to goods purchased during the year, thus excludes the
beginning inventory in computing the cost ratio (current cost ratio).

Problem 6
XYZ Corporation has the following data as of December 31, 2021:

Cost Retail
Beginning inventory 252,000.00 360,000.00
Purchases 1,008,000.00 1,440,000.00
Additional markup 400,000.00
Markup cancellation 100,000.00
Markdown 500,000.00
Markdown cancellation 80,000.00
Sales 1,350,000.00
Sales return 50,000.00
Sales allowances 10,000.00
Sales discount 15,000.00
Employee discount 30,000.00
Spoilage and breakage 5,000.00

Compute for the cost of ending inventory and cost of goods sold using the following approaches:
a. Conservative cost approach.
b. Average cost approach
c. FIFO Approach

- END OF COURSE FILE -

References
Valix, C. T., Peralta, J. F., & Valix, C. A. (2020). Intermediate Accounting Volume One. GIC Enterprises & Co., Inc.

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