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# ch6b - A P Determining Inventory by the Retail Method P E...

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Unformatted text preview: A P Determining Inventory by the Retail Method P E Chapter 6 Inventories 283 NDIX Estimating Inventory Cost A business may need to estimate the amount of inventory for the following reasons: 1. Perpetual inventory records are not maintained. 2. A disaster such as a fire or ﬂood has destroyed the inventory records and the inventory. 3. Monthly or quarterly financial statements are needed, but a physical inventory is taken only once a year. This appendix describes and illustrates two widely used methods of estimating in— ventory cost. Retail Method of Inventory Costing The retail inventory method of estimating inventory cost requires costs and retail prices to be maintained for the merchandise available for sale. A ratio of cost to retail price is then used to convert ending inventory at retail to estimate the ending inventory cost. The retail inventory method is applied as follows: Step 1. Determine the total merchandise available for sale at cost and retail. Step 2. Determine the ratio of the cost to retail of the merchandise available for sale. Step 3. Determine the ending inventory at retail by deducting the net sales from the merchandise available for sale at retail. Step 4. Estimate the ending inventory cost by multiplying the ending inventory at retail by the cost to retail ratio. Exhibit 12 illustrates the retail inventory method. --§- 1 Cost Retail 2 Merchandise inventory, January1 \$19,400 \$ 36,000 3 Purchases in January (net) 42,600 64,000 Step 1—> 4 Merchandise available for sale \$62,000 \$100,000 =— Step 2—> 5 Ratio of cost to retail price: w 62% \$100,000 Sales for January (net) 70,000 Step 3—> Merchandise inventory, January 31, at retail \$ 30,000 (\$30,000 - 02%) \$ 13,600 = 6 7 Step 4—> 8 Merchandise inventory, January 31, at estimated cost 9 0 When estimating the cost to retail ratio, the mix of items in the ending inventory is assumed to be the same as the merchandise available for sale. If the ending inven- tory is made up of different classes of merchandise, cost to retail ratios may be devel— oped for each class of inventory. An advantage of the retail method is that it provides inventory figures for prepar- ing monthly statements. Department stores and similar retailers often determine gross 284 Chapter 6 Estimating Inventory by Gross Profit Method Inventories profit and operating income each month, but may take a physical inventory only once or twice a year. Thus, the retail method allows management to monitor operations more closely. The retail method may also be used as an aid in taking a physical inventory. In this case, the items are counted and recorded at their retail (selling) prices instead of their costs. The physical inventory at retail is then converted to cost by using the cost to re- tail ratio. Gross Profit Method of Inventory Costing The gross profit method uses the estimated gross profit for the period to estimate the inventory at the end of the period. The gross profit is estimated from the preceding year, adjusted for any current-period changes in the cost and sales prices. The gross profit method is applied as follows: Step 1. Determine the merchandise available for sale at cost. Step 2. Determine the estimated gross profit by multiplying the net sales by the gross profit percentage. Determine the estimated cost of merchandise sold by deducting the estimated gross profit from the net sales. Step 3. Step 4. Estimate the ending inventory cost by deducting the estimated cost of mer- chandise sold from the merchandise available for sale. Exhibit 13 illustrates the gross profit method. I“ 1 Cost 2 Merchandise inventory, January 1 \$ 57,000 3 Purchases in January (net) 180,000 Step 1—>4 Merchandise available for sale \$237,000 5 Sales for January (net) \$250,000 Step 2—> 6 Less estimated gross proﬁt (\$250,000 -' 30%) 75,000 Step 3—> 7 Estimated cost of merchandise sold 175 000 Step 4—> 8 Estimated merchandise inventory, January 31 § 62 000 9 The gross profit method is useful for estimating inventories for monthly or quar- terly financial statements. It is also useful in estimating the cost of merchandise de— stroyed by fire or other disasters. ...
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