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INVENTORY AND OVERHEAD
Chapter Fifteen
Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
1. List the key assumptions of each inventory method.2. Calculate the cost of ending inventory and cost of goods sold
for each inventory method.
LU 15-1: Assigning Costs to Ending Inventory - Specific Identification; Weighted Average; FIFO; LIFO
LEARNING UNIT OBJECTIVES
LU 15-2: Retail Method; Gross Profit Method; Inventory Turnover; Distribution of Overhead
1. Calculate the cost ratio and ending inventory at cost for the retail method.
2. Calculate the estimated inventory using the gross profit method.
3. Explain and calculate inventory turnover.4. Explain overhead; allocate overhead according to floor
space and sales.
15-2
Perpetual Inventory System –
Keeps a running account of inventory by updating with each
transaction.
INVENTORY SYSTEMS
Periodic Inventory System –
Relies on a physical count of inventory done periodically.
15-3
Number of Cost Totalunits purchased per unit cost
Beginning inventory 40 $8 $320First purchase (April 1) 20 9 180Second purchase (May 1) 20 10 200Third purchase (Oct. 1) 20 12 240Fourth purchase (Dec. 1) 20 13 260Goods available for sale 120 $1,200Units sold 72Units in ending inventory 48
BLUE COMPANY INVENTORY INFORMATION
Step 1
15-4
Step 2. Calculate the cost of ending inventory.
Step 3. Calculate the cost of goods sold (Step 1 -- Step 2).
Step 1. Calculate the cost of goods (merchandise available for sale).
BegInv.
4/1 5/1 10/1 12/1
SPECIFIC IDENTIFICATION METHOD
15-5
Cost per Unit Total Cost
20 units from April 1 $ 9 $180
20 units from Oct. 1 12 240
8 units from Dec. 1 13 104
Cost of ending inventory $524
Cost of goods -- Cost of ending = Cost ofavailable for sale inventory goods sold
$1,200 -- $524 = $676
SPECIFIC IDENTIFICATION METHOD
Step 2
Step 3
15-6
Step 2. Calculate the cost of ending inventory.
Step 3. Calculate the cost of goods sold (Step 1 -- Step 2).
WEIGHTED-AVERAGE METHOD
Step 1. Calculate the average unit cost.
BegInv.
4/1 5/1 10/1 12/1
15-7
WEIGHTED-AVERAGE METHOD
Weighted average = Total cost of goods available for sale unit cost Total number of units available for sale
Average cost of ending inventory: 48 units at $10 = $480
Cost of goods sold =
Number of Cost TotalUnits Purchased per Unit Cost
Beginning inventory 40 $ 8 $320First purchase (April 1) 20 9 180Second purchase (May 1) 20 10 200Third purchase (Oct. 1) 20 12 240Fourth purchase (Dec. 1) 20 13 260Goods available for sale 120 $1,200Units sold 72Units in ending inventory 48
= $1,200 120
= $10
$1,200 -- $480 = $720 15-8
Step 2. Calculate the cost of ending inventory.
Step 3. Calculate the cost of goods sold (Step 1 -- Step 2).
FIRST-IN, FIRST-OUT METHOD
Step 1. List the units to be included in the ending inventory and their costs.
BegInv.
4/1 5/1 10/1 12/1
15-9
FIRST-IN, FIRST-OUT METHOD
Goods available for sale -- Cost of ending inventory = Cost of goods sold
Number of Cost TotalUnits Purchased per Unit Cost
Beginning inventory 40 $ 8 $320First purchase (April 1) 20 9 180Second purchase (May 1) 20 10 200Third purchase (Oct. 1) 20 12 240Fourth purchase (Dec. 1) 20 13 260Goods available for sale 120 $1,200Units sold 72Units in ending inventory 48
20 units from Dec. 1 at $13$26020 units from Oct. 1 at $12 240 8 units from May 1 at $10 8048 units in ending inventory$580
$1,200 -- $580 = $620
15-10
Step 2. Calculate the cost of ending inventory.
Step 3. Calculate the cost of goods sold (Step 1 -- Step 2).
LAST-IN, FIRST-OUT METHOD
Step 1. List the units to be included in the ending inventory and their costs.
BegInv.
4/1 5/1 10/1 12/1
15-11
LAST-IN, FIRST-OUT METHOD
$1,200 -- $392 = $808
Number of Cost TotalUnits Purchased per Unit Cost
Beginning inventory 40 $8 $320First purchase (April 1) 20 9 180Second purchase (May 1) 20 10 200Third purchase (Oct. 1) 20 12 240Fourth purchase (Dec. 1) 20 13 260Goods available for sale 120 $1,200Units sold 72Units in ending inventory 48
Goods available for sale -- Cost of ending inventory = Cost of goods sold
40 units from beginning inventory at $8 $320
8 units from Apr. 1 at $9 7248 units in ending inventory $392
15-12
SUMMARY
15-13
ESTIMATING INVENTORY – RETAIL METHOD
Step 1. Calculate the cost of goods available for sale at cost and retail.
Step 2. Calculate a cost ratio using the following formula:
Cost of goods available for sale at costCost of goods available for sale at retail
Step 3. Deduct net sales from cost of goods available for sale at retail.
Step 4. Multiply the cost ratio by the ending inventory at retail.
15-14
Cost Retail
Beginning inventory $4,000 $6,000
Net purchases during month 2,300 3,000
Cost of goods available for sale (Step 1) $6,300 $9,000
Less net sales for month (Step 3) 4,000
Ending inventory at retail $5,000
Cost ratio ($6,300/$9,000) (Step 2) 70%
Ending inventory at cost (.70 x $5,000) (Step 4) $3,500
ESTIMATING INVENTORY –RETAIL METHOD
15-15
ESTIMATING INVENTORY – GROSS PROFIT METHOD
Step 1. Calculate the cost of goods available for sale (Beginning inventory + Net purchases).
Step 2. Multiply the net sales at retail by the complement of the gross profit rate. This is the estimated cost of goods sold.
Step 3. Calculate the cost of estimated ending inventory (Step 1 -- Step 2).
Assuming the following, calculate the estimated inventory.Gross profit on sales 30%Beginning inventory, Jan. 1, 2013 $20,000Net purchases 8,000Net sales at retail for Jan. 12,000
15-16
Example:
Beginning inventory, January 1, 2013 $20,000
Net purchases 8,000
Cost of goods available for sale (Step 1) $28,000
Less estimated cost of good sold: Net sales at retail $12,000 Cost percentage (100% - 30%) (Step 2) x .70 Estimated cost of goods sold - 8,400 Estimated ending inventory, Jan. 31, 2013 (Step 3) $19,600
ESTIMATING INVENTORY—GROSS PROFIT METHOD
15-17
INVENTORY TURNOVER
Inventory turnover is the number of times inventory is replaced during a specific time.
Net sales Average inventory at retail
Cost of goods sold Average inventory at cost
Inventory turnover at cost =
Inventory turnover at retail =
15-18
INVENTORY TURNOVER
Net sales $32,000 Cost of goods sold $22,000
Beginning inventory at retail 11,000 Beginning inventory at cost 7,500
Ending inventory at retail 8,900 Ending inventory at cost 5,600
Average inventory = Beginning inventory + Ending inventory 2
$32,000 $11,000 + $8,900 2
$22,000 $7,500 + $5,600 2
$22,000 $6,550
= 3.36= Usually higher due to theft, spoilage, markdowns, etc.
= 3.22 $32,000 $9,950
=At retail =
At cost =
15-19
CALCULATING THE DISTRIBUTION OF OVERHEAD BY FLOOR SPACE
Step 1. Calculate the total square feet in all departments.
Step 2. Calculate the ratio for each department based on floor space.
Step 3. Multiply each department’s floor space ratio by the total overhead.
15-20
Department A - 6,000 square feet Department B - 3,000 square feet Department C - 1,000 square feet Overhead of $90,000
Floor Space Ratio
Department A 6,000 6,000 = 60%10,000
Department B 3,000 3,000 = 30%10,000
Department C 1,000 1,000 = 10%10,000
Department A .60 x $90,000 = $54,000Department B .30 x $90,000 = $27,000Department C .10 x $90,000 = $ 9,000
$90,000
CALCULATING THE DISTRIBUTION OF OVERHEAD BY FLOOR SPACE
Roy Company
Step 1 & 2
15-21
Step 3
CALCULATING THE DISTRIBUTION OF OVERHEAD BY SALES
Step 1. Calculate the total sales in all departments.
Step 2. Calculate the ratio for each department based on sales .
Step 3. Multiply each department’s sales ratio by the total overhead.
15-22
CALCULATING THE DISTRIBUTION OF OVERHEAD BY SALES
Sales RatioDepartment A $80,000 $ 80,000 = .80
$100,000Department B 20,000 $20,000 = .20
$100,000 $100,000
Department A .80 x $60,000 = $48,000Department B .20 x $60,000 = $12,000 $60,000
Morse Company distributes its overhead expenses based on the sales of its departments. For example, last year Morse’s overhead expenses were $60,000. Sales of its two departments were as follows, along with its ratio calculation.
Total overhead expenses
15-23
Step 1 & 2
Step 3
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