PROBLEM No.

16 Inventory Estimation – gross profit rate method; theft of inventory

Calasiao, Inc., owner of a trading company, engaged your services as auditor. There is a discrepancy
between the company’s income and the sales volume. The owner suspects that the staff is committing
theft. You are to determine whether or not this is true. Your investigations revealed the following:

1. Physical inventory, taken December 31, 2010 under your observation showed that cost was
P265,000 and net realizable value (NRV), P244,000. The inventory on January 1, 2010 showed
cost of P390,000 and net realizable value of P375,000. It is the corporation’s practice to value
inventory at “lower of cost or NRV”. Any loss between cost and NRV is included in “other
expenses”.
2. The average gross profit rate was 40% of net sales.
3. The accounts receivable as of January 1, 2010 were P135,000. During 2010, accounts receivable
written off during the year amounted to P10,000. Accounts receivable as of December 31, 2010
were P375,000.
4. Outstanding purchase invoices amounted to P300,000 at the end of 2010. At the beginning of
2010 they were P375,000.
5. Receipts from customer during 2010 amounted to P3,000,000.
6. Disbursements to merchandise creditors amounted to P2,000,000.

Questions:

Based on the above and the result of your audit, determine the following:

1. The total sales in 2010 is

a. P3,240,000 c. P3,250,000
b. P3,230,000 d. P2,770,000

2. The total purchases in 2010 is

a. P2,000,000 c. P1,950,000
b. P2,075,000 d. P1,925,000

3. The amount of inventory shortage as of December 31, 2010 is

a. P106,000 c. P100,000
b. P175,000 d. P 0

Answers:

1. Letter C. P3,250,000

Accounts Receivable, 12/31/10 P 375,000

Accounts written off 10,000
Collections 3,000,000
Accounts Receivable, 1/1/10 (135,000)
Sales in 2010 P3,250,000

2. Letter D. P1,925,000

Accounts Receivable, 12/31/10 P 300,000

Payments 2,000,000
Accounts Payable, 1/1/10 (375,000)
Purchases in 2010 P1,925,000
 3. Letter C. P100,000

Inventory, 1/1/10 (at cost) P 390,000

Add: Purchases 1,925,000
Total Goods available for Sale 2,315,000
Less: Cost of Sales (3,250,000 x 60%) 1,950,000
Estimated inventory, 12/31/10 (at cost) 365,000
Inventory, 12/31/10 per physical count (at cost) 265,000
Estimated inventory shortage P 100,000

PROBLEM No. 15 Change in cost flow assumption

On January 1, 2010, Binmaley Corporation changed to the average method from first in, first out (FIFO)
method. The cumulative effect of this change is impracticable to determine. Accordingly, the ending of
2009 for which the FIFO method was used is also the beginning inventory for 2010 for the average
method.

The following information was available from inventory records for the two most recent years:

TIK TAK
Units Unit Cost Units Unit Cost
2009 Purchases
First quarter 15,000 40 66,000 20
Second quarter 36,000 45 - -
Third quarter 51,000 50 55,500 25
Fourth quarter 30,000 60 - -

2010 Purchases
First quarter 9,000 70 105,000 30
Second quarter 36,000 75 - -
Third quarter 60,000 80 - -
Fourth quarter - - 91,500 35

Units on Hand
December 31, 2009 45,000 43,500
December 31, 2010 48,000 60,000

Questions:

Based on the above and the result of your audit, answer the following:

1. The total inventory as of December 31, 2009 is

a. P3,208,830 c. P2,820,000
b. P3,637,500 d. P4,552,500

2. The inventory of TIK as of December 31, 2010 is

a. P3,840,000 c. P3,318,240
b. P3,716,640 d. P3,417,600

3. The inventory of TAK as of December 31, 2010 is

a. P1,830,600 c. P1,939,800
b. P2,100,000 d. P1,860,000
 4. The change from FIFO to average method decreased net income for the year ended December 31,
2010 by
a. P791,160 c. P662,400
b. P428,670 d. P283,560

Answers:

1. Letter B. P3,637,500

Product Units Unit Cost Total Cost

TIK Fourth quarter 30,000 P60 P1,800,000
Third quarter 15,000 50 750,000
45,000 2,550,000

TAK Third quarter 43,500 50 1,087,500

Inventory, 12/31/09 (using FIFO) P3,637,500
2. Letter D. P3,417,600

Units Unit Cost Total Cost

Inventory, 1/1/10 45,000 P2,550,000
First quarter purchases 9,000 P70 630,000
Second quarter purchases 36,000 75 2,700,000
Third quarter purchases 60,000 80 4,800,000
Total 150,000 P10,680,000

Average unit cost (P10,680,000/150,000) P71.20

Inventory of TIK, 12/31/10 (48,000 units x P71.20) P3,417,600

3. Letter D. P1,860,000

Units Unit Cost Total Cost

Inventory, 1/1/10 43,500 P1,087,500
First quarter purchases 105,500 P30 3,150,000
Fourth quarter purchases 91,500 35 3,202,500
Total 240,000 P7,440,000

Average unit cost (P7,440,000/240,000) P31.00

Inventory of TAK, 12/31/10 (60,000 units x P31) P1,860,000

4. Letter C. P662,400

Inventory of TIK, 12/31/10 P3,417,600

Inventory of TAK, 12/31/10 1,860,000
Total inventory using average method 5,277,600
Total inventory using FIFO method 5,940,000
Decrease in ending inventory (Decrease in net income) P 662,400

Product Units Unit Cost Total Cost

 TIK Third quarter 48,000 P80 P3,840,000
TAK Fourth quarter 60,000 35 2,100,000
Inventory, 12/31/10 (using FIFO) P5,940,000

PROBLEM No. 17 Inventory Estimation – gross profit rate method

In conducting your audit of Mangatarem Corporation, a company engaged in import and wholesale
business, for the fiscal year ended June 30, 2010, you determined that its internal control system was
good. Accordingly, you observed the physical inventory at an interim date, May 31, 2010 instead of at
June 30, 2010.

You obtained the following information from the company’s general ledger.

Sales for eleven months ended May 31, 2010 P1,344,000

Sales for the fiscal year ended June 30, 2010 1,536,000
Purchases for eleven months ended May 31, 2010 1,080,000
(before audit adjustment)
Purchases for the fiscal year ended June 30, 2010 1,280,000
Inventory, July 1, 2009 140,000
Physical Inventory, May 31, 2010 220,000

Your audit disclosed the following additional information.

1. Shipments costing P12,000 were received in May and included in the physical inventory but
recorded as June purchases.
2. Deposit of P4,000 made with vendor and charged to purchases in April 2010. Product was
shipped in July 2010.
3. A shipment in June was damaged through the carelessness of the receiving department. This
shipment was later sold in June at its cost of P16,000.

Questions:

In audit engagements in which interim physical inventories are observed, a frequently used auditing
procedure is to test the reasonableness of the year-end inventory by the application of gross profit ratio.
Based on the above and the result of your audit, you are to provide the answers to the following:

1. The gross profit ratio for eleven months ended May 31, 2010 is
a. 20% c. 30%
b. 35% d. 25%

2. The cost of goods sold during the month of June 2010 using gross profit ratio method is
a. P132,000 c. P148,000
b. P144,000 d. P160,000

3. The June 30, 2010 inventory using the gross profit method is
a. P264,000 c. P268,000
b. P340,000 d. P260,000

Answers:
 1. Letter D. 25%

Sales for 11 months ended 5/31/10 P1,344,000

Less cost of sales for 11 months ended 5/31/10:
Inventory, July 1, 2009 P 140,000
Add adjusted purchases:
Unadjusted P1,080,000
Item No. 1 12,000
Item No. 2 (4,000) 1,088,000
Goods available for sale 1,228,000
Less Inventory, 5/31/10 220,000 1,008,000
Gross profit 336,000
Divide by sales for 11 months ended 5/31/10 1,344,000
Gross Profit rate for 11 months ended 5/31/10 25%

2. Letter C. P148,000

Sales for the fiscal year ended June 30, 2010 P1,536,000
Less: Sales for 11 months ended May 31, 2010 1,344,000
Sales for June 2010 192,000
Less: sales without profit 16,000
Sales with profit 176,000
Multiply by cost ratio (100%-25%) 75%
Cost of Sales with profit 132,000
Add cost of sales without profit 16,000
Total cost of sales for June 2010 P 148,000

3. Letter D. P260,000

Inventory, 7/1/09 P 140,000

Add adjusted purchases:
Unadjusted P1,280,000
Item No. 2 (4,000) 1,276,000
Total goods available for sale 1,416,000
Less cost of sales:
Sales without profit 16,000
Sales with profit
[(P1,536,000 – P15,000) x 75%) 1,140,000 1,156,000
Inventory, 6/30/10 P 260,000

PROBLEM No 20 Inventory Estimation – retail inventory method

 Lingayen Mart uses the average retail inventory method. The following information is available for the
current year:

Cost Retail
Beginning inventory P 1,100,000 P 2,200,000
Purchases 15,800,000 26,300,000
Freight in 400,000
Purchase returns 600,000 1,000,000
Purchase allowances 300,000
Departmental transfer in 400,000 800,000
Net markups 600,000
Net markdowns 900,000
Sales 24,700,000
Sales returns 350,000
Sales discounts 200,000
Employee discounts 600,000
Loss from breakage 50,000

Questions:

Based on the above and the result of your audit, answer the following:

1. The cost ratio using the average retail inventory method is

a. 58.13% c. 62.00%
b. 61.07% d. 60.00%

2. The estimated ending inventory at retail is

a. P3,000,000 c. P2,800,000
b. P3,600,000 d. P3,650,000

3. The estimated ending inventory at cost is

a. P1,743,945 c. P1,832,143
b. P2,198,571 d. P1,800,000

4. The estimated cost of goods sold is

a. P15,267,857 c. P15,000,000
b. P14,901,429 d. P15,056,055

5. If the inventory at retail based on physical count at December 31, 2010 is P1,700,000, the
estimated inventory shortage is
a. P780,000 c. P755,709
b. P793,929 d. P 0

Answers:
 1. Letter D. 60%

Cost Retail
Beginning inventory P 1,100,000 P 2,200,000
Purchases 15,800,000 26,300,000
Freight in 400,000
Purchase returns (600,000) (1,000,000)
Purchase allowances (300,000)
Departmental transfer in 400,000 800,000
Net markups 600,000
Net markdowns (900,000)
Goods available for sale P16,800,000 P28,000,000

Cost ratio (P16,800,000/P28,000,000) 60%

2. Letter A. P3,000,000

Goods available for sale at retail P28,000,000

Less: Sales P2,700,000
Sales returns (350,000)
Employee discounts 600,000
Loss from breakage 50,000 25,000,000
Ending Inventory, at retail P 3,000,000

3. Letter D. P1,800,000

Ending inventory, at cost (P3,000,000 x 60%) P1,800,000

4. Letter C. P15,000,000

Goods available for sale at cost P16,800,000

Less: Ending inventory, at cost 1,800,000
Estimated Cost of Sales P15,000,000

5. Letter A. P780,000

Ending inventory, at cost P1,800,000

Physical inventory, at cost (P1,700,000 x 60%) 1,020,000
Estimated inventory shortage P 780,000

PROBLEM No. 22 Biological Assets

You noted the following related to the biological assets owned by Malasiqui Farms, Inc. in connection
with your audit.

Carrying amount, January 1, 2010 P800,000

Purchases 230,000
Gain arising from changes in fair value less costs to sell
attributable to physical changes 60,000
Gain arising from changes in fair value less costs to sell
attributable to price changes 40,000
Sales 110,000
Questions:
Based on the above and the result of your audit, answer the following:

1. The carrying amount of the biological assets on December 31, 2010 is

a. P1,030,000 c. P1,020,000
b. P1,130,000 d. P 920,000

2. The amount to be recognized in 2010 profit or loss related to these biological assets is
a. P100,000 c. P 20,000
b. P210,000 d. P 110,000

Answers:

1. Letter C. P1,020,000

Carrying amount, January 1, 2010 P800,000

Purchases 230,000
Gain arising from changes in fair value less costs to sell
attributable to physical changes 60,000
Gain arising from changes in fair value less costs to sell
attributable to price changes 40,000
Sales (110,000)
Carrying Amount, December 31, 2010 P1,020,000

2. Letter A. P100,000

Gain arising from changes in fair value less costs to sell

attributable to physical changes 60,000
Gain arising from changes in fair value less costs to sell
attributable to price changes 40,000
Amount to be recognized in 2010 profit or loss P100,000