Chapter

INVENTORIES AND THE

8 COST OF GOODS SOLD

8-1
 Inventory Defined

Inventory

Goods owned Current

and held for sale asset
to customers

8-2
 The Flow of Inventory Costs

BALANCE SHEET

As purchase costs
Current assets:
(or manufacturing Inventory
costs) are incurred $ $
as goods
INCOME STATEMENT are sold
Revenue $
Cost of goods sold
Gross profit
Expenses
Net income
8-3
 The Flow of Inventory Costs

In a perpetual inventory system, inventory entries

parallel the flow of costs.

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

Entry on Purchase Date
Inventory $$$$
Accounts Payable $$$$

Entry on Sale Date

Cost of Goods Sold $$$$
Inventory $$$$
8-4
 Which Unit Did We Sell?

When identical units of inventory have

different unit costs, a question naturally
arises as to which of these costs should be
used in recording a sale of inventory.

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

Entry on Sale Date
Cost of Goods Sold $$$$
Inventory $$$$

8-5
 Inventory Subsidiary Ledger

A separate subsidiary account is maintained

for each item in inventory.
Item LL002 Primary supplier Electronic City
Description Laser Light Secondary supplier Electric Company
Location Storeroom 2 Inventory level: Min: 25 Max: 200
Purchased Sold Balance
Cost of
Unit Unit Goods Unit
Date Units Cost Total Units Cost Sold Units Cost Total
Sept. 5 100 $ 30 $ 3,000 100 $ 30 $ 3,000
Sept. 9 75 50 3,750 100 30 3,000
75 50 3,750
Sept. 10 10 ? ? ? ? ?
? ? ?

How can we determine the unit cost for the Sept. 10 sale?
8-6
 Inventory Cost Flows

We use one of these inventory valuation

methods to determine cost of inventory sold.

Specific Average
identification cost

FIFO LIFO
8-7
 Information for the Following Inventory
Examples

The Bike Company (TBC)

Cost of Goods Available for Sale
Aug. 1 Beg. Inventory 10 units @ $ 91 = $ 910
Aug. 3 Purchased 15 units @ $ 106 = $ 1,590
Aug. 17 Purchased 20 units @ $ 115 = $ 2,300
Aug. 28 Purchased 10 units @ $ 119 = $ 1,190

Retail Sales of Goods

Aug. 14 Sales 20 units @ $ 130 = $ 2,600
Aug. 31 Sales 23 units @ $ 150 = $ 3,450

8-8
 Specific Identification

When a unit
is sold, the
specific cost of
the unit sold is
added to cost
of goods sold.

8-9
 Specific Identification – Example

Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $ 106 = $ 1,590 $ 2,500

On August 14, TBC sold 20 bikes for $130 each.

Nine bikes originally cost $91 and 11 bikes
originally cost $106.

Continue
8-10
 Specific Identification – Example

Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $ 106 = $ 1,590 $ 2,500
Aug. 14 9 @ $ 91 = $ 819
11 @ $ 106 = $ 1,166 $ 515

The Cost of Goods Sold for the August 14 sale is

$1,985, leaving $515 and 5 units in inventory.

Let’s look at the entries for

Continue the Aug. 14 sale.
8-11
 Specific Identification – Example

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

Aug. 14 Cash Retail 2,600
Sales 2,600

14 Cost of Goods Sold Cost 1,985

Inventory 1,985

A similar entry is
made after each sale. Continue

8-12
 Specific Identification – Example

Inventory
Date Purchases Cost of Goods Sold Balance
Cost of Goods
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $ 106 = $ 1,590 $ 2,500
Aug. 14
Sold for 9 @ $ 91 = $ 819
August 31 = 11 @ $ 106 = $ 515
$ 1,166
Aug. 17 $2,610
20 @ $ 115 = $ 2,300 $ 2,815
Aug. 28 10 @ $ 119 = $ 1,190 $ 4,005
Aug. 31 Additional purchases were made
1 @on$August
91 = 17$and9128.
3 @ $ 106 = $ 318
Costs associated with sales on August 31 were as follows: 1 @ $91,
15 @ $ 115 = $ 1,725
3 @ $106, 15 @ $115, & 4 @ $119.
4 @ $ 119 = $ 476 $ 1,395

Continue 8-13
 Specific Identification – Example
Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $ 106 = $ 1,590 $ 2,500
Income Statement
Aug. 14 9 @ $ 91 = $ 819
COGS = $4,595 11 @ $ 106 = $ 1,166 $ 515
Aug. 17 20 @ $ 115 = $ 2,300 $ 2,815
Aug. 28 10 @ $ 119 = $ 1,190 $ 4,005
Aug. 31 1 @ $ 91 = $ 91
3 @ $ 106 = $ 318
15 @ $ 115 = $ 1,725
4 @ $ 119 = $ 476 $ 1,395
Balance Sheet
Inventory = $1,395 1 @ $ 106 = $ 106
5 @ $ 115 = 575
6 @ $ 119 = 714
End. Inv. $ 1,395
8-14
 Not really. Specific
Since specific identification is hard to use
identification is so when we sell a lot of
easy, can’t we use it inventory that has lots of
all the time? different costs.

8-15
 Average-Cost Method

When a unit is sold,

the average cost of each unit in
inventory is assigned to cost
of goods sold.

Cost of Goods Units on hand

Available for ÷ on the date of
Sale sale

8-16
 Average-Cost Method – Example

Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $ 106 = $ 1,590 $ 2,500

The average cost per unit must be

computed prior to each sale.

$100 = $2,500  25
On August 14, TBC sold 20 bikes for $130 each.

Continue
8-17
 Average-Cost Method – Example

Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $ 106 = $ 1,590 $ 2,500
Aug. 14 20 @ $ 100 = $ 2,000 $ 500

The average cost per

unit is $100. $100 = $2,500  25

Let’s look at the entries

Continue for the Aug. 14 sale.
8-18
 Average-Cost Method – Example

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

Aug. 14 Cash Retail 2,600
Sales 2,600

14 Cost of Goods Sold Cost 2,000

Inventory 2,000

A similar entry is
made after each sale. Continue

8-19
 Average-Cost Method – Example

Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $ 106 = $ 1,590 $ 2,500
Aug. 14 20 @ $ 100 = $ 2,000 $ 500
Aug. 17 20 @ $ 115 = $ 2,300 $ 2,800
Aug. 28 10 @ $ 119 = $ 1,190 $ 3,990
Additional purchases were made on August 17 and August 28.
On August 31, an additional 23 units were sold.

Continue
8-20
 Average-Cost Method – Example

Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $ 106 = $ 1,590 $ 2,500
Aug. 14 20 @ $ 100 = $ 2,000 $ 500
Aug. 17 20 @ $ 115 = $ 2,300 $ 2,800
Aug. 28 10 @ $ 119 = $ 1,190 $ 3,990

Total Purchases 55
Less: Sales to Date -20
$114 = $3,990  35
Units on Hand 35

8-21
 Average-Cost Method – Example

Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $ 106 = $ 1,590 $ 2,500
Aug. 14 20 @ $ 100 = $ 2,000 $ 500
Aug. 17 20 @ $ 115 = $ 2,300 $ 2,800
Aug. 28 10 @ $ 119 = $ 1,190 $ 3,990
Aug. 31 23 @ $ 114 = $ 2,622 $ 1,368

The average cost per $114 = $3,990  35

unit is $114.

8-22
 Average-Cost Method – Example

Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Income
Aug. 3 15Statement
@ $ 106 = $ 1,590 $ 2,500
Aug. COGS
14 = $4,622 20 @ $ 100 = $ 2,000 $ 500
Aug. 17 20 @ $ 115 = $ 2,300 $ 2,800
Aug. 28 10 @ $ 119 = $ 1,190 $ 3,990
Aug. 31 23 @ $ 114 = $ 2,622 $ 1,368

Balance Sheet
Inventory = $1,368
$114 × 12 = $1,368
8-23
 First-In, First-Out Method (FIFO)

Oldest Costs of
Costs Goods Sold

Recent Ending
Costs Inventory

8-24
 FIFO – Example

Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $ 106 = $ 1,590 $ 2,500
Aug. 14 10 @ $ 91 = $ 910
10 @ $ 106 = $ 1,060 $ 530

The Cost of Goods Sold for the August 14 sale is $1,970, leaving $530 and 5
units in inventory.

On August 14, TBC sold 20 bikes for $130 each.

Continue
8-25
 FIFO – Example

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

Aug. 14 Cash Retail 2,600
Sales 2,600

14 Cost of Goods Sold Cost 1,970

Inventory 1,970

A similar entry is
made after each sale. Continue

8-26
 FIFO – Example

Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $ 106 = $ 1,590 $ 2,500
Aug. 14 10 @ $ 91 = $ 910
10 @ $ 106 = $ 1,060 $ 530
Aug. 17 20 @ $ 115 = $ 2,300 $ 2,830
Aug. 28 10 @ $ 119 = $ 1,190 $ 4,020
Aug. 31 5 @ $ 106 = $ 530
18 @ $ 115 = $ 2,070 $ 1,420

Additional purchases were made on Aug. 17 and Aug. 28.

CostOn ofAugust
Goods Sold for August 31 = $2,600
31, an additional 23 units were sold.

Continue 8-27
 FIFO – Example

Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3
Income 15 @ $ 106 = $ 1,590
Statement $ 2,500
Aug. 14 10 @ $ 91 = $ 910
COGS = $4,570
10 @ $ 106 = $ 1,060 $ 530
Aug. 17 20 @ $ 115 = $ 2,300 $ 2,830
Aug. 28 10 @ $ 119 = $ 1,190 $ 4,020
Aug. 31 5 @ $ 106 = $ 530
18 @ $ 115 = $ 2,070 $ 1,420

Balance Sheet 2 @ $ 115 = $ 230

Inventory = $1,420 10 @ $ 119 = 1,190
End. Inv. $ 1,420

8-28
 Last-In, First-Out Method (LIFO)

Recent Costs of
Costs Goods Sold

Oldest Ending
Costs Inventory

8-29
 LIFO – Example

Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $ 106 = $ 1,590 $ 2,500
Aug. 14 15 @ $ 106 = $ 1,590
5 @ $ 91 = $ 455 $ 455

The Cost of Goods Sold for the August 14 sale is

$2,045, leaving $455 and 5 units in inventory.

On August 14, TBC sold 20 bikes for $130 each.

Continue
8-30
 LIFO – Example

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

Aug. 14 Cash Retail 2,600
Sales 2,600

14 Cost of Goods Sold Cost 2,045

Inventory 2,045

A similar entry is
made after each sale. Continue

8-31
 LIFO – Example

Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $ 106 = $ 1,590 $ 2,500
Aug. 14 15 @ $ 106 = $ 1,590
5 @ $ 91 = $ 455 $ 455
Aug. 17 20 @ $ 115 = $ 2,300 $ 2,755
Aug. 28 10 @ $ 119 = $ 1,190 $ 3,945
Aug. 31 10 @ $ 119 = $ 1,190
13 @ $ 115 = $ 1,495 $ 1,260

Additional purchases were made on Aug. 17 and Aug. 28.

Cost of Goods Sold for August 31 = $2,685
On Aug. 31, an additional 23 units were sold.

Continue
8-32
 LIFO – Example

Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3
Income 15 @ $ 106 = $ 1,590
Statement $ 2,500
Aug. 14 15 @ $ 106 = $ 1,590
COGS = $4,730
5 @ $ 91 = $ 455 $ 455
Aug. 17 20 @ $ 115 = $ 2,300 $ 2,755
Aug. 28 10 @ $ 119 = $ 1,190 $ 3,945
Aug. 31 10 @ $ 119 = $ 1,190
13 @ $ 115 = $ 1,495 $ 1,260

Balance Sheet 5 @ $ 91 = $ 455

Inventory = $1,260 7 @ $ 115 = 805
End. Inv. $ 1,260

8-33
 Inventory Valuation Methods: A Summary
Costs Allocated to:
Valuation Cost of Goods
Method Sold Inventory Comments
Specific Actual cost of Actual cost of units Parallels physical flow
identification the units sold remaining Logical method when units
are unique
May be misleading for
identical units
Average cost Number of units Number of units on Assigns all units the same
sold times the hand times the average unit cost
average unit cost average unit cost Current costs are averaged
in with older costs
First-in, First-out Cost of earliest Cost of most Cost of goods sold is based
(FIFO) purchases on recently on older costs
hand prior to the purchased units Inventory valued at current
sale costs
May overstate income during
periods of rising prices; may
increase income taxes due
Last-in, First-out Cost of most Cost of earliest Cost of goods sold shown at
(LIFO) recently purchases recent prices
purchased units (assumed still in Inventory shown at old (and
inventory) perhaps out of date) costs
Most conservative method
during periods of rising
prices; often results in lower
income taxes 8-34
 The Principle of Consistency

Once a company has

adopted a particular
accounting method, it
should follow that
method consistently,
rather than switch
methods from one
year to the next.
8-35
 Just-In-Time (JIT) Inventory Systems

This inventory arrived

just in time for us to use
in the manufacturing
process.

8-36
 Taking a Physical Inventory

The primary reason for taking a physical inventory

is to adjust the perpetual inventory records for
unrecorded shrinkage losses, such as theft,
spoilage, or breakage.

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

Dec. 31 Cost of Goods Sold $$$$
Inventory $$$$

8-37
 LCM and Other Write-Downs
of Inventory

Reduces the value

Obsolescence
of the inventory.

Lower of Cost Adjust inventory

or Market value to the lower
(LCM) of historical cost or
current
replacement cost
(market).

8-38
 Goods In Transit

A sale should be recorded when title to the

merchandise passes to the buyer.

F.O.B. F.O.B.
shipping destination
point ⎯ title point ⎯ title
passes to passes to
buyer at the Year buyer at the
point of End point of
shipment. destination.
8-39
 Periodic Inventory Systems

In a periodic inventory system, inventory entries

are as follows.

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

Entry on Purchase Date
Purchases $$$$
Accounts Payable $$$$

Note that an entry is not

made to inventory.
8-40
 Periodic Inventory Systems

In a periodic inventory system, inventory entries

are as follows.

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

Entry on Sale Date
No entry to inventory.

Accounts Receivable $$$$

Sales $$$$

8-41
 Periodic Inventory Systems

The inventory on
hand and the
cost of goods
sold for the year
are not
determined until
year-end.
8-42
 Periodic Inventory Systems

We use one of these inventory valuation

methods in a periodic inventory system.

Specific Average
identification cost

FIFO LIFO
8-43
Information for the Following Inventory
Examples
Computers, Inc.
Mouse Pad Inventory
Date Units $/Unit Total
Beginning
Inventory 1,000 $ 5.25 $ 5,250.00
Purchases:
Jan. 3 300 5.30 1,590.00
June 20 150 5.60 840.00
Sept. 15 200 5.80 1,160.00
Nov. 29 150 5.90 885.00
Goods
Available
for Sale 1,800 $ 9,725.00
Ending
Inventory 1,200 ?
Cost of
Goods Sold 600 ?
8-44
 Specific Identification – Example

By reviewing actual
purchase invoices,
Computers, Inc. determines
that the 1,200 mouse pads
on hand at year-end have
an actual total cost of
$6,400.
Determine the cost of
goods sold for the year.

8-45
Specific Identification – Example

Computers, Inc.
Mouse Pad Inventory
Date Units $/Unit Total
Beginning
Inventory 1,000 $ 5.25 $ 5,250.00
Purchases:
Jan. 3 300 5.30 1,590.00
June 20 150 5.60 840.00
Cost
Sept. 15of Goods Sold
200 5.80 1,160.00
Nov. 29 150 5.90 885.00
-
$9,725 $6,400 = $3,325
Goods
Available
for Sale 1,800 $ 9,725.00
Ending
Inventory 1,200 $ 6,400.00
Cost of
Goods Sold 600 $ 3,325.00
8-46
 Average-Cost Method

The average cost is

calculated at year-
end as follows:

Total Cost of Total Number

Goods of Units
Available for ÷ Available for
Sale Sale

8-47
 Average-Cost Method – Example

Computers, Inc.
Mouse Pad Inventory
Avg. Cost $9,725  1,800 =
Date Units $/Unit Total
$5.40278 Beginning
Ending Inventory Inventory 1,000 $ 5.25 $ 5,250.00
Avg. Cost $5.40278  1,200 = Purchases:
$6,483 Jan. 3 300 5.30 1,590.00
June 20 150 5.60 840.00
Cost of Goods Sold
Sept. 15 200 5.80 1,160.00
Avg. Cost $5.40278  600 =
Nov. 29 150 5.90 885.00
$3,242
Goods
Available
for Sale 1,800 $ 9,725.00
Ending
Inventory 1,200
1,200 $ 6,483.00
?
Cost of
Goods Sold 600 $ 3,242.00
?

8-48
 First-In, First-Out Method (FIFO)

Oldest Costs of
Costs Goods Sold

Recent Ending
Costs Inventory

8-49
 FIFO – Example

Remember: Start Computers, Inc.

Mouse Pad Inventory
with the 11/29
Date Units $/Unit Total
purchase and then Beginning
add other purchases Inventory 1,000 $ 5.25 $ 5,250.00
until you reach the Purchases:
number of units in Jan. 3 300 5.30 1,590.00
ending inventory. June 20 150 5.60 840.00
Sept. 15 200 5.80 1,160.00
Nov. 29 150 5.90 885.00
Goods
Available
for Sale 1,800 $ 9,725.00
Ending
Inventory 1,200 ?
Cost of
Goods Sold 600 ?

8-50
 FIFO – Example

Cost of
Date Beg. Inv. Purchases End. Inv. Goods Sold
1,000@$5.25 600@$5.25
400@$5.25
Jan. 3 300@$5.30 300@$5.30
June 20 150@$5.60 150@$5.60
Sept. 15 200@$5.80 200@$5.80
Nov. 29 150@$5.90 150@$5.90
Units 1,200
150 600

Now, we have allocated

Costs $6,575 $3,150
the cost to allNow,
1,200 let’s
unitscomplete the
Cost in endingAvailable
of Goods inventory. table.
for Sale $9,725

8-51
 FIFO – Example

Completing the table Computers, Inc.

Mouse Pad Inventory
summarizes the
Date Units $/Unit Total
computations just Beginning
made. Inventory 1,000 $ 5.25 $ 5,250.00
Purchases:
Jan. 3 300 5.30 1,590.00
June 20 150 5.60 840.00
Sept. 15 200 5.80 1,160.00
Nov. 29 150 5.90 885.00
Goods
Available
for Sale 1,800 $ 9,725.00
Ending
Inventory 1,200 $ 6,575.00
Cost of
Goods Sold 600 $ 3,150.00

8-52
 Last-In, First-Out Method (LIFO)

Recent Costs of
Costs Goods Sold

Oldest Ending
Costs Inventory

8-53
 LIFO – Example

Remember: Start with Computers, Inc.

Mouse Pad Inventory
beginning inventory
Date Units $/Unit Total
and then add other Beginning
purchases until you Inventory 1,000 $ 5.25 $ 5,250.00
reach the number of Purchases:
units in ending Jan. 3 300 5.30 1,590.00
inventory. June 20 150 5.60 840.00
Sept. 15 200 5.80 1,160.00
Nov. 29 150 5.90 885.00
Goods
Available
for Sale 1,800 $ 9,725.00
Ending
Inventory 1,200 ?
Cost of
Goods Sold 600 ?

8-54
 LIFO – Example

Cost of
Date Beg. Inv. Purchases End. Inv. Goods Sold
1,000@$5.25 1,000@$5.25
Jan. 3 300@$5.30 200@$5.30
100@$5.30
June 20 150@$5.60 150@$5.60
Sept. 15 200@$5.80 200@$5.80
Nov. 29 150@$5.90 150@$5.90
Units 1,000
1,200 100
600

Now, we have allocated

Costs Next, let’s complete
$6,310 $3,415
the cost to all 1,200 units the table.
Cost in
of ending inventory.
Goods Available for Sale $9,725

8-55
 LIFO – Example

Completing the table Computers, Inc.

Mouse Pad Inventory
summarizes the
Date Units $/Unit Total
computations just Beginning
made. Inventory 1,000 $ 5.25 $ 5,250.00
Purchases:
Jan. 3 300 5.30 1,590.00
June 20 150 5.60 840.00
Sept. 15 200 5.80 1,160.00
Nov. 29 150 5.90 885.00
Goods
Available
for Sale 1,800 $ 9,725.00
Ending
Inventory 1,200 $ 6,310.00
Cost of
Goods Sold 600 $ 3,415.00

8-56
 Importance of an Accurate Valuation of
Inventory
Errors in Measuring Inventory
Beginning Inventory Ending Inventory
Effect on Income Statement Overstated Understated Overstated Understated
Goods Available for Sale + - 0 0
Cost of Goods Sold + - - +
Gross Profit - + + -
Net Income - + + -
Effect on Balance Sheet
Ending Inventory 0 0 + -
Retained Earnings - + + -

An error in ending inventory in a year will result in the

same error in the beginning inventory of the next year.

8-57
8-58
The Gross Profit Method

Determine cost of goods

available for sale.
Estimate cost of goods sold
by multiplying the net sales
by the cost ratio.
Deduct cost of goods sold
from cost of goods available
for sale to determine ending
inventory.

8-59
 Gross Profit Method – Example

In March of 2003, Chemico’s inventory was

destroyed by fire. Chemico’s normal gross profit
ratio is 30% of net sales. At the time of the fire,
Chemico showed the following balances:

Sales $ 31,500
Sales returns 1,500
Beginning Inventory 12,000
Net cost of goods purchased 20,500

8-60
 Gross Profit Method – Example

Computing Inventory using the Gross Profit Method

Goods Available for Sale:
Beginning Inventory $ 12,000
Net cost of goods purchased 20,500
 Goods available for sale $ 32,500
Less estimated cost of goods sold:
Sales $ 31,500
× 70%
Less sales returns (1,500)
Net sales $ 30,000
 Estimated cost of goods sold (21,000)
Estimated March inventory loss $ 11,500

8-61
 The Retail Method
Matrix would follow the steps below to estimate
their ending inventory using the retail method.

Estimating Inventory
The Retail Method
a Goods available for sale at cost $ 32,500
b Goods available for sale at retail 50,000
c Cost ratio [a  b] 65%
d Physical count of ending inventory priced at retail 22,000
e Estimated ending inventory at cost [ c  d] $ 14,300

8-62
 Inventory Turnover Rate

Measures how quickly a company

sells its merchandise inventory.

Merchandise Cost of goods sold

Turnover = Average inventory

Average Inventory = (Beg. Inv. + End. Inv.) ÷ 2

A ratio that is low compared to competitors

suggests inefficient use of assets.
8-63
Accounting Methods Can Affect Analytical
Ratios

Remember that identical

companies that use different
inventory methods (e.g., FIFO
and LIFO) will have different
inventory turnover ratios.

8-64