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FINANCIAL
ACCOUNTING
AND
REPORTING
Prepared by: Bernadette Adelaida M. Cope
INVENTORY
ESTIMATION
• REASONS
for
making
an
estimate
on
goods
on
hand:
Ø Inventory
is
destroyed
by
fire
or
other
catastrophe,
or
theft
of
the
goods
has
occurred
Ø To
prove
the
correctness
or
reasonableness
of
a
physical
count
that
was
made.
This
is
known
as
the
“gross
profit
test”
Ø For
interim
financial
reporting
• TWO
(2)
METHODS
in
estimating
the
value
of
inventory
1. Gross
Profit
Method
2. Retail
Inventory
Method
• Sales
allowance
and
Sales
discount
are
ignored
(not
deducted
from
Sales)
in
computing
the
Net
Sales
needed
for
inventory
estimation.
Sales
allowance
and
discounts
do
not
increase
the
physical
inventory
of
goods,
thus,
an
overstatement
of
inventory
may
result
from
their
recognition.
GROSS
PROFIT
METHOD
• Based
on
the
assumption
that
the
gross
profit
remains
approximately
the
same
from
period
to
period,
thus,
the
ratio
of
the
cost
of
goods
sold
to
net
sales
is
relatively
constant
from
period
to
period
• Basic
formula:
Net
sales
xx
Less:
Cost
of
sales
or
cost
of
goods
sold
xx
Gross
profit
xx
• Gross
profit
could
be
based
on
Net
sales
or
Cost
of
goods
sold
Based
on
Net
sales
Based
on
COGS
Net
sales
100%
120%
Less:
Cost
of
sales
or
cost
of
goods
sold
80%
100%
Gross
profit
20%
20%
• Gross
profit
rate
is
used
to
extract
the
cost
of
goods
sold,
which
is
later
used
to
extract
the
Ending
inventory.
2
FINANCIAL
ACCOUNTING
AND
REPORTING
Prepared by: Bernadette Adelaida M. Cope
• SAMPLE
PROBLEM:
On
October
17,
Dragon
Company
experienced
a
storm
surge
which
caused
severe
damage
to
the
entire
inventory.
Based
on
recent
history,
the
entity
had
a
gross
profit
of
25%
on
sales.
The
following
information
is
available:
Beginning
inventory
₱
520,000
Purchases
4,120,000
Purchases
returns
45,000
Purchase
allowances
5,000
Purchase
discounts
10,000
Sales
5,600,000
Sales
returns
400,000
Sales
allowances
30,000
Sales
discounts
70,000
What
is
the
estimated
cost
of
inventory
damaged
by
the
storm?
Ø PROCESS
of
computing
the
needed
requirement
1. Identify
the
basis
of
gross
profit.
Based
on
the
problem,
“gross
profit
is
25%
of
sales”
2. Compute
for
the
Cost
of
goods
sold
by:
Based
on
Net
sales
Net
sales
(a)
100%
5,200,000
Less:
Cost
of
sales
or
cost
of
goods
sold
(b)
75%
3,900,000
Gross
profit
25%
1,300,000
(a)
Sales
5,600,000
Less:
Sales
returns
400,000
Net
sales
5,200,000
(b)
Net
sales
5,200,000
Multiply
by:
Cost
ratio
75%
Cost
of
sales
3,900,000
**
it
should
be
noted
that
Sales
ALLOWANCES
AND
DISCOUNTS
are
disregarded
in
the
computation
of
NET
SALES
3
FINANCIAL
ACCOUNTING
AND
REPORTING
Prepared by: Bernadette Adelaida M. Cope
3.
Compute
for
the
Ending
inventory
which
is
damaged
by
storm.
Beginning
inventory
520,000
Add:
Net
purchases
Purchases
4,120,000
Less:
Purchase
returns
45,000
Purchase
allowances
5,000
Purchase
discounts
10,000
60,000
4,060,000
Goods
available
for
sale
4,580.000
Less:
Cost
of
sales
3,900,000
Ending
inventory,
damaged
by
storm
680,000
4.
Supposing,
some
inventories
were
recovered
from
the
storm
and
can
still
be
sold
for
₱180,000,
how
much
is
the
inventory
damaged
by
storm?
Beginning
inventory
520,000
Add:
Net
purchases
Purchases
4,120,000
Less:
Purchase
returns
45,000
Purchase
allowances
5,000
Purchase
discounts
10,000
60,000
4,060,000
Goods
available
for
sale
4,580.000
Less:
Cost
of
sales
3,900,000
Ending
i nventory,
s hould
b e
680,000
Less:
Recovered
inventory
180,000
Inventory
d amaged
b y
s torm
500,000
RETAIL
INVENTORY
METHOD
• This
is
often
used
in
the
retail
industry
for
measuring
inventory
of
large
number
of
rapidly
changing
items
with
similar
margin.
RETAIL
because
the
selling
price
is
tagged
to
each
item.
• Basic
formula:
Goods
available
for
sale
@
selling
price
or
retail
xx
Less:
Net
sales
xx
Ending
inventory
@
selling
price
or
retail
xx
Multiply
by:
Cost
Ratio**
x%
Ending
inventory
@
cost
xx
4
FINANCIAL
ACCOUNTING
AND
REPORTING
Prepared by: Bernadette Adelaida M. Cope
Ø **COST
RATIOS
A. Conservative
or
conventional
or
lower
of
cost
or
net
realizable
value
approach
Goods
available
for
sale
(GAS)
@cost
Cost
Ratio
(%)
=
Goods
available
for
sale
(GAS)
@
selling
price
Inclusive
of
net
markups
B. Average
cost
approach
Goods
available
for
sale
(GAS)
@cost
Cost
Ratio
(%)
=
Goods
available
for
sale
(GAS)
@
selling
price
Inclusive
of
net
markups
and
net
markdowns
C. FIFO
approach
Goods
available
for
sale
(GAS)
@cost
–
Beg
inventory
Goods
available
for
sale
(GAS)
@
selling
price
Cost
Ratio
(%)
=
Inclusive
of
net
markups
and
net
markdowns
–
Beg
inventory
Ø How
to
compute
Ending
Inventory
@
Retail
or
selling
price
COST
RETAIL
Beginning
inventory
xx
xx
Purchases
xx
xx
Purchase
returns
(
xx
)
(
xx
)
Purchase
allowances
(
xx
)
Purchase
discounts
(
xx
)
Freight
in
xx
Departmental
transfer
in
xx
xx
Departmental
transfer
out
(
xx)
(
xx
)
GAS
@
cost
xx
Markup
xx
Markup
cancelation
(
xx
)
GAS
@
conservative
xx
Markdown
(
xx)
Markdown
cancelation
xx
GAS
@
average
xx
Less:
Sales
xx
Sales
returns
(
xx
)
Employee
discounts
xx
Normal
shortage
xx
xx
Ending
inventory
@
retail
xx