# GLENCOE / McGraw-Hill. Merchandise Inventory 3.Compute inventory value under the lower of cost or market rule. 4. Estimate inventory cost using the gross.

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GLENCOE / McGraw-Hill

Merchandise Inventory

3.Compute inventory value under the lower of cost or market rule. 4. Estimate inventory cost using the gross profit method. 5. Estimate inventory cost using the retail method. Inventory Valuation and Control Section Objectives

Lower of Cost or Market Rule Page 617

The lower of cost or market rule is the principle by which inventory is reported at either its original cost or its replacement cost, whichever is lower. ANSWER: QUESTION: What is the lower of cost or market rule? Page 617

Market price or replacement cost is the price the business would have to pay to buy an item of inventory through usual channels in usual quantities. ANSWER: QUESTION: What is market price? Page 617

There are three ways to apply the lower of cost or market rule: By item In total By group Page 617

Lower of Cost Unit Price or Market Valuation DescriptionQuantity CostMarket Basis Amount Stock # 1234 75\$2.00 \$2.20 Cost \$150.00 Stock # 2765 100 5.00 4.40 Market 440.00 Inventory valuation \$590.00 Lower of Cost or Market Rule by Item Page 617

Unit Price Total Total DescriptionQuantity CostMarket Cost Market Stock # 1234 75\$2.00 \$2.20 \$150.00 \$165.00 Stock # 2765 100 5.00 4.40 500.00 440.00 \$650.00 \$605.00 Inventory valuation, \$605.00 Lower of Total Cost or Total Market Page 618

Unit Price Total Total DescriptionQuantity CostMarket CostMarket Group #1 Stock #1234 75\$2.00 \$2.20\$150.00\$165.00 Stock #2765 100 5.00 4.40 500.00 440.00 Totals, Group #1\$650.00\$605.00 Group #2 Stock #3124 40\$3.40 \$3.20\$136.00\$128.00 Stock #4532 75 3.20 3.60 240.00 270.00 Totals, Group #2\$376.00\$398.00 Lower of cost or market valuation by group Group #1 Market \$605.00 Group #2 Cost 376.00 Inventory valuation \$ 981.00 Lower of Cost or Market Rule by Groups Page 618

Occasionally managers need to know the inventory cost without taking a physical count. Page 619 Gross profit method Retail method Methods used for estimating inventory value: Inventory Estimation Procedures

The gross profit method assumes the rate of gross profit on sales and the ratio of cost of goods sold to net sales are relatively constant from period to period. ANSWER: QUESTION: What is the gross profit method? Page 619

Step 1. Estimate the cost of goods sold. (sales x ratio of cost of goods sold to net sales) Step 2. Determine the cost of goods available for sale. (beginning inventory plus purchases) Step 3. Compute the ending (destroyed) inventory. (cost of goods available for sale less estimated cost of goods sold) Page 620 Gross Profit Method

For net sales in the amount of \$100 Cost of goods sold equals (60) Gross profit on sales equals \$ 40 Gross profit rate = \$ 40 ÷ \$100 = 40% Cost of goods sold ratio = \$ 60 ÷ \$100 = 60% Page 620 Gross Profit Method Assume that an analysis of income statements for two preceding years shows the following:

Page 620 Step 1 Estimate cost of goods sold. \$264,000 Estimated cost of goods sold Sales \$440,000 x 60% Cost of goods sold ratio Gross Profit Method On June 10 the store lost its entire merchandise inventory in a fire. Beginning inventory, January 1, was \$100,000. Net purchases, January 1 to June 10, were \$260,000. Net sales, January 1 to June 10, were \$440,000. What is the value of the destroyed inventory?

Page 620 Step 2 Determine the cost of goods available for sale. Beginning inventory \$100,000 Net purchases 260,000 Step 3 Compute the ending (destroyed) inventory. Estimated cost of ending inventory \$ 96,000 Cost of goods available for sale \$360,000 - Step 2 Estimated cost of goods sold (264,000) - Step 1 Cost of goods available for sale \$360,000 Gross Profit Method

The retail method estimates inventory cost by applying the ratio of cost to selling price in the current accounting period to the retail price of the inventory. ANSWER: QUESTION: What is the retail method? Page 620

Step 1. List the beginning inventory at both cost and retail. Step 2. When merchandise is purchased, record it at cost and determine its retail value. Step 3. Compute merchandise available for sale at cost and at retail. Step 4. Record sales at retail. Page 620 Retail Method

Step 5. Subtract retail sales from retail merchandise available for sale. The difference is ending inventory at retail. Page 621 Retail Method Step 6. Compute the cost ratio: Merchandise Available for Sale at Cost Merchandise Available for Sale at Retail Step 7. Multiply ending inventory at retail by the cost ratio. The result is an estimate of ending inventory at cost. Step 8. Estimate the cost of goods sold: merchandise available for sale at cost – ending inventory at cost

A company’s financial records show the following: Retail Method Sales — 238,500 At Cost At Retail Beginning inventory \$ 11,700 \$ 19,500 Purchases 183,000 273,000 Freight in 300 — Page 621

Page 620 Step 1: List beginning inventory at both cost (\$11,700) and retail (\$19,500). Retail Method Cost Retail Step 1: Beginning inventory \$11,700 \$19,500

Step 2: When merchandise is purchased, record it at cost (\$183,300 including \$300 in freight) and determine its retail value (\$273,000). Retail Method Cost Retail Step 1: Beginning inventory \$ 11,700 \$ 19,500 Step 2: Purchases 183,000 273,000 Freight in 300 Page 621

Step 3: Compute merchandise available for sale at cost (\$195,000) and at retail (\$292,500). Retail Method Cost Retail Step 1: Beginning inventory \$ 11,700 \$ 19,500 Step 2: Purchases 183,000 273,000 Freight in 300 Step 3: Total merchandise \$195,000 \$292,500 available for sale Page 621

Step 4: Record sales at retail (\$238,500). Retail Method Step 4: Less sales 238,500 Cost Retail Step 1: Beginning inventory \$ 11,700 \$ 19,500 Step 2: Purchases 183,000 273,000 Freight in 300 Step 3: Total merchandise \$195,000 \$292,500 available for sale Page 621

Page 621 Step 5: Subtract retail sales from the retail merchandise available for sale. Retail Method Cost Retail Step 1: Beginning inventory \$ 11,700 \$ 19,500 Step 2: Purchases 183,000 273,000 Freight in 300 Step 4: Less sales 238,500 Step 3: Total merchandise \$195,000 \$292,500 available for sale Step 5: Ending inventory priced at retail \$ 54,000

Page 621 Step 6: Compute cost ratio. Retail Method Merchandise Available for Sale at Cost \$195,000 Merchandise Available for Sale at Retail \$292,500 == 66.67%

Page 621 Step 7: Multiply the ending inventory at retail by the cost ratio. The result is an estimate of the ending inventory at cost. Retail Method Step 7: Conversion to approximate cost: \$54,000 x 0.6667 = \$36,000

Page 621 Step 8 Estimate the cost of goods sold by subtracting the ending inventory at cost from the merchandise available for sale at cost. Retail Method Step 8: \$195,000 Merchandise available for sale at cost – 36,000 Ending inventory at cost \$159,000 = Cost of goods sold

REVIEWREVIEW ___________ is the price a business would have to pay to buy an item of inventory through usual channels in usual quantities. There are three ways to apply the lower of cost or market rule: _______, _______, or ________. Two common techniques used to estimate the cost of inventory are the ___________ _______ and the ____________. method by item Market price Complete the following sentences: by group retail method in total gross profit

REVIEWREVIEW The _________________ assumes a constant rate of gross profit on sales from period to period. The gross profit method assumes that the ratio of _________________ to ________ is constant from period to period. The retail method applies the ratio of cost to selling price in the _____________ to the retail price of the inventory. current period cost of goods sold gross profit method Complete the following sentences: net sales

Thank You for using College Accounting, Tenth Edition Price Haddock Brock

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