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INVENTORY AND OVERHEAD

Chapter Fifteen

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McGraw-Hill/Irwin

List the key assumptions of each inventory method.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

Calculate the cost ratio and ending inventory at cost for the retail method. Calculate the estimated inventory using the gross profit method. Explain and calculate inventory turnover.Explain overhead; allocate overhead according to floor space and sales.

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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.

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Number of Cost Total units purchased per unit costBeginning 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

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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).

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Specific Identification Method

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Cost per Unit Total Cost20 units from April 1 $ 9 $18020 units from Oct. 1 12 2408 units from Dec. 1 13 104Cost 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

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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.

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Inv.

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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 Total Units Purchased per Unit CostBeginning 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

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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.

Beg

Inv.

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First-In, First-Out Method

Goods available for sale -- Cost of ending inventory = Cost of goods sold

Number of Cost

Total Units Purchased per Unit CostBeginning 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

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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.

Beg

Inv.

4/1

5/1

10/1

12/1

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Last-In, First-Out Method

$1,200 -- $392 = $808

Number of Cost

Total Units Purchased per Unit CostBeginning 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

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Summary

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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.

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Cost RetailBeginning inventory $4,000 $6,000Net purchases during month 2,300 3,000Cost of goods available for sale (Step 1) $6,300 $9,000Less net sales for month (Step 3) 4,000Ending inventory at retail $5,000Cost ratio ($6,300/$9,000) (Step 2) 70%Ending inventory at cost (.70 x $5,000) (Step 4) $3,500

Estimating Inventory –Retail Method

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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

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Example:

Beginning inventory, January 1, 2013 $20,000 Net purchases 8,000Cost of goods available for sale (Step 1) $28,000Less 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

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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 =

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Inventory Turnover

Net sales $32,000 Cost of goods sold $22,000Beginning inventory at retail 11,000 Beginning inventory at cost 7,500Ending 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 =

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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.

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Department A - 6,000 square feet Department B - 3,000 square feet Department C - 1,000 square feet Overhead of $90,000

Floor Space RatioDepartment A 6,000 6,000 = 60% 10,000 Department B 3,000 3,000 = 30% 10,000Department C 1,000 1,000 = 10% 10,000

Department A .60 x $90,000 = $54,000 Department B .30 x $90,000 = $27,000 Department C .10 x $90,000 = $ 9,000 $90,000

Calculating the Distribution of Overhead by Floor Space

Roy Company

Step 1 & 2

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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.

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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 $100,000Department 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

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Step 1 & 2

Step 3