Gross method and retail method (lower of average cost or market)

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Presentation transcript:

Gross method and retail method (lower of average cost or market) Estimating inventory Gross method and retail method (lower of average cost or market)

Reasons to estimate inventory Allows financial statements to be prepared in a Periodic system (without counting inventory) Gives data needed to file an insurance claim because of flood or fire damage, etc. Can be used to verify current records (or estimate accounts if records are damaged)

Comparison of Inventory Estimation Methods Gross profit Retail method (using lower of average cost or market ) Usable if company records show sales revenue, beginning inventory and purchases Quick and Simple approach Estimated cost of goods sold equals Sales revenue times last period’s gross profit rate (gross profit /net sales) Formula -- beginning inventory plus purchases ( cost of goods available for sale) minus estimated cost of goods sold equals estimated ending inventory Disadvantage – older data for relationship between cost and retail LACM approach or conventional retail method is common and more conservative than average cost Usable if company records show beginning inventory & purchases at retail, and have mark-up/mark- downs around original selling price Disadvantage -- more complicated approach Advantage – historical cost profit rate is from current period – more accurate Only accurate if mark-ups and mark-downs don’t exist at the same time or all items with mark-downs are sold. Formula – 1.Calculate cost of goods available for sale (cost), 2.Then add beginning inventory ( )l plus purchases (retail) plus net mark-ups, 3. divide CGAS (cost)#1 by calculation in # 2 and get the cost- to-retail ratio, 4. subtract net mark-downs and net sales (sales less returns but not discounts) from retail subtotal in #2 to get estimated ending inventory (retail). 5. estimated ending inventory retail times cost-to-retail ratio equals ending inventory (cost)