Inventory and Overhead Chapter 18 Inventory and Overhead McGraw-Hill/Irwin Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved.

Inventory and Overhead #18 Inventory and Overhead Learning Unit Objectives LU18.1 Assigning Costs to Ending Inventory - Specific Identification; Weighted Average; FIFO; LIFO List the key assumptions of each inventory method Calculate the cost of ending inventory and cost of goods sold for each inventory method

Inventory and Overhead #18 Inventory and Overhead Learning Unit Objectives Retail Method; Gross Profit Method; Inventory Turnover; Distribution of Overhead LU18.2 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

Inventory Systems Perpetual Inventory System - keeps a running account of inventory by updating with each transaction Periodic Inventory System - Relies on a physical count of inventory done periodically

Jay Company - Inventory Information Number of Cost Total Units Purchased per unit cost Beginning Inventory 50 $13 $650 First Purchase (Jan 15) 30 12 360 Second Purchase (Feb. 24) 40 10 400 Third Purchase (Apr. 17) 20 9 180 Fourth Purchase (Aug. 24) 20 8 160 Goods available for sale 160 $1,750 Units Sold 108 Units in ending inventory 52 Step 1

Specific Identification Method Beg Inv. 1/15 2/24 4/17 8/24 Step 3. Calculate the cost of goods sold (Step 1- Step 2) Step 2. Calculate the cost of ending inventory Step 1. Calculate the cost of goods (Merchandise available for sale)

Specific Identification Method Cost per unit Total cost 10 Units from Jan. 15 $12 $120 16 Units from Feb. 24 $10 160 20 Units from Apr. 17 $9 180 6 Units from Aug. 24 $8 48 $508 Cost of goods - Cost of ending = Cost of available for sale inventory goods sold Step 2 Step 3 $1,750 - $508 = $1,242

Weighted-Average Method Beg Inv. 1/15 2/24 4/17 8/24 Step 3. Calculate the cost of goods sold (Step 1- Step 2) Step 2. Calculate the cost of ending inventory Step 1. Calculate the average unit cost

Weighted Average Method Number of Cost Total Units Purchased per unit cost Beginning inventory 50 $13 $650 First purchase (Jan 15) 30 12 360 Second purchase (Feb. 24) 40 10 400 Third purchase (Apr. 17) 20 9 180 Fourth purchase (Aug. 24) 20 8 160 Goods available for sale 160 $1,750 Units sold 108 Units in ending inventory 52 Weighted avg = Total cost of goods available for sale = $1,750 = $10.9375 Unit cost Total number of units available for sale 160 Average cost of ending inventory: 52 units at $10.9375 = $568.75 Cost of goods sold = $1,750 - $568.75 = $1,181.25

First-In, First-Out Method Beg Inv. 1/15 2/24 4/17 8/24 Step 3. Calculate the cost of goods sold (Step 1- Step 2) Step 2. Calculate the cost of ending inventory Step 1. List the units to be included in the ending inventory and their costs

First-In, First-Out Method FIFO (Bottom Up) Number of Cost Total units purchased per unit cost Beginning Inventory 50 $13 $650 First Purchase (Jan 15) 30 12 360 Second Purchase (Feb. 24) 40 10 400 Third Purchase (Apr. 17) 20 9 180 Fourth Purchase (Aug. 24) 20 8 160 Goods available for sale 160 $1,750 Units Sold 108 Units in ending inventory 52 20 Units from Aug. 24 at $8 $160 20 Units from Apr. 17 at $9 180 12 Units from Feb. 24 at $10 120 52 units in ending inventory $460 Cost of goods sold: $1,750 - $460 = $1,290

Last-In, First-Out Method Beg Inv. 1/15 2/24 4/17 8/24 Step 3. Calculate the cost of goods sold (Step 1- Step 2) Step 2. Calculate the cost of ending inventory Step 1. List the units to be included in the ending inventory and their costs

Last-In, First-Out Method LIFO (Top Down) Number of Cost Total Units Purchased per unit cost Beginning Inventory 50 $13 $650 First Purchase (Jan 15) 30 12 360 Second Purchase (Feb. 24) 40 10 400 Third Purchase (Apr. 17) 20 9 180 Fourth Purchase (Aug. 24) 20 8 160 Goods available for sale 160 $1,750 Units Sold 108 Units in ending inventory 52 50 Units from beginning inventory at $13 $650 2 Units from Jan/ 15 at $12 24 52 units in ending inventory $674 Cost of goods sold: $1,750 - $674 = $1,076

Summary Top down to inventory level (52) 50 x $13 = $650 2 x $12 = 24 $ 508 $1,750 160 = $10.9375 $10.9375 x 52 = $568.75 Bottom up to inventory level (52) 20 x $8 = $160 20 x $9 = 180 12 x $10= 120 $460 Top down to inventory level (52) 50 x $13 = $650 2 x $12 = 24 $674

Estimating Inventory - Retail Method Step 4. Multiply the cost ratio by the ending inventory at retail Step 3. Deduct net sales from cost of goods available for sale at retail Step 2. Calculate a cost ratio using the following formula Cost of goods available for sale at cost Cost of goods available for sale at retail Step 1. Calculate the cost of goods available for sale at cost and retail

Estimating Inventory - Retail Method Cost Retail Beginning Inventory $2,000 $3,800 Net purchases during month 1,000 1,200 Cost of goods available for sale (Step 1) $3,000 $5,000 Less net sales for month 3,100 Ending Inventory at retail (Step 3) $1,900 Cost ratio ($3,000/$5,000) (Step 2) 60% Ending Inventory at cost ($1,900 x .60) (Step 4) $1,140

Estimating Inventory - Gross Profit Method Assuming the following, calculate the estimated inventory Gross profit on sales 25% Beginning inventory June 1, 2004 $15,000 Net purchases 5,000 Net sales at retail for June 10,000 Step 3. Calculate the cost of estimated ending inventory (Step 1- Step 2) 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 1. Calculate the cost of goods available for sale (Beginning inventory + Net purchases)

Estimating Inventory - Gross Profit Method Beginning Inventory, June 1, 2004 $15,000 Net purchases 5,000 Cost of goods available for sale (Step 1) $20,000 Less estimated cost of good sold: Net sales at retail $10,000 Cost Percentage (100% - 25%) x .75 (Step 2) Estimated cost of goods sold - 7,500 Estimated ending inventory, June 30, 2004 $12,500 (Step 3)

The number of times inventory is replaced during a specific time Inventory Turnover The number of times inventory is replaced during a specific time Inventory turnover at retail = Net sales Average inventory at retail Inventory turnover at cost = Cost of goods sold Average inventory at cost

Inventory Turnover Net sales $50,000 Cost of goods sold $35,000 Beginning inventory at retail 15,000 Beginning inventory at cost 9,000 Ending inventory at retail 10,000 Ending inventory at cost 7,000 Average inventory = Beginning inventory + Ending inventory 2 At retail = $50,000 = $50,000 = 4 $15,000 + $10,000 $12,500 2 Usually higher due to theft, spoilage, markdowns, etc. At cost = $35,000 = $35,000 = 4.375 $9,000 + $7,000 $ 8,000 2

Calculating the Distribution of Overhead by Floor Space Step 3. Multiply each department’s floor space ratio by the total overhead Step 2. Calculate the ratio for each department based on floor space Step 1. Calculate the total square feet in all departments

Calculating the Distribution of Overhead by Floor Space Department A - 2,500 square feet, Department B - 5,500 square feet Department C - 2,000 square feet, Overhead of $100,000 Floor space Ratio Department A 2,500 2,500 = 25% 10,000 Department B 5,500 5,500 = 55% Department C 2,000 2,000 = 20% Department A .25 x $100,000 = $25,000 Department B .55 x $100,000 = $55,000 Department C .20 x $100,000 = $20,000 Step 1 & 2

Calculating the Distribution of Overhead by Sales Sales Ratio Department A $150,000 $150,000 = .75 $200,000 Department B 50,000 $50,000 = .25 $200,000 $200,000 Department A .75 x $50,000 = $37,500 Department B .25 x $50,000 = $12,500 Total Overhead Expenses Step 3. Multiply the total sales in all departments Step 2. Calculate the ratio for each department based on sales Step 1. Calculate the total sales in all departments