© 2015 Cengage Learning. All Rights Reserved. LESSON 5-3 Estimating the Inventory Learning Objectives LO5 Estimate the cost of merchandise inventory. LO6 Calculate the inventory turnover ratio and days’ sales in inventory. © 2015 Cengage Learning. All Rights Reserved.

Gross Profit Method of Estimating Inventory Lesson 5-3 Gross Profit Method of Estimating Inventory LO5 Estimating inventory by using the previous year’s percentage of gross profit on operations is known as the gross profit method of estimating inventory. © 2015 Cengage Learning. All Rights Reserved.

Retail Method of Estimating Inventory Lesson 5-3 Retail Method of Estimating Inventory LO5 Estimating inventory by using a percentage based on both cost and retail prices is called the retail method of estimating inventory. © 2015 Cengage Learning. All Rights Reserved.

Financial Analysis of Merchandise Inventory Lesson 5-3 Financial Analysis of Merchandise Inventory LO6 INVENTORY TURNOVER RATIO: The number of times the average amount of merchandise inventory is sold during a specific period of time is called the inventory turnover ratio. Cost of Merchandise Sold ÷ Average Merchandise Inventory Inventory Turnover Ratio = A low inventory turnover ratio indicates a low return on investment. DAYS’ SALES IN INVENTORY: The time needed to sell an average amount of merchandise inventory is called the days’ sales in inventory. ÷ Inventory Turnover Ratio = Days’ Sales in Inventory Days in Year © 2015 Cengage Learning. All Rights Reserved.

Lesson 5-3 Audit Your Understanding 1. On what assumptions is the gross profit method of estimating inventory based? ANSWER That a continuing relationship exists between gross profit and net sales. © 2015 Cengage Learning. All Rights Reserved.

Lesson 5-3 Audit Your Understanding 2. To use the retail method of estimating inventory, what records must be kept? ANSWER Separate records of both cost and retail prices for net purchases, net sales, and the beginning merchandise inventory. © 2015 Cengage Learning. All Rights Reserved.

Lesson 5-3 Audit Your Understanding 3. Explain an inventory turnover ratio of 5.0. ANSWER An inventory ratio of 5.0 means the business sold its average merchandise inventory 5 times during the current year. © 2015 Cengage Learning. All Rights Reserved.

Lesson 5-3 Audit Your Understanding 4. Explain a days’ sales in inventory of 60. ANSWER On average, each item in merchandise inventory is sold 60 days after it is purchased. © 2015 Cengage Learning. All Rights Reserved.