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18-2 Chapter 18 Inventory and Overhead McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

18-3 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 Learning Unit Objectives Assigning Costs to Ending Inventory - Specific Identification; Weighted Average; FIFO; LIFO LU18.1

18-4 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 and Overhead #18 Learning Unit Objectives Retail Method; Gross Profit Method; Inventory Turnover; Distribution of Overhead LU18.2

18-5 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

18-6 Number of Cost Total Units Purchasedper unit cost Beginning Inventory 50$13 $650 First Purchase (Jan 15) Second Purchase (Feb. 24) Third Purchase (Apr. 17) Fourth Purchase (Aug. 24) Goods available for sale 160 $1,750 Units Sold 108 Units in ending inventory 52 Jay Company - Inventory Information Step 1

18-7 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) Beg Inv. 1/15 2/24 4/17 8/24 Specific Identification Method

18-8 Cost per unitTotal cost 10 Units from Jan. 15$12$ Units from Feb. 24$ Units from Apr. 17$ Units from Aug. 24$8 48 $508 Cost of goods - Cost of ending = Cost of available for sale inventory goods sold $1,750 - $508 = $1,242 Step 3 Step 2 Specific Identification Method

18-9 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 Beg Inv. 1/15 2/24 4/17 8/24

18-10 Number of Cost Total Units Purchasedper unit cost Beginning inventory 50$13 $650 First purchase (Jan 15) Second purchase (Feb. 24) Third purchase (Apr. 17) Fourth purchase (Aug. 24) Goods available for sale 160 $1,750 Units sold 108 Units in ending inventory 52 Weighted Average Method Weighted avg = Total cost of goods available for sale = $1,750 = $ Unit cost Total number of units available for sale 160 Average cost of ending inventory: 52 units at $ = $ Cost of goods sold = $1,750 - $ = $1,181.25

18-11 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. 1/15 2/24 4/17 8/24

18-12 FIFO (Bottom Up) Number of Cost Total units purchasedper unit cost Beginning Inventory 50$13 $650 First Purchase (Jan 15) Second Purchase (Feb. 24) Third Purchase (Apr. 17) Fourth Purchase (Aug. 24) Goods available for sale 160 $1,750 Units Sold 108 Units in ending inventory 52 First-In, First-Out Method 20 Units from Aug. 24 at $8$ Units from Apr. 17 at $ Units from Feb. 24 at $ units in ending inventory$460 Cost of goods sold: $1,750 - $460 = $1,290

18-13 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. 1/15 2/24 4/17 8/24

18-14 LIFO (Top Down) Number of Cost Total Units Purchasedper unit cost Beginning Inventory 50$13 $650 First Purchase (Jan 15) Second Purchase (Feb. 24) Third Purchase (Apr. 17) Fourth Purchase (Aug. 24) Goods available for sale 160 $1,750 Units Sold 108 Units in ending inventory 52 Last-In, First-Out Method 50 Units from beginning inventory at $13$650 2 Units from Jan/ 15 at $ units in ending inventory$674 Cost of goods sold: $1,750 - $674 = $1,076

18-15 Summary Top down to inventory level (52) 50 x $13 = $650 2 x $12 = 24 $674 Bottom up to inventory level (52) 20 x $8 = $ x $9 = x $10= 120 $460 $1, = $ $ x 52 = $ x $12 = $ x $10 = x $ 9 = x $ 8 = 48 $ 508

18-16 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 cost Cost 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

18-17 CostRetail 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 - Retail Method

18-18 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 June 1, 2004$20,000 Net purchases 8,000 Net sales at retail for June 12,000

18-19 Beginning Inventory, June 1, 2006$20,000 Net purchases 8,000 Cost of goods available for sale (Step 1)$28,000 Less estimated cost of good sold: Net sales at retail$12,000 Cost Percentage (100% - 30%) x.70 (Step 2) Estimated cost of goods sold - 8,400 Estimated ending inventory, June 30, 2006$19,600 (Step 3) Estimating Inventory - Gross Profit Method

18-20 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

18-21 Inventory Turnover Net sales $32,000Cost of goods sold $22,000 Beginning inventory at retail 11,000Beginning inventory at cost 7,500 Ending inventory at retail 8,900Ending inventory at cost 5,600 Average inventory = Beginning inventory + Ending inventory 2 At retail = $32,000 = $32,000 = 3.22 $11,000 + $8,900 $9,950 2 At cost = $22,000 = $22,000 = 3.36 $7,500 + $5,600 $ 6,550 2 Usually higher due to theft, spoilage, markdowns, etc.

18-22 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

18-23 Department A - 2,500 square feet Department B - 5,500 square feet Department C - 2,000 square feet Overhead of $100,000 Floor spaceRatio Department A2,500 2,500 = 25% 10,000 Department B5,500 5,500 = 55% 10,000 Department C2,000 2,000 = 20% 10,000 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 Floor Space

18-24 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 the total sales in all departments SalesRatio 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