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

3. 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

4. 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

5. 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

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

7. 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)

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

9. 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

10. Weighted Average Method
Number of Cost Total
Units Purchased per unit cost
Beginning inventory $ $650
First purchase (Jan 15)
Second purchase (Feb. 24)
Third purchase (Apr. 17)
Fourth purchase (Aug. 24)
Goods available for sale $1,750
Units sold
Units in ending inventory
Weighted avg = Total cost of goods available for sale = $1,750 = $
Unit cost Total number of units available for sale
Average cost of ending inventory: 52 units at $ = $568.75
Cost of goods sold = $1,750 - $ = $1,181.25

11. 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

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

13. 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

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

15. Summary Top down to inventory level (52) 50 x $13 = $650 2 x $12 = 24
$ 508
$1,750
= $
$ 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 =
$674

16. 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

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

18. Estimating Inventory - Gross Profit Method
Assuming the following, calculate the estimated inventory
Gross profit on sales %
Beginning inventory June 1, $15,000
Net purchases ,000
Net sales at retail for June ,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)

19. Estimating Inventory - Gross Profit Method
Beginning Inventory, June 1, $15,000
Net purchases ,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 (Step 2)
Estimated cost of goods sold ,500
Estimated ending inventory, June 30, 2004 $12,500 (Step 3)

20. 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

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

22. 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

23. 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 = 25%
10,000
Department B 5, ,500 = 55%
Department C 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

24. Calculating the Distribution of Overhead by Sales
Sales Ratio
Department A $150,000 $150,000 = .75
$200,000
Department B ,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