1. INVENTORY AND OVERHEAD
Chapter Eighteen
McGraw-Hill/Irwin
Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Learning unit objectives
LU 18-1: 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.
LU 18-2: Retail Method; Gross Profit Method; Inventory Turnover; Distribution of Overhead
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.
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3. 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.

4. Blue Company Inventory Information
Number of Cost Total
Units Purchased per Unit Cost
Beginning inventory 40 $ $320
First purchase (April 1)
Second purchase (May 1)
Third purchase (Oct. 1)
Fourth purchase (Dec. 1)
Goods available for sale $1,200
Units sold
Units in ending inventory 48
Step 1

5. Specific Identification Method
Beg
Inv.
4/1
5/1
10/1
12/1
Step 1. Calculate the cost of goods (merchandise available for sale).
Step 2. Calculate the cost of ending inventory.
Step 3. Calculate the cost of goods sold (Step 1 -- Step 2).

6. Specific Identification Method
Cost per Unit Total Cost
20 units from April 1 $ 9 $180
20 units from Oct
8 units from Dec
Cost of ending inventory $524
Step 2
Cost of goods Cost of ending = Cost of
available for sale inventory goods sold
$1, $ = $676
Step 3

7. Weighted-Average Method
Beg
Inv.
4/1
5/1
10/1
12/1
Step 1. Calculate the average unit cost.
Step 2. Calculate the cost of ending inventory.
Step 3. Calculate the cost of goods sold (Step 1 -- Step 2).

8. Weighted-Average Method
Number of Cost Total
Units Purchased per Unit Cost
Beginning inventory $ $320
First purchase (April 1)
Second purchase (May 1)
Third purchase (Oct. 1)
Fourth purchase (Dec. 1)
Goods available for sale $1,200
Units sold
Units in ending inventory
Weighted average = Total cost of goods available for sale
unit cost Total number of units available for sale
$1,200
120 = =
$10
Average cost of ending inventory: 48 units at $10 = $480
Cost of goods sold =
$1, $480 = $720

9. First-In, First-Out Method
Beg
Inv.
4/1
5/1
10/1
12/1
Step 1. List the units to be included in the ending inventory and their costs.
Step 2. Calculate the cost of ending inventory.
Step 3. Calculate the cost of goods sold (Step 1 -- Step 2).

10. First-In, First-Out Method
Number of Cost Total
Units Purchased per Unit Cost
Beginning inventory $ $320
First purchase (April 1)
Second purchase (May 1)
Third purchase (Oct. 1)
Fourth purchase (Dec. 1)
Goods available for sale $1,200
Units sold
Units in ending inventory
20 units from Dec. 1 at $13 $260
20 units from Oct. 1 at $
8 units from May 1 at $
48 units in ending inventory $580
Goods available for sale -- Cost of ending inventory = Cost of goods sold
$1, $ = $620

11. Last-In, First-Out Method
Beg
Inv.
4/1
5/1
10/1
12/1
Step 1. List the units to be included in the ending inventory and their costs.
Step 2. Calculate the cost of ending inventory.
Step 3. Calculate the cost of goods sold (Step 1 -- Step 2).

12. Last-In, First-Out Method
Number of Cost Total
Units Purchased per Unit Cost
Beginning inventory 40 $ $320
First purchase (April 1)
Second purchase (May 1)
Third purchase (Oct. 1)
Fourth purchase (Dec. 1)
Goods available for sale $1,200
Units sold 72
Units in ending inventory
40 units from beginning inventory at $8 $320
8 units from Apr. 1 at $
48 units in ending inventory $392
Goods available for sale -- Cost of ending inventory = Cost of goods sold
$1, $ = $808

13. Summary

14. 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.

15. Estimating Inventory – Retail Method
Cost Retail
Beginning inventory $4,000 $6,000
Net purchases during month 2, ,000
Cost of goods available for sale (Step 1) $6,300 $9,000
Less net sales for month (Step 3) 4,000
Ending inventory at retail $5,000
Cost ratio ($6,300/$9,000) (Step 2) %
Ending inventory at cost ($5,000 x .70) (Step 4) $3,500

16. Estimating Inventory – Gross Profit Method
Example:
Assuming the following, calculate the estimated inventory.
Gross profit on sales %
Beginning inventory, Jan. 1, $20,000
Net purchases ,000
Net sales at retail for Jan ,000
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).

17. Estimating Inventory – Gross Profit Method
Beginning inventory, June 1, $20,000
Net purchases ,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%) (Step 2) x
Estimated cost of goods sold ,400
Estimated ending inventory, Jan. 30, 2013 (Step 3) $19,600

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

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

20. 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.

21. Calculating the Distribution of Overhead by Floor Space
Roy Company
Department A - 6,000 square feet Department B - 3,000 square feet Department C - 1,000 square feet Overhead of $90,000
Floor Space Ratio
Department A 6, ,000 = 60%
10,000
Department B 3, ,000 = 30%
Department C 1, ,000 = 10%
Step 1 & 2
Department A .60 x $90,000 = $54,000
Department B .30 x $90,000 = $27,000
Department C .10 x $90,000 = $ 9,000

22. 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 each department’s sales ratio by the total overhead.

23. Calculating the Distribution of Overhead by Sales
Morse Company distributes its overhead expenses based on the sales of its departments. For example, last year Morse’s overhead expenses were $60,000. Sales of its two departments were as follows, along with its ratio calculation.
Sales Ratio
Department A $80,000 $ 80, = .80
$100,000
Department B 20, $20, = .20
$100,000 $100,000
Department A .80 x $60,000 = $48,000
Department B .20 x $60,000 = $12,000
$60,000
Total overhead expenses