Lesson Title: Chapter 3-Estimating Inventories
Lesson Objectives:
At the end of the module, the learners will be able to:
• Identify the techniques used to estimate the cost of inventories.
• Solve the inventory estimation problems using the following methods: gross profit rate,
FIFO retail, and average retail.
Lectures and annotations:
Inventory estimation methods – it is necessary when physical count is deemed impossible
due to some circumstances and immediate inventory data is needed. The two methods
being used are;
• Gross profit method
• Retail inventory method
Purpose for inventory valuation estimates:
• For interim financial reporting
• Inventory reasonableness
• Other extraordinary circumstances
Gross Profit Method
A type of inventory estimation that allows the use of gross profit percentage based on
either cost of goods sold or net sales to estimate inventory value:
• GPR based on sales – the amount of net sales (base amount) is assumed to be 100%
• GPR based on cost – cost of goods sold (base amount) is assumed to be 100%
GP on sales
GP on cost
Net sales
xxx
100%
more than 100%
Cost of goods sold
xxx
less than 100%
100%
GP
xxx
less than 100%
less than 100%
Illustration:
During the year, a company reported net sale of P3.6M and cost of goods sold of P2.7M.
Requirement:
Compute the GPR based on the ff:
1. Net sales
2. Cost of goods sold
Net sales
Cost of goods sold
GP
3.6M
2.7M
.9M
GP based on sales
100%
75%
25% GPR
GP based on cost
133%
100%
33% GPR
Accounting procedures for gross profit method:
1. Compute for the estimated amount of cost of goods sold (CGS)
• Formula: Net sales – Gross profit
Gross profit is computed, viz;
 If gross profit is based on sales : Net sales x GPR on sales
 If gross profit is based on cost: Net sales/100% + GPR on cost x GPR on cost
(1.33%)
Cost ratio can also be computed as follows;
1. 100% - GPR on sales
2. Cost of goods sold/Net sales
Net sales is computed as follows;
Sales
xxx
Less: sales returns
xxx
Net sales
xxx
2. Compute for the amount of inventory that should be on hand:
Inventory, beg.
xxx
Add: Purchases
xxx
Cost of goods available for sale
xxx
Less: Estimated cost of good sold (from step 1) xxx
Inventory that should be on hand
xxx
• Included in the computation of net purchases; purchase returns, allowances and
discounts
• Excluded in computation of net sale; sales allowances and discounts
3. Determine if there is an inventory shortage or overage.
Compare the actual inventory vs estimated inventory
Lesson Title: Chapter 3-Estimating Inventories
Retail inventory method – inventory estimation that applies information for retail, which is
the selling price, to determine its relationship with costs, specifically the cost ratio and
also the estimated ending inventory.
Accounting procedures:
1. Compute for the amount of goods available for sale at cost and retail
2. Compute for the amount of cost of goods sold at retail:
Sales
xxx
Sales returns
(xxx)
Sales allowances
-
Sales discounts
-
Employee discounts
xxx
Normal loss
xxx
Cost of goods sold at retail
xxx
3. Compute for the amount of estimated ending inventory at retail:
Goods available for sale at retail
xxx
Less: Cost of goods sold at retail
xxx
Estimated ending inventory at retail
xxx
4. Compute for the estimated cost of the ending inventory:
Estimated ending inventory at retail
xxx
Multiply by cost to retail ratio
%
-----
Estimated cost of ending inventory
xxx
-
Methods in computing for the Cost-to-Retail ratio
1. Conservative method
• Under this method, it considers all the effects of price markups but does not consider
price markdowns.
• Formula:
Goods available for sale at cost
---------------------------------------------
Goods available for sale at retail + net markdown
2. Average method
• Under this method, it consider both price markups and price markdowns.
• Formula
Goods available for sale at cost
-------------------------------------------------------------------------
Goods available for sale at retail
3. FIFO method
• Under this method, it is only based on current period purchases which excludes
beginning inventory based on the claim that markups and markdowns are applied only
to purchases during the period and not on beginning inventory.
• Formula:
Goods available for sale at cost – beginning inventory at cost
----------------------------------------------------------------------------------Goods available for sale at retail – beginning inventory at retail
Illustration:
Requirements: Provide an estimate of ending inventory under each method:
a. conservative method
b. average method
c. FIFO method
a. Only the price markup and related cancellation is considered to get the cost-to-retail
ratio.
b. To compute for the cost-to-retail ratio, the price markups and markdowns with related
cancellations are being considered.
c. Exclude beginning inventory, to compute for the cost-to-retail ratio include the following
purchases , price markups and markdowns with related cancellations:
References:
Millan, ZV. B. (2020). Intermediate Accounting 1A & 1B. Baguio City: Bandolin Enterprise Publishing
Ocampo, R. R. (2022). Intermediate Accounting Volume 1. Manila: DomDane Publishers
Robles, N. S., Empleo, P. M. (2022). The Intermediate Accounting Volume 2. Quezon City: EDT Book
Publishing
Valix, C. T. , Peralta, J. F., Valix C.A. M., (2021). Intermediate Accounting Volume 1. Manila: GIC
Enterprises & Co., Inc.
Villaluz, BC. S., Cruz, MS. M. (2022). Financial Accounting and Reporting. Cainta, Rizal: BCV
Accounting Bookshop