INVENTORY AND
OVERHEAD
McGraw-Hill/Irwin
Chapter Fifteen
Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.
LEARNING UNIT OBJECTIVES
LU 15-1: Assigning Costs to Ending Inventory - Specific Identification; Weighted
Average; FIFO; LIFO
1.
List the key assumptions of each inventory method.
2.
Calculate the cost of ending inventory and cost of goods sold for each
inventory method.
LU 15-2: Retail Method; Gross Profit Method; Inventory Turnover; Distribution of
Overhead
1.
Calculate the cost ratio and ending inventory at cost for the retail
method.
2.
Calculate the estimated inventory using the gross profit method.
3.
Explain and calculate inventory turnover.
4.
Explain overhead; allocate overhead according to floor space and
sales.
15-2
INVENTORY SYSTEMS
Perpetual Inventory System –
Periodic Inventory System –
Keeps a running account of inventory
by updating with each transaction.
Relies on a physical count of inventory
done periodically.
15-3
BLUE COMPANY
INVENTORY INFORMATION
Beginning inventory
First purchase (April 1)
Second purchase (May 1)
Third purchase (Oct. 1)
Fourth purchase (Dec. 1)
Goods available for sale
Units sold
Units in ending inventory
Number of
Cost
Total
units purchased
40
20
20
20
20
120
72
48
per unit
$8
9
10
12
13
cost
$320
180
200
240
260
$1,200
Step 1
15-4
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).
15-5
SPECIFIC IDENTIFICATION METHOD
Cost per Unit
Total Cost
20 units from April 1
$ 9
$180
20 units from Oct. 1
12
240
8 units from Dec. 1
13
104
Cost of ending inventory
Cost of goods
available for sale
$1,200
$524
--
Cost of ending
inventory
=
Cost of
goods sold
--
$524
=
$676
Step 2
Step 3
15-6
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).
15-7
WEIGHTED-AVERAGE METHOD
Beginning inventory
Number of
Cost
Units Purchased
40
per Unit
$ 8
Cost
$320
9
10
12
13
180
200
240
260
$1,200
First purchase (April 1)
Second purchase (May 1)
Third purchase (Oct. 1)
Fourth purchase (Dec. 1)
Goods available for sale
20
20
20
20
120
Units sold
Units in ending inventory
72
48
Weighted average =
Total cost of goods available for sale =
unit cost
Total number of units available for sale
Total
$1,200 =
120
$10
Average cost of ending inventory: 48 units at $10 = $480
Cost of goods sold =
$1,200 -- $480 = $720
15-8
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).
15-9
FIRST-IN, FIRST-OUT METHOD
Number of
Cost
Total
Units Purchased
per Unit
Cost
40
$8
$320
20
9
180
20
10
200
20
12
240
20
13
260
120
$1,200
72 20 units from Dec. 1 at $13 $260
48 20 units from Oct. 1 at $12
240
Beginning inventory
First purchase (April 1)
Second purchase (May 1)
Third purchase (Oct. 1)
Fourth purchase (Dec. 1)
Goods available for sale
Units sold
Units in ending inventory
8 units from May 1 at $10
48 units in ending inventory
Goods available for sale -- Cost of ending inventory =
$1,200
--
$580
=
80
$580
Cost of goods sold
$620
15-10
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).
15-11
LAST-IN, FIRST-OUT METHOD
Number of
Units Purchased
Cost
per Unit
Total
Cost
Beginning inventory
First purchase (April 1)
Second purchase (May 1)
Third purchase (Oct. 1)
Fourth purchase (Dec. 1)
40
20
20
20
20
$8
9
10
12
13
$320
180
200
240
260
Goods available for sale
Units sold
Units in ending inventory
120
72
48
$1,200
40 units from beginning inventory at $8 $320
8 units from Apr. 1 at $9
72
48 units in ending inventory
$392
Goods available for sale -- Cost of ending inventory =
$1,200
--
$392
=
Cost of goods sold
$808
15-12
SUMMARY
15-13
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.
15-14
ESTIMATING INVENTORY –
RETAIL METHOD
Cost
Retail
$4,000
$6,000
2,300
3,000
Cost of goods available for sale (Step 1)
$6,300
$9,000
Less net sales for month
(Step 3)
4,000
Beginning inventory
Net purchases during month
Ending inventory at retail
Cost ratio ($6,300/$9,000) (Step 2)
Ending inventory at cost (.70 x $5,000) (Step 4)
$5,000
70%
$3,500
15-15
ESTIMATING INVENTORY –
GROSS PROFIT METHOD
Example:
Assuming the following, calculate the estimated inventory.
Gross profit on sales
30%
Beginning inventory, Jan. 1, 2013
$20,000
Net purchases
8,000
Net sales at retail for Jan.
12,000
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).
15-16
ESTIMATING INVENTORY—
GROSS PROFIT METHOD
Beginning inventory, January 1, 2013
Net purchases
$20,000
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%) (Step 2)
x
.70
Estimated cost of goods sold
Estimated ending inventory, Jan. 31, 2013 (Step 3)
- 8,400
$19,600
15-17
INVENTORY TURNOVER
Inventory turnover is the number of times inventory is replaced during a specific time.
Inventory turnover at retail =
Inventory turnover at cost =
Net sales
Average inventory at retail
Cost of goods sold
Average inventory at cost
15-18
INVENTORY TURNOVER
Net sales
$32,000
Beginning inventory at retail
Ending inventory at retail
Cost of goods sold
11,000
8,900
$22,000
Beginning inventory at cost
7,500
Ending inventory at cost
5,600
Average inventory = Beginning inventory + Ending inventory
2
At retail =
At cost =
$32,000
$11,000 + $8,900
2
$22,000
$7,500 + $5,600
2
=
$32,000
$9,950
= 3.22
=
$22,000
$6,550
= 3.36 Usually higher due to
theft, spoilage,
markdowns, etc.
15-19
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.
15-20
CALCULATING THE DISTRIBUTION OF
OVERHEAD BY FLOOR SPACE
Roy Company
Department A
Department C
- 6,000 square feet
- 1,000 square feet
Department B - 3,000 square feet
Overhead of $90,000
Floor Space
Ratio
Department A
6,000
Department B
3,000
Department C
1,000
6,000 = 60%
10,000
3,000 = 30%
10,000
1,000 = 10%
10,000
Department A
Department B
Department C
.60 x $90,000 = $54,000
.30 x $90,000 = $27,000
.10 x $90,000 = $ 9,000
$90,000
Step 1 & 2
Step 3
15-21
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.
15-22
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.
Department A
Sales
$80,000
Department B
20,000
$100,000
Department A
Department B
.80 x $60,000 =
.20 x $60,000 =
Ratio
$ 80,000
$100,000
$20,000
$100,000
= .80
Step 1 & 2
= .20
$48,000
Step 3
$12,000
$60,000 Total overhead expenses
15-23