Lecture Practical business math procedures (11/e) - Chapter 18: Inventory and overhead

After studying this chapter you will be able to: list the key assumptions of each inventory method, calculate the cost of ending inventory and cost of goods sold for each inventory method, 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

Chapter Eighteen

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 18-1: Assigning Costs to Ending Inventory - Specific

Identification; Weighted Average; FIFO; LIFO

Learning unit objectives

LU 18-2: 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

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

Number of Cost Total

Beginning inventory 40 $8 $320

First purchase (April 1) 20 9 180

Second purchase (May 1) 20 10 200

Third purchase (Oct 1) 20 12 240

Fourth purchase (Dec 1) 20 13 260

Goods available for sale 120 $1,200 Units sold 72

Units in ending inventory 48

Blue Company Inventory Information

Step 1

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).

Cost per Unit Total Cost

Cost of goods Cost of ending = Cost of

available for sale inventory goods sold

$1,200 $524 = $676

Specific Identification Method

Step 2

Step 3

Step 2 Calculate the cost of ending inventory.

Weighted-Average Method

Weighted average = Total cost of goods available for sale

unit cost Total number of units available for sale Average cost of ending inventory: 48 units at $10 = $480 Cost of goods sold = Number of Cost Total Units Purchased per Unit Cost Beginning inventory 40 $ 8 $320

First purchase (April 1) 20 9 180

Second purchase (May 1) 20 10 200

Third purchase (Oct 1) 20 12 240

Fourth purchase (Dec 1) 20 13 260

Goods available for sale 120 $1,200 Units sold 72

Units in ending inventory 48

= $1,200

120 = $10

$1,200 $480 = $720

Step 2 Calculate the cost of ending inventory.

First-In, First-Out Method

Step 1 List the units to be included in the ending inventory and their

costs

Beg

Inv.

First-In, First-Out Method

Goods available for sale Cost of ending inventory = Cost of goods sold

Beginning inventory 40 $ 8 $320

First purchase (April 1) 20 9 180

Second purchase (May 1) 20 10 200

Third purchase (Oct 1) 20 12 240

Fourth purchase (Dec 1) 20 13 260

Goods available for sale 120 $1,200 Units sold 72

Units in ending inventory 48 20 units from Dec 1 at $13 $26020 units from Oct 1 at $12 240 8 units from May 1 at $10 80

48 units in ending inventory $580

$1,200 $580 = $620

Step 2 Calculate the cost of ending inventory.

Last-In, First-Out Method

Step 1 List the units to be included in the ending inventory and their costs.

Beg

Inv.

Last-In, First-Out Method

$1,200 $392 = $808

Number of Cost Total Units Purchased per Unit Cost Beginning inventory 40 $8 $320

First purchase (April 1) 20 9 180

Second purchase (May 1) 20 10 200

Third purchase (Oct 1) 20 12 240

Fourth purchase (Dec 1) 20 13 260

Goods available for sale 120 $1,200 Units sold 72 Units in ending inventory 48

Goods available for sale Cost of ending inventory = Cost of goods sold 40 units from beginning inventory at $8 $320 8 units from Apr 1 at $9 72

48 units in ending inventory $392

Summary

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.

Cost Retail

Cost of goods available for sale (Step 1) $6,300 $9,000

Ending inventory at cost ($5,000 x 70) (Step 4) $3,500

Estimating Inventory –

Retail Method

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, Jan 1, 2013 $20,000 Net purchases 8,000

Net sales at retail for Jan 12,000

Example:

Beginning inventory, June 1, 2013 $20,000

Cost of goods available for sale (Step 1) $28,000

Less estimated cost of good sold:

Cost percentage (100% - 30%) (Step 2) x .70

Estimated ending inventory, Jan 30, 2013 (Step 3) $19,600

Estimating Inventory – Gross Profit Method

Inventory Turnover

Inventory turnover is the number of times inventory is replaced during a specific time

Net sales Average inventory at retail

Cost of goods sold Average inventory at cost Inventory turnover at cost =

Inventory turnover at retail =

Inventory Turnover

Net sales $32,000 Cost of goods sold $22,000Beginning inventory at retail 11,000 Beginning inventory at cost 7,500

Ending inventory at retail 8,900 Ending inventory at cost 5,600

Average inventory = Beginning inventory + Ending inventory

At retail =

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

Department A - 6,000 square feet Department B - 3,000 square feet

Department C - 1,000 square feet Overhead of $90,000

Floor Space RatioDepartment A 6,000 6,000 = 60%

10,000Department B 3,000 3,000 = 30%

10,000Department C 1,000 1,000 = 10%

10,000Department A 60 x $90,000 = $54,000

Calculating the Distribution of Overhead by

Floor Space

Roy Company

Step 1 & 2

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

Calculating the Distribution

of Overhead by Sales

Department A $80,000 $ 80,000 = 80

$100,000Department B 20,000 $20,000 = 20

$100,000 $100,000Department A 80 x $60,000 = $48,000

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