18-1. 18-2 Chapter 18 Inventory and Overhead McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved

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Chapter 18Chapter 18Inventory and OverheadInventory and Overhead

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

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• List the key assumptions of each inventory method

• Calculate the cost of ending inventory and cost of goods sold for each inventory method

Inventory and Overhead#18#18Learning Unit ObjectivesAssigning Costs to Ending Inventory - Specific Identification; Weighted Average; FIFO; LIFO

LU18.1LU18.1

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• 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#18#18Learning Unit ObjectivesRetail Method; Gross Profit Method; Inventory Turnover; Distribution of Overhead

LU18.2LU18.2

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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

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Number of Cost Total

Units Purchased per unit cost

Beginning Inventory 50 $13 $650

First Purchase (Jan 15) 30 12 360

Second Purchase (Feb. 24) 40 10 400

Third Purchase (Apr. 17) 20 9 180

Fourth Purchase (Aug. 24) 20 8 160

Goods available for sale 160 $1,750

Units Sold 108

Units in ending inventory 52

Jay Company - Inventory Information

Step 1

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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)

BegInv.

1/15 2/24 4/17 8/24

Specific Identification Method

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Cost per unit Total cost

10 Units from Jan. 15 $12 $120

16 Units from Feb. 24 $10 160

20 Units from Apr. 17 $9 180

6 Units from Aug. 24 $8 48

$508Cost of goods - Cost of ending = Cost ofavailable for sale inventory goods sold

$1,750 - $508 = $1,242Step 3 Step 2

Specific Identification Method

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Weighted-Average Method

Step 1. Calculate the average unit cost

BegInv.

1/15 2/24 4/17 8/24

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Number of Cost Total


Beginning inventory 50 $13 $650

First purchase (Jan 15) 30 12 360

Second purchase (Feb. 24) 40 10 400

Third purchase (Apr. 17) 20 9 180

Fourth purchase (Aug. 24) 20 8 160


Units sold 108


Weighted Average Method

Weighted avg = Total cost of goods available for sale = $1,750 = $10.9375

Unit cost Total number of units available for sale 160

Average cost of ending inventory: 52 units at $10.9375 = $568.75

Cost of goods sold = $1,750 - $568.75 = $1,181.25

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First-In, First-Out Method

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

BegInv.

1/15 2/24 4/17 8/24

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FIFO (Bottom Up) Number of Cost Total

units purchased per unit cost







Units Sold 108


First-In, First-Out Method

20 Units from Aug. 24 at $8 $160

20 Units from Apr. 17 at $9 180

12 Units from Feb. 24 at $10 120

52 units in ending inventory $460

Cost of goods sold:

$1,750 - $460 =

$1,290

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Last-In, First-Out Method

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

BegInv.

1/15 2/24 4/17 8/24

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LIFO (Top Down) Number of Cost Total








Units Sold 108


Last-In, First-Out Method

50 Units from beginning inventory at $13 $650

2 Units from Jan/ 15 at $12 24

52 units in ending inventory $674

Cost of goods sold:

$1,750 - $674 =

$1,076

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Summary

Inventory Cost of Goods Cost of endingmethod available for sale inventory

Specific Id. 1,750$ $1,750 - $508 = $1,242

Weighted Avg. 1,750$ $1,750 - $568.75 = $1181.25

FIFO 1,750$ $1,750 - $460 = $1,290

LIFO 1,750$ $1,750 - $674 = $1,076

Cost of goodssold

Top down to inventory level (52)50 x $13 = $650 2 x $12 = 24 $674

Bottom up to inventory level (52)20 x $8 = $16020 x $9 = 18012 x $10= 120 $460

$1,750

160 = $10.9375

$10.9375 x 52 = $568.75

10 x $12 = $12016 x $10 = 16020 x $ 9 = 180 6 x $ 8 = 48 $ 508

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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 costCost 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

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Cost Retail

Beginning Inventory $2,000 $3,800

Net purchases during month 1,000 1,200

Cost of goods available for sale (Step 1) $3,000 $5,000

Less net sales for month 3,100

Ending Inventory at retail (Step 3) $1,900

Cost ratio ($3,000/$5,000) (Step 2) 60%

Ending Inventory at cost ($1,900 x .60) (Step 4) $1,140

Estimating Inventory - Retail Method

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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 June 1, 2004 $20,000

Net purchases 8,000

Net sales at retail for June 12,000

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Beginning Inventory, June 1, 2006 $20,000

Net purchases 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%) x .70 (Step 2)

Estimated cost of goods sold - 8,400

Estimated ending inventory, June 30, 2006 $19,600 (Step 3)

Estimating Inventory - Gross Profit Method

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Inventory Turnover

The number of times inventory is replaced during a specific time

Inventory turnover at retail = Net salesAverage inventory at retail

Inventory turnover at cost = Cost of goods soldAverage inventory at cost

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Inventory Turnover

Net sales $32,000 Cost of goods sold $22,000

Beginning 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 2

At retail = $32,000 = $32,000 = 3.22 $11,000 + $8,900 $9,950

2

At cost = $22,000 = $22,000 = 3.36 $7,500 + $5,600 $ 6,550

2

Usually higher due to theft, spoilage, markdowns, etc.

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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

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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 2,500 = 25%10,000

Department B 5,500 5,500 = 55%10,000

Department C 2,000 2,000 = 20%10,000

Department A .25 x $100,000 = $25,000Department B .55 x $100,000 = $55,000Department C .20 x $100,000 = $20,000

Step 1 & 2

Calculating the Distribution of Overhead by Floor Space

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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 the total sales in all departments

Sales RatioDepartment A $150,000 $150,000 = .75

$200,000Department B 50,000 $50,000 = .25

$200,000 $200,000

Department A .75 x $50,000 = $37,500Department B .25 x $50,000 = $12,500

TotalOverhead Expenses

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18-1. 18-2 Chapter 18 Inventory and Overhead McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved