8 Inventory Estimation

HAND-OUT NO.
8: INVENTORY ESTIMATION
Brian Christian S. Villaluz, CPA
FINANCIAL ACCOUNTING AND REPORTING
HAND-OUT NO. 8: Inventory Estimation
The cost of inventories may be estimated using either the:

(1) Gross profit method
(2) Retail method
Gross Profit Method

 This can be used to estimate ending inventory and cost of goods sold when a physical count is not possible.
 It can also be used to evaluate the reasonableness of a given inventory amount and in reconstructing financial
records.
 This method may be used to estimate inventories for interim reporting purposes but generally not acceptable for
external financial reporting.
 Under the gross profit method, gross profit is assumed to be relatively constant from period to period.
Problem 1: (Gross profit method)

PP Company reported the following information for the current year:
Beginning inventory P 5,000,000

Purchases 26,000,000
Freight in 2,000,000
Purchase returns and allowances 3,500,000
Purchase discounts 1,500,000
Sales 40,000,000
Sales returns 3,000,000
Sales allowances 500,000
Sales discounts 1,000,000
A physical inventory taken at year-end resulted in an ending inventory of P4,000,000.
At year-end, unsold goods out on consignment with selling price of P1,000,000 are in the hands of a consignee.
The gross profit was 40% of sales.
1. What is the estimated cost of inventory shortage?

A. 1,800,000 B. 2,700,000
C. 1,200,000 D. 2,100,000
Problem 2: (Gross profit method)

On the night of September 30, 2020, a fire destroyed most of the merchandise inventory of AA Company.
All goods were completely destroyed except for partially damaged goods that normally sell for P100,000 and that had an
estimated net realizable value of P25,000 and undamaged goods that normally sell for P60,000.
Inventory, January 1 P 660,000

Net purchases, January through September 30 4,240,000
Net sales, January 1 through September 30 5,600,000
Total 2019 2018 2017

Net sales 9,000,000 5,000,000 3,000,000 1,000,000
Cost of sales 6,750,000 3,840,000 2,200,000 710,000
Gross profit 2,250,000 1,160,000 800,000 290,000
What is the estimated amount of fire loss on September 30, 2020?

A. 700,000 B. 615,000
C. 630,000 D. 580,000
Page 1 of 3
HAND-OUT NO. 8: INVENTORY ESTIMATION
RETAIL METHOD
This method is often used in the retail industry (e.g., supermarkets and department stores) for measuring large quantities
of inventories with rapidly changing items and with similar margins and for which it is impracticable to use other costing
methods. Net markups and net markdowns are considered in this method.
The retail method is applied using:

1. Conservative approach
2. Average cost approach
3. FIFO approach
Problem 3: (Comprehensive: Retail Method)

Ching Company used the retail inventory method to approximate the ending inventory:
Cost Retail
Beginning inventory 650,000 1,200,000
Purchases 9,220,000 15,070,000
Freight in 200,000
Purchase returns 300,000 500,000
Purchases allowances 150,000
Departmental transfer in 320,000 560,000
Departmental transfer out 120,000 260,000
Markup 400,000
Markup cancellation 100,000
Markdown 1,200,000
Markdown cancellation 200,000
Sales 9,500,000
Sales discounts 100,000
Employee discounts 500,000
Estimated normal shoplifting loss 600,000
Estimated normal shrinkage 400,000
Abnormal spoilage 220,000 370,000
1. What is the estimated cost of ending inventory using the conservative approach?
A. 2,400,000 B. 2,460,000
C. 3,060,000 D. 2,700,000
2. What is the estimated cost of ending inventory using the average cost approach?
A. 2,560,000 B. 2,624,000
C. 3,264,000 D. 2,880,000
3. What is the estimated cost of ending inventory using the FIFO approach?
Problem 4: (Answer: A)
DDT Company had the following amounts all at retail:
Beginning inventory 180,000

Purchases 6,000,000
Purchase return 300,000
Net markup 900,000
Net markdown 140,000
Sales 3,600,000
Sales return 90,000
Employee discounts 80,000
Normal shortage 130,000
Abnormal shortage 200,000
What is the ending inventory at retail?

A. 2,720,000 B. 2,800,000
C. 2,880,000 D. 2,920,000
Page 2 of 3
HAND-OUT NO. 8: INVENTORY ESTIMATION
Problem 5: (Retail Method; FIFO) (Answer: A)
Last Company used the FIFO retail method of inventory valuation. The company provided the following information for the
current year:
Cost Retail
Beginning inventory 600,000 1,500,000
Purchases 3,000,000 5,500,000
Net additional markups 500,000
Net markdowns 1,000,000
Sales revenue 4,500,000
What is the estimated cost of ending inventory?

A. 1,200,000 B. 1,040,000
C. 1,000,000 D. 960,000
FINANCIAL ACCOUNTING THEORIES

1. The gross profit method of estimating ending inventory may be used for all of the following, except
A. Internal as well as external interim reports.
B. Internal as well as external year-end reports.
C. Estimate of inventory destroyed by fire or other casualty.
D. Rough test of the validity of an inventory cost determined under either periodic or perpetual system.
2. The gross profit method assumes that

A. The amount of gross profit is the same as in prior years.
B. Sales and cost of goods sold have not changed from previous years.
C. Inventory values have not increased from previous years.
D. The relationship between selling price and cost of goods sold is similar to prior years.
3. To produce an inventory valuation which approximates the lower of cost and NRV using the retail method, the
computation of the ratio of cost to retail should
A. Include markups but not markdowns.
B. Include markups and markdowns.
C. Ignore both markups and markdowns.
D. Include markdowns but not markups.
END OF HANDOUT
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HAND-OUT NO.

The cost of inventories may be estimated using either the:

Gross Profit Method

Problem 1: (Gross profit method)

Beginning inventory P 5,000,000

A physical inventory taken at year-end resulted in an ending inventory of P4,000,000.

The gross profit was 40% of sales.

1. What is the estimated cost of inventory shortage?

Problem 2: (Gross profit method)

Inventory, January 1 P 660,000

Total 2019 2018 2017

What is the estimated amount of fire loss on September 30, 2020?

The retail method is applied using:

Problem 3: (Comprehensive: Retail Method)

Beginning inventory 180,000

What is the ending inventory at retail?

What is the estimated cost of ending inventory?

FINANCIAL ACCOUNTING THEORIES

2. The gross profit method assumes that

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