INVENTORY ESTIMATION

Why do we use Inventory Estimation?

1. The inventory is destroyed by fire and other catastrophe, or theft of the merchandise has occurred, and the
amount of inventory is required for insurance purposes.
• Girl, The inventories are on fire!! So in order to determine how much you’ve lost from the fire, we do
estimation.
2. A physical count of the goods on hand is made and it is necessary to prove the correctness of reasonableness of
such count by making an estimate.
3. Interim financial statements are prepared and a physical count of the goods on hand is not necessary either
because it may take time to do the same or because only an estimate thereof is required to fairly present the
financial position and performance of the entity.
• Besh, It will take a lot of time and effort to do actual count, especially if its only interim FS (Means more or
less 6 – 9 months yung inaaudit mo). To save those time and effort and make more memorable moment
with your loved ones, you will just estimate the inventories held.

There are 2 approaches in estimating the value of the inventory

1. Gross Profit Method

2. Retail Inventory Method

GROSS PROFIT METHOD

The basis of our gross method is the entity’s past experience, the average gross profit may be used to estimate the cost
of goods as well as the ending inventory to be reported in interim financial statements. Gross profit method may be used
when the relationship between gross profit and sales remains stable over time.

You should NOT use gross profit method when there is a significant change in the mix of products being sold and gross
margin percentages significantly during the year and you should not estimate inventories to be reported in the annual
financial statement, because the basis of such must be based on ACTUAL INVENTORY COUNT and adjustments discussed
earlier (In transit goods, consigned goods, etc.)

FORMULA:

Depending on what is given, the following are the procedural steps in computing for estimated cost of inventory and
inventory loss:

1. Determine the Gross Profit Rate

2. Determine the Cost Ratio (Cost Ratio = 100% - GP Rate)
3. Compute for Net Sales (Sales less sales return ONLY)
4. Compute for the estimated COGS (COGS = Cost ratio x Net Sales)
5. Compute for estimated inventory and inventory fire loss
RETAIL INVENTORY METHOD

It is a way of determining cost by starting with the selling price and deducting a suitable estimate of the profit margin.
The retail method is often used in the retail industry for measuring inventories of large numbers of rapidly changing
items with similar margins for which it is impracticable to use other costing methods.

The ratio exploited in this method is not the gross profit ratio but rather the cost ratio.

Following Computation illustrated the use of retail inventory method: