Inventory Estimation Examples, Concepts, Illustrations, Sample Help Online
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Understanding the concept of Inventory Estimation
A company may use periodic or perpetual inventory system but physical count of goods are assumed to be correct and if there is a difference in the result should be adjusted in accounting record. Sometimes physical count becomes impossible due to cost and then inventory estimates are employed.
Gross Profit Method is one such Inventory Estimation technique. Under this method gross profit as a percentage of sales is used to estimate the amount of gross profit and cost of sales. It is used for preparing financial statements.
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Let’s understand this concept with help of an example.
Example: suppose Mr. X’s inventory was destroyed by fire. Sales for the year, prior to the date of the fire were $1,000,000, and Mr. X usually sells goods at a 40% gross profit rate. Therefore, Mr. X can estimate that cost of goods sold was $600,000. Assuming sales to be 100% and the deducting gross profit rate which is 40%. This results in cost of goods sold rate as 60%. And 60% 0f $1000000= $600000. Beginning of year inventory was $500,000, and $800,000 in purchases had occurred prior to the date of the fire. The inventory destroyed by fire can be calculated as follows
Inventory lost in fire= $500000+$800000- $6000000 = $7000000.
there is another inventory estimation technique that is Retail Method.The cost-to-retail percentage is multiplied times ending inventory at retail. Ending inventory at retail can be calculated by a physical count of goods on hand, at their retail value. Or, sales is subtracted from goods available for sale at retail.
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