Inventory estimation techniques
B-COM Part 1 Accounts Notes
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INVENTORY ESTIMATION TECHNIQUES
If a business uses a periodic or perpetual inventory system, a physical asset-in-hand account should occur from time to time. The quantities determined by the physical count are presumed to be correct, and any difference between the physical account and the amounts reflected in the accounting records must be accompanied by an adjustment of the accounting records. Sometimes, however, a physical account may not be possible or is not profitable. Then, estimation methods are used.
GROSS PROFIT METHOD
Such an estimation technique is the gross profit method. This method could be used to estimate the available stocks for the purposes of preparing monthly or quarterly financial statements, and would certainly come into play if a fire or other disaster destroyed the inventory.Such estimates are often used by insurers to establish the amount lost by the Insured Party.Quite simply, a company's historical normal gross profit rate (ie gross profit as a percentage of sales) would be used to estimate the amount of gross margin and cost of sales. Once these data are known, it is relatively simple to project the lost inventory. For example, suppose the Tiki inventory was destroyed by fire. Sales for the year, before the date of the fire, were $ 1,000,000 and Tiki usually sells goods at a gross profit rate of 40%. As a result, Tiki can easily estimate that the cost of the goods sold was $ 600,000. Tiki's start-of-year stock was $ 500,000 and purchases of $ 800,000 had taken place prior to the date of the fire. Inventory destroyed by fire can be estimated using the gross profit method, as indicated.
Retail method
One method that is widely used by merchandising companies to estimate or estimate end-of-year stocks is the retail method. This method would only work when a retail inventory category has a constant mark-up. The percentage of the retail cost is multiplied multiplied by the end-of-sale inventory. The end of retail inventory can be determined by a physical account of the assets available, at their retail value. Or, sales could be subtracted from goods available for retail sale. This option is illustrated in the following example. For example, Crock Buster, a specialty kitchenware store, sells jars costing $ 7.50 for $ 10, representing a 75% retail cost. Initial inventory was $ 200,000 (at cost), purchases at $ 300,000 (at cost), and sales at $ 460,000 (retail). The calculations suggest a final inventory that has a cost of $ 155,000. When reviewing these calculations, note that the only "data" is circled in yellow. These three data points are manipulated by the cost for the percentage of detail to be solved for several unknowns. Be sure to note that the percentage factor is divided in the red arrows and multiplied in the blue.
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