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INVENTORIES AND
THE COST OF GOODS
SOLD
Chapter
8
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Inventory
Inventory
Goods ownedand held for sale
to customers
Goods ownedand held for sale
to customers
Currentasset
Currentasset
Inventory Defined
Inventory Defined
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INCOME STATEMENT
Revenue
Cost of goods sold Gross proft
E!penses
Net ncome
As purchase cost"or manufacturng
costs# are ncurred
as goodsare sold
$A%ANCE S&EET
Current assets'
Inventory
$ $
$
The Flow of Inventory Costs
The Flow of Inventory Costs
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GENERA% (O)RNA%
*ate Account Ttles and E!planaton *e,t Credt
Entry on +urchase *ate
Inventory ----
Accounts +aya,le ----
Entry on Sale *ate
Cost of Goods Sold ----
Inventory ----
In a perpetual nventory system. nventory entresparallel the flow of costs/
The Flow of Inventory Costs
The Flow of Inventory Costs
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0hen dentcal unts of nventory havedfferent unt costs. a 1ueston naturally
arses as to whch of these costs should ,e
used n recordng a sale of nventory/
Which Unit Did We Sell?
Which Unit Did We Sell?
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A separate subsidiary account is maintained foreach item in inventory.
A separate subsidiary account is maintained foreach item in inventory.
&ow can we determne the unt cost for the Sept/ 23 sale4
Item %%335 +rmary suppler Electronc Cty
*escrpton %aser %ght Secondar
y suppler Electrc Company%ocaton Storeroo
m 5 Inventory level' Mn' 56 Ma!' 533
+urchased Sold $alance
*ate )nts
)nt
Cost Total )nts
)nt
Cost
Cost of
Goods
Sold )nts
)nt
Cost Total
Sept/ 6 233 73- 7.333- 233 73- 7.333-
Sept/ 8 96 63 7.963 233 73 7.333
96 63 7.963
Sept/ 23 23 4 4 4 4 4
4 4 4
Inventory Subsidiary Leder
Inventory Subsidiary Leder
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Specfcdentfcaton
%I:O
Averagecost
:I:O
0e use one of these nventory valuatonmethods to determne cost of nventory sold/
Inventory Cost FlowsInventory Cost Flows
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The $;e Company "T$C#
Infor!ation for the Followin Inventory"#a!les
Infor!ation for the Followin Inventory"#a!les
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8-
Secific Identification Secific Identification
0hen a unts sold. the
specfc cost ofthe unt sold s
added to cost ofgoods sold/
0hen a unt
s sold. thespecfc cost ofthe unt sold s
added to cost ofgoods sold/
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8-1!
On August 2
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The Cost of Goods Sold for the August 2< sale s-2.8>6. leavng -626 and 6 unts n nventory/
The Cost of Goods Sold for the August 2< sale s-2.8>6. leavng -626 and 6 unts n nventory/
Continue%et?s loo; at the entres for
the Aug/ 2< sale/
Secific Identification Secific Identification
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Continue
RetalRetal
CostCost
A smlar entry s
made after each sale/
A smlar entry smade after each sale/
Secific Identification Secific Identification
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Addtonal purchases were made on August 29 and 5>/
Costs assocated wth sales on August 72 were as follows' 2 @ -82.7 @ -23=. 26 @ -226. < @ -228/
Addtonal purchases were made on August 29 and 5>/
Costs assocated wth sales on August 72 were as follows' 2 @ -82.7 @ -23=. 26 @ -226. < @ -228/
Continue
Secific Identification Secific Identification
Cost of Goods
Sold forAugust 72 B
-5.=23
Cost of Goods
Sold forAugust 72 B
-5.=23
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$alance Sheet
Inventory B -2.786
Income Statement
COGS B -
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Snce specfcdentfcaton s so
easy. can?t we use tall the tme4
Not really/ Specfcdentfcaton s hard to use
when we sell a lot of
nventory that has lots ofdfferent costs/
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Cost of #oods Avai$ab$e for
%a$e
&nits on handon the date of
sa$e
%verae&Cost 'ethod%verae&Cost 'ethod
'hen a unit is so$d(the avera)e cost of each unit
in inventory is assi)ned tocostof )oods so$d.
'hen a unit is so$d(the avera)e cost of each unit
in inventory is assi)ned tocostof )oods so$d.
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On August 2
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Continue
The average cost perunt s -233/
The average cost perunt s -233/
%et?s loo; at the entres
for the Aug/ 2< sale/
%verae&Cost 'ethod%verae&Cost 'ethod
-233 B -5.633 ÷ 56-233 B -5.633 ÷ 56
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Continue
RetalRetal
CostCost
A smlar entry s
made after each sale/
A smlar entry smade after each sale/
%verae&Cost 'ethod%verae&Cost 'ethod
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Addtonal purchases were made on August 29 andAugust 5>/
On August 72. an addtonal 57 unts were sold/
Addtonal purchases were made on August 29 and
August 5>/
On August 72. an addtonal 57 unts were sold/
Continue
%verae&Cost 'ethod%verae&Cost 'ethod
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-22< B -7.883 ÷ 76-22
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-22< B -7.883 ÷ 76-22
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Income Statement
COGS B -
-22< D 25 B -2.7=>-22< D 25 B -2.7=>
%verae&Cost 'ethod%verae&Cost 'ethod
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Costs of
Goods Sold
Costs ofGoods Sold
EndngInventory
EndngInventory
Oldest
Costs
OldestCosts
RecentCosts
RecentCosts
First&In( First&)ut 'ethod *FIF)+First&In( First&)ut 'ethod *FIF)+
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On August 2
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RetalRetal
CostCost
ContinueA smlar entry s
made after each sale/
A smlar entry smade after each sale/
First&In( First&)ut 'ethod *FIF)+First&In( First&)ut 'ethod *FIF)+
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Addtonal purchases were made on Aug/ 29 and Aug/ 5>/
On August 72. an addtonal 57 unts were sold/
Addtonal purchases were made on Aug/ 29 and Aug/ 5>/
On August 72. an addtonal 57 unts were sold/
Continue
First&In( First&)ut 'ethod *FIF)+First&In( First&)ut 'ethod *FIF)+
Cost of Goods Sold for August 72 B -5.=33Cost of Goods Sold for August 72 B -5.=33
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$alance Sheet
Inventory B -2.
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Costs of
Goods Sold
Costs ofGoods Sold
EndngInventory
EndngInventory
Recent
Costs
RecentCosts
OldestCosts
OldestCosts
Last&In( First&)ut 'ethod *LIF)+Last&In( First&)ut 'ethod *LIF)+
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On August 2
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Continue
RetalRetal
CostCost
A smlar entry smade after each sale/
A smlar entry smade after each sale/
Last&In( First&)ut 'ethod *LIF)+Last&In( First&)ut 'ethod *LIF)+
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Continue
Last&In( First&)ut 'ethod *LIF)+Last&In( First&)ut 'ethod *LIF)+
Addtonal purchases were made on Aug/ 29 and Aug/ 5>/
On Aug/ 72. an addtonal 57 unts were sold/
Addtonal purchases were made on Aug/ 29 and Aug/ 5>/
On Aug/ 72. an addtonal 57 unts were sold/
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Continue
Last&In( First&)ut 'ethod *LIF)+Last&In( First&)ut 'ethod *LIF)+
Cost of Goods Sold for August 72 B -5.=>6Cost of Goods Sold for August 72 B -5.=>6
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$alance Sheet
Inventory B -2.5=3
Income Statement
COGS B -36
End/ Inv/ 2.5=3-
6 @ 82- "
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Once a company hasadopted a partcular
accountng method. tshould follow that
method consstently.
rather than swtchmethods from oneyear to the ne!t/
The ,rincile of ConsistencyThe ,rincile of Consistency
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In a perodc nventory system. nventory entres areas follows/
Note that an entry s notmade to nventory/
Note that an entry s not made to nventory/
,eriodic Inventory Syste!s,eriodic Inventory Syste!s
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In a perodc nventory system. nventory entres areas follows/
,eriodic Inventory Syste!s,eriodic Inventory Syste!s
8 38
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The nventory onhand and thecost of goods
sold for the year
are notdetermned untlyearend/
,eriodic Inventory Syste!s,eriodic Inventory Syste!s
8 3
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Specfcdentfcaton
%I:O
Averagecost
:I:O
0e use one of these nventory valuatonmethods n a perodc nventory system/
,eriodic Inventory Syste!s,eriodic Inventory Syste!s
8 4!
I f i f h F ll i I
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Computers. Inc/Mouse +ad Inventory
*ate )nts -F)nt Total
$egnnng
Inventory 2.333 6/56- 6.563/33-
+urchases'
(an/ 7 733 6/73 2.683/33
(une 53 263 6/=3 >3 2.2=3/33
Nov/ 58 263 6/83 >>6/33
Goods
Avala,le
for Sale 2.>33 8.956/33-
Endng
Inventory 2.533 4
Cost of
Goods Sold =33 4
Infor!ation for the Followin Inventory"#a!les
Infor!ation for the Followin Inventory"#a!les
8 41
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$y revewng actualpurchase nvoces.
Computers. Inc/ determnes
that the 2.533 mouse padson hand at yearend have
an actual total cost of-=.
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Computers. Inc/Mouse +ad Inventory
*ate )nts -F)nt Total
$egnnng
Inventory 2.333 6/56- 6.563/33-
+urchases'
(an/ 7 733 6/73 2.683/33
(une 53 263 6/=3 >3 2.2=3/33
Nov/ 58 263 6/83 >>6/33
Goods
Avala,le
for Sale 2.>33 8.956/33-
Endng
Inventory 2.533 =.
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*ota$ Cost of#oods
Avai$ab$e for%a$e
*ota$ +umberof &nits
Avai$ab$e for%a$e
The average cost scalculated at year
end as follows'
The average cost scalculated at year
end as follows'
%verae&Cost 'ethod%verae&Cost 'ethod
8-44
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Computers. Inc/Mouse +ad Inventory
*ate )nts -F)nt Total
$egnnng
Inventory 2.333 6/56- 6.563/33-
+urchases'
(an/ 7 733 6/73 2.683/33 (une 53 263 6/=3 >3 2.2=3/33
Nov/ 58 263 6/83 >>6/33
Goods
Avala,le
for Sale 2.>33 8.956/33-
Endng
Inventory 2.533 4
Cost of
Goods Sold =33 4
Avg/ Cost -8.956 ÷ 2.>33 B-6/
Avg/ Cost -8.956÷
2.>33 B-6/
%verae&Cost 'ethod%verae&Cost 'ethod
Computers. Inc/Mouse +ad Inventory
*ate )nts -F)nt Total
$egnnng
Inventory 2.333 6/56- 6.563/33-
+urchases'
(an/ 7 733 6/73 2.683/33 (une 53 263 6/=3 >3 2.2=3/33
Nov/ 58 263 6/83 >>6/33
Goods
Avala,le
for Sale 2.>33 8.956/33-
Endng
Inventory 2.533 =.7/33-
Cost of
Goods Sold =33 7.5
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Costs of
Goods Sold
Costs ofGoods Sold
EndngInventory
EndngInventory
Oldest
Costs
OldestCosts
RecentCosts
RecentCosts
First&In( First&)ut 'ethod *FIF)+First&In( First&)ut 'ethod *FIF)+
8-46
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Remem,er' Startwth the 22F58
purchase and thenadd other purchasesuntl you reach the
num,er of unts nendng nventory/
First&In( First&)ut 'ethod *FIF)+First&In( First&)ut 'ethod *FIF)+
Computers. Inc/Mouse +ad Inventory
*ate )nts -F)nt Total
$egnnng
Inventory 2.333 6/56- 6.563/33-
+urchases'
(an/ 7 733 6/73 2.683/33 (une 53 263 6/=3 >3 2.2=3/33
Nov/ 58 263 6/83 >>6/33
Goods
Avala,le
for Sale 2.>33 8.956/33-
Endng
Inventory 2.533 4
Cost of
Goods Sold =33 4
8-47
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*ate $eg/ Inv/ +urchases End/ Inv/Cost of
Goods Sold
Nov/ 58 263@-6/83 263@-6/83
)nts 263
Now. let?s complete theta,le/
Now. let?s complete theta,le/
First&In( First&)ut 'ethod *FIF)+First&In( First&)ut 'ethod *FIF)+
*ate $eg/ Inv/ +urchases End/ Inv/Cost of
Goods Sold
2.333@-6/56 =33@-6/56
3 533@-6/>3
Nov/ 58 263@-6/83 263@-6/83
)nts 2.533 =33
Now. we have allocatedthe cost to all 2.533 unts
n endng nventory/
*ate $eg/ Inv/ +urchases End/ Inv/Cost of
Goods Sold
2.333@-6/56 =33@-6/56
3 533@-6/>3
Nov/ 58 263@-6/83 263@-6/83
)nts 2.533 =33
Costs -=.696 -7.263
Cost of Goods Avala,le for Sale -8.956
8-48
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Completng the ta,lesummares the
computatons Hustmade/
First&In( First&)ut 'ethod *FIF)+First&In( First&)ut 'ethod *FIF)+
Computers. Inc/Mouse +ad Inventory
*ate )nts -F)nt Total
$egnnng
Inventory 2.333 6/56- 6.563/33-
+urchases'
(an/ 7 733 6/73 2.683/33 (une 53 263 6/=3 >3 2.2=3/33
Nov/ 58 263 6/83 >>6/33
Goods
Avala,le
for Sale 2.>33 8.956/33-
Endng
Inventory 2.533 =.696/33-
Cost of
Goods Sold =33 7.263/33-
8-4
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Costs of
Goods Sold
Costs ofGoods Sold
EndngInventory
EndngInventory
Recent
Costs
RecentCosts
OldestCosts
OldestCosts
Last&In( First&)ut 'ethod *LIF)+Last&In( First&)ut 'ethod *LIF)+
8-5!
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Remem,er' Start wth,egnnng nventoryand then add otherpurchases untl youreach the num,er of
unts n endngnventory/
Last&In( First&)ut 'ethod *LIF)+Last&In( First&)ut 'ethod *LIF)+
Computers. Inc/Mouse +ad Inventory
*ate )nts -F)nt Total
$egnnng
Inventory 2.333 6/56- 6.563/33-
+urchases'
(an/ 7 733 6/73 2.683/33 (une 53 263 6/=3 >3 2.2=3/33
Nov/ 58 263 6/83 >>6/33
Goods
Avala,le
for Sale 2.>33 8.956/33-
Endng
Inventory 2.533 4
Cost of
Goods Sold =33 4
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*ate $eg/ Inv/ +urchases End/ Inv/Cost of
Goods Sold
2.333@-6/56 2.333@-6/56
)nts 2.333
Last&In( First&)ut 'ethod *LIF)+Last&In( First&)ut 'ethod *LIF)+
*ate $eg/ Inv/ +urchases End/ Inv/Cost of
Goods Sold
2.333@-6/56 2.333@-6/56
(an/ 7 733@-6/73 533@-6/73
233@-6/73
)nts 2.533 233
Now. we have allocatedthe cost to all 2.533 unts
n endng nventory/
Ne!t. let?scomplete the
ta,le/
Ne!t. let?scomplete the
ta,le/
*ate $eg/ Inv/ +urchases End/ Inv/Cost of
Goods Sold
2.333@-6/56 2.333@-6/56
(an/ 7 733@-6/73 533@-6/73
233@-6/73
(une 53 263@-6/=3 263@-6/=3
Sept/ 26 533@-6/>3 533@-6/>3
Nov/ 58 263@-6/83 263@-6/83
)nts 2.533 =33
Costs -=.723 -7.
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Completng the ta,lesummares the
computatons Hustmade/
Last&In( First&)ut 'ethod *LIF)+Last&In( First&)ut 'ethod *LIF)+
Computers. Inc/Mouse +ad Inventory
*ate )nts -F)nt Total
$egnnng
Inventory 2.333 6/56- 6.563/33-
+urchases'
(an/ 7 733 6/73 2.683/33 (une 53 263 6/=3 >3 2.2=3/33
Nov/ 58 263 6/83 >>6/33
Goods
Avala,le
for Sale 2.>33 8.956/33-
Endng
Inventory 2.533 =.723/33-
Cost of
Goods Sold =33 7.
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Errors n Measurng Inventory$egnnng Inventory Endng Inventory
Effect on Income Statement Overstated )nderstated Overstated )nderstated
Goods Avala,le for Sale NE NE
Cost of Goods Sold
Gross +roft
Net Income
Effect on $alance Sheet
Endng Inventory NE NE
Retaned Earnngs
An error n endng nventory n a year wll result n the same error n the ,egnnng nventory of the ne!t year/
An error n endng nventory n a year wll result n the same error n the ,egnnng nventory of the ne!t year/
I!ortance of an %ccurate -aluation ofInventory
I!ortance of an %ccurate -aluation ofInventory
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: or nt er m f nancal st at ement s. w e may need t o est mat e endng nv ent or y and cost of
goods sold/
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*etermne cost of goods
avala,le for sale/
Estmate cost of goods
sold ,y multplyng the net
sales ,y the cost rato/
*educt cost of goods sold
from cost of goodsavala,le for sale to
determne endng
nventory/
*etermne cost of goods
avala,le for sale/
Estmate cost of goods
sold ,y multplyng the netsales ,y the cost rato/
*educt cost of goods sold
from cost of goodsavala,le for sale to
determne endng
nventory/
The .ross ,rofit 'ethodThe .ross ,rofit 'ethod
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,n arch of 2!!5( ChemCos inventory /as destroyedby fire. ChemCos norma$ )ross profit ratio is 3!0 of
net sa$es. At the time of the fire( ChemCo sho/edthe fo$$o/in) ba$ances
,n arch of 2!!5( ChemCos inventory /as destroyedby fire. ChemCos norma$ )ross profit ratio is 3!0 of
net sa$es. At the time of the fire( ChemCo sho/edthe fo$$o/in) ba$ances
Sales 72.633-
Sales returns 2.633 $egnnng Inventory 25.333
Net cost of goods purchased 53.633
Sales 72.633-
Sales returns 2.633 $egnnng Inventory 25.333
Net cost of goods purchased 53.633
The .ross ,rofit 'ethodThe .ross ,rofit 'ethod
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#oods Avai$ab$e for %a$e
e)innin) ,nventory 12(!!!
+et cost of )oods purchased 2!(5!!
#oods avai$ab$e for sa$e 32(5!!
ess estimated cost of )oods so$d
%a$es 31(5!!
ess sa$es returns 1(5!!
+et sa$es 3!(!!!
stimated cost of )oods so$d 21(!!!
stimated arch inventory $oss 11(5!!
Estmatng InventoryThe Gross +roft Method
The .ross ,rofit 'ethodThe .ross ,rofit 'ethod
D 93J
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The /etail 'ethodThe /etail 'ethod
*he retai$ method of estimatin) inventory reuiresthat mana)ement determine the va$ue of endin)
inventory at retai$ prices.
*he retai$ method of estimatin) inventory reuiresthat mana)ement determine the va$ue of endin)
inventory at retai$ prices.
#oods avai$ab$e for sa$e at cost 32(5!!
#oods avai$ab$e for sa$e at retai$ 5!(!!!
9hysica$ count of endin) inventory priced at retai$ 22(!!!
Informaton for ChemCo
The Retal Method
,n arch of 2!!5( ChemCos inventory /as destroyedby fire. At the time of the fire( ChemCos
mana)ement co$$ected the fo$$o/in) information
,n arch of 2!!5( ChemCos inventory /as destroyedby fire. At the time of the fire( ChemCos
mana)ement co$$ected the fo$$o/in) information
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The /etail 'ethodThe /etail 'ethod
a #oods avai$ab$e for sa$e at cost 32(5!!
b #oods avai$ab$e for sa$e at retai$ 5!(!!! c Cost ratio :a ÷ b; 650
d 9hysica$ count of endin) inventory priced at retai$ 22(!!!
e stimated endin) inventory at cost : c × d; 14(3!!
Estmatng Inventory
The Retal Method
ChemCo /ou$d fo$$o/ the steps be$o/ toestimate their endin) inventory usin) the retai$
method.
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"nd of Chater 8"nd of Chater 8