The Mathematics of Money

598 Chapter 15 Payroll and Inventory

Cost of goods sold 
 Starting inventory  Purchases  Ending inventory

Cost of goods sold 
 $545,636  $1,275,936  $659,800

Cost of goods sold 
 $1,161,772

The method of inventory valuation does not matter here; regardless of how the inven-

tory was calculated, the cost of goods sold can be determined in the same way. However,

different inventory methods place different values on inventory. If a business wants to

minimize its calculated profits (and hence minimize its calculated taxes), the business may

have reason to select the valuation method that tends to make its cost of goods sold appear

highest.

Valuing Inventory at Retail

Sometimes a business may choose to evaluate its inventory on the basis of retail prices

rather than on cost. Valuing inventory at retail would not require Stassler Hardware to

make any assumptions about which lot each light bulb came from. The store’s manage-

ment simply needs to count the number of light bulbs it has and multiply this by the retail

price. To determine the overall business’s inventory at retail, the management would

simply need to add up the total retail prices for all the merchandise in inventory.

Knowing the inventory value at retail can also provide a way of estimating the inven-

tory at cost. Any business’s management should have a reasonable idea of what percent of

retail sales the merchandise’s cost represents, on average. Applying this percentage to the

inventory’s value at retail provides an estimate of the value at cost.

Example 15.2.6 Stassler Hardware has 1,675 Kandelrite brand 14-watt compact

fl uorescent light bulbs in stock, which sell for a retail price of $2.75. The store’s

management knows that on average the cost of the light bulbs it sells is 55% of the

retail price. Use these facts to estimate the inventory value at cost.

The total inventory of these bulbs at cost would be (1,675 bulbs)($2.75/bulb) 


$4,606.25.

Assuming that the cost is 55% of the retail price, this inventory would be valued at:

(55%)($4,604.25) 
 $2,533.44

While this example calculates the inventory value for only one particular item, a similar

calculation could be used to estimate the inventory value at cost for the company’s entire

inventory. For a company with a very large number of different products, using this method

could be much simpler than having to examine the company’s orders for hundreds or thou-

sands of different products. Unfortunately this method provides only an estimate of the

inventory value at cost.

A similar approach can be applied to estimate the cost of goods sold.

Example 15.2.7 The Plum Street Pharmacy had retail sales totaling $1,475,023 in

the third quarter. Their cost of goods sold normally averages approximately 78%. Use

these facts to estimate the cost of the goods sold in the third quarter.

(78%)($1,475,023) 
 $1,150,517.94

Cost Basis

Investors who buy and sell stocks (and other similar investments) are required to pay capital

gains taxes (a type of income tax) on the profits (called capital gains) they make from their

investments. If a stock investment is made all at once, and the entire investment is sold at

once, calculating the capital gain is simple a matter of finding the difference between the

sale price and the amount paid for the shares sold (called the cost basis). If, however, the

purchases are made at different prices at different times, and the stock is not sold all at once,

determining the capital gain depends on which shares of stock are assumed to be sold.