GROSS PROFIT METHOD

WIDELY ACCEPTED PROCEDURES FOR APPROXIMATING THE VALUE OF

INVENTORY
1. Gross profit method
2. Retail inventory method

Reasons for estimating the cost of goods on hand

• The inventory is destroyed by fire and other catastrophe
• Theft has occurred and the amount of inventory is required for insurance purposes
• Physical count of goods on hand is made and it is necessary to prove the
correctness or reasonableness of such count by making an estimate
• Interim FS are prepared and a physical count of the goods on hand is not necessary
because it may take time to do the same.

Sales allowances and sales discounts are ignored in gross profit method.
GROSS PROFIT METHOD
Goods available for Sale (GAS) xxx
Less: Cost of goods sold (COGS) xxx
Ending Inventory xxx

Beginning Inventory xxx

Purchases xxx
Add: Freight In xxx
Total xxx
Less: Purchase returns xxx xxx
Goods available for sale (GAS) xxx

Sales xxx
Less: COGS xxx
Gross Income xxx
GROSS PROFIT METHOD
Gross profit based on sales
Sales 100%
Less: COGS
Gross income
For example: gross profit is 40% based on sales
Sales 100%
Less: COGS 60%
Gross income 40%

Gross profit based on cost

Sales
Less: COGS 100%
Gross income
For example: gross profit is 40% based on cost
Sales 140%
Less: COGS 100%
Gross income 40%
13-1
Gross profit (based on sales) is 40%; Sales is the 100%
Sales 100% 4,500,000 Sales 100% 4,500,000
Less: COGS c Less: COGS 60% 2,700,000
Gross Profit/Income 40% 1,800,000 Gross Profit 40% 1,800,000

Beg. Inv. 650,000

Net Purchases (3,200,000 – 75,000 + 50,000) 3,175,000
Goods available for sale (GAS) 3,825,000
Less: COGS 2,700,000
Ending Inventory per record 1,125,000 A
13-2
Gross profit (based on sales) is 25%; Sales is the 100%
Net Sales 100% 3,300,000* Sales 100% 3,300,000
Less: COGS c Less: COGS 75% 2,475,000
Gross Profit/Income 25% 825,000 Gross Profit 25% 825,000

*Gross sales of P3,400,000 less P100,000 sales return; sales discount is ignored)

Beg. Inv. 650,000

Net Purchases (2,400,000 – 50,000 + 150,000) 2,500,000
Goods available for sale (GAS) 3,150,000
Less: COGS 2,475,000
Ending Inventory per record 675,000
Less: Physical inventory 400,000
Cost of missing inventory 275,000 A
13-3
Sales 5,600,000
Less: Sales return 400,000
Net sales 5,200,000
X cost ratio (100% - 25%) 75%
COGS 3,900,000 C
13-4 Gross profit (based on COGS) is 30%; COGS is the 100%
Sales 130% 7,280,000
Less: COGS 100% 5,600,000
Gross income/profit 30% 1,680,000
*COGS = 7,280,000 / 130% = 5,600,000

Beg. Inv. 1,100,000

Purchases 6,000,000
GAS 7,100,000
Less: COGS 5,600,000
Ending Inventory per record 1,500,000
Less: realizable value of damaged goods 100,000
Fire loss on inventory 1,400,000 B
13-5
(gross profit is based on sales – 40%)
Net sales (40,000,000 – 3,000,000) 37,000,000
COGS = 37,000,000 x 60% = 22,200,000

Beginning inventory 5,000,000

Net purchases (26,000,000 + 2,000,000 – 3,500,000 – 1,500,000) 23,000,000
Goods available for sale 28,000,000
Less: COGS 22,200,000
Inventory per record 5,800,000
Less: Physical count of goods 4,000,000
Goods out on consignment at COST (1,000,000 x 60%) 600,000
Cost of inventory shortage 1,200,000 C

Note: Purchase allowances and discounts should be considered

13-6
2021
COGS = Net Purchases less Ending Inv. = 5,600,000 – 100,000 – 1,000,000 = 4,500,000
Gross Profit = Net sales – COGS = 6,000,000 – 4,500,000 = 1,500,000
GP rate based on sales = 1,500,000 / 6,000,000 = 25%

2021
(gross profit is based on sales; Sales is 100%)
GP rate based on sales (as per company policy) = last year’s GP rate + 5% = 25% + 5% = 30%
Beg. Inv. 1,000,000
Net Purchases (8,000,000 – 500,000) 7,500,000
GAS 8,500,000
Less: COGS ( 9,000,000 x 70%) 6,300,000
Ending Inv. 2,200,000 A
13-7
A/R, beginning 700,000
Add: Credit Sales (SQUEEZE) 8,800,000
Subtotal 9,500,000 Work upward
Less: Collections 8,400,000
A/R, ending 1,100,000

Credit Sales 8,800,000

Add: Cash sales 900,000
Total Sales 9,700,000

(Gross profit based on sales – 40%; Sales is the 100%)

Beg. Inv. 1,500,000

Purchases 5,500,000
GAS 7,000,000
Less: COGS (9,700,000 x 60%) 5,820,000
Inventory Loss 1,180,000 A
13-8
Net Sales (2019-2021) 9,000,000
COGS (2019-2021) 6,750,000
GP (2019-2021) 2,250,000
Average GP Rate on sales = 2,250,000 / 9,000,000 = 25%
(Sales is 100%)

Inv. – Jan 01 660,000

Purchases 4,240,000
GAS 4,900,000
Less: COGS (5,600,000 x 75%) 4,200,000
Inv. – Sept 30 700,000
Less: undamaged goods (60,000 x 75%) 45,000
Partially damaged goods
cost (100,000 x 75%) 75,000
nrv 25,000
lcnrv 25,000 25,000
Fire loss 630,000 C
13-9
Net sales in 2021 (8,200,000 – 200,000) 8,000,000
Less: Cost of goods sold
Beginning inventory 2,000,000
Net Purchases (5,000,000 – 200,000) 4,800,000
Goods available for sale 6,800,000
Less: Ending Inventory 1,200,000 5,600,000
Gross profit 2,400,000
Gross profit rate (on sales) 2,400,000 / 8,000,000 = 30%

Beginning inventory 1,200,000

Add: Purchases 5,200,000
Purchase returns and allowances (240,000) 4,960,000
Cost of goods available for sale 6,160,000
Less: COGS (7,880,000 – 80,000) x 70%) 5,460,000
Inventory per record 700,000
Less: remaining inventory (not stolen) 100,000
Cost of stolen inventory 600,000 B
13-10
Gross profit is based on cost; cost is 100%, and sales is 120%)

Total sales for June (7,200,000 + 720,000) 7,920,000

Divide by Sales ratio 120%
COGS for the month of June 6,600,000 D

Total sales for July (7,360,000 + 800,000) 8,160,000 Total sales for Aug (7,600,000 + 1,040,000) 8,640,000
Divide by Sales ratio 120% Divide by Sales ratio 120%
COGS for the month of July 6,800,000 COGS for the month of Aug 7,200,000

Beginning inventory for the month of July = COGS of July x 30% = 6,800,000 x 30% = 2,040,000
Beginning inventory for the month of Aug = COGS of Aug x 30% = 7,200,000 x 30% = 2,160,000

Beginning inventory 2,040,000

Add: Purchases (SQUEEZE) 6,920,000
GAS 8,960,000 Work upward
Less: Ending inventory 2,160,000
COGS 6,800,000
13-11
Sales, 2018-2020 (2,500,000 + 2,700,000 + 2,800,000) 8,000,000
Gross profit, 2018-2020 (860,000 + 1,080,000 + 1,260,000) 3,200,000
Gross profit rate = 3,200,000 / 8,000,000 = 40%; COGS = 60%

1
A/P, beginning 400,000
Add: Purchases (SQUEEZE) 1,700,000 A
2,100,000
Less: Payments 1,600,000
A/P, ending 500,000

2
A/R, beginning 480,000
Add: Sales (SQUEEZE) 2,600,000 A
3,080,000
Less: Collections 2,640,000
A/R, ending 440,000
440,000 = 480,000 + sales – 2,640,000
13-11

3
Beginning inventory 500,000
Add: Purchases 1,700,000
Goods available for sale 2,200,000
Less: COGS (2,600,000 x 60%) 1,560,000
Inventory per record 640,000
Less: Goods out on consignment, cost 200,000 x 60% 120,000
salvage value of inventory 20,000 140,000
Fire loss 500,000 D
13-12
1
Raw materials used = raw materials, beginning + purchases + freight in – raw materials, ending
= 1,700,000 + 3,800,000 + 200,000 – 2,000,000
= 3,700,000 B
2
Total manufacturing cost = raw materials used + direct labor + manufacturing overhead
= 3,700,000 + 5,000,000 + 60%(5,000,000)
= 11,700,000 C *factory supplies are already included in manufacturing overhead
3
COGS = 20,000,000 X 70% = 14,000,000 D *Gross profit on sales is 30%
4
Total manufacturing cost 11,700,000
Add: Goods in process, Jan 01 4,300,000
Total cost of goods in process 16,000,000
Less: Goods in process, Dec 31 (SQUEEZE) 3,500,000 A
Cost of goods manufactured 12,500,000
Add: Finished goods, Jan 01 6,000,000
Goods available for sale 18,500,000
Less: Finished goods, Dec 31 4,500,000
Cost of goods sold 14,000,000
13-13

Physical inventory, 05/31/22 Purchases up to 05/31/22 Purchases up to 06/30/22

Balances 950,000 6,750,000 8,000,000
A 75,000
B (10,000) (15,000)
C (20,000) (20,000)
D (55,000) (55,000)
Adjusted 895,000 6,740,000 7,965,000

1
Cost of sales = 875,000 + 6,740,000 – 895,000 = 6,720,000
Sales – cost of sales = gross profit
8,400,000 – 6,720,000 = gross profit
Gross profit = 1,680,000

Gross profit rate = 1,680,000 / 8,400,000 = 20%; COGS rate = 80%

13-13
2
Sales as of June 30, 2022 9,600,000
Less: Sales as of May 31, 2022 8,400,000
Sales for the month of June 2022 1,200,000
3
Total sales 1,200,000
Less: products sold at COST 100,000
Products sold with profit 1,100,000

COGS with profit (1,100,000 x 80%) 880,000

COGS without profit 100,000
COGS during June 2022 980,000
4
Inventory, July 01, 2021 875,000
Add: Purchases for the month of June – as adjusted 7,965,000
Goods available for sale 8,840,000
Less: COGS
Sales with profit (9,500,000 x 80%) 7,600,000
Sales without profit 100,000 7,700,000
Inventory, June 30, 2022 1,140,000
13-14

1.
A/R, April 30 = A/R, March 31 + sales – collections – write-off
1,040,000 = 920,000 + sales – (440,000-20,000) – 60,000
1,040,000 – 920,000 + 420,000 + 60,000 = sales
Sales for the month of April = 600,000
Add: Sales up to March 31 3,600,000
Sales up to April 30 4,200,000

2
Accounts payable – April 30 (for April shipments) 340,000
Payment for April merchandise shipments 80,000
Purchase for the month of April 420,000
Purchases up to March 31 1,680,000
Total purchases up to April 30 2,100,000
13-14

3
Inventory. Jan 01 1,880,000
Add: Purchases 2,100,000
Less: purchase return 20,000 2,080,000
Goods available for sale 3,960,000
Less: COGS (4,200,000 x 60%) 2,520,000
Inventory, April 30 1,440,000

4
Inventory per record 1,440,000
Less: Goods in transit 100,000
Salvage value 140,000 240,000
Fire loss 1,200,000

13-15 DCDDA