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FINANCIAL ACCOUNTING AND REPORTING

GROSS PROFIT AND RETAIL METHOD TO ESTIMATE INVENTORY

 Common reasons to estimate the amount of inventory on hand are the following:

a) Inventory has been destroyed by an unforeseen event such as fire, typhoon and other
natural calamities and the value of the inventory that was lost is needed for claims
against insurance companies.

b) To verify the value of the inventory based on the physical count. If the difference
between the physical count and the estimate is significant, an investigation or a higher
degree of diligence shall be exerted on the count.

c) To determine the amount of inventory for interim reporting purposes. The actual
amount is not necessary and an estimate shall be sufficient.

 Gross Profit Method – Based on the assumption that the gross profit applied by an entity
to its products remains approximately the same from period to period and therefore the
relationship between cost of goods sold and sales is constant.

Goods available for sale X

Less: Estimated cost of goods sold
Net sales* X
Less: Gross profit X X
Estimated ending inventory X

The cost of goods sold can also be computed if the net sale is multiplied by 1 less the GP
rate if the gross profit rate based on sales or net sales divided by 1 plus the gross profit
rate if the gross profit rate is based on cost.

*Net sales shall be gross sales less “sales returns and allowance” or “sales returns” only in
order for the estimate in ending inventory not to be overstated.

 Retail Method – Employed by retailers dealing with numerous different items for sale with
varying mark up percentages to keep track unit cost.

Goods available for sale at retail X

Less: Net sales X
Employee discounts X
Normal losses X X
Estimated ending inventory X
Multiplied by the cost ratio %
Estimated ending inventory at cost X

 Conservative Cost Ratio = GAS at cost divided by GAS at retail before net markdown
 Average Cost Ratio = GAS at cost divided by GAS at retail (after net markdown)
 FIFO Cost Ratio = Purchases at cost divided by Purchases at retail after net markdown
 Net sales similar to the “gross profit method” of estimation is computed by ignoring the
sales discount and sales allowance if it is separated from sales returns.

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