2.

Estimate the cost of goods sold by multiplying the net

sales by the cost ratio.

3. Deduct the cost of goods sold from the cost of goods

available for sale to find the estimated ending inventory.

To illustrate, assume that X Company has a

beginning inventory of L.E 57000 on January l. During the

month of January, net purchases amount to L.E 180000 and

net sales total 250000. Assume that the company's normal

gross profit rate is 30% of net sales; if follows that the cost

ratio is 70%. Using these facts, the inventory on January 31

may be estimated as follows:

Chapter Four: Inventories and the cost of goods sold

191

Exhibit 8

Goods available for sale: L.E 57000

Beginning inventory, Jan 1 180000

Purchases in January (net) L.E 237000

Cost of goods available for sale

Deduct: Estimated cost of goods sold:

Sales in January (net) L.E 250000

Less: estimated gross profit 75000

( L.E 250000 x 30% )

Estimated cost of goods sold 175000

Estimated ending inventory L.E 62000

The gross profit method of estimating inventory has

several uses apart from the preparation of monthly financial

statements. For example, if an inventory is destroyed by

fire, the company must determine the amount of the

inventory on hand at the date of the fire in order to file an

insurance claim. The most convenient way to determine

this inventory amount is often the gross profit method.

Chapter Four: Inventories and the cost of goods sold

192

The gross profit method is also used at year-end after

the taking of a physical inventory to confirm the overall

reasonableness of the amount determined by the counting

and pricing process.

B- The retail method:

The retail method of estimating inventory cost and the

cost of goods sold is based on the relationship of the cost of

goods available for sale to the retail price of the same

goods. This method is widely used by retail businesses,

such as department stores. To determine the ratio of cost to

retail (Selling) price of the current period, the business

must keep track of both the cost of all goods available for

sale during the period and also the retail sales prices

assigned to these goods. To use this method, as illustrated

in Exhibit 9, the retail prices of all goods acquired are

accumulated. Next, the inventory at retail is determined by

deducting net sales for the period from the retail price of
the goods that were available for sale during the period.

The estimate of inventory cost is then calculated by