C.

Gross Profit Method of Estimating

Inventory
• To determine ending inventory.
• When do we use gross profit method ?
• When we only need to estimate company’s inventory.
• When fire or other catasthrophe destroys either inventory or inventory
records.
• Relies on 3 assumptions :
• The beginning inventory plus purchases equal total goods to be accounted for.
• Goods not sold must be on hand.
• The sales, reduced to cost, deducted from the sum of the opening inventory
plus purchases, equal ending inventory.
• Illustration
• Cetus Corp. has a beginning inventory of €60,000 and purchases of €200,000, both at
cost. Sales at selling price amount to €280,000. The gross profit on selling price is 30
percent. Cetus applies the gross profit method as follows.
• Answer
Beginning inventory (at cost) € 60.000
Purchases (at cost) 200.000
Goods available (at cost) 260.000
Sales (at selling price) € 280.000
Less: Gross profit (30%*280.000) 84.000
Sales (at cost) 196.000
Approximate inventory (at cost) 64.000
Computation of Gross Profit Percentage
• Gross profit percentage  percentage of selling price.
• Gross profit on selling price is the common method for quoting the
profit, because :
• Most companies state goods on a retail basis, not a cost basis.
• A profit quoted on seliing price is lower than one based on cost.
• The gross profit based on selling price can never exceed 100%.
• There’s 2 method :
• Markup / Retail
• Markup / Cost
•  Example : Assume that an article costs $ 15 and sells for $20, a gross
profit of $5.
• = = 25% at retail
• = = 33,3% on cost
• Basic relationship between markup on cost and markup on selling
price :
Example  Assume that a company marks up a given item by 25% on
cost. What, then, is the gross profit on selling price ?
 Answer  Assume that the item sells for $1. Here’s the following formula
applies.
Cost + Gross Profit = Selling price
C + 0,25 C = SP
(1+0,25) C = SP
1,25C = $ 1
C = $ 0,80
So, the rate of gross profit on selling price is
$ 1 - $ 0,80 = $ 0,20
Gross profit on selling price = $ 0,20 / $1 = 20%
• Conversevely, assume that the gross profit on selling price 20%. What is the markup
cost ?
• Answer  Assume that the item sells for $1. Again, the same formula holds:
Cost + Gross Profit = Selling Price
C + 0,20 SP= SP
C = (1-0,20) SP
C = 0,80 SP
C = 0,80 * $1
C = $ 0,80
So, the markup on cost is
$1 - $ 0,80 = $ 0,20
Gross on cost = $ 0,20 / $ 0,80 = 25%
•  Formula to express these relationship :
• Gross Profit on Selling Price =
• Percentage Markup on Cost =
• Illustration