INTERMEDIATE

ACCOUNTING I
Chapters 13-14
GROSS PROFIT
METHOD
Chapter 13
Learning objectives
1. To identify the methods of estimating inventory value.
2. To understand the rationale for making an estimate of inventory value.
3. To apply the gross profit method and retail inventory method of estimating inventory
value.
Use of estimate in inventory valuation
a. The inventory is destroyed by fire and other catastrophe, or theft of the merchandise
has occurred and the amount of inventory is required for insurance purposes.

b. A physical count of the goods on hand is made and it is necessary to prove the
correctness or reasonableness of such count by making an estimate.

c. Interim financial statements are prepared and a physical count of the goods on hand is
not necessary because it may take time to do the same.
■ It is assumed that the gross profit remains approximately the same from period to period.
■ Basic formula under gross profit method:
GOODS AVAILABLE FOR SALE (GAS) xxx
Less: COST OF GOODS SOLD xxx
ENDING INVENTORY xxx

■ GOODS AVAILABLE FOR SALE

Beginning inventory xxx
Purchases xxx
Add: Freight in xxx
Total xxx
Less: Purchases return, allowance and discount (xxx) xxx
Goods available for sale xxx
Cost of goods sold
The cost of goods sold is computed as follows:
a. Gross profit rate is based on sales: Net sales * Cost ratio

b. Gross profit rate is based on cost: Net sales / Sales ratio

GP based on sales
Problem 13-3
At year-end, Delectable Company experienced a storm surge which caused severe damage
to the entire inventory. Based on recent history, the entity had a gross profit of 25% on
sales.
The following information is available for the current year.

Beginning inventory 520,000

Purchases 4,120,000
Purchase returns 60,000
Sales 5,600,000
Sales returns 400,000
Sales allowances 100,000

What is the estimated cost of goods sold for the current year?
GP based on cost
Problem 13-4
On September 30, a fire at Elusive Company’s only warehouse caused severe damaged to
the entire inventory.
Based on recent history, the entity has a gross profit of 30% on costs of goods sold.
A physical inventory disclosed usable damaged goods which can be sold to a jobber for
P100,000.
The following information is available from the records for the nine months ended
September 30:
Inventory, January 1 1,100,000
Purchases 6,000,000
Net sales 7,280,000

What is the estimated amount of fire loss?

RETAIL INVENTORY
METHOD
Chapter 14
Information required
The use of the retail inventory method requires that record be kept which must show the
following data:
a. Beginning inventory at cost and at retail price.
b. Purchases during the period at cost and at retail price.
c. Adjustments to the original retail price such as additional markup, markup cancelation,
markdown and markdown cancelation.
d. Other adjustments such as departmental transfer, breakage, shrinkage, theft, damaged goods
and employee discount.
Basic formula
■ Ending inventory is expressed in terms of of selling price.
Goods available for sale at retail price xxx
Less: Net sales (Gross sales – sales returns only) xxx
Ending inventory at selling price xxx
*Multiply by cost ratio xxx
Ending inventory at cost xxx

*Cost ratio= GAS at cost / GAS at selling price

Treatment of items
AT COST AT RETAIL
Purchase discount deducted disregarded
Purchase return deducted deducted
Purchase allowance deducted disregarded
Freight in added disregarded
Departmental transfer in Dr added added
Departmental transfer out Cr deducted deducted
Sales discount and allowance disregarded disregarded
Sales return Deducted from sales
Employee discount Added to sales
Normal shortage, shrinkage etc. disregarded deducted
Abnormal shortage, shrinkage etc. deducted deducted
Items related to retail method
a. Initial markup – original markup cost on the cost of goods.
b. Original retail – the sales price at which the goods are first offered sales.
c. Additional markup – increase in sales price above the original sales price.
d. Markup cancelation - decrease in sales price that does not decrease the sales price below
the original sales price.
e. Net additional markup - markup minus markup cancelations.
f. Markdown – decrease in sales price below original sales price.
g. Markdown cancelation - increase in sales price that does not increase the sales price above
the original price.
h. Net markdown – markdown minus markdown cancelation.
i. Maintained markup – difference between cost and sales price after adjustment for all the
above items.
Conventional and average method
Cost Retail
Beginning inventory 180,000 250,000
Net purchases 1,020,000 1,575,000
Additional markup 200,000
Markup cancelation 25,000
Markdown 140,000
Markdown cancelation 15,000
Sales 1,450,000
Sales return 50,000
Sales allowance 10,000
Sales discount 20,000
Employee discount 40,000
Spoilage and breakage 35,000
Computation of cost of goods sold

Conservative Average
Goods available for sale 1,200,000 1,200,000
Ending inventory (240,000) (256,000)
Cost of goods sold 960,000 944,000
FIFO retail
Cost Retail
Beginning inventory 495,000 900,000
Purchases 1,800,000 3,300,000
Net markup 300,000
Net markdown 600,000
Net sales 2,700,000