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    Joanne Rheena Boo
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    The gross profit method is used to estimate inventory value when a physical count is not possible or too costly. It assumes the gross profit percentage remains consistent over time. The basic formula takes goods available for sale, subtracts cost of goods sold to get the estimated ending inventory value. Cost of goods sold is calculated by applying the gross profit percentage to net sales. Sales allowances and discounts are not deducted from sales since they do not impact the physical inventory quantity. Examples are provided on pages 383-390 to illustrate the gross profit method calculations.

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    Lecture Chapter 13 - Intermediete Acccounting by Valix

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    The gross profit method is used to estimate inventory value when a physical count is not possible or too costly. It assumes the gross profit percentage remains consistent over time. The basic formula takes goods available for sale, subtracts cost of goods sold to get the estimated ending inventory value. Cost of goods sold is calculated by applying the gross profit percentage to net sales. Sales allowances and discounts are not deducted from sales since they do not impact the physical inventory quantity. Examples are provided on pages 383-390 to illustrate the gross profit method calculations.

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    55 views2 pages

    Intermediate-Accounting Handout Chap 13

    Uploaded by

    Joanne Rheena Boo
    The gross profit method is used to estimate inventory value when a physical count is not possible or too costly. It assumes the gross profit percentage remains consistent over time. The basic formula takes goods available for sale, subtracts cost of goods sold to get the estimated ending inventory value. Cost of goods sold is calculated by applying the gross profit percentage to net sales. Sales allowances and discounts are not deducted from sales since they do not impact the physical inventory quantity. Examples are provided on pages 383-390 to illustrate the gross profit method calculations.

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    Chapter 13 – Gross Profit Method

    Estimate in Inventory Valuation


     In many cases, it is necessary to know the approximate value of inventory when it is not possible to take
    a physical count
     Even if the physical count is possible, the same may prove costly, difficult or inconvenient at the moment
     There are two widely accepted procedures for approximating the value of inventory, namely:
    a. Gross profit method
    b. Retail inventory method

    The most common reasons for making an estimate of the cost of goods on hand are:
    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 in hand is made and it is necessary to prove the correctness or
    reasonableness of such count by making an estimate. This is known as the gross profit test in the
    accounting parlance
    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. Moreover, only an estimate is required to fairly present the
    financial position and financial performance of the entity for interim reporting purposes

    Gross profit method


     This method is based on the assumption that the rate of gross profit remains approximately the same
    form period to period and therefore the ratio of t cost of goods sold to net sales is relatively constant
    form period to period
     Basic formula under the gross profit method

    Goods available for sale (GAS) xx


    Less: Cost of goods sold xx
    Ending inventory xx

    Goods available for sale


     The usual items affecting the goods available for sale are:

    Beginning inventory xx
    Purchases xx
    Add: Freight-in xx
    Total xx
    Less: Purchase return, allowance & disc xx xx
    Goods available for sale xx

    Cost of goods sold


     The gross profit method is so called because the cost of goods sold is computed through the use of
    the gross profit rate
     The cost of goods sold is computed as follows:
    a. Net sales multiplied by cost ratio
     This formula is used when the gross profit rate is based on sales
    b. Net sales divided by sales ratio
     This formula is used when the gross profit rate is based on cost

    Illustrations and explanations: page 383-388

    Sales allowance and sales discount


     Sales allowance and sales discount are ignored, that is, not deducted from sales
     The reason is that while these items decrease the amount of sales, they do not affect the physical volume
    of goods sold
     Sales allowance and sales discount do not increase the physical inventory of goods, unlike in sales return
    where there is an actual addition to goods on hand
     To deduct sales allowance and sale discount form sales would result to overstatement of inventory with
    a consequent understatement of cost of goods sold and overstatement of gross income
     Why overstate inventory when there is no addition to physical inventory created by sales allowance and
    sales discount?

    Illustration: pages 389-390

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