Tips on Inventory –Gross Profit and Retail Methods
Gross Profit Method
TIP:
Gross profit is synonymous with gross margin.
TIP:
The gross profit percentage (expressed as a percentage of selling price) and the cost of goods sold
percentage(also expressed as a percentage of selling price) are complements; that is, they sum to 100%.
When the gross profit method of inventory estimation is used and the gross margin is expressed in terms
of cost, the gross margin must first be expressed in terms of selling price before you can proceed with
the compuations.
One method of conversion is to memorize and use the following formula:
Gross Margin on Selling Price =
Percentage Markup on Cost
100% + Percentage markup on cost
Another approach to deriving this formula is shown below.
It uses the familiar formula:
Sales – Cost of Goods Sold
= Gross Profit(GP)
Example:
If
GP = 25% of cost, then cost of goods sold is 100%.
Putting this much information into our formula above, Sales – 100%
= 25%
Therefore, Sales = 125%.
Expressing GP as a percentage of Sales
we get 25% /125% = 20%.
Thus, gross profit = 20% of sales.
TIP:
Gross profit on selling price will always be less than gross profit expressed as a percentage of cost.
TIP:
The terms gross margin percentage, gross profit percentage, rate of
gross profit, and percentage of
markup are thought of to be synonymous, although companies more commonly use the term markup in
referring to a relationship to cost and then use the term gross profit in referring to sales.
TIP:
The gross profit(gross margin) method only provides an estimate of inventory cost.
The method is
deficient in that it uses past percentages in determining the markup and the markup is usually not
uniform for all items in inventory.
The method is normally unacceptable for financial reporting
purposes (except for interim reports.)
The method is useful in estimating inventory when the inventory
has been destroyed and for verifying the reasonableness of inventory amounts determined by other
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 Spring '08
 ROTELLA
 Marketing, Financial Accounting, gross margin, retail price

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