Given these facts and assumptions kishwaukee can

Info icon This preview shows pages 28–30. Sign up to view the full content.

View Full Document Right Arrow Icon
year. Given these facts and assumptions, Kishwaukee can compute the estimated cost of the ending inventory at January 31 under the gross profit method as follows. Step 1: Net sales $200,000 Less: Estimated gross profit (30% H11003 $200,000) 60,000 Estimated cost of goods sold $140,000 Step 2: Beginning inventory $ 40,000 Cost of goods purchased 120,000 Cost of goods available for sale 160,000 Less: Estimated cost of goods sold 140,000 Estimated cost of ending inventory $ 20,000 a174 Two circumstances explain why companies sometimes estimate inventories. First, a casualty such as fire, flood, or earthquake may make it impossible to take a physical inventory. Second, managers may want monthly or quarterly financial statements, but a physical inventory is taken only annually.The need for estimating inventories occurs primarily with a periodic inventory system because of the ab- sence of perpetual inventory records. There are two widely used methods of estimating inventories: (1) the gross profit method, and (2) the retail inventory method. Gross Profit Method The gross profit method estimates the cost of ending inventory by applying a gross profit rate to net sales.This method is relatively simple, but effective.Accountants, auditors, and managers frequently use the gross profit method to test the reason- ableness of the ending inventory amount. It will detect large errors. To use this method, a company needs to know its net sales, cost of goods avail- able for sale, and gross profit rate. The company then can estimate its gross profit for the period. Illustration 6B-1 shows the formulas for using the gross profit method. The gross profit method is based on the assumption that the gross profit rate will remain constant. But it may not remain constant, due to a change in merchandising PDF Watermark Remover DEMO : Purchase from to remove the watermark
Image of page 28

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
At Cost At Retail Beginning inventory $14,000 $ 21,500 Goods purchased 61,000 78,500 Goods available for sale $75,000 100,000 Net sales 70,000 Step (1) Ending inventory at retail H11549 $ 30,000 Step (2) Cost-to-retail ratio $75,000 H11548 $100,000 H11549 75% Step (3) Estimated cost of ending inventory H11549 $30,000 H11547 75% H11549 $22,500 policies or in market conditions. In such cases, the company should adjust the rate to reflect current operating conditions. In some cases, companies can obtain a more accurate estimate by applying this method on a department or product-line basis. Note that companies should not use the gross profit method to prepare finan- cial statements at the end of the year.These statements should be based on a phys- ical inventory count. Retail Inventory Method A retail store such as Home Depot , Ace Hardware , or Wal-Mart has thousands of different types of merchandise at low unit costs. In such cases it is difficult and time-consuming to apply unit costs to inventory quantities.An alternative is to use the retail inventory method to estimate the cost of inventory. Most retail compa- nies can establish a relationship between cost and sales price. The company then applies the cost-to-retail percentage to the ending inventory at retail prices to de- termine inventory at cost.
Image of page 29
Image of page 30
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern