Gross Profit Method
Gross Profit Method of Inventory Estimation
The gross profit method assumes that the ratio of gross margin for a business remains relatively stable from year to year. It is used in place of the retail method when records of the retail prices of beginning inventory and purchases are not kept. It is considered acceptable for estimating the cost of inventory for interim reports, but is not acceptable for valuing inventory in the annual financial statements. It is also useful in estimating the amount of inventory lost or destroyed by theft, fire, or other disasters.
Using the gross profit method, you
would first calculate the Cost of Goods Available for Sale by adding
your purchases at cost to your beginning inventories. Second, you
would subtract the estimated gross margin from the net sales to calculate
the estimated Cost
of Goods Sold. Third, subtract the estimated Cost of Goods Sold
from the Cost of Goods Available for Sale. This will provide you the
estimated cost of ending inventory.
The Gross Profit Method of Inventory Valuation
1. Beginning Inventory at Cost $ 50,000
Purchases at Cost 290,000
Cost of Goods Available for Sale $340,000
2. Less Estimated Cost of Goods Sold
Sales at Selling Price $400,000
Less Estimated Gross Margin of 30% 120,000
Estimated Cost of Goods Sold 280,000
3. Estimated Cost of Ending Inventory $60,000