Question

Mark Price Company uses the gross profit method to estimate inventory for monthly reporting purposes. Presented below is information for the month of May. Inventory, May 1 $ 160,000 Purchases (gross) 640,000 Freight-in 30,000 Sales revenue 1,000,000 Sales returns 70,000 Purchase discounts 12,000 Instructions (a) Compute the estimated inventory at May 31, assuming that the gross profit is 30% of sales. (b) Compute the estimated inventory at May 31, assuming that the gross profit is 30% of cost.

Short answer

(a) The estimated inventory on May 31 equals $167,000.

(b) The estimated inventory on May 31 equals $102,644.

Step-by-step solution

Calculation of net purchases

Net purchases is calculated as follows:

$\begin{array}{rcl}\mathrm{Net}\mathrm{purchases}& =& \mathrm{Purchases}+\mathrm{Freight}-\mathrm{in}-\mathrm{Purchase}\mathrm{discounts}\\ & =& \$640,000+\$30,000-\$12,000\\ & =& \$658,000\end{array}$

Calculation of cost of goods sold in (a)

Cost of goods sold is calculated as follows:

$\begin{array}{rcl}\mathrm{Cost}\mathrm{of}\mathrm{goods}\mathrm{sold}& =& \left(\mathrm{Sales}\mathrm{revenue}-\mathrm{Sales}\mathrm{return}\right)\times \left(1-\mathrm{Gross}\mathrm{profit}\mathrm{percentage}\right)\\ & =& \left(\$1,000,000-\$70,000\right)\times \left(1-30\%\right)\\ & =& \$651,000\end{array}$

Calculation of estimated inventory at May 31

(a) Estimated inventory on May 31 is calculated as follows:

$\begin{array}{rcl}\mathrm{Estimated}\mathrm{inventory}\mathrm{at}\mathrm{May}31& =& \mathrm{Inventory}\mathrm{at}\mathrm{May}1+\mathrm{Net}\mathrm{purchases}-\mathrm{Cost}\mathrm{of}\mathrm{goods}\mathrm{sold}\\ & =& \$160,000+\$658,000-\$651,000\\ & =& \$167,000\end{array}$

Calculation of gross profit percentage on sales

Gross profit percentage on sales is calculated as follows:

$\begin{array}{rcl}\mathrm{Gross}\mathrm{profit}\mathrm{percentage}\mathrm{on}\mathrm{sales}& =& \frac{\mathrm{Percentage}\mathrm{markup}\mathrm{on}\mathrm{cost}}{100\%+\mathrm{Percentage}\mathrm{markup}\mathrm{on}\mathrm{cost}}\\ & =& \frac{30\%}{100\%+30\%}\\ & =& 23.08\%\end{array}$

Calculation of cost of goods sold in (b)

Cost of goods sold is calculated as follows:

$\begin{array}{rcl}\mathrm{Cost}\mathrm{of}\mathrm{goods}\mathrm{sold}& =& \left(\mathrm{Sales}\mathrm{revenue}-\mathrm{Sales}\mathrm{returns}\right)\times \left(1-\mathrm{Gross}\mathrm{profit}\mathrm{percentage}\right)\\ & =& \left(\$1,000,000-\$70,000\right)\times \left(1-23.08\%\right)\\ & =& \$715,356\end{array}$

Calculation of estimated inventory at May 31

(b) Estimated inventory at May 31 is calculated as follows:

$\begin{array}{rcl}\mathrm{Estimated}\mathrm{inventory}\mathrm{at}\mathrm{May}31& =& \mathrm{Inventory}\mathrm{at}\mathrm{May}1+\mathrm{Net}\mathrm{purchases}-\mathrm{Cost}\mathrm{of}\mathrm{goods}\mathrm{sold}\\ & =& \$160,000+\$658,000-\$715,356\\ & =& \$102,644\end{array}$

Thus, ending inventory on May 31, in part (a) equals $167,000, and in part (b) equals $102,644.