When is gross profit method used

The gross profit method produces a reasonably accurate result as long as the historical gross profit margin still applies to the current period. However, increasing competition, new market conditions, and other factors may cause the historical gross profit margin to change over time. Retail inventory method.

Retail businesses track both the cost and retail sales price of inventory. This information provides another way to estimate ending inventory.

Suppose a retail store wants to estimate the cost of ending inventory using the information shown below. The first step is to calculate the retail value of ending inventory by subtracting net sales from the retail value of goods available for sale. Previous Inventory Errors and Financial Statements. Definition: The gross profit method is a way to estimate the cost of ending inventory during a period without doing a physical inventory count. At the end of every accounting period an inventory count should be taken to accurately calculate the cost of the inventory that was sold along with the amount of inventory that is left over at the end of a period.

The gross profit method calculation starts with the value of the goods in your inventory the last time you performed a physical count. Remember that the "value" of inventory represents the cost to you, not the retail price. Now add the amount you have spent on goods since that count. Next, look at your sales revenue since the last inventory. This amount will reflect the retail price of the goods sold. Apply your gross profit margin to your sales revenue to determine the cost of the goods you sold.

The calculation for the retail inventory method works much the same as that for the gross profit method. Start with the inventory cost at the last hand-count and then add to that the cost of goods purchased since the count. Also, if the long-term rate of losses due to theft, obsolescence, or any other causes are not recognized in the historical gross profit percentage, then the ending inventory will probably be an inaccurate estimation. But if a business manufactures its own goods then components of the inventory would need to include labor and overhead costs, making the gross profit method too basic to produce reliable results.

Overall, any inventory estimation technique should only be used for short periods of time. A well-run cycle counting program is a better method for routinely keeping inventory record accuracy at a high level. On the other hand, a physical inventory could be counted at the end of each reporting period manually.

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