Friday, 11 July 2014
GROSS PROFIT METHOD
ON THIS POST, I WILL DISCUSS, GROSS PROFIT METHOD AND RETAIL INVENTORYMETHOD OF DETERMINING THE INVENTORY AMOUNT.
THE GROSS PROFIT METHOD OF ESTIMATING INVENTORY COST IS BASED ON AN ASSUMED RELATIONSHIP OF GROSS PROFIT AND SALES. A GROSS PROFIT RATIO IS APPLIED TO SALES AMOUNT TO DETERMINE THE GROSS PROFIT AND FINALLY THE COST OF SALES .
ON THE OTHER HAND GIVEN THE AMOUNT OF COST OF SALES , YOU CAN DETERMINE THE VALUE OF INVENTORY BY COMPUTING FOR THE GOODS AVAILABLE FOR SALE( BEG INV. + PURCHASE) LESS THIS COST OF SALES , THEN YOU GET THE ESTIMATED INVENTORY.
BEG INV. 3,000
PURCHASE 4,000
AVAILABLE FOR SALE 7,000
LESS: COST OF SALES 3,000
estimated inventory end 4,000
take note that you can compute this cost of sales by way of knowing the gross profit percentage and finally the cost of sales percentage.
Example:1 GROSS PROFIT AS PERCENTAGE OF SALES ( MARK UP ON SALES).
When we say mark up on sales, that means the gross profit is a certain percent of SALES AMOUNT.
assume a sales of 100,000, the company applies 40% gross profit on sales , therefore:
sales 100,000 100%
cost of sales 60,000 60%
gross profit 40,000 40%
so assuming the available goods for sale is 85,000, the estimated inventory would be:
available for sales 85,000
less cost of sales 60,000
estimated inventory 25,000
example 2 GROSS PROFIT AS PERCENTAGE OF COST ( MARK UP ON COST) When we say mark up on cost , that means the gross profit is a certain percent of COST OF THE PRODUCT.
EXAMPLE: A PRODUCT COSTING 100.00 AND SAID TO HAVE PRICED 20% MARK UP ON COST , IT DOES NOT MEAN THAT 20% IS THE GROSS PROFIT PERCENTAGE AGAINST SALES AMOUNT BECAUSE THE 20% IS BASED ON THE COST AND NOT ON THE SALES PRICE. SO, THE SELLING PRICE OF 100.00 IS 120.00 ( 100.00 X 20% =20 MARK UP + 100.00). IF GET THE PERCENTAGE OF GROSS PROFIT OF 20.00 VS. 120.00 IS NOT 20% BUT 16.67%.
When a product is said to have a gross profit ratio of say 40% based on cost. That means the base is the cost of the product , and this cost is of course the 100% because this is where the 40% was based , NOW CONSIDERING THAT IN THE ORDINARY COMPUTATION OF GROSS PROFIT IT IS THE SALES AMOUNT THAT IS BEING USED AS THE BASE OF GROSS PROFIT PERCENTAGE , RATIO. NOW IF THE COST IS 100% AND THE GROSS PROFIT IS 40%, THEREFORE MATHEMATICALLY THE SALES PERCENTAGE RATIO IS 140%
Assume sales is 100,000 and gross profit ratio is 60% of cost .If sales are made at a gross profit based on cost then to get the gross profit ratio is.
sales ? %
cost of sales ( 100%)
gross profit 40%
since , mathematically, cost is deducted from sales to arrive at gross profit, in the above example , using a work back approach, the sales percentage ratio is 140% , arrived by 40% + 100% is 140%, therefore in making the normal reading of gross profit percentage ratio , you have to divide 40% with 140% to get the gross profit percentage based on SALES PRICES which is 28.57%.
sales 140%
cost ( 100%)
gross profit 40% 40% divide 140% = 28.57%
since the sales amount is given, and the cost amount is not given, and it says the gross profit is 40% of cost, then to get the gross profit amount and its percentage to sales , and also the cost amount and percent to sales , you have to divide the 100,000 by 140% to get the cost amount of 71,430.00
sales 100,000 100%
cost of sales 71,430 71.43%
gross profit 28,570 28.57%
so if the product cost is 71,430.00 , adding 40% to it is 28,570 ( round off diff.) but basing the 28,570 on sales amount , it is 28.57%.
so, when the problem says the gross profit is said to be a certain percent of cost, to be able to get the gross profit percentage against sales , all you have to do is divide the gross profit percent against the sum total percentage of gross profit and cost of sales percentage.
TO BE ABLE TO ESTIMATE THE ENDING INVENTORY USING THAT COST OF SALES, ALL YOU HAVE TO DO IS , OBTAIN THE GOODS AVAILABLE FOR SALES LESS THIS COST OF SALES = ESTIMATED INVENTORY COST.
BEG INV. 80,000
PURCHASE 40,000
AVAILABLE FOR SALE 120,000 available 120,000
LESS: COST OF SALES 71,430 INV. END ( 48,570)
ENDING INVENTORY 48,570 COST OF SALES 71,430
THIS METHOD OF INVENTORY VALUATION IS VALUABLE ESPECIALLY WHEN IT IS IMPOSSIBLE OR DIFFICULT TO UNDERTAKE PHYSICAL INVENTORY COUNTING BECAUSE OF LOSS OR DESTRUCTION OF GOODS.
EXAMPLE assume in oct 31, 2001a fire destroyed the inventory . :
inventory dec 31, 2000 329,500.
payments of purchases based on check issued in 2001 1,015,000.00
unpaid suppliers invoices beginning jan 2001 260,000.00
balance of accts.payable according to suppliers at the time of fire 315,000.00
bank deposits from jan to oct 31, 1,505,000.00
accts. receivable dec 31, 2000 328,000.00
accts receivable oct 31, 2001 275,000.00
gross profit percentage 2000 24% 1999, 23%, 1998 25%, 1997 28%
based on the above the inventory at thetime of fire could be as ff:
what is still unknown here is the amount sales made jan to oct . Now since there is a beginning accounts receivable dec 31,2000 and there is also a collections made during the year up to oct, and the ending receivable , by reconstructing IN T ACCOUNTS , you can compute for the sales amount.
Having sales amount you can compute the cost of sales percentage because you simply compute the average gross profit for the 4 year period .
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RETAIL INVENTORY METHOD
when this method is maintained , the purchases is valued at cost and at retail price. a cost percentage is computed by dividing the goods available for sale at cost against the goods available for sale at retail price . this cost percentage can be applied to the ending inventory at RETAIL to get the inventory at cost.
As you maybe aware, the immediately available figure for a product is its RETAIL OR SELLING PRICE because this is the figure that must be shown to the buyer of your products. The purchase cost of those products is not always given or identified at a click of the finger unlike the retail price, especially when a company is handling multiple or varied line of products. HENCE , to easily compute for the ending inventory cost, without resorting to a perpetual or counting of inventories , a cost ratio of the product against its selling price is established and use this ratio to compute for inventory cost.
at cost retail
beg 100 200
purchases 200 400
available for sale 300 600 300 divide 600 is 50% this the ratio of cost vs. retail
to be able to determine the inventory at retail , the following procedure:
available for sale at retail 600
sales made out of this available at retail (400)
REMAINING INVENTORY at retail 200
sales 400
beg. inventory retail 200
purchases retail 400
available for sale retail 600
Less: inventory retail ( 200) ( 400 ) cost of sales at retail
inventory at cost therefore is 200 x 50% = 100
Use of this retail inventory method offers the ff advantages .
1. no need physical count of inventory at interim period
2. when physical inventory is taken for financial statement preparation, of course since each item has a retail pricing easily available therefore inventory at retail can easily computed without having to dig up records of its cost and it will just be multiplied by the cost ratio vs retail price to get the INVENTORY AT COST.
THE ACCOUNTING ENTRIES IS SIMILAR TO A PERIODIC METHOD OF INVENTORY.
Purchases 200
accts. payable 200
accts receivable 400
sales 400
cost of sales 100
beg inv 100
cost of sales 200
purchases 200
end inve. 100
cost of sales 100
the net cost of sales of the above is 200. so the following computation
beg inve. 100
purchases 200
available 300
less: ending inv. 100
= COST OF SALES 200
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EXERCISES 1. on august 15,1996 , a hurricane damage the entire inventory .
inventory jan 1 375,000
purchases jan 1 aug 15 1,385,000
cash sales jan 1 aug 15 225,000
collection jan 1 augs 15 2,115,000
accounts receivable jan 1 175,000
accts receivable aug 15 265,000
salvage value of inventory 5,000
gross profit percent on sales 32%
COMPUTE THE INVENTORY LOSS.
1. DETERMINE SALE AMOUNT:
Accts receivable beg 175,000
less collection (2,115,000)
accts. rec. end 265,000
SALES AMOUNT 2,205,000
2. DETERMINE COST OF SALES:
SALES 2,205,000 X (100% -32 % ) = 1,499,400
3 DETERMINE GOODS AVAILABLE FOR SALE
BEG INV 375,000
PURCHASES 1,385,000
TOTAL 1,760,000
4 DETERMINE INVENTORY:
TOTAL AVAILABLE FOR SALE 1,760,000
LESS: COST OF SALES 1,499,400
ENDING INVENTORY 260,600 L
LESS SALVAGE VALUE 5,000
ACTUAL INVENTORY LOSS 255,600
4. TO PROVE:
SALES 2,205,000
COST OF SALES:
AVAILABLE FOR SALES 1,760,000
LESS ENDING INV. 260,600 1,499,400 68%
GROSS PROFIT 705,600 32%
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IF IN CASE THE SALES, THE RECEIVABLE , INVENTORY , THE COST OF SALES IS UNKNOWN, TRY TO MAKE A T ACCOUNTS FOR THEM AND PUT THE AVAILABLE FIGURES OR THE GIVEN FIGURES THEN COMPUTE THE UNKNOWN FIGURE by simple mathematical computation :
EXAMPLE :
accts. receivable accts receivable
____dr___________________cr_______ dr cr
beg bal 1,000 : beg 100
sales 3,000 : collection ? coll 50
end balance 200 : sales ?
end bal 80
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MARKUPS AND MARKDOWN - CONVENTIONAL RETAIL
In the previous discussion , it was assumed there were no changes in retail prices. Frequently , retail prices do change .
the following terms are used in retail method.
1. original retail price - the initial sales price, arrived at adding markup called INITIAL MARKUP
2. additional markups- increases that raise sales price above the original price
3. mark up cancellation - decrease in additional mark up that do not reduce sales price below original
4. net markups - additional markups less markup cancellation
5. markdowns - decrease that reduce sales price from the original
6. markdown cancellation - decrease in markdown that do not raise the sales price above original
7. net markdowns -markdowns less markdown cancellation
EXAMPLE:
cost retail
original 4 6 the 2 is 50%markup on cost
add'l markup 1.50 increase the original price
NEW PRICE 7.50
markup cancellation .50 reduce the orig. markup of 1.50
NEW PRICE 7.00
NET MARKUP IS 1.50 LESS .50 =1.00
+++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
ORIGINAL 6.00
markdowns 1.00 reduce below original of 6
NEW PRICE 5.00 below original
mark down cancellation .25 the 1.00 decrease it to.75 instead
NEW PRICE 5.25
NET MARKDOWN IS 1.00 LESS .25 = .75
Retail inventory results will vary depending on whether net markdowsn are used in computing the cost percentage. When applying retail method , NET MARKUP are added to GOODS AVAILABLE FOR SALES AT RETAIL ,before calculating the cost percentage, net markdowsn , however are not deducted in arriving at the percentage. this method is CONVENTIONAL RETAIL INVENTORY METHOD.
EXAMPLE
COST RETAIL
BEGINNING INVENTORY 8,600 14,000
PURCHASES 72,100 110,000
ADDITIONAL MARK UP 13,000
MARKUP CANCELLATION ( 2,500)
GOODS AVAILABLE FOR SALE 80,700 134,500
LESS: SALES 108,000
MARKDOWN 4,800
MARKDOWN CANCEL ( 800) 112,000
ending inventory at retail 22,500
cost percentage ( 80,700 divide 134,500) = 60%
inventory end at cost 60% x 22,500 = 13,500
YOU MAY ASK WHY THE ADDITIONAL MARK UP IS ADDED TO AVAILABLE FOR SALE, IT IT IS BECAUSE , THE SALES AMOUNT THAT WILL BE DEDUCTED INCLUDES THAT MARK UP . SO IF YOU WILL NOT ADD THE ADDITIONAL MARK UP TO THE AVAILABLE FOR SALE THE RESULTING INVENTORY AT RETAIL WILL BE UNDERSTATED
USING THE ABOVE EXAMPLE.
THE AVAILABLE FOR SALE WOULD BE 124,000
LESS : SALES 112,000
ENDING INVENTORY 12,000
ON THE OTHER HAND IF INSTEAD OF THE NET MARK UP IS ADDED TO THE AVAILABLE FOR SALE , THE NET MARKDOWNS WERE ADDED TO THE AVAILABLE FOR SALE, THE COST PERCENTAGE WILL BE HIGHER BECAUSE THE AVAILABLE FOR SALE WILL BECOME LOWER.
BUT THE SALES AMOUNT TO BE DEDUCTED FROM THAT AVAILABLE FOR SALE TO ARRIVE AT INVENTORY AT RETAIL WOULD NOT INCLUDE THE NET MARKDOWN ,BECAUSE IT WAS ALREADY ADDED TO THE AVAILABLE FOR SALE, THUS BRINGING THE SAME INVENTORY AT RETAIL .
GOODS AVAILABLE FOR SALES 134,500
DEDUCT NET MARKDOWN 4,000
GOODS AVAILABLE FOR SALE 130,500
LESS: SALES WITHOUT MARK DOWN 108,000
ENDING INV 22,500
COST PERCENTAGE WILL BECOME HIGHER BECAUSE THE NET MARKDOWN WILL BE DEDUCTED TO THE AVAILABLE FOR SALE .
80,700 DIVIDE 130,500 = 61.48% X 22,500 = 13,914.00
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