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What Is And How To Use The Gross Profit Method To Estimate Or Value Ending Inventory Explained

In this video we discuss what is, and how to use the gross profit method to estimate or value ending inventory for a business. We go through an example step by step Transcript/notes To save on costs, many companies will estimate their inventory, and one of the ways they do this is called the gross profit method to estimate inventory. There are 3 steps to estimating inventory using the gross profit method. Calculate the total cost of goods available for sale at cost, which is the beginning inventory at cost plus any purchases at cost. Multiply the net sales at retail by the complement of the gross profit rate, which will provide the estimated cost of goods sold at cost. And then calculate the cost of estimated ending inventory at cost, which is actually step 1 minus step 2. One note, cost is how much a business paid for a particular item and retail is how much the business sells the item for. Let’s go through a very basic example, and we will create a chart as we go. A business sells an item, say a desk lamp. The beginning inventory at cost is $300 and over a given time period the business re-stocks the item as it sells. Over this period the purchases made have a value of $1240 at cost. The net sales during this period were $1365 at retail and the gross profit rate is 30%. What is the estimated ending inventory at cost? Step 1 is to calculate the total cost of goods available for sale at cost. The beginning inventory at cost was $300, and the purchases at cost were $1240, so, $300 plus $1240 equals $1540, and that is the total cost of goods available for sale at cost, and step 1 is complete. Step 2 is to multiply the net sales at retail by the complement of the gross profit rate, which will provide the estimated cost of goods sold at cost. We were given the gross profit rate is 30%, so we need to find the complement of that. The complement of 30% is 100% minus 30%, which is 70% or .70. We were also given that net sales were $1365, so, we multiply $1365 times .70, which calculates to $955.50, and this is the estimated cost of goods sold at cost, and step 2 is complete. Step 3 is to calculate the cost of estimated ending inventory at cost, which is step 1 minus step 2. So, we have $1540 from step 1, the total cost of goods available for sale at cost, minus $955.50 from step 2, the estimated cost of goods sold at cost. And this calculates to $584.50, which is the estimated ending inventory at cost. And the calculation is complete. Chapters/Timestamps 0:00 Into/3 steps in using the gross profit method to estimate inventory 0:40 Example problem 1:11 Step 1 - calculate total cost of goods available for sale at cost 1:35 Step 2 - multiply net sales at retail by the compliment of the gross profit rate 2:14 Step 3 - calculate the cost of estimated inventory at cost