Prepared by: Ms. HAZEL JADE E.
VILLAMAR
E-mail Address: _hazeljade.villamar@clsu2.edu.ph________
Central Luzon State University
Science City of Muñoz 3120
Nueva Ecija, Philippines
Instructional Module for the Course
ACCTG 2105 / Intermediate Accounting 1
Module 3
Topic 4 (GROSS PROFIT METHOD)
Overview
This course covers the detailed discussion, appreciation, and
application of the Philippine Financial Reporting Standards (PFRS) on the
assets, financial and non-financial of a business enterprise. Emphasis is
given on the interpretation and application of the accounting standards on
Financial Assets and their required disclosures. The related internal control,
ethical issues and management of assets are also covered. Exposure to
computerized system in receivables, inventory and lapsing schedules is a
requirement.
I. Objectives
At the end of the module, the following are expected:
A. Understand the meaning of inventories.
B. Identify the major classes of inventory.
C. Account for inventory transactions using periodic and perpetual inventory system.
D. Apply the FIFO, weighted average, moving average cost formula and specific
identification methods.
E. Explain the lower of cost and net realizable value basis of measurement.
F. Account for inventory method using direct and allowance method.
II. Learning Activities
GROSS PROFIT METHOD
Valuing Inventory
An inventory valuation allows a company to provide a monetary value for items
that make up their inventory. Inventories are usually the largest current asset of a
business, and proper measurement of them is necessary to assure accurate financial
statements. If inventory is not properly measured, expenses and revenues cannot be
properly matched and a company could make poor business decisions.
A company will choose an inventory accounting system, either perpetual or
periodic. In perpetual inventory the accounting records must show the amount of
inventory on hand at all times. Periodic inventory is not updated on a regular basis.
Definition of Gross Profit Method
The gross profit method is a technique for estimating the amount of ending
inventory. The gross profit method might be used to estimate each month's ending
inventory or it might be used as part of a calculation to determine the approximate
amount of inventory that has been lost due to theft, fire, or other reasons.
The gross profit method assumes that a company’s gross profit rate in the current
period is similar to that of the previous periods. It estimates the cost of ending inventory
by using the relationship between cost of goods available for sale, cost of goods sold,
and ending inventory in the cost of goods sold model.
The gross profit method includes the following steps:
Step 1. Calculate the historical gross profit rate, as shown below:
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡 𝑓𝑟𝑜𝑚 𝑝𝑟𝑖𝑜𝑟 𝑃𝑒𝑟𝑖𝑜𝑑𝑠
Historical Gross Profit Rate=
Net sales from prior Periods
Step 2. Calculate the cost of goods available for sale in the current period, as shown below:
Cost of Goods Available for Sale = Beginning Inventory + Net Purchases
Step 3. Estimate the gross profit for the current period, as shown below:
Estimated Gross Profit= Historical Gross Profit Rate
x Net Sales Revenue (current period)
Step 4. Estimate the cost of goods sold for the period
Estimate Costs of Goods Sold = Net Sales Revenue (current period)
– Estimated Gross Profit
Step 5. Determine the estimated cost of the ending inventory
Ending Inventory = Cost of Goods Available for Sale
– Estimated Cost of Goods Sold
Example: Gross Profit Method
Hardin Company has the following information related to its inventory:
Net Sales for the period 130,000
Beginning inventory, cost 10,000
Net purchases for the period 90,000
Estimated historical gross profit rate on net sales 40%
Solution:
Estimated gross profit rate (given) 40%
Beginning inventory, at cost 10,000
Net purchases 90,000
Cost of goods available for sale 100,000
Less: Estimated cost of goods sold *** 78,000
Estimated cost of ending inventory 22,000
*** Net sales 130,000
Gross profit rate x 0.40
Estimated gross profit 52,000
Sales 130,000
Estimated gross profit (52,000)
Cost of goods sold 78,000
References
Intermediate Accounting Volume 1, 2019 by Valix, Peralta & Valix
