A fire destroyed the Churchill Company's warehouse on March 15, 2016. Only goods with a normal selling price of $12,500 and a net realizable value of $5,000 were saved. The following information is available from the company's records:
?
Inventory in warehouse, 1/1/16
$250,000
Purchases, 1/1/16-3/15/16
620,000
Purchase returns
9,500
Freight-in
14,000
Sales, 1/1/16-3/15/16
850,000
Sales returns
20,000
For the period from 2011 through 2015, Churchill had a gross profit of $2,100,000 on net sales of $6,000,000.Required:
a.Estimate Churchill's inventory loss from the fire using the gross profit method.b.What assumptions allow the use of the gross profit method in these circumstances?
What will be an ideal response?
| a. | Historical gross profit % | = $2,100,000/$6,000,000 = 35% |
| Estimated current gross profit | = 35% × ($850,000 ? $20,000) = $290,500 | |
| Estimated cost of goods sold | = $830,000 ? $290,500 = $539,500 | |
| Estimated cost of ending inventory | = $250,000 + $620,000 ? $9,500 + $14,000 | |
| ? $539,500 | ||
| = $335,000 | ||
| Estimated fire loss | = $335,000 ? $5,000 = $330,000 | |
| b. | The gross profit method assumes that a company's gross profit rate in the current period (1/1/16-3/15/16) is not materially different from the previous period or periods (in this case the years 2011-2015). This implies that the product mix and profit and cost ratios have not materially changed. | |
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