Question

Simone computes the gross profit percentage on the basis of previous years' figures. The fact that she is determining this percentage in this way means she must be using the _____________ method of estimating ending inventory.

Answer 1

Simone is using the gross profit method to estimate ending inventory based on past gross profit percentages. This method applies historical profit margins to current sales to estimate cost of goods sold and then determines ending inventory. It's a common approach in accounting when a physical count is impractical.

Step-by-step explanation:

When Simone calculates the gross profit percentage based on the figures from previous years, she is utilizing a method of estimating ending inventory known as the gross profit method. This method involves taking the historical gross profit margin (the gross profit as a percentage of sales) and applying it to the current period's total sales to estimate the cost of goods sold (COGS). Once the COGS is estimated, it can be subtracted from the total cost of goods available for sale to approximate the ending inventory.

This approach is commonly used in situations where a physical count of inventory is impractical or when an interim financial statement is prepared. The gros profit method relies on the relationship between sales and cost of goods sold remaining relatively constant over time. It's important to remember that this is only an estimation technique and should be supplemented with regular physical inventory counts for more accurate financial reporting. Understanding the gross profit method is essential for knowledge in fields such as accounting and finance, where the ability to make accurate estimations of financial figures is crucial for decision-making, strategic planning, and reporting.

Answer 2

Simone uses the gross profit method to estimate ending inventory by basing the gross profit percentage on previous years' figures, which allows her to infer costs and values without a physical count, although this method requires periodic verification.

Step-by-step explanation:

Simone computes the gross profit percentage on the basis of previous years' figures. The fact that she is determining this percentage in this way means she must be using the gross profit method of estimating ending inventory. The gross profit percentage is important for a business because it represents the portion of each dollar of revenue that the company retains as profit before accounting for overhead, payroll, taxation, and other expenses. In the context of inventory management, by applying the gross profit percentage to the total net sales, a company can estimate the cost of goods sold and hence infer the ending inventory without taking a physical count.

To understand this within the framework of accounting principles, we can refer to several concepts outlined in Chapter 22, such as the definition of accounting profit, which is the total revenues minus explicit costs, including depreciation. Additionally, the chapter discusses concepts like average profit, average total cost, and average variable cost, which all play a role in understanding how profitability metrics influence business decisions such as inventory valuation. Estimating ending inventory using the gross profit method involves using historical gross profit rates to estimate the cost of goods sold, and by extension, the value of unsold inventory.

This method assumes that the relationship between cost of goods sold and sales remains relatively steady over time, which may not always be accurate due to factors like price changes, new products, or changes in consumer demand. Therefore, while the gross profit method can be a useful tool for quickly estimating inventory levels, it is also essential to conduct physical inventory counts periodically to ensure accuracy in financial reporting.