Barclay Company’s tea distribution center in Boston suffered severe fire damage on April 28, 2014. You have been hired by Barclay to estimate the amount of fire loss for insurance purposes. Barclay uses the perpetual inventory system and last conducted a physical count on January 1, 2014. In reviewing Barclay’s general ledger, you note the following:
Beginning Inventory
$500,000
Purchases
$2,000,000
Purchase Returns and Allowances
$100,000
Purchase Discounts
$40,000
Freight-in
$60,000
Sales
$3,100,000
Sales Returns
$45,000
You also note that included in Barclay’s purchases are $42,000 of goods-in-transit from a supplier on April 28th that were shipped fob shipping point. The goods have not yet arrived.
a. Compute the estimated loss using an historic gross profit ratio of 30% of net sales.
b. Compute the estimated loss using the current year markup (over cost of goods sold) of 36%.
I am struggling particularly with deriving COGS ratios for each part, however, I can compute Beg. Inv., purchases, ending inventory and estimated loss perfectly. Thank you!!!!
To calculate the estimated loss using the historic gross profit ratio of 30% of net sales, we need to determine the cost of goods sold (COGS) for the period.
First, calculate the net purchases by subtracting purchase returns and allowances, purchase discounts, and freight-in from purchases:
Net Purchases = Purchases - Purchase Returns and Allowances - Purchase Discounts - Freight-in
Net Purchases = $2,000,000 - $100,000 - $40,000 - $60,000 = $1,800,000
Next, compute the cost of goods available for sale by adding the beginning inventory to the net purchases:
Cost of Goods Available for Sale = Beginning Inventory + Net Purchases
Cost of Goods Available for Sale = $500,000 + $1,800,000 = $2,300,000
To calculate the COGS, we need to find the ending inventory. Since the last physical count was conducted on January 1, 2014, we need to account for the inventory sold from that date until April 28, 2014.
To estimate the ending inventory, we use the gross profit method, which is the historic gross profit ratio applied to the net sales.
Net Sales = Sales - Sales Returns
Net Sales = $3,100,000 - $45,000 = $3,055,000
Gross Profit = Net Sales * Historic Gross Profit Ratio
Gross Profit = $3,055,000 * 30% = $916,500
Estimate Ending Inventory = Cost of Goods Available for Sale - COGS
Estimate Ending Inventory = $2,300,000 - $916,500 = $1,383,500
Finally, calculate the COGS:
COGS = Cost of Goods Available for Sale - Ending Inventory
COGS = $2,300,000 - $1,383,500 = $916,500
Now, calculate the estimated loss:
Estimated Loss = COGS * Historic Gross Profit Ratio
Estimated Loss = $916,500 * 30% = $274,950
Therefore, the estimated loss using the historic gross profit ratio of 30% of net sales is $274,950.
For part b, to calculate the estimated loss using the current year markup of 36%:
COGS = Net Purchases + Beginning Inventory - Ending Inventory
COGS = $1,800,000 + $500,000 - $1,383,500 = $916,500
Estimated Loss = COGS * Current Year Markup
Estimated Loss = $916,500 * 36% = $330,540
Therefore, the estimated loss using the current year markup of 36% is $330,540.