Gross Profit Method

The gross profit method can be used to estimate ending inventory and cost of goods
sold when a physical count is not possible. It can also be used to evaluate the
reasonableness of a given inventory amount and in reconstructing financial records.
The gross profit method may be used to estimate inventories for interim reporting
purposes but is generally not acceptable for annual financial reporting.
Under the gross profit method, gross profit is assumed to be relatively constant
from period to period. Thus, gross profit is used to compute for the gross profit rate
which will in turn used to determine the cost ratio. The cost ratio will be used in
estimating the cost of inventory and cost of goods sold.
Gross profit rate can be expressed as a percentage based on sales or based on cost
of goods sold.
Gross profit rate based on sales is computed by dividing gross profit by net sales,
while gross profit rate based on cost is computed by dividing gross profit by the cost
of goods sold.