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Gross Profit Method or Retail Inventory Method

When would you use gross profit method or retail inventory method?

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1. When would you use gross profit method or retail inventory method?

Inventories are usually the largest current asset of a business; therefore, proper measurement is necessary to assure accurate financial statements. If inventory is not properly measured, expenses and revenues cannot be properly matched. When ending inventory is incorrect, the following balances of the balance sheet will also be incorrect as a result: merchandise inventory, total assets, and owner's equity. When ending inventory is incorrect, the cost of merchandise sold, and net income will also be incorrect on the income statement.

In some cases, an inventory amount may be needed to prepare an income statement when it is impractical or impossible to take a physical inventory or to maintain perpetual inventory records. For example, taking a physical inventory each month may be too costly, even though monthly income statements are necessary. Taking a physical inventory may be impossible when a catastrophe, such as a fire, has destroyed the inventory. In such cases, the inventory cost might be estimated for use in preparing the income statement Two commonly used methods of estimating inventory cost are (1) the gross profit method, and (2) the retail method.

a. What is the gross profit method and when is it used?

The gross profit method is a technique used to estimate the amount of ending inventory. The technique could be used for monthly financial statements when a physical inventory is not feasible. (However, it is no substitute for an annual physical inventory.) It is ...

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This solution discusses when you would use gross profit method or retail inventory method. References are provided.