A firm's inventory was destroyed by fire on August 14 of the current year. Fortunately, the firm had insurance to cover the loss. However, most of the inventory records were also destroyed in the fire. The average gross margin percentage is 40%, beginning inventory was $200,000, and $1,000,000 of purchases had been made through August 13.

 A firm's inventory was destroyed by fire on August 14 of the current year. Fortunately, the firm had insurance to cover the loss. However, most of the inventory records were also destroyed in the fire. The average gross margin percentage is 40%, beginning inventory was $200,000, and $1,000,000 of purchases had been made through August 13. The firm had recorded sales of $1,200,000 through that date. Estimate the cost of the inventory lost in the fire.
$0
$480,000
$720,000
$280,000

Answer

$480,000

 You Answered Correctly!
The gross margin method estimates the cost of inventory at the time of the fire as follows: Beginning inventory $200,000 + $1,000,000 Purchases = Ending inventory + Cost of goods sold. The estimate of cost of goods sold is found by multiplying the cost to sales ratio and sales. The gross margin percentage plus the cost to sales ratio is 1; therefore, cost/sales is .60 (= 1 - .40). Estimated cost of goods sold is $720,000 (= .60($1,200,000)). The equation is Beginning inventory $200,000 + Purchases $1,000,000 = Ending inventory + Cost of goods sold $720,000. Solving for ending inventory yields $480,000.