Question

Smith Distributors, Inc., supplies ice cream shops with various toppings for making sundaes. On November 17, 2016, a fire resulted in the loss of all of the toppings stored in one section of the warehouse. The company must provide its insurance company with an estimate of the amount of inventory lost. The following information is available from the company’s accounting records:

	Fruit toppings	Marshmellow toppings	Chocolate toppings
Inventory, January 1, 2016	$20,000	$7,000	$3,000
Net purchaes thru Nov. 17	150,000	36,000	12,000
Net sales thru Nov. 17	200,000	55,000	20,000
Historical gross profit ratio	20%	30%	35%

Required:

1. Calculate the estimated cost of each of the toppings lost in the fire.

2. What factors could cause the estimates to be over-or understated?

Answer 1

1.

Particulars	Fruit toppings	Marshmellow toppings	Chocolate toppings
Cost Percentage (100 - Historical gross profit ratio)	80%	70%	65%
x Net Sales	$200,000	$55,000	$20,000
Estimate of cost of goods sold	$160,000	$38,500	$13,000
Beginning Inventory	$20,000	$7,000	$3,000
Add: Net purchaes	150,000	36,000	12,000
Cost of goods available for sale	170,000	43,000	15,000
Less: Estimate of cost of goods sold	160,000	38,500	13,000
Estimate of cost of inventory lost	$10,000	$4,500	$2,000

2.

• The historical gross profit percentages and thus the cost percentages are a main factor in the determination of the estimate.  If they are not representative of the current relationship between cost and selling price, then the resulting estimate would fail to be representative.
• If the company failed to properly account such things as theft, sales returns or spoilage in its inventory, then the estimate could fail to be representative.