Problem 14 - Accounting Principles

Question

Songbird Company has sales of \(\$ 150,000\) and cost of (SO 8) goods available for sale of \(\$ 135,000\). If the gross profit rate is \(30 \%\), the estimated cost of the ending inventory under the gross profit method is: a. \(\$ 15,000\). c. \(\$ 45,000\). b. \(\$ 30,000\). d. \(\$ 75,000\).

Step-by-Step Solution

Answer

The estimated cost of the ending inventory is \( \$ 30,000 \).

Step 1: Understand Given Data

Identify the information provided in the problem statement. Songbird Company has sales of \( \\( 150,000 \), the cost of goods available for sale is \( \\) 135,000 \), and the gross profit rate is 30\%.

Step 2: Calculate Gross Profit in Dollars

Use the given sales and gross profit rate to calculate the gross profit in dollars using the formula: \( \text{Gross Profit} = \text{Sales} \times \text{Gross Profit Rate} \). Substitute the given values: \( \text{Gross Profit} = 150,000 \times 0.30 = \$ 45,000 \).

Step 3: Determine the Cost of Goods Sold (COGS)

Calculate the cost of goods sold by subtracting the gross profit from sales: \( \text{COGS} = \text{Sales} - \text{Gross Profit} \). Using the calculated gross profit: \( \text{COGS} = 150,000 - 45,000 = \$ 105,000 \).

Step 4: Estimate the Ending Inventory

Use the cost of goods available for sale and the cost of goods sold to find the ending inventory. The formula is: \( \text{Ending Inventory} = \text{Cost of Goods Available for Sale} - \text{COGS} \). Substitute: \( \text{Ending Inventory} = 135,000 - 105,000 = \$ 30,000 \).

Key Concepts

Ending Inventory

Ending inventory is a crucial value representing the cost of goods that a company still holds for sale at the end of an accounting period. In the context of the gross profit method, it is estimated using the cost of goods available for sale and the calculated cost of goods sold.

By applying the gross profit method, businesses can estimably conclude their inventory values without counting physical inventory. This is especially beneficial when physical inventory counts are impractical.

• Begin by identifying the cost of goods available for sale.
• Next, subtract the cost of goods sold from this total.

In summary, for Songbird Company, the ending inventory is determined by calculating:- Cost of Goods Available for Sale (\(\\(135,000\))- Subtracting the Cost of Goods Sold (\(\\)105,000\))- Resulting in the Ending Inventory of \(\$30,000\).

This method allows companies to promptly gauge their inventory levels, aiding in effective stock management.

Cost of Goods Sold

The Cost of Goods Sold (COGS) is a measure of the direct costs attributable to the production of the goods sold by a company. This includes the cost of the materials used in creating the good along with the direct labor costs used to produce the good. It excludes indirect expenses like distribution costs and sales force costs.

In the context of the gross profit method, calculating COGS is pivotal to find the ending inventory. Here’s how it works for Songbird Company:

• Start with the total sales reported (\(\\(150,000\)).
• Subtract the gross profit calculated from sales, which was determined to be \(\\)45,000\).

This yields the COGS of \(\$105,000\), which represents the direct costs incurred by the company to sell its goods.

Understanding COGS is essential as it impacts the gross profit and, consequently, the net income of a business. A lower COGS indicates efficient production and inventory management processes.

Gross Profit Calculation

Gross profit is the difference between sales and the cost of goods sold. It measures how efficiently a company uses its resources, like labor and supplies, in producing goods. To calculate gross profit using the gross profit method, you'll rely on the gross profit rate provided by the company.

• Multiply total sales by the gross profit rate to find the dollar amount of gross profit.
• For Songbird Company, use the formula: \(\text{Gross Profit} = \text{Sales} \times \text{Gross Profit Rate}\).

So, \(\\(150,000\) in sales multiplied by a 30% gross profit rate results in a gross profit of \(\\)45,000\).

This figure is vital as it is subtracted from total sales to derive the cost of goods sold. Gross profit also acts as a primary indicator of the company's core profitability, paving the way for covering other business expenses and driving future growth. Hence, keeping a keen eye on calculation accuracy and understanding its implications helps in strategic business planning.