1

4
5
a

b
c
254356&infoId=398506

Gross Profit Method

The Shelly Corporation is an importer and wholesaler. Its merchandise is

purchased from several suppliers and is warehoused by Shelly Corporation until
sold to consumers

In conducting her audit for the year ended June 30, 2007 the corporation’s CPA
determined that the system of internal control was good. Accordingly, she
observed the physical inventory at an interim date, May 31, 2007, instead of at
year-end.

The CPA obtained the following information from the general ledger:
Inventory,July 1,2006
Physical Inventory,May 31,2007
Sales for 11 months ended May 31,2007
Sales for Year ended June 30,2007
Purchases for 11 months ended May 31,2007(before audit adjustments)
Purchases for year ended June 30,2007(before audit adjustments)

The CPA’s audit disclosed the following information:

Adjustments Required
Shipments received in May and included in the physical inventory but recorded as
June Purchases
Purchases

Shipments Received in unusable condition and excluded from physical inventory

Total for May 2007
Purchase Return
Purchase Return

Advance deposit made to vendor and charged purchases in April 2007.Shipment

received only in July
Purchases

Advance deposit made to vendor and charged purchases in May 2007.Shipment

received only in June(FOB destination)
Purchases
Inventory

Damage of June shipment-sold in June at cost

cost of goods sold

Total adjustment required

Purchases
Purchase s returns
Inventory

Required
In audit engagements in which interim physical inventories are observed, a
frequently used auditing procedure is to test the reasonableness of the year-end
inventory by the application of gross profit ratios.

Prepare in good form the following schedules:

1. Computation of the gross profit ratio for 11 months ended May 31, 2007.
$

Sales for 11 months ended May 31,2007

Cost of goods sold

Inventory,July 1,2006
Total purchases after audit adjustments for 11 months ended May 31, 2007. 675000
Increased Purchase Return after audit adjustments -1000
Net Purchases after audit adjustments
Less Inventory after audit adjustments, May 31,2007=$95000-5500
Cost of goods sold after audit adjustments for 11 months ended May 31, 2007
Gross Profit for 11 months ended May 31, 2007

gross profit ratio for 11 months ended May 31, 2007.=Gross Profit for 11 months
ended May 31, 2007/Sales for 11 months ended May 31,2007

2. Computation by the gross profit ratio method of cost of goods sold during
June 2007.
$
sales in June 2007 =(Sales for 12 months ended June 30,2007-sales of 11 months
ended may 2007)

cost of Goods sold in June 2007 by Gross profit method=sales in June 2007 x (1-
Gross profit ratio)
($960000-840000) x(1-20%)

3. Computation by the gross profit ratio method of June 30, 2007 inventory.

End Inventory on June 30,2007 $

Inventory,May 31,2007
Purchases for the year ended June 30,2007(after audit adjustments) 798000
Increased Purchase Return after audit adjustments -1500
Net Purchases for the Year ended June 30,2007 after audit adjustments 796500
Less Net Purchases for 11 months ended May 31, 2007.after audit adjustments 674000
Net Purchases in the Month June 2007
cost of Goods sold in June 2007 by Gross profit method
End Inventory on June 30,2007=a+b-c
 $
87500
95000
840000
960000
675000
800000

May-07 Jun-07

7500 0

-1000
-1500

-2000 -2000
 -5500 0
-5500 0

10000

0 -2000
-1000 -1500
-5500 0

$ $

840000

87500

674000
89500
672000
168000

20.00%

$ $
 120000

96000

$ $

89500

122500
96000
116000