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.

	Fruit toppings	Marshmellow toppings	Chocolate toppings
Inventory, January 1, 2016 $	20000	7000	3000
Add: Net purchases thru Nov. 17, 2016	150000	36000	12000
Cost of inventory available for sale	170000	43000	15000
Less: Cost of goods sold*	160000	38500	13000
Estimated cost of inventory lost on Nov. 17, 2016 $	10000	4500	2000
*Cost of goods sold
Net sales thru Nov. 17, 2016 $	200000	55000	20000
Historical gross profit ratio	20%	30%	35%
Cost of goods sold ratio	80%	70%	65%
Cost of goods sold $	160000	38500	13000

2. The gross profit ratios and hence the percentage of cost of goods sold could cause the estimates to be over or understated. If the actual gross profit ratio for January 1 to Novemebr 17 is higher than the historical percentage used, the actual cost of goods sold would be lower and thus the estimation could be understated and vice-versa.