 Hello and welcome to this session in which you would look at an exercise or a CPA simulation that shows us how to compute gross profit percentage and through the gross profit percentage we will be able to estimate ending inventory and cost of goods sold in case we lost inventory, in case of fire, theft, natural disaster or similar activities. So let's go ahead and get started. Adam requires an estimate of the cost of goods sold lost by a fire on March 12th. So something happened at the warehouse, they lost some inventory. So here's what we know. We know that merchandise inventory on hand as of January 1st was 40,000. How do we know this? Well, we can look at last year's record and we know that ending inventory was 40, therefore the beginning inventory must be 40,000. So this number is easy to get, it's from the accounting record. Purchases since January 1st were 75,000. Well, since January 1st, we purchased 75,000 worth of inventory. Well, that's easy. That's also from the accounting record. So we're going to add this to our beginning inventory. Freight in worth 3,000. Freight in is basically cost of transportation for what you purchase. So if you purchase 75,000, it costs you an additional 3,000 to ship it. Guess what? Then you add the 3,000 to that. So the freight in remember is added because think about it. If you purchase something from Amazon and they shipped it, well, you're going to pay for the shipping cost. The shipping cost gets added to the cost of the product itself. Now, purchase returns and allowances. Well, you returned what they gave you allowances of $2,000. Well, guess what? You're going to have to deduct this. Why do you have to deduct this? Because if you return, remember, return is the opposite of the purchase. Therefore, you deduct purchase returns and allowances. And basically what we are told, what we are giving here is beginning inventory plus net purchases. And the reason I say net purchases because you purchase 75,000, you add to it freight, you deduct from it purchase returns and allowances. If you are giving discount, also you will deduct the discount. That's why I say net purchases. When we have this formula, those two numbers, beginning inventory plus net purchases, that's going to give us something good, something called goods available or merchandise available for sale at cost. And if we do so, we come up with a number of 116,000. Now, that's fine. But what does that mean if it's 116,000? How is that going to help us figure out how much of the inventory lost in the fire, how much of the inventory we still have? Now, the good news, we know we still have 11,000. Goods costing 11,000 were left undamaged. Now, of this 116,000, some of it is sold, it's going to be cost of goods sold, and some of it was lost in the fire. What else do we know? We know that sales are made at 33 and one-third percent above cost, and sales happen to total 90,000. Again, we know the sales from the sales record. Goods costing 11,000, we already notice. Now, what we need to do is to find out what was our cost of goods sold? How do we find out our cost of goods sold? This is where we use the gross profit percentage to figure out our cost of goods sold. Before we compute cost of goods sold, most likely you are an accounting student or a CPA candidate, and that's why you are watching. That's great. Please visit my website farhatlectures.com for additional resources, whether you are a CPA candidate using any of these CPA review courses or any other CPA review course, or you are taking your accounting course. I provide you with additional help, lectures, PowerPoint slides, multiple choice, true, false, exercises. My courses are aligned with your college courses and breaking down by chapters and topic. My CPA review course is aligned with your Roger, Becker, Wiley, Gleam, Myles. So it's very easy to go back and forth between my material and your CPA review course. If you have not connected with me on LinkedIn, please do so. Take a look at my LinkedIn recommendation. Like this recording. If it's helping you, it will help other people connect with me on Instagram, Facebook, Twitter, Reddit. And recently I started a CPA exam support group on GroupMe. Please join us. Now we have to figure out our gross profit percentage. Well, what do we know? We know that this company sells, Adam company, sales are made at 33.3% above cost. So let's assume cost is a dollar. What is the sales? Well, they're going to add to the cost 0.3333. So cost is a dollar. This is the cost plus the profit equal to the sales. So sales is 1.3333. Hopefully you can see this. Now what is the gross profit percentage? Well, we know that profit, which is if we take sales 1.3333 minus cost of a dollar, give us gross profit percentage, gross profit, gross profit, not gross profit percentage, gross profit of 0.3333. Now what we do is we take 0.3333 divided by 1.3333 and this is rounding. And if you round it, it's going to come up to 25%. So what we did is we figure out gross profit percentage. Be careful. What you are told here is 33% above cost. You are not giving the gross profit percentage at 33.33%. So you have to kind of think backward. If sales are 0.3333 above cost, assuming cost a dollar, add to it the profit of 0.3333 gives you sales. Then you figure out what's the gross profit divided by sales because gross profit percentage is gross profit divided by sales. You come up with 25%. And this is the formula for the gross profit percentage, which is 25%. Now if we know the profit is 25%, we know that the profit is 25%. Therefore what's left, if the profit is 25%, it means the cost is 75% of sales. We know sales is 90,000 multiplied by 75%, cost of goods sold for our sales was 67,500. Well now we're figuring out where that 116 is going. 67,500 is cost of goods sold. We know 11,000 is ending inventory, which is undamaged property. So cost of goods sold is 67,500. Ending inventory in total should have been 48,500. Well, undamaged goods is 11,000. Therefore the amount that's lost in the fire, the amount that's lost in the fire is 37,500. Now let's assume you are giving gross profit as 33.33. So that's why you have to be very careful. If you are giving gross profit, not 33 above cost, you are giving the gross profit of 33.33. Here's what you do then. You will take the 90,000 of sales times 66.67. Why 66.67? Well, if you are making a dollar in sales, you are told 33.33 is profit. What's left is 0.6667 as cost of goods sold percentage. So your cost of goods sold will be 0.6030. So basically now $60,000 and not $30,000 and $3.00. You will go with $60,000 and $3.00. Then what you have to do, the 116 will be split between this amount ending undamaged goods and what's left is ending inventory, which is, I'm sorry, part of it will be $60,000, $3.00, $11,000 and ending inventory and what's left will be the estimated fire loss. So again, this is a great exercise because it shows you how to go through the cost of goods sold formula. You need to have a good understanding of cost of goods sold. Traditionally, it's beginning inventory plus purchases equal to goods available for sale, minus ending will give you cost of goods sold. This is the traditional one. Now we're manipulating this basically working backward and this is why we have to know it. If you have any questions, any comments, please let me know. Study hard. Good luck. Stay safe and subscribe. Don't sure change yourself.