When Mary Potts arrived at her store on the morning of January 29, she found empty shelves and display racks; thieves had broken in during the night and stolen the entire inventory. Accounting records showed that Potts had inventory costing $50,000 on January 1. From January 1 to January 28, Potts had made net sales of $70,000 and net purchases of $80,000. The gross profit during the past several years had consistently averaged 42 percent of net sales. Potts plans to file an insurance claim for the theft loss. Required:
a. Using the gross profit method, estimate the cost of inventory at the time of the theft.
b. Doe Potts use the periodic inventory method or does she account for inventory using the perpetual method?

a. The cost of inventory at the time of the theft is $89,400.

b. Potts uses the periodic inventory method.

Explanation:

a. Using the gross profit method, estimate the cost of inventory at the time of the theft.

The cost of inventory at the time of the theft can be estimated using gross profit method as follows:

Inventory cost on January 1 = $50,000

Net sales = $70,000

Net purchases = $80,000

Gross profit = Net sales *  42% = $70,000 * 42% = $29,400

Cost of goods sold = Net sales - Gross profit = $70,000 - $29,400 = $40,600

Inventory cost on January 28 = Inventory cost on January 1 + Net purchases - Cost of goods sold = $50,000 + $80,000 - $40,600 = $89,400

Inventory cost on January 28 is the same as the cost of inventory at the time of the theft; therefore, the cost of inventory at the time of the theft is $89,400.

b. Doe Potts use the periodic inventory method or does she account for inventory using the perpetual method?

Periodic inventory method refers to an accounting stock valuation practice in which updates to inventory are made at specified intervals such as weekly, monthly, or annually.

Perpetual inventory method refers to an accounting stock valuation practice in which updates to inventory are made continuously and automatically as inventory is received or sold.

From the question, the fact that the only available accounting records showed that Potts had inventory costing $50,000 on January 1 without any other record January 28, this implies that Potts uses the periodic inventory method which could be monthly or annually.

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