The estimation of the amount of the ending inventory by gross profit method is based on the assumptions that the percentage (or rate) of the gross margin on sales (or simply gross profit) is known. This is possible when the said rate is more or less constant over a number of years. It is, therefore, necessary that a careful study of the past data should be made. The inventory assumed to be on hand at the end of the current period is that amount which will result in a rate of gross margin equal to assumed rate. The calculation involves application of the assumed gross margin on sales in order to determine the cost of goods sold.

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