1. Jayne Industries Limited recently suffered losses from a fire. In an attempt to prepare support for an insurance claim, the following information has been assembled:

Sales (to date of fire) $3,500,000
Mark up on cost 40%
Inventory at close of prior year 2,450,000
Purchases (to date of fire) 1,800,000
The estimate for inventory destroyed in the fire would be?

a) $1,400,000
b) $2,499,700
c) $1,750,000
d) $1,800,000

My calculation is as below and I get the answer is $2,150,000 which is none of the answer above. If you know where I did wrong, please let me know. Thanks!

-Opening balance + purchases=2,450,000+1,800,000=4,250,000
-Cost of sales=3,500,000-40%*3,500,000=2,100,000

4,250,000-2,100,000=2,150,000

-Cost of sales=3,500,000-40%*3,500,000=2,100,000

Right here's the problem. You're subtracting 40% as though the markup were 40% of the sales price. The 40% is marked up from cost.

That means cost is some unknown, plus 40% of that unknown number, equals the sales price. So you have to work backwards.

If you use an algebra approach:
C + .40C = Sales
1.40C = 3.5 million
Etc.

Or, if you want to use a base, rate, part type of approach, your sales is the base PLUS an additional part. Base is always 100%. The addition part is 40%. So sales is 140% of cost. (That isn't the same thing as cost being 40% less than sales.) So we divide by the 140% to get back to the 100%, or cost. So 3.5 million divided by 1.40.

Everything else is fine and your approach to the problem is good. You just did it as though they'd given you the gross profit rate, which is easier.

Thanks a lot! That makes a lot more sense!

You're welcome. :-)