Dexall Company recently had a fire in its store. Management must determine the inventory loss for the insurance company. Since the firm did not have perpetual inventory records, the insurance company has suggested that it might accept an estimate using the gross profit test.

The beginning inventory, as determined from the last financial statements, was $10,000. Purchase invoices indicate purchases of $100,000. Credit and cash sales during the period were $120,000. Last year, the gross profit for the firm was 40%, which was also the industry average.

Required

a. Based on these data, estimate the inventory loss.

b. If the industry average gross profit was 50%, why might the insurance company be leery of the estimated loss?