The conventional retail method produces an ending inventory that approximates

What Is the Retail Inventory Method?

The retail inventory method is an accounting method used to estimate the value of a store's merchandise. The retail method provides the ending inventory balance for a store by measuring the cost of inventory relative to the price of the merchandise. Along with sales and inventory for a period, the retail inventory method uses the cost-to-retail ratio.

Key Takeaways

• The retail inventory method is an accounting method used to estimate the value of a store's merchandise.
• The retail method provides the ending inventory balance for a store by measuring the cost of inventory relative to the price of the goods.
• Along with sales and inventory for a period, the retail inventory method uses the cost-to-retail ratio.
• The retail method of valuing inventory only provides an approximation of inventory value since some items in a retail store will most likely have been shoplifted, broken, or misplaced.
• The retail inventory method is only an estimate and should always be supported by period physical inventory counts.

Understanding the Retail Inventory Method

Having a handle on your inventory is an important step in managing a successful business. It allows you to understand your sales, when to order more inventory, how to manage the cost of your inventory, as well as how much of your inventory is making it into the hands of consumers, as opposed to being stolen or broken.

The retail inventory method should only be used when there is a clear relationship between the price at which merchandise is purchased from a wholesaler and the price at which it is sold to customers. For example, if a clothing store marks up every item it sells by 100% of the wholesale price, it could accurately use the retail inventory method, but if it marks up some items by 20%, some by 35%, and some by 67%, it can be difficult to apply this method with accuracy.

The retail method of valuing inventory only provides an approximation of inventory value since some items in a retail store will most likely have been shoplifted, broken, or misplaced. It's important for retail stores to perform a physical inventory valuation periodically to ensure the accuracy of inventory estimates as a way to support the retail method of valuing inventory.

Calculating Ending Retail Inventory

The retail inventory method calculates the ending inventory value by totaling the value of goods that are available for sale, which includes beginning inventory and any new purchases of inventory. Total sales for the period are subtracted from goods available for sale. The difference is multiplied by the cost-to-retail ratio (or the percentage by which goods are marked up from their wholesale purchase price to their retail sales price).

The cost-to-retail ratio, also called the cost-to-retail percentage, provides how much a good's retail price is made up of costs. If, for example, an iPhone costs $300 to manufacture and it sells for $500 each, the cost-to-retail ratio is 60% (or $300/$500) * 100 to move the decimal.

Disadvantages of the Retail Inventory Method

The retail inventory method's primary advantage is the ease of calculation, but some of the drawbacks include:

• The retail inventory method is only an estimate. Results can never compete with a physical inventory count.
• The retail inventory method only works if you have a consistent markup across all products sold.
• The method assumes that the historical basis for the markup percentage continues into the current period. If the markup was different (as may be caused by an after-holiday sale), then the results of the calculation will be inaccurate.
• The method does not work if an acquisition has been made, and the acquiree holds large amounts of inventory at a significantly different markup percentage from the rate used by the acquirer.

Example of the Retail Inventory Method

Using our earlier example, the iPhone costs $300 to manufacture and it sells for $500. The cost-to-retail ratio is 60% ($300/$500 * 100). Let's say that the iPhone had total sales of $1,800,000 for the period.

• Beginning inventory: $1,000,000
• New Purchases: $500,000
• Total goods available for sale: $1,500,000 
• Sales: $1,080,000 (Sales of $1,800,000 x 60% cost-to-retail ratio)               
• Ending inventory: $420,000 ($1,500,000 - $1,080,000)

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Found in: Page 474

Book edition 16th

Author(s) Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield

Pages 1552 pages

ISBN 9781118743201

Short Answer

Question:The conventional retail inventory method yields results that are essentially the same as those yielded by the lower-of-cost-or-market method. Explain. Prepare an illustration of how the retail inventory method reduces inventory to market.

Answer

The conventional retail method values the inventory at cost per the cost to retail percentage, which is similar to the valuation of inventory per the lower-of-cost-or-market method.

See the step by step solution

Step by Step Solution

Step 1: Explanation of conventional retail method

Under the conventional retail method, ending inventory at cost is estimated by multiplying the cost-to-retail percentage by ending inventory at retail. This ending inventory at cost is taken as market value, compared with ending inventory at retail.

Ending inventory at cost is always lower than the ending inventory at retail, which is the same as the value estimated under Lower-of-cost-or-market.

Step 2: Example of conventional retail method

For example, ending inventory at cost is calculated using the conventional retail method for the following.

Step 3: Calculation of ending inventory at retail

Ending inventory at retail is calculated as follows

Step 4: Calculation of the cost-to-retail ratio

Cost to retail ratio is calculated as follows:

Step 5: Calculation of inventory value at cost

Inventory at cost is calculated as follows:

In the example, inventory at cost equals $233,100, and inventory at retail (market) equals $370,000. Per the lower-of-cost-or-market, the value of inventory is $233,100, which is the same under both methods.

Most popular questions for Business-studies Textbooks

(a) Determine the ending inventory under the conventional retail method for the furniture department of Mayron Department Stores from the following data. Cost Retail Inventory, Jan. 1 $ 149,000 $ 283,500 Purchases 1,400,000 2,160,000 Freight-in 70,000 Markups, net 92,000 Markdowns, net 48,000 Sales revenue 2,175,000 (b) If the results of a physical inventory indicated an inventory at retail of $295,000, what inferences would you draw?

As of January 1, 2017, Aristotle Inc. adopted the retail method of accounting for its merchandise inventory. To prepare the store’s financial statements at June 30, 2017, you obtain the following data. Cost Selling Price Inventory, January 1 $ 30,000 $ 43,000 Markdowns 10,500 Markups 9,200 Markdown cancellations 6,500 Markup cancellations 3,200 Purchases 104,800 155,000 Sales revenue 154,000 Purchase returns 2,800 4,000 Sales returns and allowances 8,000 Instructions (a) Prepare a schedule to compute Aristotle’s June 30, 2017, inventory under the conventional retail method of accounting for inventories. (b) Without prejudice to your solution to part (a), assume that you computed the June 30, 2017, inventory to be $59,400 at retail and the ratio of cost to retail to be 70%. The general price level has increased from 100 at January 1, 2017, to 108 at June 30, 2017. Prepare a schedule to compute the June 30, 2017, inventory at the June 30 price level under the dollarvalue LIFO retail method. (AICPA adapted)

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