Retail Inventory Method

• Retail inventory method


  Method of estimating the value of inventory
• PAS 2, paragraph 22, provides that the retail inventory method is often used in the retail industry for measuring inventory of large number of rapidly changing items with similar margin for which it is impracticable to use other costing method
• Retail inventory method


  Generally employed by department stores, supermarkets and other retail concerns where there is a wide variety of goods
• Keeping track of unit cost at all times is difficult
• Retail


  Selling price
• Information required for the retail inventory method

  • Beginning inventory at cost and at retail price
  • Purchases during the period at cost and at retail price
  • Adjustments to the original retail price such as additional markup, markup cancelation, markdown and markdown cancelation
  • Other adjustments such as departmental transfer, breakage, shrinkage, theft, damaged goods and employee discount
• Goods available for sale at retail or selling price

  Ending inventory at selling price
• Basic formula for the retail inventory method

  1. Goods available for sale at retail or selling price

  2. Less: Net sales (Gross sales minus sales return only)

  3. Ending inventory at selling price

  4. Multiply by cost ratio

  5. Ending inventory at cost
• Cost ratio


  Goods available for sale at cost / Goods available for sale at selling price
• By reason of the computation of the cost ratio, it is necessary that the goods available for sale should be determined not only in terms of selling price but also in terms of cost
• Like gross profit method, the amount of net sales is computed by deducting sales return only from gross sales
• Treatment of items in the retail inventory method

  • Purchase discount - deducted from purchases at cost only
  • Purchase return - deducted from purchases at cost and at retail
  • Purchase allowance - deducted from purchases at cost only
  • Freight in addition to purchases at cost only
  • Departmental transfer in or debit - addition to purchases at cost and at retail
  • Departmental transfer out or credit - deduction from purchases at cost and retail
  • Sales discount and sales allowance - disregarded, meaning, not deducted from sales
  • Sales return - deducted from sales
  • Employee discounts - added to sales
  • Normal shortage, shrinkage, spoilage, breakage - deducted from goods available for sale at retail
  • Abnormal shortage, shrinkage, spoilage, breakage - deducted from goods available for sale at both cost and retail
• Items related to retail method

  • Initial markup - original markup on the cost of goods
  • Original retail - the sales price at which the goods are first offered for sale
  • Additional markup - increase in sales price above the original sales price
  • Markup cancelation - decrease in sales price that does not decrease the sales price below the original sales price
  • Net additional markup or net markup - markup minus markup cancelation
  • Markdown - decrease in sales price below the original sales price
  • Markdown cancelation - increase in sales price that does not increase the sales price above the original sales price
  • Net markdown - markdown minus markdown cancelation
  • Maintained markup - difference between cost and sales price after adjustment for all of the above items
• Approaches in the use of retail method

  • Conservative or conventional or lower of cost and net realizable value approach
  • Average cost approach
  • FIFO approach
  • LIFO approach
• IFRS expressly prohibits LIFO
• Conservative approach


  Includes net markup and excludes net markdown in determining the cost ratio in order to arrive at a conservative cost
• Average cost approach


  Includes both net markup and net markdown in determining cost ratio to arrive at an inventory that will approximate or equal historical cost
• PAS 2, paragraph 22, provides that the percentage used under the retail method shall take into consideration inventory that has been marked down to below the original selling price
• An average percentage for each retail department is often used
• The average cost approach shall be applied in conjunction with the retail inventory method
• FIFO retail and LIFO retail

  Similar to the average cost approach in that both net markup and net markdown are considered in computing the cost ratio, but a current cost ratio is determined every year considering the net purchases during the current year and excluding the beginning inventory
• The FIFO retail and LIFO retail are based on the assumption that markup and markdown apply to goods purchased during the current year and not to beginning inventory
• Illustration - FIFO retail

  • Beginning inventory-cost ratio 55%
  • Purchases
  • Net markup
  • Net markdown
  • Net sales
  • Current year cost ratio (1,800,000/3,000,000) 60%
  • Goods available for sale
  • Ending inventory at retail
  • FIFO cost (1,200,000 x 60%)
• Illustration - LIFO retail

  • From beginning inventory 55%
  • From current year purchases 60%
  • LIFO cost