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Intermediate-Accounting Handout Chap 14

This document provides an overview of the retail inventory method. It begins by explaining that the retail inventory method is often used in the retail industry for items that have similar margins and it would be impractical to track costs individually. The key aspects of the retail inventory method include: - Tracking beginning and ending inventory values at both cost and retail price - Maintaining records of purchases, sales, markups, markdowns, and other adjustments - Using a cost ratio to convert ending retail inventory to an ending inventory value at cost The document then provides the basic formula for calculating the cost ratio and applying it to the ending retail inventory. It also discusses how various items like purchases, returns, transfers, and discounts should be treated

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Joanne Rheena Boo
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135 views3 pages

Intermediate-Accounting Handout Chap 14

This document provides an overview of the retail inventory method. It begins by explaining that the retail inventory method is often used in the retail industry for items that have similar margins and it would be impractical to track costs individually. The key aspects of the retail inventory method include: - Tracking beginning and ending inventory values at both cost and retail price - Maintaining records of purchases, sales, markups, markdowns, and other adjustments - Using a cost ratio to convert ending retail inventory to an ending inventory value at cost The document then provides the basic formula for calculating the cost ratio and applying it to the ending retail inventory. It also discusses how various items like purchases, returns, transfers, and discounts should be treated

Uploaded by

Joanne Rheena Boo
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Chapter 14 – Retail Inventory Method

Retail inventory method


 PAS 2, paragraph 22, provides that this 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
 In other words, the retail inventory method is generally employed by department stores, supermarkets
and other retail concerns where there is a wide variety of goods
 This is so because keeping track of unit cost at all times is difficult
 The retail inventory method came to its name because the selling price or retail price is tagged to each
item
 The term retail simply means selling price

Information required
The use of retail inventory method required that records be kept which must show the following data:
a. Beginning inventory at cost and at retail price
b. Purchase during the period at cost and at retail price
c. Adjustments to the original retail price such as additional markup, markup cancellation, markdown and
markdown cancelation
d. Other adjustments such as departmental transfer, breakage, shrinkage, theft, damaged goods and
employee discount

Basic formula
 In principle and procedurewise, the formula for the retail inventory method is very similar to the gross
profit method
 The difference is that under the gross profit method, the ending inventory is stated at cost while under
the retail inventory method, the ending inventory is expressed in terms of selling price
 Observe the following basic formula for the retail method:

Goods available for sale at retail or selling price xx


Less: Net sales (Gross sales minus sales return only) xx
Ending inventory at selling price xx
Multiply by cost ratio xx
Ending inventory at cost xx

Goods available for sale at cost


Cost ratio = -----------------------------------------------------------
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

Illustration: page 408

Treatment of items
a. Purchase discount – deducted form purchases at cost only
b. Purchase return – deducted from purchases at cost and at retail
c. Purchase allowance – deducted form purchases at cost only
d. Freight in – addition to purchases at cost only
e. Departmental transfer in or debit – addition to purchases at cost and at retail
f. Departmental transfer out or credit – deduction fomr purchases at cost and retail
g. Sales discount and sales allowance – disregard, meaning, not deducted form sales
h. Sales return – deducted from sales. If the account is “sales return and allowance”, the same should be
deducted from sales
i. Employee discounts – added to sales. Employee discounts are special discounts usually not recorded
because they are directly deducted form the sales price. Only the net sales price is recorded.
Consequently, the amount of sales in understated. Thus, the employee discounts are added back to
sales
j. Normal shortage, shrinkage, spoilage, breakage – This is deducted from goods available for sale at retail.
Any normal shortage is usually absorbed or included in cost of goods sold
k. Abnormal shortage, shrinkage, spoilage, breakage – This is deducted form goods available for sale at
both cost and retail so as not to distort the cost ratio. Any abnormal amount is reported separately as
loss

Items related to retail method


Accordingly, in the determination of the inventory at retail and for purposes of computing the cost ratio,
the following items should be considered:

The original sales price is frequently raised or lowered particularly at the end of the selling season where
replacement costs are changing.

a. Initial markup – original markup on the cost of goods


b. Original retail – the sales price at which the goods are first offered for sale
c. Markup cancelation – decrease in sales price above the original sales price
d. Markup cancelation – decrease in sales price that does not decrease the sales price below the original
sales price
e. Net additional markup or net markup – markup minus markup cancellation
f. Markdown – decrease in sales price below the original sales price
g. Markdown cancelation – increase the sales price that does not increase the sales price above the original
sales price
h. Net markdown – markdown minus markdown cancelation
i. Maintained markup – difference between cost and sales price after adjustment for all of the above items.
Sometimes, maintained markup is referred to as “markon”

Illustration: page 411-413

FIFO retail approach


 This is similar to the average cost approach in that it considers both net markup and net markdown in
computing the cost ratio
 However, the current cost ratio is determined every year considering the net purchases during the year
and excluding the beginning inventory
 The FIFO approach is based on the assumption that markup and markdown apply to goods purchased
during the year and not to beginning inventory

Illustration: page 414

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