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.
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. 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. The retail inventory method's primary advantage is the ease of calculation, but some of the drawbacks include:
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.
You're Reading a Free Preview
Companies have used the retail method of inventory accounting for many years. According to the Committee on Ways and Means, the retail inventory method has been the best accounting method since 1941. Professor N.P. McNair wrote the first major book detailing the pros of using this method. While some have begun to question the usefulness of this method in recent years, due to advances in tracking costs and inventory, as Smyth Retail points out, it's still used with efficiency by many businesses today.
The retail inventory method is one of only two methods accepted for tax reporting purposes and accepted by the American Institute of CPAs under the Generally Accepted Accounting Principles. The direct cost method comprises the other accepted method. RIM also stands as the most widely used method by merchandising companies to calculate inventory values.
According to California State University Northridge, the retail method is especially useful for quarterly financial statements. It is based on the relationship between the merchant's cost and the retail prices of inventory. Additional factors, like mark-ups and mark-downs, as well as employee discounts must be factored into the calculations. However, before you can do that, you need to understand the basics of the retail method.
The cost/retail ratio makes up one of the main components used to calculate the retail inventory method. Two methods exist for calculating the cost/retail ratio. The first method, called the conventional retail method includes markups but excludes markdowns. This method results in a lower ending inventory value. The second method, simply called the retail method, uses both markups and markdowns to calculate the ratio. This method results in a higher-ending inventory value.
When using the conventional retail inventory method for inventory costing, the following data inputs create the cost/retail ratio formula: beginning inventory at cost and retail, purchases at cost and retail plus the retail value of any markups:
The product of this calculation equals the cost/retail ratio. For example beginning inventory values are $10,000 at cost and 20,000 at retail, purchases total $40,000 at cost and $80,000 at retail and markups totaled $6,000 at retail. $10,000 + $40,000 = $50,000 total value at cost. $20,000 + $80,000 + $6,000 = $106,000 total value at retail. $50,000 / $106,000 = 0.472 for a cost/retail ratio of 47 percent.
Once the cost/retail ratio gets determined the small business owner uses that ratio to value his period-end inventory. Using the $50,000 total inventory value at cost and the $106,000 total inventory value at retail, the owner now subtracts all sales and any markdowns from the total inventory value at retail. This gives the owner a total ending inventory value at retail selling price.
To determine the total ending inventory value at cost, the owner multiplies the ending inventory value at retail selling price times the cost/retail ratio. For example, if sales total $75,000 and markdowns totaled $9,000 he subtracts these numbers from the $106,000 leaving $22,000 in ending inventory value at retail. He then multiplies the $22,000 times the cost/retail ratio of 47 percent and gets an ending inventory value at cost of $10,340 ($22,000 x 0.47 = $10,340.)
Because the retail inventory method uses weighted averages to calculate the ending values it does not represent an exact cost value of the inventory. Also, because it uses markdowns, this method gives the most conservative value for inventory valuation. In practice, the retail inventory method, with markups and markdowns, can become complicated to figure out, so it's best to track these using a database or, at the very least, a spreadsheet. |
When using the conservative retail method What effect does freight have on the cost retail ratio?
Pos Terkait
Copyright © 2024 kemunculan Inc.
