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CHAPTER14
RETAIL INVENTORY METHOD

TECHNICAL KNO WLEDGE

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Toapplytheretail invéntorymethodusingtheconservative
or conventional approach. .

To apply the retail inventory method using the average cost

approach.

To apply the retail inventory method using the FIFO

approach.
 Introduction

The retail inventory method is the other method of

estimating the value of inventory.

PAS 2, paragraph 22, provides that this method is often used

in the retail industry for. measuring inventory of large
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number of rapidly changing items With similar margin for
Which it is impracticable to use other costing method. .
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Ih otherwords,the retail inventorymethodis 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.

Theretail inventorymethodcameto its namebecausethe

selling price or retail price is tagged toeach item.
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The term "retail" simply means Selling price.

Information required
' The use of the retail
inventory method requires that records
be kept Which must show the following data:

inventoryat costand at retail price

a. Beginning

1)., Purchases during the period at cost and at retail price

c. Adjustments to the original retail price such as additional

markup, markup cancelation, markdown and markdown
cancelation

d. Other adjustments such as departmental transfer, breakage,

shrinkage, theft, damaged goods and employee discount
 Basfc formula
\ rinci 1e an d procedurewme,
.
the formulafor the .
retall
gygntorypmeth1s very similar to the gross method. profit
ThediEerenceis that underthe gross
profit method,the ending
inventory 1_sstated at cost while under the
thé retail inventory
endLing is expressed
inventory in of
terms selling
geggod,
Observethe fOHOWingbasic formula for the retail method:
Goodsavailable for sale at retail or XX
sellingprice
Less: Net
sales(Grosssalesminus sales return only) X.X
Ending inventory at selling price xx
Multiply by cost ratio xx
Endinginventdry 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.
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Illustration using assumed figures

Cost Retail .
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Beginning inventory _ 150,000 230,000
Purchases ~ 400,000 650,000
Freight in . . 10,000
Purchase return ( 55,000) ( 80,000)
Purchase allowance ( 5,000)
Purchase discount ( 20,000)
Goodsavailable for sale (GAS) 480,000 800,000

Cost ratio (480,000/800,000) 60%

Less: Sales 630,000
Salesreturn . ( 30,000) 600,000
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Endinginventory at retail 200,000
Ending inventoxy atcost (200,000 x 60%) 120,000
'lreatment of items

a. Purchasediscount- deductedfrom purchasesat cost only.

I). Pumhasemtumdeductedfrom purchasesat costand at retail.

~c.Purchase - deducted
allowance from at.cost
purchases only.
in - addition
(1.height topurchases
atcost
only.
e Departmentaltransferm or debit addition to purchases at
cost and at retail.
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f. Departmental transfer out or credit - deduction from
purchasesat cost and retail.

g. Sales discountand sales allowance disregarded, meaning,

not deductedfrom 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

recordedbecausethey are directly deducted from the sales
price. .

Onlythenetsalespriceis recorded. the

Conseciuently,
amount of sales is linderstated. Thus, the employee
discounts are added back to sales.

j. Normalshortage, breakageThis is
spoilage,
shrinkage,
deducted from goods available for sale at retail.

Any normal shortageis usually absorbed or included in cost of

goods sold

k. Abnormal shortage, shrinkage, spoilage, breakage

This is deducted from goods available for sale at both cost
and retail so as not to distort the cost ratio.

Any abnormalamountis reportedseparatelyas loss.

 to retail method
[temsOrelated
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 hrst
offered for sale

Additional markup ' inereesein salesprice abovethe-

original sales price.
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. Markup cancelation- decreasein salesprice that doesnot

decreasethe sales price belowthe original sales price.

Net additional markup or net markup- markup minus

markup cancelation. x . .
O t

1nsalespricebelow
Markdown decrease theoriginalsales
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.

i. Maintainedmarkup - differencebetweencostand sales

price after adjustment for all of the above items.

Sometimes, maintained markup is referred to as

markon.
Illustration
200
Cost 40
a. Initialmarkup .,
' 2:0
b. Original retail or salesprice ,
- 60
c. Additional markup
'New
sales
price " 333
d. Markup cancelation
New sales below sales
original
the P1109) 260
(not
price
e. Netmarkup(60-40) 2:0.
If atthispoint, is
item down
marked to 210
the
cancelation 20
Markup
f. Markdown(decrease in salespricebelowthe .
originalsalesprice) ,' -
' .32 ___5_Q
Newsalesprice * 210
g. Markdown cancelation(increase1nsalesprice
that does not increase the new sales price
above theorigmal priceof240) __2_Q
New salesprice ' sales|
"
. . 213.9.

h. N et markdown (30 - 20) _ 1

' . 10
i. Maintained markup (230 - 200) t , __3_9

Approaches in the use of retail method '.

To obtainthe appropriateinventoryvalue under the retail

inventory method, three approaches are followed, namely:

a. Conservative or conventional or lower of cost and net

realizable value approach

b. Average cost approach

0. FIFO approach
 Illustration

Cost Retail
Beginning inventory
180.000
Net purchases I 250.000
Additional markup 1.020.000 1,575,000
200.000
Markup cancelation
" 25.000
Markdown
140,000
Markdown cancelation ..
I 15,000
Sales
" 1,450,000
Sales return '
50,000
Sales allowance , 10,000
Sales discount 2
20,000
Employee discount 40,000
Spoilage and breakage 35,000

Conservative and average cost

Cost Retail

Be ginning inventory 180,000 250,000

N et purchases 1,020,000 1,575,000
Additional markup 200,000
Markup cancelation 25 000

GAS conservative '

1,200,000 2,000,000
Cost ratio (1,200,000 / 2,000,000) 60%
Markdown ( 140,000)
Markdown cancelation 15,000

GAS - average 1,200,000 1,875,000

Cost ratio (1,200,000 / 1,875,000) 64%

Less: Sales 1,450,000
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Salés return ( 50,000)
Employee discount 40,000
Spoilage and breakage 35,000 1,47 5,000

Ending inventory at retail 400,000

_Conservative cost(400,000x 60%) 240,000

Average cost (400,000x 64%) 256,000

 costof goodssold
Computation/of
Conservative Average"

Gootisavailablefor sale 1,200,000 ' 1,200,000

Endmginventory ( 240,000) ( 256,000)
Cost of goodssold . 960,000 944,000

Observe the difference between the conservative approach and

average cost approach.
The conservative approach includes net markup and excludes net
markdown in determining the cost ratio in order to arrive a
conservative cost. ,

Notice that the conservative cost is lower than the average cost.
Thus, this approach 1s also known as the lower of average cost or
market.

Ontheother theaverage
hand, cost bothnet
includes
approach
markup and net markdown 1n determining cost ratio.

The reason for such an approach 1s to arrive at an inventory

that will approximate or equal historical cost.
PAS 22,provides
2,paragraph thatthepercentage under
used
shall take into consideration
the retail method that inventory
has been marked down to below the original selling price.

An average percentage for each retail department is .often

used. \

This means that the average cost approach shall be applied in

conjunction wtth the retatl tnventory method.

FIFO retail approach

TheFIFOretail appi'oach
is similarto the averagecost
approach in that it considers both net markup and net
markdown 1n computing the cost ratio.

However, a current cost ratio is determined every year

considering the net purchases during the year and excluding
the beginning inventory. '

The FIFO approach13based on the assumption that markup

and markdownapplyto goodspurchasedduring the year and
M to beginning inventory.
 Illinstratitm- FIFO retail
. .' Cost Retail
33%:mvenmry
. 495,000900,000
markup
11:12: 1,800,000
markdown
Net -3,33%,333
600 000 .
Net sales . 2,700:000
The ending inventory using the FIFO retail approach is
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computed as follows:

_ Cost _ Retail _
Beginninginventory 495,000 900,000
Purchases , 3,300,000
' 1,800,000
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Net markup , , 300,000
Net markdown _ (. 600,000)
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Net purchases ' ' _1,800,000 3,000,000
Current year cost ratio
(1,800,000 / 3,000,000) 60%
Goods available for sale _ _ 2,295,000 3 3,900,000
' - """ - 2,700,000
Less: Net sales .
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Endinginventoryat retail , 1,200,000
FIFOcost - ' 720,000
(1,200,000x60%)_.
yearcostratioof60%issimply
Thecurrent Bythe
multiplied
ending inventory at retail of P1,200,000 to get the FIFO cost
becauseunder FIFO, the inventorycomesfrom the mostrecent
or current year purchases.
The costof goodsgold is ordinarily computed.
Goods forsale
available , 2,295,000
Endinginventoryat FIFO cost ( 720,000)
Coctofgoodssold 1,575,000