Which inventory method approximates inventory valuation at the lower of cost or market?
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July 14, 2022/ Steven Bragg
The retail inventory method is used by retailers that resell merchandise to estimate
their ending inventory balances. This method is based on the relationship between the cost of merchandise and its retail price. The method is not entirely accurate, and so should be periodically supplemented by a physical inventory count. Its results are not adequate for the year-end
financial statements, for which a high level of inventory record accuracy is needed. To calculate the cost of ending inventory using the retail inventory method, follow these steps: Calculate the cost-to-retail percentage, for which the formula is (Cost ÷ Retail price). Calculate the
cost of goods available for sale, for which the formula is (Cost of beginning inventory + Cost of purchases). Calculate the cost of sales during the period, for which the formula is (Sales × cost-to-retail percentage). Calculate ending inventory, for which the formula is (Cost of goods available for sale - Cost of sales during the period). Example of the Retail Inventory MethodMilagro Corporation sells home coffee roasters for an average of $200, and which cost it $140. This is a cost-to-retail percentage of 70%. Milagro’s beginning inventory has a cost of $1,000,000, it paid $1,800,000 for purchases during the month, and it had sales of $2,400,000. The calculation of its ending inventory is:
Retail Method Advantages and DisadvantagesThe retail inventory method is a quick and easy way to determine an approximate ending inventory balance. However, there are also several issues associated with it, which are as follows:
Terms Similar to Retail Inventory MethodThe retail inventory method is also known as the retail method and the retail inventory estimation method. 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
Understanding the Retail Inventory MethodHaving 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 InventoryThe 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 MethodThe retail inventory method's primary advantage is the ease of calculation, but some of the drawbacks include:
Example of the Retail Inventory MethodUsing 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.
What is meant by market in lower of cost or market calculations?The lower of cost or market rule states that a business must record the cost of inventory at whichever cost is lower – the original cost or its current market price. This situation typically arises when inventory has deteriorated, or has become obsolete, or market prices have declined.
Is the retail inventory method FIFO?Retail Inventory Method
The retail method can be used with FIFO, LIFO, or the weighted average cost flow assumption. It is based on the (known) relationship between cost and retail prices of inventory. In addition it is used in conjunction with the dollar value LIFO method.
Is LIFO or FIFO better during inflation?During periods of inflation, the use of FIFO will result in the lowest estimate of cost of goods sold among the three approaches, and the highest net income.
What is the retail 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 goods.
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