CHAPTER 21

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.
This method is generally employed by department stores, supermarkets and other retail concerns
where there is a wide variety of goods.
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 the retail inventory method requires that records be kept which must show the following
data:
a. Beginning inventory at cost and at retail price
b. 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.

Basic formula
In principle and procedurewise, the formula for the retail inventory 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 xxx
Less: Net sales (Gross sales minus sales return only) xxx
Ending inventory at selling price xxx
Multiply by cost ratio xxx
Ending inventory at cost xxx

𝐺𝑜𝑜𝑑𝑠 𝑎𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝑠𝑎𝑙𝑒 𝑎𝑡 𝑐𝑜𝑠𝑡

𝐶𝑜𝑠𝑡 𝑟𝑎𝑡𝑖𝑜 =
𝐺𝑜𝑜𝑑𝑠 𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝑠𝑎𝑙𝑒 𝑎𝑡 𝑠𝑒𝑙𝑙𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒

NOTE: Goods available for sale should be determined not only in terms of selling price but also
in terms of cost.
Illustration
Cost Retail
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) _______
Goods available for sale (GAS) 480,000 800,000
Cost ratio (480,000/800,000) 60%
Less: Sale 630,000
Sales return (30,000) 600,000
Ending inventory at retail 200,000
Ending inventory at cost (200,000 x 60%) 120,000

Treatment of items
1. Purchase discount – deducted from purchases at cost only.
2. Purchase return – deducted from purchases at cost and at retail.
3. Purchase allowance – deducted from purchases at cost and at retail.
4. Freight in – addition to purchases at cost only.
5. Departmental transfer in or debit – addition to purchases at cost and retail.
6. Departmental transfer out or credit – deduction from purchases at cost and retail.
7. Sales discount and sales allowance – disregarded, meaning, not deducted from sales.
8. Sales return – deducted from sales.
If the account is “sales return and allowance”, the same should be deducted form sales.
9. Employee discount – added to sales.
Employee discounts are special discounts usually not recorded because they are directly
deducted from the sales price.
Only the net sales price is recorded. Consequently, the amount of sales is understated. Thus,
the employee discounts are added back to sales.
10. 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.
11. 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 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 cost are changing.
1. Initial markup – original markup on the cost of goods.
2. Original retail – the sales price at which the goods are first offered for sale.
 3. Additional markup – increase in sales price above the original sales price.
4. Markup cancelation – decrease in sales price that does not decrease the sales price below
the original sales price.
5. Net additional markup or net markup – markup minus markup cancelation.
6. Markdown – decrease in sales price below the original sales price.
7. Markdown cancelation – increase in sales price that does not increase the sales price above
the original sales price.
8. Net markdown – markdown minus markdown cancelation.
9. Maintained markup – difference between cost and sales price after adjustment for all of the
above items.
Sometimes, the maintained markup is referred to as “markon”

Illustration
Cost 200
1. Initial markup 40
2. Original retail or sales price 240
3. Additional markup 60
New sales price 300
4. Markup cancelation 40
New sales price (not below the original sales price) 260
5. Net markup (60-40) 20
If at this point, the item is marked down to 210
Markup cancelation 20
6. Markdown (decrease in sales price below the original sales price) 30 50
New sales price 210
7. Markdown cancelation (increase in sales price that does not
increase the new sales price above the original sales price of 240) 20
New sales price 230
8. Net markdown (30-20) 10
9. Maintained markup (230-200) 30

Approaches in the use of retail method

To obtain the appropriate inventory value under the retail inventory method, three approaches are
followed, namely:
1. Conservative or conventional or lower of cost and net realizable value approach
2. Average cost approach
3. FIFO approach

Illustration
Cost Retail
Beginning inventory 180,000 250,000
Net purchases 1,020,000 1,575,000
Additional markup 200,000
Markup cancelation 25,000
Markdown 140,000
Markdown cancelation 15,000
Sales 1,450,000
Sales return 50,000
Sales Allowance 10,000
Sales Discount 20,000
Employee discount 40,000
Spoilage and breakage 35,000

Conservative and average cost

Cost Retail
Beginning inventory 180,000 250,000
Net purchases 1,020,000 1,575,000
Additional markup 200,000
Markup cancelation ________ (25,000)
GAS – conservative 1,200,000 1,875,000
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 (1,000,000/1,875,000) 64%
Less: Sales 1,450,000
Sales return (50,000)
Employee discount 40,000
Spoilage and breakage 35,000 1,475,000
Ending inventory at retail 400,000
Conservative cost (400,000 x 60%) 240,000
Average cost (400,000 x 64%) 256,000

Computation of cost of sales

Conservative Average
Goods available for sale 1,200,000 1,200,000
Less: Ending Inventory 240,000 256,000
Cost of sales 960,000 944,000

The conservative approach includes net markup and excludes net markdown.
Conservative cost is lower than the average cost.

FIFO retail approach

The FIFO retail approach is similar to the average cost approach in that it considers both net mark
up and net markdown in 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 approach is based on the assumption that mark up and markdown apply to goods
purchased during the year end not to beginning inventory.
Illustration – FIFO retail
Cost Retail
Beginning inventory 495,000 900,000
Purchases 1,800,000 2,300,000
Net markup 300,000
Net markdown 600,000
Net sales 2,700,000

The ending inventory using FIFO retail approach is computed as follows:

Cost Retail
Beginning inventory 495,000 900,000
Purchases 1,800,000 3,300,000
Net markup 300,000
Net Markdown ________ (600,000)
Net purchases 1,800,000 3,000,000
Current year cost ratio (1,000,000/3,000,000) 60%
Goods available for sale 2,295,000 3,900,000
Less: Net sales 2,700,000
Ending inventory at retail 1,200,000
FIFO cost (1,200,000 x 60%) 720,000

Goods available for sale 2,295,000

Ending inventory at FIFO cost (720,000)
Cost of goods sold 1,575,000