Retail Inventory Method

The retail inventory method is a method of estimating the value of closing inventory in the absence of a physical inventory count at the end of an accounting period.

As the name implies, the retail inventory method is used primarily by retailers who often maintain their memorandum inventory records at retail values.

Retail Inventory Method Process

The method involves the follows steps.

  1. Calculate the cost to retail ratio
  2. Calculate the ending inventory at retail
  3. Calculate the ending inventory at cost
  4. Calculate the cost of sales
Calculate the Cost to Retail Ratio

In general, the cost to retail ratio is calculated by the following formula:

Cost to retail ratio = (Opening inventory at cost + Purchases at cost) / (Opening inventory at retail + Purchases at retail)

For example consider a retail business with the following information from its accounting system:

Cost to Retail Ratio
Item Cost Retail
Opening inventory 20,500 30,000
Purchases during the year 62,000 80,000
Goods available for sale 82,500 110,000

Based on this information using the retail inventory method, we can calculate the cost to retail ratio as follows:

Cost to retail ratio = (Opening inventory at cost + purchases at cost) / (Opening inventory at retail + Purchases at retail)
Cost to retail ratio = (20,500 + 62,000) / (30,000 + 80,000)
Cost to retail ratio = (82,500) / (110,000)
Cost to retail ratio = 75%

Calculate the Ending Inventory at Retail

Suppose for example a business uses the retail inventory method to value closing inventory, and the sales during the accounting period were 70,000, then the ending inventory at retail is calculated as follows:

Closing inventory = Opening inventory + Purchases - Cost of sales
Using retail values
Closing inventory = 30,000 + 80,000 - 70,000
Closing inventory = 40,000

As all the numbers used here are retail values, the closing inventory of 40,000 is also at retail value.

Calculate the Ending Inventory at Cost

Under the retail inventory method, the cost to retail ratio is now be used to calculate the closing inventory at cost.

Closing inventory at cost = Cost to retail ratio x Closing inventory at retail
Closing inventory at cost = 75% x 40,000
Closing inventory at cost = 30,000

We now have the closing inventory at cost and can use the standard formula to calculate the cost of sales.

Calculate the Cost of Sales

The cost of sales can now be calculated as follows:

Cost of sales = Opening inventory + Purchases - Closing inventory
Cost of sales = 20,500 + 62,000 - 30,000
Cost of sales = 52,500

In this simple retail inventory method example, the cost of sales can also be calculated by applying the cost to retail ratio to the sales giving 90,000 x 75% = 52,500.

The retail inventory method process is summarized in the following table.

Retail Inventory Method Accounting
Item Retail Ratio Cost
Opening inventory 30,000 20,500
Purchases 80,000 62,000
Sales -70,000 -52,500
Closing inventory 40,000 75% 30,000

The retail inventory method is a convenient and quick method for retailers to use as they often maintain their accounting memorandum records at retail price.

Despite its apparent accuracy, it must be remembered that the method only provides an estimated value for inventory as it assumes that closing inventory has the same cost to retail ratio as the opening inventory and purchases. Any significant shift in the type of ending inventory and its cost to retail ratio will cause inaccuracies in the calculation. Regular physical inventory counts should always be carried out so that correcting adjustments can be made.

Retail Inventory Method November 6th, 2016Team

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