The retail inventory method groups similar products to estimate an average percentage of the retail cost price, making it a useful tool for businesses with a variety of products. It eliminates the need for physical counts and provides a quick way to create an inventory value report.
The retail inventory method is a technique that companies can use to accurately manage their individual components and finished merchandise. Often considered a version of cost accounting, the retail inventory method is a procedure in which similar products are grouped together to estimate an average percentage of the retail cost price. The accuracy of this system generally depends on the amount of a company’s goods sold, which equals the amount of goods available for sale.
Businesses that operate in the retail industry may have a difficult time accounting for their inventory. If they only carry a particular type of product, they can keep track of each product through a specific identification method. However, if they carry many different types of products, this approach to assessing inventory may not work. The retail inventory method is one possible solution.
Retail is an industry where there is a discernible pattern between the cost of an item and its price. This pattern allows companies to create a formula by which prices can be converted to costs, which is the fundamental principle of the retail inventory method. For a retail inventory method to be successful, accurate records must be kept of the total cost and retail value of merchandise purchased, goods available for sale, and the total number of sales for a fiscal period.
When using the retail inventory method, companies take sales for the period and deduct that number from the retail value of merchandise available for sale. This produces an estimated inventory of merchandise available at retail. Total merchandise available for sale at cost is divided by total merchandise available at retail to produce a cost-to-sell ratio for all merchandise. Finally, valued inventory at retail is translated into ending inventory at cost when the cost/retail ratio is applied.
One of the main advantages of using the retail inventory method is that it virtually eliminates the need for a physical count. If a year-end physical count is necessary, using the retail inventory method can speed up the process, as accountants only need to record the retail prices of the items. Another potential benefit of using the retail inventory method is that it provides a quick and accurate way to create an inventory value report.
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