The retail method is an accounting method used to provide a complete inventory of the account at the item's retail price and thereby detect loss, damage and theft of inventory. The retail method thus allows small business leaders to track costs, account for goods bought or sold, track inventory status, and maintain the right amount of inventory at all times.
What is retail in accounting?
An inventory system is used by retail businesses to have a complete inventory of available items and their financial value. The cost of inventory affects the actual profit of the business, and inventory in stock is considered an asset for tax and business valuation purposes. Using the retail method of accounting, retailers use the projected retail cost to value inventory.
This method is based on estimating the retailer's ending inventory balances. For this method, retail amounts and associated cost amounts must be available for inventory and starting purchases.
How does the retail method works?
To calculate the value of the final inventory, it is necessary to follow several steps:
A complete record of purchases and goods available at cost and retail price should be kept.
The cost / retail ratio must then be calculated: Cost price x 100 / Retail price
To estimate the final inventory at retail prices, subtract the retail price of the goods sold from the retail price of the goods in stock.
Finally, you will need to convert the estimated inventory at retail to cost by applying the percentage of retail cost.
Retail Accounting Advantages and Disadvantages
The retail method allows for a quick and easy estimate of the ending inventory balance. One of the major advantages of this method is that it does not require a physical inventory.
This method of accounting is therefore particularly interesting if the company has several locations and the realization of a physical inventory is therefore a long and expensive process.
The retail inventory method also allows the business to create an inventory value report which is going to be useful for budgeting or preparing financial statements.
In contrast, the retail inventory method is only an estimate. It is only accurate when all prices are the same and all price changes occur at the same rate. Other than this, its results are not entirely accurate.
This is because in most cases the retail method of accounting is unrealistic due to product price variations.
Damaged products, markdown periods, theft from inventory, depreciation have an impact on the price of inventory. Therefore, calculations made using the retail inventory method should only be used as an estimate.
There are three other main methods of cost accounting for valuing inventory: first in first out, last in first out, and weighted average cost. Both the direct cost method and the retail inventory method can be used for tax reporting purposes. Please note, depending on the method chosen, there may be significant differences in the evaluation.