Search within this section
Select a section below and enter your search term, or to search all click Inventory Guide
Favorited Content
2.1 Retail inventory method overview
Publication date: 31 Dec 2021
us Inventory guide
The retail inventory method (RIM) is commonly used by retail companies for inventory accounting and management reporting purposes. RIM has long been considered an acceptable inventory method under generally accepted accounting principles. However, authoritative literature does not provide specific guidance on the application of RIM. As such, entities need to consider whether their application of RIM is consistent with general inventory principles and reasonable in relation to their particular facts and circumstances. The primary source of existing FASB authoritative guidance on inventory is ASC 330, Inventory.
RIM is an averaging technique used by retailers to reduce the amount of recordkeeping associated with accounting for inventories. In general terms, RIM allows retailers to compute an average cost-to-retail percentage (commonly referred to as a cost complement percentage) used to value ending inventories. The use of RIM eliminates the need to maintain detailed inventory records on a cost basis and allows retail companies to price physical inventory counts at estimated cost based on the retail value of merchandise.
Some key concepts under RIM are:
- Initial markon – The original retail value recorded for an item (or a group of items) over its cost. For example, a purchase with a recorded cost of $220 originally marked at a retail amount of $400 has an initial markon of $180.
- Markup – An additional markon to increase the original retail price. For example, assume a purchase that cost $220 is originally marked to sell for $400. If the retail price is increased to $420, the markup is $20 and the markon increases from $180 to $200.
- Markup cancellation – A reduction in the amount of a prior markup. Markup cancellations are generally used to correct unintentional errors in the original markup, or when the original markup is of a special nature and understood to be temporary at the time it was made. A markup cancellation should not bring the retail price down to an amount lower than the initial markon. In addition, markup cancellations should only be taken to correct markups on purchases during the current season. They should not be taken to correct markups on opening inventory amounts, which should be accounted for as markdowns. Markup cancellations may also be used in the rare case of a major change in merchandising philosophy, for example, a change to “everyday low pricing.”
- Markdowns – a decrease in the original sales price. Markdowns are generally made to motivate the purchase of slow-moving inventory, for special sales events, or to meet competitors’ prices. Markdowns are usually characterized as permanent or temporary in nature, based on whether the company expects to adjust the sales price after a markdown to equal or exceed the original sales price (i.e., a permanent markdown would be inventory that is not expected to be sold for the original sales price in the future). The classification of markdowns is significant to the RIM calculation in that generally permanent markdowns affect inventory and cost of goods sold immediately in the period taken whereas temporary markdowns are generally recognized when the inventory is sold.
- Markdown cancellation – An upward revision of previous markdowns. A markdown cancellation should not exceed the markdown previously taken.
2.1.1 Traditional retail inventory method
Traditional RIM (also referred to as FIFO RIM) determines inventory cost based on the lower of FIFO cost or market valuation of inventory. The RIM methodology utilizes a cost complement percentage that represents the relationship of the cost of goods to their retail value. The objective is to establish the relationship between cost and retail price prior to subsequent retail price adjustments (e.g., markdowns). The cost complement percentage is developed over a representative accumulation period (e.g., annually or seasonally). Inventories are usually grouped by department, class, or style (and sometimes by store as well). Groupings normally contain related merchandise with similar markon percentages. Large department stores, for example, may have several hundred different groupings. Some retailers calculate a separate cost complement for each stock keeping unit (SKU) in inventory.
Figure IV 2-1 illustrates how the cost complement percentage is calculated.
Figure IV 2-1
Calculation of cost complement percentage
Calculation of cost complement percentage
Cost |
Retail |
Cost complement % |
|
Beginning inventory
|
5,000
|
9,000
|
|
Net purchases, at initial markon (1)
|
46,000
|
87,000
|
|
Net markups (2)
|
-
|
4000
|
|
51,000
|
100,000
|
51%
|
(1) Net purchases are calculated as purchases less vendor returns and appropriate vendor allowances.
(2) Net markups do not impact the cost and include markups less markup cancellations.
The cost complement percentage is applied to ending inventory at retail value, based on a physical inventory taken in retail dollars, net of markdowns, or based on perpetual inventory records maintained in retail dollars, to determine the cost of ending inventory and cost of goods sold as illustrated in Example IV 2-1.
Retail dollar book inventory using perpetual inventory records can be determined by reducing total goods available for sale at retail value by net sales (sales less sales returns), net markdowns (markdowns less markdown cancellations) and other retail price reductions (e.g., shrinkage provision).
EXAMPLE IV 2-1
Traditional retail inventory method
Traditional retail inventory method
Retail Company has opening inventory with a cost of $5,000 (determined using the retail inventory method) and a retail value of $9,000.
Purchases during the period had a net cost of $49,000 and a retail value of $92,000. Purchases totaling $3,000, with a retail value of $5,000 were subsequently returned to vendors.
Additional markups of $6,000 were made during the period. Markup cancellations of $2,000 were taken due to an error in the computation of the original retail value.
Retail sales during the period were $85,000, of which $5,000 was returned by customers.
Markdowns of $8,000 were taken during the period; $1,400 of these markdowns were subsequently canceled.
Past physical inventories have indicated that shrinkage is has been generally consistent at 3% of net retail sales.
How would the Company calculate the amounts to be reflected in costs of goods sold and inventory as of period end using the retail method?
Analysis
Based on the facts provided, the cost complement percentage would be calculated as follows:
Cost |
Retail |
|||
Opening inventory |
$5,000 |
$9,000 |
||
Purchases |
49,000 |
92,000 |
||
Purchase returns |
(3,000) |
(5,000) |
||
Additional markups |
6,000 |
|||
Markup cancellations |
(2,000) |
|||
Goods available for sale |
$51,000 |
$100,000 |
||
Cost complement percentage is 51% ($51,000/$100,000) |
The cost of goods sold would be calculated as follows:
Cost |
Retail |
|||
Goods available for sale |
$51,00 |
$100,000 |
||
Sales |
(85,000) |
|||
Sales returns |
5,000 |
|||
Markdowns |
(8,000) |
|||
Markdown cancellations |
1,400 |
|||
Shrinkage provision |
(2,400) |
|||
Retail reductions |
(89,000) |
|||
Ending inventory |
5,610
|
$11,000 |
||
Cost of goods sold |
$45,390 |
* Ending inventory at cost is calculated as ending inventory at retail ($11,000) multiplied by the cost complement percentage (51%).
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
Link copied
