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When applying the inventory retail method, inventory balances are adjusted for shrinking, aging, obsolescence, seasonality, and permanent markdown accruals.

2.3.1 Shrinkage

Shrinkage can often be material to a retailer's bottom-line earnings. The portability of many retail goods makes such merchandise an easy target for shoplifters in the absence of adequate security measures. While the causes of shrinkage vary by type of retailer, company, geographic region, and even individual store, the most common causes include shoplifting, employee theft, and paperwork error. Food retailers also experience significant shrinkage from product spoilage. As shrinkage at most retailers can only be identified upon the performance of a physical inventory, common retail practice involves the recording of accruals to reflect an estimated inventory shortage. These accrual rates should be periodically adjusted based on actual physical inventory results to reflect current experience. Most retailers estimate shrinkage between physical inventories as a percentage of sales, often basing the percentage on historical shrinkage rates adjusted for the effects of any trends or other known factors that could affect inventory shrinkage.

2.3.2 Aging, obsolescence, and seasonality

Most retail inventories are affected by aging, obsolescence, and seasonality. The nature and extent of these factors is determined by the types of inventory maintained. The timely clearance of inventory subject to such factors is important in order to minimize the carrying costs of the inventory and reduce realizability concerns. In many instances, it is more cost effective for a retailer to markdown a seasonal item in inventory instead of storing it during the offseason (and incurring carrying charges) only to have to mark it down at the beginning of the next season because it is old merchandise. Declines in inventory value due to age, obsolescence or seasonality are considered in the lower of cost or market analysis pursuant to ASC 330-10-35-1C through ASC 330-10-35-7.

2.3.3 Permanent markdown accruals

For entities that use RIM, there is no specific GAAP that requires accrual of future permanent markdowns. However, we believe it is consistent with the lower of cost or market principle in ASC 330‑10‑35 to account for future permanent markdowns on either an “as incurred” or accrual basis. For companies that follow an as incurred policy, permanent markdowns may be recorded on the date reflected in a company's point of sale system (i.e., the date available to customers) or on an “as approved” basis (i.e., when management decides to sell the product for less). For companies that accrue for permanent markdowns, such accruals should reflect an estimate of permanent markdowns to be taken through the ultimate disposition of the inventory on hand. That said, permanent markdowns that occur subsequent to a period end resulting from factors specifically related to the subsequent period would not require accrual as of the prior period end.
Some inventory markdowns may be directly attributable to a decision to exit or restructure an activity. However, it may be difficult to distinguish such markdowns from inventory markdowns attributable to external market factors. Inventory markdowns generally are considered to be normal, recurring activities integral to the management of the ongoing business, and should be classified as a component of cost of goods sold rather than as a restructuring cost consistent with ASC 420-10-S99-3.
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