Question

Question:The conventional retail inventory method yields results that are essentially the same as those yielded by the lower-of-cost-or-market method. Explain. Prepare an illustration of how the retail inventory method reduces inventory to market.

Short answer

Answer

The conventional retail method values the inventory at cost per the cost to retail percentage, which is similar to the valuation of inventory per the lower-of-cost-or-market method.

Step-by-step solution

Explanation of conventional retail method

Under the conventional retail method, ending inventory at cost is estimated by multiplying the cost-to-retail percentage by ending inventory at retail. This ending inventory at cost is taken as market value, compared with ending inventory at retail.

Ending inventory at cost is always lower than the ending inventory at retail, which is the same as the value estimated under Lower-of-cost-or-market.

Example of conventional retail method

For example, ending inventory at cost is calculated using the conventional retail method for the following.

	Cost	Retail
Beginning inventory	$200,000	$280,000
Purchases	1,375,000	2,140,000
Markups		95,000
Markup cancellations		15,000
Markdowns		35,000
Markdowns cancellations		5,000

Calculation of ending inventory at retail

Ending inventory at retail is calculated as follows

	Cost		Retail
Beginning inventory	$200,000		$280,000
Purchases	1,375,000		2,140,000
Totals	1,575,000		2,420,000
Add: Net markups
Markups		95,000
Markup cancellations	________	15,000	80,000
Totals	1,575,000		2,500,000
Deduct: Net markdowns
Markdowns		35,000
Markdowns cancellations		5,000	30,000
Sales price of goods available			2,470,000
Deduct: Sales (net)			2,100,000
Ending inventory at retail			$370,000

Calculation of the cost-to-retail ratio

Cost to retail ratio is calculated as follows:

$$\begin{gathered} \mathit{C}\mathit{o}\mathit{s}\mathit{t}\mathbf{}\mathit{t}\mathit{o}\mathbf{}\mathit{R}\mathit{e}\mathit{t}\mathit{a}\mathit{i}\mathit{l}\mathbf{}\mathit{r}\mathit{a}\mathit{t}\mathit{i}\mathit{o}\mathbf{=}\frac{\mathbf{I}\mathbf{n}\mathbf{v}\mathbf{e}\mathbf{n}\mathbf{t}\mathbf{o}\mathbf{r}\mathbf{y}\mathbf{}\mathbf{a}\mathbf{t}\mathbf{}\mathbf{cos}\mathbf{t}}{\mathbf{I}\mathbf{n}\mathbf{v}\mathbf{e}\mathbf{n}\mathbf{t}\mathbf{o}\mathbf{r}\mathbf{y}\mathbf{}\mathbf{a}\mathbf{t}\mathbf{}\mathbf{r}\mathbf{e}\mathbf{t}\mathbf{a}\mathbf{i}\mathbf{l}} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\frac{\mathbf{\$}\mathbf{1}\mathbf{,}\mathbf{575}\mathbf{.}\mathbf{000}}{\mathbf{\$}\mathbf{2}\mathbf{.}\mathbf{500}\mathbf{,}\mathbf{000}} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\mathbf{63}\mathbf{\%} \end{gathered}$$

Calculation of inventory value at cost

Inventory at cost is calculated as follows:

$$\begin{gathered} \mathbf{}\mathit{E}\mathit{n}\mathit{d}\mathit{i}\mathit{n}\mathit{g}\mathbf{}\mathit{i}\mathit{n}\mathit{v}\mathit{e}\mathit{n}\mathit{t}\mathit{o}\mathit{r}\mathit{y}\mathbf{}\mathit{a}\mathit{t}\mathbf{}\mathit{c}\mathit{o}\mathit{s}\mathit{t}\mathbf{=}\mathit{I}\mathit{n}\mathit{v}\mathit{e}\mathit{n}\mathit{t}\mathit{o}\mathit{r}\mathit{y}\mathbf{}\mathit{a}\mathit{t}\mathbf{}\mathit{r}\mathit{e}\mathit{t}\mathit{a}\mathit{i}\mathit{l}\mathbf{}\mathbf{\times }\mathit{C}\mathit{o}\mathit{s}\mathit{t}\mathbf{}\mathbf{-}\mathit{t}\mathit{o}\mathbf{-}\mathit{r}\mathit{e}\mathit{t}\mathit{a}\mathit{i}\mathit{l}\mathbf{}\mathit{r}\mathit{a}\mathit{t}\mathit{i}\mathit{o} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\mathbf{\$}\mathbf{370}\mathbf{,}\mathbf{000}\mathbf{\times }\mathbf{63}\mathbf{\%} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\mathbf{\$}\mathbf{233}\mathbf{,}\mathbf{100} \end{gathered}$$

In the example, inventory at cost equals $233,100, and inventory at retail (market) equals $370,000. Per the lower-of-cost-or-market, the value of inventory is $233,100, which is the same under both methods.