Question

Saurez Company, your client, manufactures paint. The company’s president, Maria Saurez, has decided to open a retail store to sell Saurez paint as well as wallpaper and other supplies that would be purchased from other suppliers. She has asked you for information about the conventional retail method of pricing inventories at the retail store. Instructions Prepare a report to the president explaining the retail method of pricing inventories. Your report should include the following points. (a) Description and accounting features of the method. (b) The conditions that may distort the results under the method. (c) A comparison of the advantages of using the retail method with those of using cost methods of inventory pricing. (d) The accounting theory underlying the treatment of net markdowns and net markups under the method.

Short answer

The different points of the retail inventory method are given in the following steps.

Step-by-step solution

Description and accounting features

(a) Under the retail inventory method, retailers use a formula to convert the selling price to the cost price. It requires the retailers to maintain proper record cost and retail price of goods purchased and sold and the sales for the current period. Ending inventory value is valued at the retail price using the cost-to-retail ratio. It is estimated by subtracting sales revenue from the sum of beginning inventory and purchases and valuing the ending inventory on the basis of the cost-to-retail ratio.

 Step2: Conditions that may distort

(b) Conditions are as follows:

• Incorrect estimation of the cost-to retail ratio
• Incorrect calculation of markups and markdowns
• Ineffective internal control related to inventory

Advantages of retail inventory method

(c) Advantages are as follows:

• The ending value of the inventory can be estimated without m maintaining the proper record.
• Loss due to fire or any other accident can be estimated easily.
• Interim financial statements can be prepared easily.

Treatment of net markup and net markdown

Under this method, net markups are added to the sum of beginning inventory and net purchases at retail. Then this total value is used to calculate the cost-to-retail ratio. And then, the net markdown is subtracted to estimate the sale price of goods available.