Retail Accounting Basics: Understanding the Retail Inventory Method

To illustrate, assume that the company in can identify the 20 units on hand at year-end as 10 units from the August 12 purchase and 10 units from the December 21 purchase. The company computes the ending inventory as shown in; it subtracts the USD 181 ending inventory cost from the USD 690 cost of goods available for sale to obtain the USD 509 cost of goods sold. Note that you can also determine the cost of goods sold for the year by recording the cost of each unit sold. The USD 509 cost of goods sold is an expense on the income statement, and the USD 181 ending inventory is a current asset on the balance sheet. The specific identification costing method attaches cost to an identifiable unit of inventory.

However, the averaging process reduces the effects of buying or not buying. Because a company using FIFO assumes the older units are sold first and the newer units are still on hand, the ending inventory consists of the most recent purchases. When using periodic inventory procedure to determine the cost of the ending inventory at the end of the period under FIFO, you would begin by listing the cost of the most recent purchase. If the ending inventory contains more units than acquired in the most recent purchase, it also includes units from the next-to-the-latest purchase at the unit cost incurred, and so on. You would list these units from the latest purchases until that number agrees with the units in the ending inventory. When a company uses the Weighted-Average Method and prices are rising, its cost of goods sold is less than that obtained under LIFO, but more than that obtained under FIFO.

Unifying Retail and Ecommerce Operations: A Complete Guide to Ecommerce POS Integration

By contrast, if you mark up some styles by 50% and other designs by 75%, it’ll be difficult to use this method effectively. Although there are many ways you can determine and track the value of your inventory, the retail inventory method is among the most common techniques used today. Inventory is the growth factor that retailers have the most control over. And with the retail inventory method, it’s the lever you can pull to grow your DTC brand.

The retail method accounting system for inventory operates by using the current retail price to calculate inventory value. The retail method of accounting is a popular valuation strategy https://www.harlemworldmagazine.com/retail-accounting-why-is-it-essential-for-inventory-management/ for retail stores primarily because of its simplicity. If you use a flat markup rate across all products, then you can calculate your ending inventory cost without counting it.

Impact on the Financial Statements

The specific identification method of inventory costing applies primarily to high-ticket items, like automobiles. Typically, retailers who use the specific identification method don’t have a large number of items in stock, making what could otherwise be a cumbersome inventory costing task more manageable. Inventory is actually considered an asset — something your business owns, which is recorded on your business’s balance sheet — until you sell it or account for it as shrinkage from theft or damage. At that point, the expense for the purchase of the inventory is recorded as cost of sales or cost of goods sold on your profit and loss statement.