Which information would not be needed to determine inventory based on the retail method?

Companies have used the retail method of inventory accounting for many years. According to the Committee on Ways and Means, the retail inventory method has been the best accounting method since 1941. Professor N.P. McNair wrote the first major book detailing the pros of using this method. While some have begun to question the usefulness of this method in recent years, due to advances in tracking costs and inventory, as Smyth Retail points out, it's still used with efficiency by many businesses today.

Basics of the Retail Method

The retail inventory method is one of only two methods accepted for tax reporting purposes and accepted by the American Institute of CPAs under the Generally Accepted Accounting Principles. The direct cost method comprises the other accepted method. RIM also stands as the most widely used method by merchandising companies to calculate inventory values.

According to California State University Northridge, the retail method is especially useful for quarterly financial statements. It is based on the relationship between the merchant's cost and the retail prices of inventory. Additional factors, like mark-ups and mark-downs, as well as employee discounts must be factored into the calculations. However, before you can do that, you need to understand the basics of the retail method.

The Cost/Retail Ratio

The cost/retail ratio makes up one of the main components used to calculate the retail inventory method. Two methods exist for calculating the cost/retail ratio. The first method, called the conventional retail method includes markups but excludes markdowns. This method results in a lower ending inventory value. The second method, simply called the retail method, uses both markups and markdowns to calculate the ratio. This method results in a higher-ending inventory value.

Retail Inventory Method Formula

When using the conventional retail inventory method for inventory costing, the following data inputs create the cost/retail ratio formula: beginning inventory at cost and retail, purchases at cost and retail plus the retail value of any markups:

1. Total the beginning inventory and any purchases using the cost of these items. 
2. Total the beginning inventory, any purchases and the value of any markups using the retail value of these items.
3. Divide the total value calculated of the cost items by the total value calculated of the retail items. 

The product of this calculation equals the cost/retail ratio. For example beginning inventory values are $10,000 at cost and 20,000 at retail, purchases total $40,000 at cost and $80,000 at retail and markups totaled $6,000 at retail. $10,000 + $40,000 = $50,000 total value at cost. $20,000 + $80,000 + $6,000 = $106,000 total value at retail. $50,000 / $106,000 = 0.472 for a cost/retail ratio of 47 percent.

The Retail Method In Action

Once the cost/retail ratio gets determined the small business owner uses that ratio to value his period-end inventory. Using the $50,000 total inventory value at cost and the $106,000 total inventory value at retail, the owner now subtracts all sales and any markdowns from the total inventory value at retail. This gives the owner a total ending inventory value at retail selling price.

To determine the total ending inventory value at cost, the owner multiplies the ending inventory value at retail selling price times the cost/retail ratio. For example, if sales total $75,000 and markdowns totaled $9,000 he subtracts these numbers from the $106,000 leaving $22,000 in ending inventory value at retail. He then multiplies the $22,000 times the cost/retail ratio of 47 percent and gets an ending inventory value at cost of $10,340 ($22,000 x 0.47 = $10,340.)

Because the retail inventory method uses weighted averages to calculate the ending values it does not represent an exact cost value of the inventory. Also, because it uses markdowns, this method gives the most conservative value for inventory valuation. In practice, the retail inventory method, with markups and markdowns, can become complicated to figure out, so it's best to track these using a database or, at the very least, a spreadsheet.

• IFRIC 20 Stripping Costs in the Production Phase of a Surface Mine
• SIC-1 Consistency - Different Cost Formulas for Inventories. SIC-1 was superseded by and incorporated into IAS 2 (Revised 2003).

The objective of IAS 2 is to prescribe the accounting treatment for inventories. It provides guidance for determining the cost of inventories and for subsequently recognising an expense, including any write-down to net realisable value. It also provides guidance on the cost formulas that are used to assign costs to inventories.

Inventories include assets held for sale in the ordinary course of business (finished goods), assets in the production process for sale in the ordinary course of business (work in process), and materials and supplies that are consumed in production (raw materials). [IAS 2.6]

However, IAS 2 excludes certain inventories from its scope: [IAS 2.2]

• work in process arising under construction contracts (see IAS 11 Construction Contracts)
• financial instruments (see IAS 39 Financial Instruments: Recognition and Measurement)
• biological assets related to agricultural activity and agricultural produce at the point of harvest (see IAS 41 Agriculture).

Also, while the following are within the scope of the standard, IAS 2 does not apply to the measurement of inventories held by: [IAS 2.3]

• producers of agricultural and forest products, agricultural produce after harvest, and minerals and mineral products, to the extent that they are measured at net realisable value (above or below cost) in accordance with well-established practices in those industries. When such inventories are measured at net realisable value, changes in that value are recognised in profit or loss in the period of the change
• commodity brokers and dealers who measure their inventories at fair value less costs to sell. When such inventories are measured at fair value less costs to sell, changes in fair value less costs to sell are recognised in profit or loss in the period of the change.

Inventories are required to be stated at the lower of cost and net realisable value (NRV). [IAS 2.9]

Cost should include all: [IAS 2.10]

• costs of purchase (including taxes, transport, and handling) net of trade discounts received
• costs of conversion (including fixed and variable manufacturing overheads) and
• other costs incurred in bringing the inventories to their present location and condition

IAS 23 Borrowing Costs identifies some limited circumstances where borrowing costs (interest) can be included in cost of inventories that meet the definition of a qualifying asset. [IAS 2.17 and IAS 23.4]

Inventory cost should not include: [IAS 2.16 and 2.18]

• abnormal waste
• storage costs
• administrative overheads unrelated to production
• selling costs
• foreign exchange differences arising directly on the recent acquisition of inventories invoiced in a foreign currency
• interest cost when inventories are purchased with deferred settlement terms.

The standard cost and retail methods may be used for the measurement of cost, provided that the results approximate actual cost. [IAS 2.21-22]

For inventory items that are not interchangeable, specific costs are attributed to the specific individual items of inventory. [IAS 2.23]

For items that are interchangeable, IAS 2 allows the FIFO or weighted average cost formulas. [IAS 2.25] The LIFO formula, which had been allowed prior to the 2003 revision of IAS 2, is no longer allowed.

The same cost formula should be used for all inventories with similar characteristics as to their nature and use to the entity. For groups of inventories that have different characteristics, different cost formulas may be justified. [IAS 2.25]

NRV is the estimated selling price in the ordinary course of business, less the estimated cost of completion and the estimated costs necessary to make the sale. [IAS 2.6] Any write-down to NRV should be recognised as an expense in the period in which the write-down occurs. Any reversal should be recognised in the income statement in the period in which the reversal occurs. [IAS 2.34]

IAS 18 Revenue addresses revenue recognition for the sale of goods. When inventories are sold and revenue is recognised, the carrying amount of those inventories is recognised as an expense (often called cost-of-goods-sold). Any write-down to NRV and any inventory losses are also recognised as an expense when they occur. [IAS 2.34]

Required disclosures: [IAS 2.36]

• accounting policy for inventories
• carrying amount, generally classified as merchandise, supplies, materials, work in progress, and finished goods. The classifications depend on what is appropriate for the entity
• carrying amount of any inventories carried at fair value less costs to sell
• amount of any write-down of inventories recognised as an expense in the period
• amount of any reversal of a write-down to NRV and the circumstances that led to such reversal
• carrying amount of inventories pledged as security for liabilities
• cost of inventories recognised as expense (cost of goods sold).

IAS 2 acknowledges that some enterprises classify income statement expenses by nature (materials, labour, and so on) rather than by function (cost of goods sold, selling expense, and so on). Accordingly, as an alternative to disclosing cost of goods sold expense, IAS 2 allows an entity to disclose operating costs recognised during the period by nature of the cost (raw materials and consumables, labour costs, other operating costs) and the amount of the net change in inventories for the period). [IAS 2.39] This is consistent with IAS 1 Presentation of Financial Statements, which allows presentation of expenses by function or nature.

Which of the following would not likely be reported as inventory?

Which statement is true about the retail inventory method quizlet?

Which of the following is a major advantage of the retail inventory method?

On what assumption is the retail inventory method based?