CHAPTER 9
INVENTORIES:
ADDITIONAL ISSUES
Sommers – ACCT 3311
Retail Inventory Method
Explain the retail inventory method of estimating ending
inventory.
Inventory Notation
Beginning
Balance
Purchases
Cost of Goods
Available for Sale
Ending
Balance
Cost of
Goods Sold
?
?
Introduction to Conventional Retail Method
Smith-Kline Company maintains inventory records at selling
prices as well as at cost. For 2011, the records indicate the
following data:
Cost Retail
Beginning inventory
$ 80 $ 125
Purchases
671
1,006
Freight-in on purchases
30
Purchase returns
1
2
Net markups
4
Net markdowns
8
Net sales
916
Use the conventional retail method to approximate cost of
ending inventory.
Introduction to Conventional Retail Method
Cost Retail
$ 80 $ 125
671
1,006
30
(1)
(2)
4
780
1,133
Beginning inventory
Purchases
Freight-in on purchases
Purchase returns
Net markups
Goods available for sale
Cost-to-retail percentages:
Conventional cost ratio: $780 / $1,133 = 68.84%
Deduct: Net sales
Net markdowns
Ending inventory at retail
Ending inv at cost ($209 x 68.84%)
$144
(916)
(8)
$ 209
Example 4: Conventional Retail Method
Sparrow Company uses the retail inventory method to estimate ending
inventory and cost of goods sold. Data for 2011 are as follows:
Cost
Retail
Beginning inventory
$ 90,000
$180,000
Purchases
355,000
580,000
Freight-in
9,000
Purchase returns
7,000
11,000
Net markups
16,000
Net markdowns
12,000
Normal spoilage
3,000
Abnormal spoilage
4,800
8,000
Sales
540,000
Sales returns
10,000
The company records sales net of employee discounts. Discounts for
2011 totaled $4,000. Estimate Sparrow’s ending inventory and cost of
goods sold for the year using the conventional retail inventory method
Example 4: Conventional
Cost
Beginning inventory
Plus: Purchases
Freight-in
Less: Purchase returns
Plus: Net markups
Less: Abnormal spoilage
Cost-to-retail percentage:
Less: Net markdowns
Goods available for sale
Normal spoilage
Sales:
Net sales
Employee discounts
Estimated ending inventory at retail
Estimated ending inventory at cost
Estimated cost of goods sold
Retail
Inventory Disclosures (CVS from MD&A)
Inventory
Our inventory is stated at the lower of cost or market on a first-in,
first-out basis using the retail method of accounting to determine
cost of sales and inventory in our CVS/pharmacy stores, weighted
average cost to determine cost of sales and inventory in our mail
service and specialty pharmacies and the cost method of
accounting on a first-in, first-out basis to determine inventory in our
distribution centers. Under the retail method, inventory is stated at
cost, which is determined by applying a cost-to-retail ratio to the
ending retail value of our inventory. Since the retail value of our
inventory is adjusted on a regular basis to reflect current market
conditions, our carrying value should approximate the lower of cost
or market. In addition, we reduce the value of our ending inventory
for estimated inventory losses that have occurred during the interim
period between physical inventory counts.
LIFO Retail Inventory Method
When applying LIFO, if inventory increases during the year,
none of the beginning inventory is assumed sold. Ending
inventory includes the beginning inventory plus the current
year’s layer. To determine layers, we compare ending
inventory at retail to beginning inventory at retail and
assume that no more than one inventory layer is added if
inventory increases. Each layer carries its own cost-toretail percentage that is used to convert each layer from
retail to cost.
Example 5: LIFO Retail Inventory
Crosby Company owns a chain of hardware stores throughout
the state. The company uses a periodic inventory system and
the retail inventory method to estimate ending inventory and cost
of goods sold. The following data are available for the three
months ending March 31, 2011:
Cost
Retail
Beginning inventory $ 160,000
$ 280,000
Net purchases
607,760
840,000
Net markups
20,000
Net markdowns
4,000
Net sales
800,000
Estimate the LIFO cost of ending inventory and cost of goods
sold for the three months ending March 31, 2011. Assume stable
retail prices during the period.
Example 5: Continued
Cost
Beginning inventory
Plus: Net purchases
Net markups
Less: Net markdowns
Goods available for sale (excl. beg. Inventory)
Cost-to-retail percentage:
Goods available for sale (incl. beg. Inventory)
Less: Net sales
Estimated ending inventory at retail
Estimated ending inventory at cost:
Retail
Cost
Beginning inventory
Current period’s layer
Total
Estimated cost of goods sold
Retail
Inventory Disclosures (Walmart from MD&A)
Inventories
The Company values inventories at the lower of cost or market as
determined primarily by the retail method of accounting, using the lastin, first-out (“LIFO”) method for substantially all of the Walmart U.S.
segment’s merchandise inventories. The retail method of accounting
results in inventory being valued at the lower of cost or market since
permanent markdowns are currently taken as a reduction of the retail
value of inventory. The Sam’s Club segment’s merchandise is valued
based on the weighted-average cost using the LIFO method.
Inventories for the Walmart International operations are primarily
valued by the retail method of accounting and are stated using the firstin, first-out (“FIFO”) method. At January 31, 2011 and 2010, our
inventories valued at LIFO approximated those inventories as if they
were valued at FIFO.
Inventory Disclosures (Walmart from MD&A)
Inventories (Continued)
Under the retail method, inventory is stated at cost, which is determined by
applying a cost-to-retail ratio to each merchandise grouping’s retail value.
The FIFO cost-to-retail ratio is based on the initial margin of beginning
inventory plus the fiscal year purchase activity. The cost-to-retail ratio for
measuring any LIFO reserves is based on the initial margin of the fiscal
year purchase activity less the impact of any markdowns. The retail
method requires management to make certain judgments and estimates
that may significantly impact the ending inventory valuation at cost, as well
as the amount of gross profit recognized. Judgments made include
recording markdowns used to sell through inventory and shrinkage. When
management determines the salability of inventory has diminished,
markdowns for clearance activity and the related cost impact are recorded
at the time the price change decision is made. Factors considered in the
determination of markdowns include current and anticipated demand,
customer preferences and age of merchandise, as well as seasonal and
fashion trends. Changes in weather patterns and customer preferences
related to fashion trends could cause material changes in the amount and
timing of markdowns from year to year.
Dollar-Value LIFO Retail
• We need to eliminate the effect of any price changes
before we compare the ending inventory with the
beginning inventory.
Example 6: Dollar-Value LIFO Retail Method
Smith-Kline Company maintains inventory records at selling
prices as well as at cost. For 2011, the records indicate the
following data:
Cost Retail
Beginning inventory
$ 80 $ 125
Purchases
671
1,006
Freight-in on purchases
30
Purchase returns
1
2
Net markups
4
Net markdowns
8
Net sales
916
Assuming the price level increased from 1.00 at January 1 to
1.10 at December 31, 2011, use the dollar-value LIFO retail
method to approximate cost of ending inventory and cost of
goods sold.
Example 6: Continued
Cost
Beginning inventory
Plus: Purchases
Freight-in
Net markups
Less: Purchase returns
Net markdowns
Goods available for sale (exclud beg inv)
Goods available for sale (includ beg inv)
Base layer cost-to-retail %:
2011 layer cost-to-retail %:
Less: Net sales
Estimated ending inv at current year retail prices
Retail
Example 6: Continued
Ending
Inventory at
Year-end
Retail Prices
Step 1: Ending
Inventory at Base
Year Retail Prices
Step 2:
Inventory
Layers at
Base Year
Retail
Prices
Step 3:
Inventory
Layers
Converted to
Cost
Cost of goods available for sale (including beginning inventory)
Less estimated ending inventory at cost
Estimated cost of goods sold
Evaluation of Retail Inventory Method
Widely used for the following reasons:
(1) To permit the computation of net income without a
physical count of inventory.
(2) Control measure in determining inventory shortages.
(3) Regulating quantities of merchandise on hand.
(4) Insurance information.
Some companies refine the retail method by computing
inventory separately by departments or class of
merchandise with similar gross profits.
IFRS
RELEVANT FACTS - Similarities

IFRS and GAAP account for inventory acquisitions at historical cost and
evaluate inventory for lower-of-cost-or-market subsequent to acquisition.

Who owns the goods—goods in transit, consigned goods, special sales
agreements—as well as the costs to include in inventory are essentially
accounted for the same under IFRS and GAAP.
IFRS
RELEVANT FACTS - Differences

The requirements for accounting for and reporting inventories are more
principles-based under IFRS. That is, GAAP provides more detailed
guidelines in inventory accounting.

A major difference between IFRS and GAAP relates to the LIFO cost
flow assumption. GAAP permits the use of LIFO for inventory valuation.
IFRS prohibits its use. FIFO and average-cost are the only two
acceptable cost flow assumptions permitted under IFRS. Both sets of
standards permit specific identification where appropriate.

In the lower-of-cost-or-market test for inventory valuation, IFRS defines
market as net realizable value. GAAP, on the other hand, defines market
as replacement cost subject to the constraints of net realizable value
(the ceiling) and net realizable value less a normal markup (the floor).
IFRS does not use a ceiling or a floor to determine market.
IFRS
RELEVANT FACTS - Differences

Under GAAP, if inventory is written down under the lower-of-cost-ormarket valuation, the new basis is now considered its cost. As a result,
the inventory may not be written back up to its original cost in a
subsequent period. Under IFRS, the write-down may be reversed in a
subsequent period up to the amount of the previous write-down. Both
the write-down and any subsequent reversal should be reported on the
income statement.

IFRS requires both biological assets and agricultural produce at the
point of harvest to be reported at net realizable value. GAAP does not
require companies to account for all biological assets in the same way.
Furthermore, these assets generally are not reported at net realizable
value. Disclosure requirements also differ between the two sets of
standards.
LIFO to FIFO Conversion – Dow Chemical
LIFO
FIFO