Chapter 8, Problem 11E

Retail Inventory Method The following information relates to the retail inventory method used by Jeffress Company:

Required:

1. 1. Compute the ending inventory by the retail inventory method using the following cost flow' assumptions (round the cost-to-retail ratio to 3 decimal places):
   1. a. FIFO
   2. b. average cost
   3. c. LIFO
   4. d. lower of cost or market (based on average cost)
2. 2. Next Level What assumptions are necessary for the retail inventory method to produce accurate estimates of ending inventory?

To determine

Calculate the cost of ending inventory by the retail method using FIFO, average cost, LIFO, and LCM cost flow assumptions.

Explanation of Solution

Retail inventory method: It takes into account all the retail amounts that is, the current selling prices. Under this method, the goods available for sale, at retail is deducted from the sales, at retail to determine the ending inventory, at retail.

Conventional Retail Method: Conventional retail method refers to the estimation of the lower of average cost or market by eliminating the markdowns from the calculation of the cost-to-retail percentage.

In this case, the cost-to-retail percentage will be determined by dividing the goods available for sale at cost by the goods available for at retail (excluding markdowns). Thus, the conventional retail method will always result in lower estimation of ending inventory when the markdowns exist.

a.

FIFO: Under this inventory method, the units that are purchased first are sold first. Thus, it starts from the selling of the beginning inventory, followed by the units purchased in a chronological order of their purchases took place during a particular period.

Calculate the cost of ending inventory by the retail method using FIFO cost flow.

Ending Inventory - FIFO
Details	Cost ($)	Retail ($)
Purchases	54,600	92,400
Freight-in	840
Markups (net)		600
Markdowns	0	(1,144)
	55,440	91,856
Add: Beginning inventory	11,160	18,000
Goods available for sale	66,600	109,856
Less: Sales		(94,056)
Ending inventory at retail		$15,800
Ending inventory at cost	$9,543

Table (1)

Working note 1:

Calculate ending inventory at cost:

Step 1: Calculate cost-to-retail ratio.

$\begin{array}{c}\text{Cost-to-retail ratio= }\left(\frac{\text{Goods available for sale at cost (After markdowns)}}{\text{Goods available for sale at retail (After markdowns)}}\right)\\ =\left(\frac{\text{\$55,440}}{\$91,856}\right)\\ =.604\end{array}$

Step 2: Calculate ending inventory at cost.

$\begin{array}{c}\text{Ending inventory at cost = }\left(\begin{array}{l}\text{Ending inventory at retail}\\ \times \text{Cost-to-retail ratio}\end{array}\right)\\ \text{=}\left(\$15,800\times .604\right)\\ =\$9,543\end{array}$

b.

Average cost method: Under this method, the cost of the goods available for sale is divided by the number of units available for sale during a particular period.

Calculate the cost of ending inventory by the retail method using average cost flow.

Ending Inventory - Average Cost
Details	Cost ($)	Retail ($)
Beginning inventory	11,160	18,000
Add:  Net purchase	54,600	92,400
Freight in	840
Net markups (net)		600
Less:  Net markdowns	0	(1,144)
Goods available for sale	66,600	109,856
Less: Sales		(94,056)
Estimated ending inventory at retail		$15,800
Estimated ending inventory at cost	$9,575

Table (2)

Working note 1:

Calculate ending inventory at cost.

Step 1: Calculate cost-to-retail ratio.

$\begin{array}{c}\text{Cost-to-retail ratio= }\left(\frac{\text{Goods available for sale at cost (After markdowns)}}{\text{Goods available for sale at retail (After markdowns)}}\right)\\ =\left(\frac{\text{\$66,600}}{\$109,856}\right)\\ =.606\end{array}$

Step 2: Calculate ending inventory at cost.

$\begin{array}{c}\text{Ending inventory at cost = }\left(\begin{array}{l}\text{Ending inventory at retail}\\ \times \text{Cost-to-retail ratio}\end{array}\right)\\ \text{=}\left(\$15,800\times .606\right)\\ =\$9,574\end{array}$

c.

LIFO: Under this inventory method, the units that are purchased last are sold first. Thus, it starts from the selling of the units recently purchased and ending with the beginning inventory.

Calculate the cost of ending inventory by the retail method using LIFO cost flow.

Ending Inventory - LIFO
Details	Cost ($)	Retail ($)
Beginning inventory	11,160	18,000
Net purchase	54,600	92,400
Freight-in	840
Net markups		600
Less:  Net markdowns	0	(1,144)
	55,440	91,856
	11,160	18,000
Goods available for sale	66,600	109,856
Less: Sales		(94,056)
Estimated ending inventory at retail		$15,800
Estimated ending inventory at LIFO cost	9,796

Table (3)

Working note 1:

Calculate ending inventory at cost for beginning layer.

Step 1: Calculate cost-to-retail ratio (Beginning layer).

$\begin{array}{c}\text{Cost-to-retail ratio= }\left(\frac{\text{Beginning inventory for cost}}{\text{Beginning inventory for retail}}\right)\\ =\left(\frac{\text{\$11,160}}{\$18,000}\right)\\ =.62\end{array}$

Step 2: Calculate ending inventory at cost (Beginning layer).

$\begin{array}{c}\text{Ending inventory at cost = }\left(\begin{array}{l}\text{Ending inventory at retail}\\ \times \text{Cost-to-retail ratio}\end{array}\right)\\ \text{=}\left(\$15,800\times .62\right)\\ =\$9,796\end{array}$

d.

Lower-of-cost-or-market: The lower-of-cost-or-market (LCM) is a method which requires the reporting of the ending merchandise inventory in the financial statement of a company, either at current market value or at historical cost price of the inventory, whichever is less.

Calculate the cost of ending inventory by the retail method using lower of cost or market rule:

Ending Inventory - LCM
Details	Cost ($)	Retail ($)
Beginning inventory	11,160	18,00
Add:  Net purchase	54,600	92,400
Freight-in	840
Net markups	0	600
Goods available for sale before markdowns	66,600	111,000
Less:  Net markdowns	0	(1,144)
Sales		(94,056)
Estimated ending inventory at retail		$15,800
Estimated ending inventory at cost (LCM)	$9,480

 Table (4)

Working note 1:

Calculate ending inventory at cost:

Step 1: Calculate cost-to-retail ratio.

$\begin{array}{c}\text{Cost-to-retail ratio= }\left(\frac{\begin{array}{l}\text{Goods available for sale at cost }\\ \text{(before markdowns)}\end{array}}{\begin{array}{l}\text{Goods available for sale at retail }\\ \text{(before markdowns)}\end{array}}\right)\\ =\left(\frac{\text{\$66,600}}{\$111,000}\right)\\ =.6\end{array}$

Step 2: Calculate ending inventory at cost.

$\begin{array}{c}\text{Ending inventory at cost = }\left(\begin{array}{l}\text{Ending inventory at retail}\\ \times \text{Cost-to-retail ratio}\end{array}\right)\\ \text{=}\left(\$15,800\times .6\right)\\ =\$9,480\end{array}$

To determine

Indicate the needed assumptions for the retail inventory method to produce correct estimated of ending inventory.

Explanation of Solution

There are two general assumptions are required for the retail inventory method to produce a correct estimates of inventory.

• Firstly, the company’s inventory items should be adequately homogeneous so that all of the items have the same markup, or if different markups exist and the items in ending inventory should be in the same proportion to those items in goods available for sale.
• Secondly, over the accounting period the cost-to-retail ratio must remain constant.