This paper seeks to discuss the concept of the retail method of pricing inventories and how it differs from the method that might be utilized by most manufacturing companies. This would also discuss when would say retail method be most likely be utilized by companies and under what conditions might the use of the method distort the resulting financial statements.
The retail inventory method, just like any method in accounting, is used as an option if the alternative method would become impractical and costly. Thus, it should be useful in retailing business since individual costing-based costing like job order costing may not be encouraging in terms of higher cost for doing so as against expected benefit (Bernstein, 1993) where there could be hundreds of variety of products.
On other hand, job order costing as an alternative costing is usually used by manufacturing companies where there are few varieties of product and the periodic physical count is not prohibitive in terms of cost and time (Meigs and Meigs, 1995). As a general rule, inventory valuation is required for producing reliable accounting information for decision-making by companies but each method has its own required conditions for effectiveness.
Managing inventory using the retail method is most crucial for the success of a retail business because the business would most likely not deal on one single product only. Hence the retail inventory method is adaptable to a retailing environment as compared to a manufacturing company that may be just manufacturing standardized products. Manufacturing companies may then most like apply standardized costing or job-order costing or process costing or whichever could be matched with the practicality of periodic physical count (Atkinson, et al,2005).
The retail inventory method has also its other downside. The result of inventory estimate or valuation under the retail method would produce a likely distorted result in times of inflation since prices may go up that would make the computed ratio of cost to retail no longer valid. Hence, this would result in understated ending inventory because the increased price based on the current price would be used and yet the original cost would still be maintained in the books as the basis of valuation.
This would make the retail inventory method not work well therefore if combined with the first in first out (FIFO) method for inventory costing since in times of inflation, the price would be high at the latter period which would be used in computing retail price. Since the base price would be high, the tendency is to have a lost cost ratio, and a lower cost ratio may understate ending inventory and in turn overstate income for the period. Thus the best solution suggested for the retail inventory method for it to function well is to combine the same with the last in first out method (LIFO) because the defect in using FIFO would at least be kept in check (Meigs and Meigs, 1995; Reeher, 2009).
To conclude, one that would best serve the purpose of accounting should be viewed as the benefit of which should exceed the cost. The name “retail inventory” method must be associated more with retail business which is bound to have a variety of goods over that of a manufacturing concern. Since the same method was found to be applicable in case of a wide variety of goods when the tracking of unit cost at all times would be difficult and costly, it would not be a surprise to find its use in department stores, supermarkets if the latter companies would have to maximize profits.
References
Atkinson, Anthony, et al (2005). Management Accounting. New Jersey: Person Custom Publishing.
Bernstein, J. (1993). Financial Statement Analysis, Sydney: IRWIN.
Meigs, R, Meigs, W., & Meigs, M. (1995). Financial Accounting. New York: McGraw-Hill.
Reeher, J. (2009). Retail Method of Inventory. Web.