Question

a) What are some of the advantages of the retail method and why do firms use it?

b) What are some of the drawbacks of the retail method?

Answer 1

Retail method-

This is a inventory valuation method where inventory is valued as per a specific method.Under this method a cost to retail ratio is calculated for each product,and this ratio is assigned to know the cost of goods sold.The closing inventory is valued by reducing the cost of goods sold from cost of goods available for sale.

For eample

Total cost of goods available for sale is $ 1,000,000

Sale for the period is 1,500,000

Cost to retail ratio is 65 %

Now estimate -

COGS (1,500,000*65%) = $975,000

Closing inventory (1000000-975,000) = $25,000

Advantages of this method-

This is simple method to apply and easy to inderstand the values assigned.

This also helps businesses to maintain low cost inventory valuation.

Disadvantages-

There are several disadvantages of thus method-

• Correct cost to retail ratio may not be calculated.
• Some of the inventory which has been damaged or spoiled may be valued incorrectly.
• Overbooking of profits may be done because the cost to retail ratio is different for products and keep changing from time to time.
• This method may be used only when there are consistent markup of each product.

Please comment for any explanation.

Thanks