The retail method of accounting is an inventory estimation technique used to compute the value of ending inventory without having to take a physical count. Businesses with large volumes of inventory, like grocery stores, use the retail method because it’s quick and affordable to perform, unlike a physical count.
Use the calculator below to compute your estimated ending inventory at cost using the conventional or average method of retail accounting.
When To Use The Retail Method & Who Is It Best For
Retail Method vs Normal Periodic Method
Retail Method | Normal Periodic Method | |
|---|---|---|
Best For | Retailers with large values of inventory or multilocation retailers | Businesses with low volumes of inventory |
Cost of Inventory | Estimated cost | Actual cost |
Way of Determining Inventory Cost | Cost vs retail value of purchases | Cost flow assumption, such as last-in, first-out (LIFO), first-in, first-out (FIFO), or average cost |
Measurement of Inventory | Estimated cost based on retail values | Actual cost based on physical count and cost flow assumption |
Physical Count | Not required | Required |
Even businesses that choose to use the retail method during the year generally will do a physical count at the end of the year and apply a cost flow assumption to arrive at the actual cost of inventory.
Term | Definition |
|---|---|
Initial Markup | Amounts included in the original retail price on top of the cost of the product or service. |
Markup | Amounts added to the original retail price of a product or service. |
Markdown | Amounts deducted from the original retail price of a product or service. |
Cost-to-Retail Ratio | Percentage of the actual cost of goods available for sale (COGAS) over the original retail price of goods available for sale. |
Retail Method Basic Example
Let’s look first at the retail method without any complicated adjustments to the initial retail price of the goods. Essentially, the retail method tracks sales, COGS, and inventory at their retail value before making an adjustment to estimate the actual costs. The advantage of this is that COGS at retail is just sales and is much easier to track than actual COGS.
Tip:
If you have a high-quality bookkeeping program like QuickBooks Online that keeps track of your actual COGS throughout the year using a perpetual inventory system, there’s no need to use the retail method. Visit QuickBooks Online to learn more.
The cost should be the amount recorded in the books, while the retail price refers to the amount you generally will charge your customers for the goods.
Inventory & Sales Information | Cost | Retail |
|---|---|---|
Beginning Inventory | 1,000 | 1,500 |
Net Purchases | 3,000 | 4,500 |
Gross Sales | 5,300 |
Tip:
Our initial markup is 50% [(4,500 – 3,000) ÷ 3,000]. This markup is reflected in our beginning inventory and net purchases.
Inventory & Sales Information | Cost | Retail |
|---|---|---|
Beginning Inventory Purchases | 1,000 3,000 | 1,500 4,500 |
COGAS | 4,000 | 6,000 |
In our simple example, the COGS at retail is Sales of $5,300.
Tip:
This step substitutes sales for COGS. Actual COGS is very difficult to track and calculate, whereas sales is easy. This is the primary reason companies use the Retail method to estimate COGS.
Subtract the answers from steps 2 and 3 to compute inventory at retail price.
COGAS at Retail (Step 2) Less COGS at Retail | 6,000 - 5,300 |
Equals Ending Inventory at Retail | 700 |
This ending inventory at retail will be used later in step 6 and serve as your beginning inventory at retail for your next period calculation.
COGAS at Cost Divided by COGAS at Retail | 4,000 ÷ 6,000 |
Equals Cost-to-Retail Ratio | 0.666667 |
Ending Inventory at Retail Times Cost-to-Retail Ratio | 700 x 0.666667 |
Ending Inventory at Cost | 467 |
COGAS at Cost Ending Inventory at Cost | 4,000 (467) |
COGS at Cost | 3,533 |
In our simple example with a constant initial markup percentage and no subsequent adjustments, we can double-check our final COGS at Cost by multiplying it by one plus our initial markup percentage to arrive at our COGS at Retail ($3,533 X 1.50% = $5,300). This simple check will be unavailable in real-world situations where subsequent adjustments to sales price are commonplace.
The retail method becomes more complicated when there are subsequent markups and markdowns to the initial retail price. These adjustments can be dealt with using either the Conventional Method or Average Cost Method.
Retail Method In-depth Example
Markups and markdowns are unavoidable in normal business operations. In this section, we’ll illustrate how markdowns and markups affect retail method calculations under two approaches: conventional and average cost.
Conventional Approach
Also called the conservative approach, the conventional retail method determines the cost-to-retail ratio by considering markups, but not markdowns. Ignoring markdowns makes the cost-to-retail ratio lower, resulting in a lower estimate of the actual cost of inventory.
Take note that you only exclude markdowns when computing the cost-to-retail ratio. You include them nonetheless when computing the COGAS at retail.
Inventory & Sales Information | Cost | Retail |
|---|---|---|
Beginning Inventory | 1,000 | 1,500 |
Net Purchases | 3,000 | 4,500 |
Subsequent Markups | 2,000 | |
Subsequent Markdowns | 200 | |
Gross Sales | 5,300 |
Cost | Retail | |
|---|---|---|
Beginning Inventory From Prior Period Retail Method Calculations Markups Markdowns Purchases | 1,000 3,000 | 1,500 2,000 (200) 4,500 |
COGAS | 4,000 | 7,800 |
In our example, the cost of goods sold at retail is Sales of $5,300.
Subtract the answers from steps 2 and 3 to compute inventory at retail price.
COGAS at Retail (Step 2) Minus by COGS at Retail | 7,800 (5,300) |
Equals Ending Inventory at Retail | 2500 |
This ending inventory at retail will be used later in Step 6 and serve as your beginning inventory at retail for your next period calculation.
Since we’re using the conventional method, let’s not forget to exclude markdowns in COGAS at Retail. Markdowns are deducted from COGAS at Retail, so let’s add it back.
COGAS at Cost Divided by COGAS at Retail Without Markdowns (7,800 + 200) | 4,000 ÷ 8,000 |
Equals Cost-to-Retail Ratio | 0.5 |
Ending Inventory at Retail Times Cost-to-Retail Ratio | 2,500 x 0.50 |
Ending Inventory at Cost | 1,250 |
COGAS at Cost Minus Ending Inventory at Cost | 4,000 (1,250) |
COGS at Cost | 2,750 |
Average Cost Approach
The average cost method considers both markups and markdowns in the determination of the cost-to-retail ratio. As a result, the cost-to-retail ratio will be higher than in the conservative method.
Inventory & Sales Information | Cost | Retail |
|---|---|---|
Beginning Inventory | 1,000 | 1,500 |
Net Purchases | 3,000 | 4,500 |
Markups | 2,000 | |
Markdowns | 200 | |
Gross Sales | 5,300 | |
Actual Sales Returns | 500 |
Since we’re using the conventional method, let’s not forget to include markups in the retail column.
Cost | Retail | |
|---|---|---|
Beginning Inventory From Prior Period Retail Method Calculations Markups Markdowns Purchases | 1,000 3,000 | 1,500 2,000 (200) 4,500 |
COGAS | 4,000 | 7,800 |
In our example, the cost of goods sold at retail is Sales of $5,300.
Subtract the answers from steps 2 and 3 to compute inventory at retail price.
COGAS at Retail (Step 2) Minus by COGS at Retail | 7,800 - 5,300 |
Equals Ending Inventory at Retail | 2,500 |
This ending inventory at retail will be used later in step 6 and serve as your beginning inventory at retail for your next period calculation.
Since we’re using the average method, we don’t need to make adjustments to COGAS at Retail. Let’s directly divide $4,000 with COGAS at Retail we computed in the table above.
COGAS at Cost Divided by COGAS at Retail | 4,000 ÷ 7,800 |
Equals Cost-to-Retail Ratio | 0.51282 |
Ending Inventory at Retail Times Cost-to-Retail Ratio | 2,500 x 0.51282 |
Ending Inventory at Cost | 1,282 |
COGAS at Cost Ending Inventory at Cost | 4,000 (1,282) |
COGS at Cost | 2,718 |
Tip:
Take note that the COGS at Cost under the conventional method ($2,750) is higher than in the average method ($2,718) and ending inventory in the average method ($1,282) is higher than in the conventional method ($1,250). That’s the reason why the conventional method is also known as the “conservative approach”—it reports a lower income due to high COGS and lower assets due to a low ending inventory.
Tying Up Retail Inventory With the Physical Count
Retailers will inevitably have a physical count at the end of the year. Since the retail inventory method is just an estimation technique, expect that there will be differences in the physical count and retail method estimations.
A journal entry can be made for the difference between the estimated and actual ending inventory. For instance, assume that estimated inventory is $1,000 more than the actual inventory per the physical count. This adjustment can be recorded with the following journal entry:
Debit | Credit | |
|---|---|---|
COGS | 1,000 | |
Inventory | 1,000 | |
To Adjust Estimated Inventory to Actual per Physical Count | ||
With the retail method, it’s difficult to distinguish between inventory shrinkage and the effect of the estimation technique. In contrast, a perpetual inventory system like that used by QuickBooks Online will provide the number of units that should be in the ending inventory. You can then compare those units to the actual units on hand to determine inventory shrinkage.
Frequently Asked Questions (FAQs)
No, but it is a faster way of determining ending inventory and the COGS without performing a physical count.
The retail price is the amount that the customer pays to purchase goods or services while the selling price is the amount that the seller receives after deducting taxes and fees, such as shipping and handling.
Bottom Line
Retail accounting is a method of estimating ending inventory. Since it’s inefficient and expensive to conduct physical counts more than once or twice a year, retailers can use the retail method to estimate ending inventory and determine net income during interim periods. The retail method can make it easier for companies to value their inventory and prepare interim financial statements.
