Retail inventory method definition, formula, and an example
Inventory estimation method
The inventory estimation is used by the business concern in the case when some events occur or if a business is a retail business. This method forecasts the price and it gets near the price of the actual price. The inventory estimation includes two methods first Retail inventory method and the second Gross profit method.
Retail Inventory Method
Retail inventory method is a type from inventory estimation method. This method is used by the retailer to estimate the cost of goods sold and the cost of ending inventory. The retailer keep records of goods sold and purchase at the retail price. Therefore, this inventory method is appropriate for the retailer to determine the net profit or loss from performed transactions during the period.
Under this method following steps are occurred:
First step-1 – Calculate the cost of goods available for sale cost and retail price cost.
Step-2 – Divide cost of goods available for sale by the retail price of goods available for sale to set of cost/ retail price ratio. Also, in mathematical forms,
Cost/retail price ratio = Cost of goods available for sale / Retail price of goods available for sale
Step-3 – Multiply the inventory sold records at retail price by the cost/ retail price ratio, which gives the cost of goods sold. Mathematically represents as,
Cost of goods sold = Retail price of goods sold * cost/retail price ratio
The last step-4 – Deduct the cost of goods sold from the cost of goods available for sale or alternatively multiply the retail price of ending inventory by cost/retail price ratio to determine the cost of ending inventory. In mathematical form,
Cost of ending inventory = Cost of goods available for sale - Cost of goods sold
OR
Cost of ending inventory = (Retail price of goods available for sale - Retail price of goods sold) * Cost/retail price ratio
For, Profit or Loss = Retail price of goods sold – Cost of goods sold
For example:
Following information is given of ABC Company.
| Details | Cost Price | Retail Price |
| Beginning inventory Purchase of inventory Transportation | 20,000 60,000 5,000 | 30,000 70,000 |
| Cost of goods available for sale | 85,000 | 1,00,000 |
During the year the company sold goods Rs. 90,000 at retail price.
Determine the cost of the ending inventory, cost of goods sold, and show the company is in profit or loss by using the Retail Inventory Estimation Method.
Solution:
By using the Retail Inventory Method
Calculation of cost/retail price ratio
Cost/retail price ratio = Cost of goods available for sale / Retail price of goods available for sale = 85,000 / 1,00,000 = 0.85
Calculation of cost of goods sold (COGS)
Cost of goods sold = Retail price of sold goods * Cost/retail price ratio = Rs. 90,000 * 0.85 = Rs. 76,500
Calculation of cost of ending inventory
Cost of ending inventory = Cost of goods available for sale – Cost of goods sold = 85,000 – 76,500 = Rs. 8,500
Alternatively,
Cost of ending inventory = (Retail price of goods available for sale – Retail price of sold goods) * Cost/retail price ratio = (1,00,000 – 90,000) * 0.85 = 10,000 * 0.85 = Rs. 8,500
Calculation of profit or loss
Profit or Loss = Retail price of sold goods – Cost of goods sold = 90,000 – 76,500
= Rs. 13,500 (Profit)