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For some companies, taking a physical inventory is impossible or impractical so the Retail Inventory Method is used to estimate.
Explain how to calculate inventory using the retail inventory method
In certain business operations, taking a physical inventory is impossible or impractical. In such a situation, it is necessary to estimate the inventory cost through methods such as RMA.
The advantage of the RMA method is that companies can estimate ending inventory (at cost) without taking a physical inventory. Thus, the use of this estimate permits the preparation of interim financial statements (monthly or quarterly) without taking a physical inventory.
Because RIM/RMA only provides an approximation of inventory value, physical inventory must also be performed periodically to ensure the accuracy of inventory estimates due to issues such as shoplifting.
The difference between net sales and the cost of goods sold.
To illustrate how you can determine inventory shortages using the retail method, assume that a physical inventory taken at year end, showed only USD 62,000 of retail-priced goods in the store. Assume that use of the retail method for the fourth quarter showed that USD 66,000 of goods should be on hand, thus indicating a USD 4,000 inventory shortage at retail. After converting the USD 4,000 to USD 2,400 of cost (USD 4,000 X 0.60) you would report this as a "Loss from inventory shortage" in the income statement. Knowledge of such shortages may lead management to reduce or prevent them, by increasing security or improving the training of employees.
The retail inventory method uses a cost to retail price ratio. The physical inventory is valued at retail, and it is multiplied by the cost ratio (or percentage) to determine the estimated cost of the ending inventory. Note that both the gross margin and the retail inventory methods can help you detect inventory shortages.
The advantage of this method is that companies can estimate ending inventory (at cost) without taking a physical inventory. Thus, the use of this estimate permits the preparation of interim financial statements (monthly or quarterly) without taking a physical inventory.
Because RIM only provides an approximation of inventory value, physical inventory must also be performed periodically to ensure the accuracy of inventory estimates due to issues such as shoplifting.
How to find the ending inventory with RMA
The steps for finding the ending inventory by the retail inventory method are:
Total the beginning inventory and the net amount of goods purchased during the period at both cost and retail prices.
Divide the cost of goods available for sale by the retail price of the goods available for sale to find the cost/retail price ratio.
Deduct the retail sales from the retail price of the goods available for sale to determine ending inventory at retail.
Multiply the cost/retail price ratio or percentage by the ending inventory at retail prices to reduce it to the ending inventory at cost.
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cost of goods sold / selling price of goods available for sale, cost of goods sold / total revenue, cost of goods sold / retail price, and cost of goods sold / the retail price of goods available for sale