Under the retail inventory method a companys records

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Under the retail inventory method, a company’s records must show both the cost and retail value of the goods available for sale. Illustration 6B-3 presents the formulas for using the retail inventory method. 276 Chapter 6 Inventories Goods Ending Step 1: Available for H11546 Net Sales H11549 Inventory Sale at Retail at Retail Goods Goods Cost-to- Step 2: Available for H11548 Available for H11549 Retail Sale at Cost Sale at Retail Ratio Ending Cost-to- Estimated Step 3: Inventory H11547 Retail H11549 Cost of at Retail Ratio Ending Inventory Illustration 6B-3 Retail inventory method formulas Illustration 6B-4 Application of retail inventory method We can demonstrate the logic of the retail method by using unit-cost data. Assume that Ortiz Inc. has marked 10 units purchased at \$7 to sell for \$10 per unit. Thus, the cost-to-retail ratio is 70% (\$70 H11004 \$100). If four units remain unsold, their retail value is \$40 (4 H11003 \$10), and their cost is \$28 (\$40 H11003 70%). This amount agrees with the total cost of goods on hand on a per unit basis (4 H11003 \$7). Illustration 6B-4 shows application of the retail method for Valley West Co. Note that it is not necessary to take a physical inventory to determine the esti- mated cost of goods on hand at any given time. PDF Watermark Remover DEMO : Purchase from to remove the watermark

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Self-Study Questions 277 The retail inventory method also facilitates taking a physical inventory at the end of the year. Valley West can value the goods on hand at the prices marked on the merchandise, and then apply the cost-to-retail ratio to the goods on hand at re- tail to determine the ending inventory at cost. The major disadvantage of the retail method is that it is an averaging tech- nique.Thus, it may produce an incorrect inventory valuation if the mix of the ending inventory is not representative of the mix in the goods available for sale. Assume, for example, that the cost-to-retail ratio of 75% for Valley West Co. consists of equal proportions of inventory items that have cost-to-retail ratios of 70%, 75%, and 80%. If the ending inventory contains only items with a 70% ratio, an incorrect inventory cost will result. Companies can minimize this problem by applying the retail method on a department or product-line basis. H E L P F U L H I N T In determining inventory at retail, companies use selling prices of the units. (SO 1) (SO 1) (SO 2) (SO 2) SUMMARY OF STUDY OBJECTIVE FOR APPENDIX 6B 8 Describe the two methods of estimating inventories. The two methods of estimating inventories are the gross profit method and the retail inventory method. Under the gross profit method, companies apply a gross profit rate to net sales to determine estimated cost of goods sold. They then subtract estimated cost of goods sold from cost of goods available for sale to determine the estimated cost of the ending inventory.
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