Retail method of estimating inventory can be used by retailers maintaining the record of both the inventory’s cost as well as retail prices. In this method, cost-to-retail price ratio is calculated using the following formula.
Cost-to-retail price ratio is multiplied with the closing inventory’s retail price to estimate the cost of closing inventory.
Let’s take a look at the following example to understand the retail method of estimating inventory.
Example – Retail method of estimating inventory
ABC Company involved in the retail business is preparing quarterly financial statement for the three months ended 31 March 20X1. As the company uses periodic system of inventory record keeping and stock counting is done only at year end, it needs to estimate closing inventory. The company maintains the retail price record of all its inventory, therefore, retail method of estimating inventory can be used. Following additional information related to the current quarter is available from the company’s records:
- Cost of opening inventory is $30,000.
- Retail price of opening inventory is $40,000
- Cost of purchases is $65,000
- Freight charges on purchases are $5,000
- Retail selling price of purchases is $95,000
- Retail sales during the quarter are $100,000
Estimate the closing inventory on 31 March 20X1.