Methods in Retail Inventory

Retail Inventory Method (RIM or RMA)

In certain business operations, taking a physical inventory is impossible or impractical. In such a situation, it is necessary to estimate the inventory cost. Two very popular methods are:

1. Retail inventory method, and
2. Gross profit (or gross margin) method.

Businesses need to manage their inventories.

Here a woman is checking stock of certain items to maintain an accurate record for dollars of inventory in stock.

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.

Advantages

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.

Disadvantages

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:

1. Total the beginning inventory and the net amount of goods purchased during the period at both cost and retail prices.
2. 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.
3. Deduct the retail sales from the retail price of the goods available for sale to determine ending inventory at retail.
4. Multiply the cost/retail price ratio or percentage by the ending inventory at retail prices to reduce it to the ending inventory at cost.

Example

To illustrate how you can determine inventory shortages using the retail method, assume that a physical inventory taken at year end, showed only $62,000 of retail-priced goods in the store. Assume that use of the retail method for the fourth quarter showed that $66,000 of goods should be on hand, thus indicating a $4000 inventory shortage at retail. After converting the $4000 to $2400 of cost ($$4,000 \cdot 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.