Chapter 8, Problem 7P

Retail Inventory Method EKC Company uses the retail inventory method. The following information for 2019 is available:

Required:

Compute the cost of the ending inventory under each of the following cost flow assumptions (round the cost-to-retail ratio to 3 decimal places):

1. 1. FIFO
2. 2. average cost
3. 3. LIFO
4. 4. lower of cost or market (based on average cost)

To determine

Calculate the cost of ending inventory by the retail method using FIFO cost flow.

Explanation of Solution

Retail inventory method: It takes into account all the retail amounts that is, the current selling prices. Under this method, the goods available for sale, at retail is deducted from the sales, at retail to determine the ending inventory, at retail.

Conventional Retail Method: Conventional retail method refers to the estimation of the lower of average cost or market by eliminating the markdowns from the calculation of the cost-to-retail percentage.

In this case, the cost-to-retail percentage will be determined by dividing the goods available for sale at cost by the goods available for at retail (excluding markdowns). Thus, the conventional retail method will always result in lower estimation of ending inventory when the markdowns exist.

FIFO: Under this inventory method, the units that are purchased first are sold first. Thus, it starts from the selling of the beginning inventory, followed by the units purchased in a chronological order of their purchases took place during a particular period.

Calculate the cost of ending inventory by the retail method using FIFO cost flow.

Ending Inventory - FIFO
Details	Cost ($)	Retail ($)
Purchases	320,000	600,000
Less: Purchases discount taken	(6,000)	0
Freight -in	16,000	0
Net additional markups	0	48,000
Net markdowns	0	(11,000)
Goods available for sale after markdowns	330,000	637,000
Add: Beginning inventory	100,000	180,000
Goods available for sale	430,000	817,000
Less: Net sales		(580,000)
Ending inventory at retail		$237,000
Ending inventory at cost	$122,766

Table (1)

Working note 1:

Calculate the amount of net additional markups.

$\begin{array}{c}\text{Net additional markups = }\left(\begin{array}{l}\text{Additional markups at retail}-\\ \text{Markup cancellations}\end{array}\right)\\ =\left(\$60,000-\$12,000\right)\\ =\$48,000\end{array}$

Working note 2:

Calculate the amount of net additional markdowns.

$\begin{array}{c}\text{Net additional markdowns = }\left(\begin{array}{l}\text{Markdowns at retail}-\\ \text{Markdown cancellations}\end{array}\right)\\ =\left(\$15,000-\$4,000\right)\\ =\$11,000\end{array}$

Working note 3:

Calculate ending inventory at cost.

Step 1: Calculate cost-to-retail ratio.

$\begin{array}{c}\text{Cost-to-retail ratio= }\left(\frac{\begin{array}{l}\text{Goods available for sale at cost }\\ \text{(After markdowns)}\end{array}}{\begin{array}{l}\text{Goods available for sale at retail }\\ \text{(After markdowns)}\end{array}}\right)\\ =\left(\frac{\text{\$330,000}}{\$637,000}\right)\\ =.518\end{array}$

Step 2: Calculate ending inventory at cost.

$\begin{array}{c}\text{Ending inventory at cost = }\left(\begin{array}{l}\text{Ending inventory at retail}\\ \times \text{Cost-to-retail ratio}\end{array}\right)\\ \text{=}\left(\$237,000\times .518\right)\\ =\$122,766\end{array}$

Conclusion

Therefore, the cost of ending inventory by the retail method using FIFO cost flow is $122,766.

To determine

Calculate the cost of ending inventory by the retail method using average cost flow.

Explanation of Solution

Average cost method: Under this method, the cost of the goods available for sale is divided by the number of units available for sale during a particular period.

Calculate the cost of ending inventory by the retail method using average cost flow.

Ending Inventory - Average Cost
Details	Cost ($)	Retail ($)
Beginning inventory	100,000	180,000
Purchases	320,000	600,000
Less: Purchases discount taken	(6,000)	0
Freight -in	16,000	0
Net additional markups	0	48,000
Net markdowns	0	(11,000)
Goods available for sale after markdowns	430,000	817,000
Less: Net sales		(580,000)
Estimated ending inventory at retail		$237,000
Estimated ending inventory at cost	$124,662

Table (2)

Working note 1:

Calculate ending inventory at cost.

Step 1: Calculate cost-to-retail ratio.

$\begin{array}{c}\text{Cost-to-retail ratio= }\left(\frac{\begin{array}{l}\text{Goods available for sale at cost }\\ \text{(After markdowns)}\end{array}}{\begin{array}{l}\text{Goods available for sale at retail }\\ \text{(After markdowns)}\end{array}}\right)\\ =\left(\frac{\text{\$430,000}}{\$817,000}\right)\\ =.536\end{array}$

Step 2: Calculate ending inventory at cost.

$\begin{array}{c}\text{Ending inventory at cost = }\left(\begin{array}{l}\text{Ending inventory at retail}\\ \times \text{Cost-to-retail ratio}\end{array}\right)\\ \text{=}\left(\$237,000\times .526\right)\\ =\$124,662\end{array}$

Conclusion

Therefore, the cost of ending inventory by the retail method using average cost flow is $124,662.

To determine

Calculate the cost of ending inventory by the retail method using LIFO cost flow.

Explanation of Solution

LIFO: Under this inventory method, the units that are purchased last are sold first. Thus, it starts from the selling of the units recently purchased and ending with the beginning inventory.

Calculate the cost of ending inventory by the retail method using LIFO cost flow.

Ending Inventory - LIFO
Details	Cost ($)	Retail ($)
Beginning inventory	100,000	180,000
Purchases	320,000	600,000
Less: Purchases discount taken	(6,000)	0
Freight -in	16,000	0
Net additional markups	0	48,000
Net markdowns	0	(11,000)
Goods available for sale after markdowns	330,000	637,000
Goods available for sale	430,000	817,000
Less: Net sales		(580,000)
Estimated ending inventory at retail		$237,000
Estimated ending inventory at LIFO cost:
Beginning layer	100,000
New layer	29,526
Total cost	$129,526

Table (3)

Working note 1:

Calculate ending inventory at cost for beginning layer:

Step 1: Calculate cost-to-retail ratio (Beginning layer).

$\begin{array}{c}\text{Cost-to-retail ratio= }\left(\frac{\text{Beginning inventory for cost}}{\text{Beginning inventory for retail}}\right)\\ =\left(\frac{\text{\$100,000}}{\$180,000}\right)\\ =.556\end{array}$

Step 2: Calculate ending inventory at cost (Beginning layer).

$\begin{array}{c}\text{Ending inventory at cost = }\left(\begin{array}{l}\text{Beginning inventory at retail}\\ \times \text{Cost-to-retail ratio}\end{array}\right)\\ \text{=}\left(\$180,000\times .556\right)\\ =\$100,000\left(\text{Rounded}\right)\end{array}$

Working note 2:

Calculate ending inventory at cost for new layer.

Step 1: Calculate cost-to-retail ratio (new layer).

$\begin{array}{c}\text{Cost-to-retail ratio= }\left(\frac{\begin{array}{l}\text{Goods available for sale at cost }\\ \text{(After markdowns)}\end{array}}{\begin{array}{l}\text{Goods available for sale at retail }\\ \text{(After markdowns)}\end{array}}\right)\\ =\left(\frac{\text{\$330,000}}{\$\text{637,000}}\right)\\ =.518\end{array}$

Step 2: Calculate ending inventory at cost (new layer).

$\begin{array}{c}\text{Ending inventory at cost = }\left(\begin{array}{l}\text{\$57,000}\left(\begin{array}{l}\$637,000\\ -\$580,000\end{array}\right)\\ \times \text{Cost-to-retail ratio}\end{array}\right)\\ \text{=}\left(\$57,000\times .518\right)\\ =\$29,526\end{array}$

Conclusion

Therefore, the cost of ending inventory by the retail method using LIFO cost flow is $129,526.

To determine

Calculate the cost of ending inventory by the retail method using lower of cost or market rule.

Explanation of Solution

Lower-of-cost-or-market: The lower-of-cost-or-market (LCM) is a method which requires the reporting of the ending merchandise inventory in the financial statement of a company, either at current market value or at historical cost price of the inventory, whichever is less.

Calculate the cost of ending inventory by the retail method using lower of cost or market rule.

Ending Inventory - LCM
Details	Cost ($)	Retail ($)
Beginning inventory	100,000	180,000
Purchases	320,000	600,000
Less: Purchases discount taken	(6,000)	0
Freight -in	16,000	0
Net additional markups	0	48,000
Goods available for sale before markdowns	430,000	828,000
Less: Net markdowns		(11,000)
Net sales		(580,000)
Estimated ending inventory at retail		$237,000
Estimated ending inventory at cost (LCM)	$123,003

Table (4)

Working note 1:

Calculate ending inventory at cost.

Step 1: Calculate cost-to-retail ratio.

$\begin{array}{c}\text{Cost-to-retail ratio= }\left(\frac{\begin{array}{l}\text{Goods available for sale at cost }\\ \text{(before markdowns)}\end{array}}{\begin{array}{l}\text{Goods available for sale at retail }\\ \text{(before markdowns)}\end{array}}\right)\\ =\left(\frac{\text{\$430,000}}{\$828,000}\right)\\ =.519\end{array}$

Step 2: Calculate ending inventory at cost.

$\begin{array}{c}\text{Ending inventory at cost = }\left(\begin{array}{l}\text{Ending inventory at retail}\\ \times \text{Cost-to-retail ratio}\end{array}\right)\\ \text{=}\left(\$237,000\times .519\right)\\ =\$123,003\end{array}$

Conclusion

Therefore, the cost of ending inventory by the retail method using LCM cost flow is $123,003.