Answer
Conditions that may distort the results range from:
1. Since the retail method is founded on an estimated cost ratio involving total merchandise available during the period, its validity depends on the underlying assumption that the merchandise in ending inventory is a representative mixture of all merchandise handled. If this condition does not exist, the cost ratio may not be appropriate for the merchandise in ending inventory and can result in significant error.
2. Where there are a number of inventory subdivisions for which differing rates of markup are maintained, there is no assurance that the ending inventory mix will be representative of the total merchandise handled during the period.
3. Seasonal variations in the rate of markup will nullify the ending inventory “representative mix” assumption. Since the estimated cost ratio is based on total merchandise handled during the period, the same rate of markup should prevail throughout the period.
4. Material quantities of special sale merchandise handled during the period may also bias the result of this method because merchandise data included in arriving at the estimated cost ratio may not be proportionately represented in ending inventory.
Work Step by Step
Distortion of the ending inventory approximation under this method is often caused by an inadequate system of inventory control. Adequate accounting controls are necessary for the accurate accumulation of the data needed to arrive at a valid cost ratio. Physical controls are equally important because, for interim purposes, this method is usually applied without taking a physical inventory.
