Many companies started shifting their accounting method of
valuating inventory from Retail method to Cost accounting. Cost accounting is
better way to track inventory and also results in accurate financial reporting.
WHAT?:
Retail Method of Accounting:
A recent study indicated that
even now 50% of the retails use this old retail method of accounting. The retail method of accounting (or retail method), according to Investopedia, is “an accounting procedure for estimating the value of a
store’s merchandise. It calculates a store’s total inventory value by taking
the total retail value of the items that were originally in inventory,
subtracting the total sales, [and] then multiplying that dollar amount by the
cost-to-retail ratio (the percentage by which goods are marked up from their
wholesale purchase price to their retail sales price).”
Loop holes
in this valuation method:
Retail leadership used to give targets to store manager’s
in terms of selling inventory. Target for a sales manager can be $1000, 000.00
($1 Million)
If the store manager gets an inventory worth $1million
and unable to sell this, the prices can be marked down and be sold for $70,000.
Manager can procure $30,000 worth of fast selling inventory and can complete the
target by end of the period.
Unable to identify cash cow in business to
make right business decisions:
With this margin calculations, business cannot
identify the exact product that is giving profit and ones creating loss as they
are getting mixed up in one umbrella.
Cost Method of Accounting:
Inventory valuation in cost accounting is based is
difference between sales and cost of goods sold including other adjustments. Cost of goods sold is calculated as part of moving
average price calculation. Also called weighted average cost. This is
calculated at every unit level at store. Every item sold is defined as a SKU and the cost of
SKU keeps changing based on change in procuring cost.
Weighted Average Cost = Total Inventory Value /
Balance on hand
HOW?:
Moving to Cost method requires a major
change in the mindset of the planner who is used to planning using Retail
Method. The change is even more difficult for fashion because it is seasonal
based and generally has fixed cycles of Full-price sales, promotions and
markdowns. Hence, the planner is accustomed to think in the same fashion –
markdowns, which reduce inventory, increasing OTB thus giving way to flow of
new merchandise.
WHY?:
Here is a list of some of the reasons why
Cost Accounting is attractive to retailers.
3. No longer requires planning and management of markdown budgets 4. Only selling creates open-to-buy, not markdowns 5. Fewer data points to manage, i.e. less KPIs to plan
6. Inventory values are based upon what you actually paid for the item 7. Accuracy
1. Cost value of inventory is independent of retail price changes 2. Inventory values are based upon what you actually paid for the item 3. Gross Margin: Cost Accounting -> at Item level, and in retail method of accounting -> blended at category 8. Does not require on hand counts when a retail price is changed
