What Is Retail Accounting? Definition And Steps You Can Use

By Indeed Editorial Team

Updated 7 December 2022

Published 14 May 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Managing inventory is an important process for many businesses. By accurately tracking the valuation of items in an inventory, a business can better monitor any losses they sustain and make predictions about future profits. Understanding accounting for retail can help you become more effective in your role. In this article, we learn the answer to, 'What is retail accounting?', discuss how it works, review its advantages and disadvantages, explore how retail accounting is different from cost accounting, identify the applications of retail accounting in special cases, examine frequently asked questions about the method, and review an example of calculating it.

What Is Retail Accounting?

You may be wondering, 'What is retail accounting?'. It is a technique for determining the value of inventory, depending on the selling price of the products. Many retailers use this technique to calculate their inventory balances. In some retail businesses, there can be a requirement to manage inventory at different levels. Retail accounting can help in managing the inventory at a category or department level. According to this method, a retailer can list inventory at each stage of the accounts, depending on the final retail price.

For example, a store pays ₹1000 for a set of five bags. If it sells three of these bags at ₹250 each, the store then has ₹750 in cash and stock worth ₹500. Even though the store actually pays ₹1000 for the bags, the sale price for all five is ₹1250.

Read more: What Are The Functions Of Accounting? (Definition And Types)

How To Use The Retail Method Of Accounting

Here are some steps that can help you use the retail method of accounting to calculate ending inventory:

1. Calculate cost-to-retail percentage

The first step involves finding the cost-to-retail percentage of a retail inventory. You require the total purchase price of the inventory and the selling or retail price. Here is a formula to calculate the cost-to-retail percentage:

Cost-to-retail percentage = (cost of inventory / retail price of the inventory) x 100

For example, if a store buys an inventory for ₹500 and sells it for ₹1000, they can calculate the cost-to-retail percentage by using this formula:

Cost-to-retail percentage = (₹500 / ₹1000) x 100 = 50%

2. Find the cost of inventory available for sale

After determining the cost-to-retail percentage, calculate the specific time period of reporting. Then, find the cost of inventory at the start of that time and the cost of additional purchases during this time. Here is the formula that you can use to find the cost of inventory available for sale:

Cost of inventory available for sale = cost of beginning inventory + cost of additional purchases

For example, suppose a store has a beginning inventory of ₹1000 and later it purchases more inventory at a cost of ₹1500. To calculate the cost of inventory available, the accountant can use this formula:

Cost of inventory available for sale = ₹1000 + ₹1500 = ₹2500

3. Determine the cost of sales

Next, you can calculate the total cost of sales for a particular time period. You can use the total amount of sales and the cost-to-retail percentage for the calculation. The result represents the total amount gained when selling the inventory. Here is a formula that you can use to determine the cost of sales:

Cost of sales = total amount of sales x cost-to-retail percentage

For example, the cost-to-retail percentage of an inventory is 50% and the store has sales of ₹500 during a particular time period. Then, the cost of sales is:

Cost of sales = ₹500 x 50% = ₹25000

4. Determine the ending inventory

After calculating the cost of sales and the cost of inventory available for sale, you can calculate the ending inventory. Ending inventory is the value of stock that a retail business has at the end of a particular reporting period. After determining the ending inventory, retailers can include this information on the balance sheet. Here is a formula to find the ending inventory value:

Ending inventory = cost of inventory available for sale - cost of sales during the reporting period

For example, if the cost of inventory for sale is ₹1000 and the cost of sales during the reporting period is ₹500, the ending inventory is:

Ending inventory = ₹1000 - ₹500 = ₹500

Read more: Basics Of Accounting - Terminology, Principles And Concepts

Advantages And Disadvantages Of Retail Accounting

Retail accounting can be an effective method, but in some cases may be more complex than other types of accounting. Some advantages and disadvantages include:

Advantages

Here are some advantages of retail accounting:

  • It is convenient for retailers operating multiple stores, as it can save time in conducting physical inventories.

  • This accounting method involves easy calculations, as all units of one item have the same price and experience the same changes in the price.

  • In retail accounting, preparing financial statements gets easier due to simple calculations.

  • This method is independent of labour-intensive physical inventory counts.

Read more: What Does A Retail Salesperson Do? (Duties And Career Path)

Disadvantages

Here are some disadvantages of retail accounting:

  • This method can be inaccurate in the event of pricing changes.

  • Retail accounting often involves assuming unrealistic pricing conditions and it may be unable to provide the exact price values.

  • This type of accounting can be ineffective or more complex with the introduction of discounts.

Difference Between Retail And Cost Accounting

Here are some notable points that explain the difference between retail and cash accounting:

  • In retail accounting, the value of inventory depends on the selling price while in cost accounting, the inventory value depends on its cost to the retailer.

  • In many cases, cost accounting is more accurate than retail methods of accounting.

  • Retail accounting is convenient for small businesses. Comparatively, cost accounting may be complicated for a small business.

Read more: What Does A Retail Manager Do? (With Duties And Skills)

Applications Of Retail Accounting In Special Cases

Here are some special cases for retail accounting to consider:

Retail accounting for returns

If an order gets processed, delivered and then returned within the same accounting period, retailers can make the necessary adjustments to the balance sheets. When the return happens in the sales time period, it may show an extra profit in the sales. Usually, the return process involves a credit to the receivable account and a debit to the sales return account.

Retail accounting for discount in sales

Sometimes, retailers may offer a reduction in the cost of the product in exchange for early payment by the customer. In many cases, retailers offer a discount when they are short of cash. When a customer takes advantage of this sale and pays less than the full amount of the invoice, the retailer records the discount as a credit to a receivable account and a debit to a sales discount account.

FAQ Related To Retail Accounting Method

Here are some answers to frequently asked questions related to the retail method of accounting:

What is inventory?

Inventory is the accounting of items or products that a retail business may use in production or sales. Businesses sell their inventory to customers for a profit. Inventory is also a current asset of a business in the balance sheet. Some examples of inventory include the number of shoes a store can sell, raw materials to manufacture a toy or ingredients to prepare fries for a fast food centre.

What are the benefits of using accounting software for a retail business?

Here are some benefits of using accounting software:

  • Provides accurate data: Accounting software can facilitate the faster and more accurate calculation of inventories and other financial data.

  • Helps in saving time: Accounting software can automate financial operations and save time.

  • Improves inventory management: With accounting software, retailers can efficiently manage their inventory and assets.

Example Of Retail Accounting Method

Here is a helpful example of using the retail accounting method:

Suresh wishes to find the value of his ending inventory over a two-month reporting period for his store. He sells shirts for ₹100 each and purchases them at a cost of ₹50 each. Suresh can use the retail accounting method and find the cost-to-retail percentage:

(₹50/₹100) x 100 = 50%

He had a beginning inventory of ₹5000 and he made additional purchases of ₹3000 during the two-month reporting period. Suresh can calculate the cost of inventory available for sales:

₹5000 + ₹3000 = ₹8000

Suresh also gained ₹10000 in sales over the two-month reporting period. He can use the total sales and cost-to-retail percentage to find his cost of sales:

50% x ₹10000 = ₹5000

Now, for determining his ending inventory for the two-month reporting period, he can subtract the cost of sales, which is ₹5000, from the cost of inventory available for sale, which is ₹8000. The ending inventory of Suresh's business is:

₹8000 - ₹5000 = ₹3000


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  • What Is Cost Accounting? (Definition And Objectives)

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