Estimating the Cost of Inventory Using the Retail Method and Gross Profit Method
There are two main methods for estimating the cost of inventory when a physical inventory cannot be taken or perpetual inventory records are not maintained: the retail method and the gross profit method.
The retail method is often used by retail businesses and involves estimating the cost of inventory based on the relationship between the cost and retail price of the merchandise available for sale. To use this method, the cost-to-retail ratio is calculated and the ending inventory is determined at the retail price. The estimated cost of the ending inventory is then calculated using the cost-to-retail ratio.
The gross profit method involves estimating the gross profit realized during the period to estimate the cost of inventory. The gross profit rate may be estimated based on the average of previous periods' gross profit rates. The estimated gross profit is calculated, and the cost of merchandise sold is then estimated using the sales and estimated gross profit figures. The estimated cost of the ending inventory is then determined by subtracting the estimated cost of merchandise sold from the cost of merchandise available for sale.