Accounting Cost Ratio

Businesses use the accounting cost ratio to value their inventory.

The accounting cost ratio or cost-to-retail ratio is a key number for businesses that track their inventories using the retail inventory method. This method of accounting for inventories is particularly useful for those companies that have a variety of retail products. However, virtually any business can benefit from using this method of evaluating inventories.

History

As described by Malcolm Perrine McNair in "The Retail Method of Inventory," the retail inventory method and cost-to-retail ratio were widely adopted by department stores in the 1920s. Because of this widespread adoption and its accuracy and ease of use, the retail inventory method has been considered the best accounting practice since 1941.

Calculation

Three steps are taken to determine and use the cost-to-retail ratio. First, determine the retail value of the inventory by subtracting the total sales of the business from the retail value of goods available for sale. Then divide the cost of goods available for sale by the retail value of goods available for sale to find the cost-to-retail ratio. If you would like to estimate the cost of the remaining inventory, multiply the retail value of the inventory by the cost-to-retail ratio.

Advantages

The cost-to-retail ratio has numerous advantages: It is a simple calculation that can be used for most retail stores; it can help businesses quickly determine the amount of inventory that has been sold as well as the amount of inventory that remains. Another benefit is that, providing good records are kept, the cost benefit ratio can be updated perpetually. Changes can be monitored in real time.

Drawbacks

One drawback to cost-to-retail ratio is that the cost of different items may vary widely from one type of product to another. Because the cost-to-retail ratio is simply an average of all products, items that vary widely in price may cause the estimation to be inaccurate. One way many companies combat this flaw is to group similar items or departments together when calculating cost-to-retail ratios.

References

• Wiley: Appendix D Retail Inventory Method
• New York Times: Malcolm Perrine McNair, 90, Retailing Expert at Harvard
• Committee on Ways and Means: Full Committee, March 12, 1997, Testimony