By its definition of a seller of finished goods to consumers, a retail business can be argued to have a longer operating cycle. This is a characteristic associated with merchandising companies. The operating cycle is lengthened by the processes of purchasing and selling inventory. As demonstrated in Kimmel et al. (2016), the management of inventory takes a significant share of the operations of a retail business. Purchasing and selling of inventory are processes that should be handled with care to ensure desirable flow of finances. The complexity in the flow of costs calls for the use of a detailed income statement. Therefore, a merchandising income statement fits the role because of its multi-step approach to capturing inventory. This type of income statement factors in the beginning inventory, cost of goods purchased, the total cost of goods available for sale, cost of goods sold, and ending inventory (cost of unsold goods). A merchandising income statement can be applied regardless of the retailer’s approach to inventory management – perpetual or periodic inventory system. It adopts a traditional approach to inventory management that emphasizes the flow of costs.
The inventory valuation methods discussed by Kimmel et al. (2016) depict the variation in organizational preferences that may be informed by the commodity being sold. The FIFO method (first in, first out) is by any means a logical method. It operates on the principle that the first goods purchased should be the first to be sold. The approach is particularly relevant to retailers dealing in commodities with short shelf life including fashion products that can be overtaken by trends. The LIFO (last in, first out) evaluation method operates on the principle of selling the last goods to be purchased first. The weighted average cost evaluation method assigns costs based on the average cost of goods in inventory. The average cost is calculated by dividing the total cost of goods in the inventory by the number of units available for sale.
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Fernandes, Gouveia, and Pinho (2013) highlighted that the current economic dispensation is defined by expansion in competitiveness, growth in product varieties, and increases in capital costs. The developments have put immense pressure on companies to reduce inventory as a cost-cutting strategy. In the current market conditions characterized by multi-echelon supply chains and market uncertainty, evaluation of inventory poses immense challenges. The situation is worsened by the argument advanced by Fosbre, Fosbre, and Kraft (2010) that the dependency of the US companies on the LIFO method presents significant barriers to international trade. Based on these observations, the FIFO evaluation method appears to be the most suited in the prevailing economic conditions. In addition, the International Financial Reporting Standards, (IFRS) endorses FIFO as an acceptable inventory evaluation method.
References
Fernandes, R., Gouveia, B., & Pinho, C. (2013). Integrated inventory valuation in multi-echelon production/distribution systems. International Journal of Production Research , 51(9), 2578-2592.
Fosbre, A. B., Fosbre, P. B., & Kraft, E. M. (2010). A roadblock to US adoption of IFRS is LIFO inventory valuation. Global Journal of Business Research , 4(4), 41-49.
Kimmel, P. D., Weyghandt, J. J., & Kieso, D. E. (2016). Accounting; Tools for business decision making (6th ed.). Wiley
