When the conventional retail inventory method is used, markdowns are commonly ignored in the computation of the cost to retail ratio because
A) there may be no markdowns in a given year.
B) this tends to give a better approximation of the lower of cost or net realizable value.
C) markups are also ignored.
D) this tends to result in the showing of a normal profit margin in a period when no markdown goods have been sold.

Question

Quizplus · Accepted Answer

The conventional retail inventory method assumes that the cost of goods sold and the ending inventory are valued at the lower of cost or net realizable value. By ignoring markdowns in the computation of the cost to retail ratio, the method provides a better approximation of the net realizable value of the ending inventory, which may include goods that are expected to be sold at their original selling price. This is consistent with the principle of conservatism in accounting, which requires that losses be recognized as soon as they are probable and reasonably estimable, but prohibits the recognition of gains until they are realized. Markups are also ignored in the computation of the cost to retail ratio, but this does not affect the valuation of the inventory. The method assumes that the markup will be applied consistently to all goods sold during the accounting period, regardless of whether they were purchased or produced at different costs. Similarly, the method assumes that any abnormal profit margin earned on sales of goods at their original selling price will offset any abnormal loss incurred on sales of goods at a markdown. Therefore, the method tends to produce a more conservative estimate of the cost of goods sold and the ending inventory, compared to other inventory methods that use predetermined markup percentages or the first-in, first-out (FIFO) or last-in, first-out (LIFO) cost flow assumptions.

When the Conventional Retail Inventory Method Is Used, Markdowns Are