Chapter 48 Auditing Retail Companies.docx

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Chapter 48 Auditing Retail Companies.docx

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Chapter 48 Auditing Retail Companies.docx

Chapter48AuditingRetailCompanies

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AuditingRetailCompanies

48.1ACCOUNTINGPRINCIPLESANDPRACTICES

（a）Inventory,

（i）CostMethod,

（ii）GrossProfitMethod,

（iii）RetailMethod,

（iv）Last-in,First-outMethods,

（v）StockLedger,

（vi）Transfers,

（vii）PhysicalInventories,

（viii）Shrinkage,

（b）Leases,

（c）AssetImpairment,

（d）52-53WeekYear,

（e）PreopeningCosts,

（f）StoreClosingReserves,

（g）SlottingFees,

（h）DiscountsandRebates,

（i）Advertising,

（j）Commissions,

（k）SeparatelyPricedServiceContracts,

（l）ConsignmentInventory,

（m）Layaways,

（n）AreaFranchiseFees,

（o）CreditCardSales,

48.2RISKFACTORSANDAUDITREACTION

（a）FinancialRatiosandPerformanceIndicators,

48.3TYPICALTRANSACTIONS,CONTROLS,ANDAUDITTESTS

（a）InformationTechnology,

（b）RevenueCycle,

（i）Cash/Credit/LayawaySales,

（ii）ControlsoverSales,

（iii）SubstantiveTests,

（c）PurchasingCycle,

（d）InventoryCycle,

（i）PriceAdjustments,

（ii）RetailMethod,

（iii）SubstantiveTests,

（e）PayrollCycle,

（f）LeasingCycle,

（g）ArrangementswithVendors,

Retailingisthesellingofgoodstotheultimateconsumer,usuallyinsmallquantities.Retailersvarygreatlyinsize,format,geographicalbase,productmix,sophistication,andtypeofcustomer.Althoughtherearemanywaystocategorizeretailers（forexample,bytypeofcustomerorproductline）,oneofthemostusefulwaysforpurposesofunderstandingtheirbusinessprocessesistoclassifythemaccordingtowhethertheyarestore-basedordirectresponseretailers.Store-basedretailersincludedepartmentstores,supermarkets,warehousestores,homecenters,outlets,anddrugstores-anyretailerthatsellsmerchandisefromaphysicallocationwhereconsumerscometopurchaseproducts.Directresponseretailersincludecatalogmerchants,cabletelevisionhomeshoppingservices,andcomputer-basedshoppingservices.Theseretailersdonothaveface-to-facecontactwiththeircustomers.Manyretailersoperateinacombinationoftheseformats.

48.1ACCOUNTINGPRINCIPLESANDPRACTICES

（a）Inventory

Oneoftheprimaryareasoffocusforaretailentityismerchandiseinventory.Severalinventoryaccountingmethodsareusedintheretailindustry.

（i）CostMethod.Thecostmethodtrackssalesandcostsbyspecificstockkeepingunits（SKUs）.Thismethodcanbeburdensomewithoutacomputersystembecauseindividualcostrecordsmustbekeptforeachitem.Historically,thismethodwaspracticalonlyforretailoperationsthatcarriedalimitednumberofSKUs,suchasjewelrystores,furnituredealers,andconsumerelectronicsandapplianceretailers.However,ascomputersystemsbecamemoresophisticated,thecostmethodhasbecomeincreasinglypracticalevenforretailerswithmanySKUs.Accountingcontrolunderthecostmethodisbasedonacumulativerecordofcostfigures.

（ii）GrossProfitMethod.Thegrossprofitmethod,usedbysomeretailers（oftendrugandconveniencestorechains）,isanestimatingtechniqueinwhichcostofgoodssoldiscalculatedusinganestimatedcostpercentagethatiscomputedas1-theestimatedgrossprofitpercentage.Therearetwowaysofestimatingthecostpercentage.Oneistocountarepresentativesampleofitemsthatarevaluedatbothcostandretail;theinventoryatcostisdividedbytheinventoryatretailtocomputethecostpercentage.Theotherwayofestimatingthecostpercentageistousegrossprofitregisterstorecordallsalesatbothcostandretail.（Theuseofgrossprofitregistersrequiresthatallstoreinventorybecostcoded.）Toarriveattheamountofinventoryonhand,theretailerfirstdeterminesthecostofgoodsavailableforsalebyaddingthecostofbeginninginventorytothecostofcurrent-periodpurchases.Then,salesfortheperiodaremultipliedbytheestimatedcostpercentagetoarriveatestimatedcostofgoodssold.Thedifferencebetweenthetwocalculationsistheestimatedinventoryonhand.Whenretailersusethegrossprofitmethod,itisimportantthatphysicalinventoriesbetakenatornearyear-endtoadjustthebookinventorytoactual.

Thegrossprofitmethodisparticularlyusefulinestimatingcostofgoodssoldandinventoryforinterimreportingpurposes.Thereare,however,anumberofdisadvantagestoitsuse:

1.Theestimatedgrossprofitmaybedistortedbecausethemixofproductsactuallysoldduringtheperiodmaybedifferentfromthemixusedtocalculatetheestimatedgrossprofitpercentage.

2.Theestimatedgrossprofitpercentagecanbechangedtomanipulategrossprofitsanddistortinterimresults.

3.Theamountofinventoryshrinkage（discussedlaterinthechapter）cannotbedeterminedbecausepartofitmaybecausedbyaninaccurategrossprofitpercentage.

Grossprofitcannotbedeterminedaccuratelyuntilacompletephysicalinventoryatcostistakenattheendoftheperiodandappropriateadjustmentstobookendinginventoriesaremade.

（iii）RetailMethod.Theretailmethodisthemethodmostcommonlyusedbystore-basedretailers.Itwasdevelopedinresponsetothedifficultyofcostingindividualitems.Intheretailmethod,purchasesandsalesarerecordedatretailprices,pricechangesarerecognizedatretailprices,anestimatedvalueforendinginventoryiscalculatedatretail,andthenendinginventoryisconvertedfromretailpricetocost.Theretailmethodrequiresthatallchangesinsellingpricesbeaccountedfor.

Theretailmethodisanaveragingmethodusedwithreasonablyhomogeneousinventorygroupings,inwhichtheretailerestablishestherelationship,generallybydepartment,betweengoodsavailableforsaleatcostandatretail.Usingthisrelationship,theretailerderivesacostmultiplier,whichisusedtoconverttheperiod-endinventoryfromretailtocost.Becausethisisanaveragingmethod,consistencyingrossprofitpercentageswithinadepartmentisimportanttoavoidskewingthecostmultiplierasaresultofchangesinthedepartmentalitemmix.Propertreatmentofmarkupsandmarkdownswillresultininventorystatedatthelowerofcostormarket,whichisrequiredregardlessoftheaccountingmethodused.

Theretailmethodhasseveraladvantages,includingprovidingperiodicinventoryandcostofgoodssoldcalculationswithoutaphysicalinventory.Whenphysicalinventoriesaretaken,theycanbepricedatretailonly.Becausetheretailmethodisaperpetualmethod,itcanbecomparedwithphysicalcountsandtheamountsofshortagescanbedetermined.

Figure48.1illustratesthecalculationofendinginventoryatthelowerofcostormarketusingtheretailmethod.

Figure48.1RetailMethodCalculation

Calculation

Description

Totalmerchandisehandled

Componentsoftotalmerchandisehandled:

Cost

Retail

Openinginventory

$60,000

$100,000

∙Openinginventoryatcostandretail

Purchases

30,000

50,000

∙Purchasesatcostandretail（costincludesinvoicecost,freight-in,andadditionalcapitalizedcosts）

Markups,netofmarkupcancellationsof$3,000cancellations

10,000

∙Markupsnetofanymarkup

Totalmerchandisehandled

$90,000

$160,000

Cumulativemarkonpercentage

43.75%

Cumulativemarkondividedbyretailtotalofmerchandisehandled:

（$160,000-$90,000）÷$160,000

Costmultiplier

56.25%

Complementofthecumulativemarkonpercentage:

100%-43.75%=56.25%

Canbecalculatedbydividingtotalcostbytotalretail:

（$90,000÷$160,000）

Inventoryreductions

Componentsofinventoryreductions:

Sales,net

$28,000

∙Sales

Salesdiscounts

1,120

∙Salesdiscounts

Markdowns,netofmarkdowncancellationsof$2,000

3,920

∙Markdownstakenandmarkdowncancellationstorestoretemporarypricereductions

Shrinkage

560

∙Estimatedvalueofbookinventoryinexcessofactualphysicalinventory

Totalofinventoryreductions

$33,600

Endinginventoryatretail

$126,400

Differencebetweentotalmerchandisehandled（atretail）andtotalinventoryreductions（atretail）:

$160,000-$33,600=$126,400

Endinginventoryatlowerofcostormarket

$71,000

Conversionofretailpriceofinventorytolowerofcostormarket.Productofmultiplyingendingretailinventorybycostmultiplier:

56.25%´$126,400=$71,100

（iv）Last-in,First-outMethods.Last-in,first-out（LIFO）methodsmatchthemostrecentcostsofpurchasesagainstcurrentrevenues.LIFOmethods,includingretailLIFO,typicallyusedbyretailersaredollarvalueLIFOmethods.WhenretailLIFOisusedinconnectionwiththeretailmethodofvaluinginventories,inventoryincrementsordecrementsaremeasuredinretaildollars.（OtherdollarvalueLIFOmethodsmeasureincrementsordecrementsatcost.）LIFOtypicallyischosenbyretailersbecauseoftaxbenefitsobtainedduringperiodsofpriceandinventorylevelincreases.IfLIFOisadoptedfortaxpurposes,italsomustbeusedforfinancialreportingpurposes.TherearedisadvantagestotheLIFOmethod,includingasignificantlyincreasedrecord-keepingburdenandreducedearningsandinventoryvaluesinperiodsofrisingprices.Alternatively,deflationorlowerinventorylevelscanincreasetaxableincome.

（v）StockLedger.Thestockledgeristheprimaryrecordusedtorecordandvalueinventories.Theledgermaybemaintain

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