The Retail Method of Accounting Is Still A Troublesome Anachronism
Last week I was speaking with a client about managing merchandise plans.In the course of the conversation I asked “How many of your clients are still using the Retail Method of accounting?” Much to my surprise, and to their own apparent dismay, the answer was “most of them.”
In fact, they wanted to know if I’d ever written anything about this issue, and I replied that I had.It wasn’t available on RSR’s website, so I went looking through my personal archives.I actually wrote about this in 2007.Because I strongly believe this practice should be retired to live out eternity with 80 column cards and 402 machines (if you know what that is…you’ve been around a while), I decided to talk about the issue again.
Back in 2007, the following news item was published by the Associated Press:“The Securities and Exchange Commission (SEC) said Wednesday that Saks Inc. has agreed to settle a lawsuit that Saks Fifth Avenue understated sales to some vendors and didn't record markdowns properly, inflating its earnings.” On the surface, this seems to be a straightforward case of individuals misleading their vendors and Wall Street.But delving a little deeper, it’s quite possible to understand that this malfeasance was made possible by the Retail Method of Accounting. And it begs the question – in the 21st century, isn’t it time retailers shifted to the cost method accounting?And nine years later, I find myself asking the very same question: isn’t it long past time?
You might be asking, “Why does a technology research analyst care what form of accounting we use?” The answer is, because the Retail Method of Accounting came into existence because of a LACK of technology, and is obsolete because of the PRESENCE of technology.In the age of Sarbanes-Oxley, this analyst is amazed that this method of accounting is still considered “GAAP”.
A Brief History of Time (and Retail Accounting)
On the surface the Retail Method of Accounting sounds simple enough – A definition on the web called it, “A way by which the closing inventory value is determined by calculating the average relationship between the cost and retail values of merchandise available for sale during a period”. Of course it’s not that simple. Seemingly arcane terms and concepts like “cost compliment” and “markup cancelation” become second nature to retailers using this accounting method.
The Retail Method of Accounting was the only choice available in a pre-POS low-tech world.Without electronic Point of Sale and frequent polling, it was difficult to calculate what you actually owned of any item at any point in time.And what you owned at retail wasn’t really useful financially.The value of inventory had to be the lesser of cost or retail – so you had to impute your remaining inventory cost value.Physical inventories were done by capturing department and retail of each item counted.So that didn’t help much.
Permanent markdowns presented a bit of a problem as well. Because the value of inventory is imputed, markdowns affect the retailer’s balance sheet.So the timing of recording a markdown can affect monthly or quarterly results.
Times have Changed, Too Many Retailers Haven’t
This brings us to the Saks story.Many things have changed.We have polling and back office systems that capture the retail selling price of every item.Our physical inventory systems now routinely capture SKU.Our master files have a record of the current retail price of every sku.We can track cost of remaining inventory in any number of ways (LIFO, FIFO, rolling average cost). But retailers who have been in business for a long time, like Saks, still use the retail method of accounting.
Long-time retailers know that the retail method of accounting lends itself to holding back markdowns until a quarter or month has closed, taking mark-up cancellations instead of markdowns to make initial markup (IMU) look better and other transactions that are beyond my comprehension.
Cost accounting is much simpler.It is what it is.Newer retailers tend to use that method of accounting more frequently.
It’s Time to Change
The Saks story just pointed out what I thought was obvious.In an era when we talk about the supply chain as a “glass pipeline”, we take payments from customers’ fingerprints and mobile phones, pass sales information along to our vendors for replenishment purposes, and talk about creating one-on-one promotions, shouldn’t we also account for our merchandise with the precision our technology allows?It’s hard converting, that’s obvious, but it’s also hard to get sued by vendors, who actually DO keep score of what they sold us and how much we paid.
One also has to wonder if one of the reasons retailers have such poor visibility into their existing sku inventory is this same accounting method. When “the book” inventory is based on imputed cost, rather than actual value, unit data can be harder to come by.
It’s hard for me to believe that I’ve been able to recycle most of an article that I wrote nine years ago, yet here we are. In an omni-channel world, where we talk about Beacons and IoT to track customers and products, we’re pretending that we count our inventory by hand, using department and price as our sole source of data.
Seriously. It’s time to change.