Inventories – LIFO, FIFO and RIM (Retail Inventory Method)

You can use LIFO and FIFO combined for different departments in your store. LIFO has tax benefits and it is permitted by GAAP in some cases (not permitted at all by IFRS) so they use it wherever they can.

Think of it as two different segments – perishables and non-perishables, each with a different set of financials, then combined together to form what you see in the 10-K.

We need to do some reading, here are few links, many more exist on the web:

read this one:  http://www.accountingtools.com/retail-inventory-method

and this one : http://www.accounting4bgu.co.cc/library/finance/standards/ias2.pdf section 21, 22.

and last one: http://lawrenceakramer.financial.officelive.com/LIFOInventory.aspx

Since in retail such as in SVU there is a short relative time of turnover for the inventory, for instance in SVU it is 27-28 days and for Rami Levy it is only 15 days (no warehouses), there is no logic in holding physical inventory. The inventory is turned so many times in a year that we need a more feasible method than tracking each item.

Remember that there are dead inventories (expired products, damaged, etc), shoplifted artifacts, mistakes at the cash register, etc. Bookkeeping here can be tiresome.

Moreover, the price fluctuations of inventory in such short periods is close to nothing.

These two facts show that we can use an estimate rather than keep exact inventory – and here comes RIM and replacement costs, which are only estimates.

The explanation SVU gives to its system is laconic, here is a more elaborated one from a company called Ruddic Corp (RDK):

Inventory Valuation

The inventories of the Company’s operating subsidiaries are valued at the lower of cost or market with the cost of substantially all domestic U.S. inventories being determined using the last-in, first-out (LIFO) method. Foreign inventories and limited categories of domestic inventories are valued on the weighted average and on the first-in, first-out (FIFO) cost methods. LIFO assumes that the last costs in are the ones that should be used to measure the cost of goods sold, leaving the earlier costs residing in the ending inventory valuation. The Company uses the “link chain” method of computing dollar value LIFO whereby the base year values of beginning and ending inventories are determined using a cumulative price index. The Company generates an estimated internal index to “link” current costs to the original costs of the base years in which the Company adopted LIFO. The Company’s determination of the LIFO index is driven by the change in current year costs, as well as the change in inventory quantities on hand. Under the LIFO valuation method at Harris Teeter, all retail store inventories are initially stated at estimated cost as calculated by the Retail Inventory Method (RIM). Under RIM, the valuation of inventories at cost and the resulting gross margins are calculated by applying a calculated cost-to-retail ratio to the retail value of inventories. RIM is an averaging method that has been widely used in the retail industry due to its practicality. Inherent in the RIM calculation are certain significant management judgments and estimates, including markups, markdowns, lost inventory (shrinkage) percentages and the purity and similarity of inventory sub-categories as to their relative inventory turns, gross margins and on hand quantities. These judgments and estimates significantly impact the ending inventory valuation at cost, as well as gross margin. Management believes that the Company’s RIM provides an inventory valuation which reasonably approximates cost and results in carrying the inventory at the lower of cost or market. Management does not believe that the likelihood is significant that materially higher LIFO reserves are required given its current expectations of on-hand inventory quantities and costs.The proper valuation of inventory also requires management to estimate the net realizable value of the Company’s obsolete and slow-moving inventory at the end of each period. Management bases its net realizable values upon many factors including historical recovery rates, the aging of inventories on hand, the inventory movement of specific products and the current economic conditions. When management has determined inventory to be obsolete or slow moving, the inventory is reduced to its net realizable value by recording an obsolescence reserve. Given the Company’s experiences in selling obsolete and slow-moving inventory, management believes that the amounts of the obsolescence reserves to the carrying values of its inventories are materially adequate.With regard to the proper valuations of inventories, management reviews its judgments, assumptions and other relevant, significant factors on a routine basis and makes adjustments where the facts and circumstances dictate.

As we saw in the links above, RIM is an incremental method of ESTIMATING inventory by taking a start inventory and adding an increment. The increment is calculated (estimated) by taking all purchases minus all sales as described in link #1.

Then, "layers" are kept in the inventory while COGS will be taken from the last layer in case we need to use inventory (LIFO).