How to Handle Markups and Markdowns in Accounting

By Maire Loughran from Intermediate Accounting For Dummies

You may get quite a thrill when you’re out shopping and you see something fantastic on the discount rack. When you see it, you probably think, “Ching-ching, I just scored!” However, have you ever thought about what markups or markdowns mean to the retailer? Well, wonder no longer — here’s how to handle markups and markdowns from an accounting point of view.

First, some important definitions:

Original retail price: The price at which a company offers items for sale.
Markup: The difference between the cost of the item and the original retail price (what the item is selling for). For example, Penway Manufacturing may pay $1.00 for an item and sell it for $2.00. (Retailers refer to a 100 percent increase between cost and sales price as keystoning.)
Additional markup: Increasing the price of an item above its original retail price. Due to demand, Penway increases the retail price from $2.00 to $2.25.
Markup cancellation: Moving the price back down from the additional markup but not decreasing the price below the original selling price. The Penway item price can’t reduce to less than $2.00; if the price goes below $2.00, it’s a markdown.
Markdown: Reducing the price of an item below its original selling price. If Penway reduces the price of the item to $1.25, the markdown is 75 cents.
Markdown cancellation: Increasing the item price after a markdown, not increasing the price above the original selling price. A good example of this is a sale for a specific period of time. The price of the item goes back to $2.00. If it goes above $2.00, it’s an additional markup.
Purchase returns: A contra-purchases account that reflects goods returned by customers after purchase.

Now that you have a handle on the lexicon of retail markups and markdowns, lay all those ugly snakes in a straight line and calculate ending inventory for Penway Manufacturing using the retail and cost account balances provided in the following figure.

Ready? After considering the information, what figure do you get for inventory at cost under conventional retail? Go to the following figure and check your answer!