How to Handle Markups and Markdowns in Accounting

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.

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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!

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