How the accounting could change profitability in the middle of the prices

While more prices take effect on goods imported into the United States, a specific accounting method could have major implications on how American retailers calculate the impact.

A price adds to the cost of an imported article when received and paid when it crosses a border. Although there is a debate on which pays for this price – the manufacturer, the retailer, the consumer or a combination – the blow will probably appear in the results of the retailers.

But a specific accounting practice, called accounting of the retail stock method, or RIM, can make profitability higher than it is in the short term.

“The accounting of the retail stock method (RIM) is less sensitive to the initial changes in products in relation to costs accounting and can initially overestimate profitability,” said Ali Furman, leader in the American consumption market industry PWC. “This would normalize once the prices stabilize, depending on the amount of costs that the retailers absorb.”

Since RIM uses a price ratio cost-at average detail in a large group of articles, rather than the real cost of each item, as in cost accounting, RIM does not fully capture the immediate impact of the cost increase.

Almost a quarter of American retailers use the retail stock accounting method, according to PWC. Walmart,, Target And Home Depot are among them. The three retailers are publishing quarterly results this week, and their results may not be entirely how prices have reduced their profitability so far.

Take Walmart, the largest American retailer, who will publish the financial results of the second quarter on Thursday.

TD Cowen TD analyst Oliver Chen, estimated that around half of the quarter of Walmart will include the impact of levies, because the company has made an inventory at different cost levels before and after new prices take effect. This could temporarily distort the profitability of the gross margin, said Chen.

Walmart’s accounting has partially informed its strategy in recent months when it sails the unpredictable price policy of President Donald Trump.

A week after Trump’s announcement on April 2 of the so-called “reciprocal prices” on a large band of business partners, Walmart withdrew its advice for operating income during its first budgetary quarter. However, the company maintained its annual forecasts, partly citing the influence of RIM’s accounts.

Then, when he published his budgetary budgetary profits in May, Walmart said that it would reduce higher costs as much as possible, but should probably increase certain prices at current tariff rates.

In response, Trump wrote on his Truth social platform that Walmart should “simply eat” the prices.

This could actually benefit from the results of a retailer, at least initially, according to Furman.

“The more retailers absorb costs in retail accounts, the higher the risk of profitability of overvaluation is high during periods of cost increase, such as prices increase,” she said.

The management of Walmart informed Trump this spring of the impact that his accounting method can have on the results in a high price environment, according to a person familiar with the discussion, which asked to stay nameless by speaking of private conversations.

However, James Bowie, director general of the EY technical accounting consulting group, warned that “all inventory costs methodologies will be affected in some respects”.

You usually need a large non -fast fashion retailer using RIM about two to four quarters for cost volatility to set and profitability to get closer to its real level, according to PwC. The method could make profitability higher initially, then more drops in a later quarter, before having time to stabilize.

“It’s a bit like you had a speed boat on the price,” he said. “I can shoot fairly quickly, but I have a cruise lining that transports my entire average of my inventory. It takes a little more time for it to turn and therefore even if they could finally be able to go at the same speed, it takes a little time for this turn to take place.”

Although RIM is more likely to lead to a temporary overvaluation of profitability, it can also end up understanding the benefits if the prices are negotiated below.

Bowie said that if a retailer reacts to lower rate rates by reducing retail prices, under Rim Accounting, “it seems that my margin has been eroded, but it is only because I am now waiting for the cost relationship, so [it] It might seem that there is a margin compression even in a period of decreasing prices. “”

Furman added that PwC notes “a clear disconnection” for companies that use RIM accounts.

“Companies could do all the right things: navigate the challenges of supply, manage suppliers and even mitigate prices,” she said. “But, these efforts are often not reflected in finances.

The retail stocks accounting method is an older method that was most useful for retailers when they had many items from a range of categories without easy or technological means of following the inventory.

“The stock accounting methods existed before this thing called Excel,” said Bowie. “”[A retailer] had an abacus and a dream trying to understand what you are going to do. “”

Over time, technology has facilitated the use of real costs rather than averages, so that the cost accounting has become more common.

As retailers develop and the accounting methods are anchored, it is difficult, but not impossible, to change tactics. Macy And Nordstrom recently brought change to cost accounting.

PWC said it took an average of two to three years to transition from one accounting method to another and may require millions of dollars and financial reservoirs for previous years to provide apple comparisons. However, the accounting office said that around half of the retailers who use RIM have planned to change.

CNBC worked with Furman and Suni Shamapande of PWC, the leader of the customer experience and the operations of the company’s American customers, to develop a simplified example demonstrating the difference between the edge and the accounting of weighted average costs in the way in which they affect gross beneficiary margins.

The example shows how RIM’s accounting can “overestimate” real profitability at a time when costs increase quickly.

For this example, PwC and CNBC used the accounting of weighted average costs, which takes an average weight at the SKU level and mixes all costs, regardless of the date of purchase. A SKU is a holding unit in stock, which retailers use to follow the inventory of specific items.

Basic case: no prices

The basic case, which does not include prices, uses three different types of t-shirts from three different countries. Each type of t-shirt, or individual SKU, has a different cost and is sold to consumers at a different retail price. The retailer bought each type of t-shirt in different quantities, as well as consumers.

Here’s how mathematics differ to start.

The gross profit margin of the calculated elements using the accounting of weighted average costs is 46%. Using RIM, it’s 53%.

Case of price 1: the increase in the costs of the retailer, everything else remains the same

If the cost of the retailer for each T -shirt increases as a result of prices, but everything else – the units purchased, the units sold and the retail price – remains the same, the gross margin falls if it is calculated using the cost accounting and the rim. But it would always be higher under Rim than if the company used costs accounting.

Here is the calculation of our simplified example:

Case Price 2: The retailer increases prices to compensate for higher costs

If the retailer transmits the total value of the dollar from the price cost for the customer and the units purchased and sold remain the same, the gross margin improves under the two accounting methods.

In our example, it goes 36% in costs accounting and 47% with RIM.

The two percentages of gross margin are lower than those of the basic case, which assumes no price, but the percentage of variation is lower under RIM than under the cost accounting.

Price case 3: the retailer increases the prices and the units purchased and sold at the same time

Here is where it becomes interesting and probably more realistic, to reflect the choices of supply and demand, a retailer and a consumer would probably increase.

If the retailer transmits the total value of the tariffs for the customer and also sells fewer items to consumers at higher retail price, RIM makes the margins temporarily more pink.

The gross margin in our example falls to 27% under cost accounting, but is stable under RIM at 47% even if the units sold have changed.

Here is where you see how the cost of the goods of goods sold at the sale price did not have time to adapt.

– CNBC JDI GRALNICK has contributed to this report.