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Accounting · Inventories

Techniques of Cost Measurement: Standard Cost and Retail Method (AS 2)

Updated 1 October 2026 · Fact-checked

Standard cost and retail method are shortcuts AS 2 allows to approximate the cost of inventories when they give results close to actual cost. Standard cost uses normal levels of material, labour and efficiency. Retail method converts closing stock at selling price to cost by deducting the average gross margin percentage.

Understand Techniques of Cost Measurement: Standard Cost and Retail Method

AS 2 says inventory is valued at the lower of cost and net realisable value. Finding actual cost for every item can be slow. So the Standard allows two practical techniques for convenience, if the result approximates cost.

Standard cost method: You fix a standard cost for each item in advance. It is based on normal levels of materials and supplies, labour, efficiency and capacity utilisation. You then value inventory at this standard. Standard costs must be reviewed regularly and revised if current conditions change. If they are not reviewed, the figure drifts away from actual cost and the method is no longer acceptable.

Retail method: Used mostly in retail trade, where there are many fast-moving items with similar margins and it is not practical to track the cost of each item. You know the selling price of closing stock, from the price tags or the retail records. You convert it to cost by deducting an appropriate percentage of gross margin.

The percentage must be a sensible average for the stock. If some goods have been marked down below their original selling price, the percentage should take that into account. Where a store has departments with different margins, an average percentage is often used for each department separately.

Think of both methods as estimates of cost, not new valuation bases. After you get the approximate cost, the usual rule still applies: compare it with NRV and take the lower.

Key rules to remember

Standard cost method
Inventory value = Quantity on hand × Standard cost per unit
Standards must be based on normal levels and reviewed regularly. Use it only if it approximates actual cost.
Retail method: gross margin percentage
Gross margin % = Gross margin ÷ Selling price × 100
The percentage is on selling price, not on cost. This is the most common trap.
Retail method: cost of closing stock
Cost of closing stock = Closing stock at selling price − (Closing stock at selling price × Gross margin %)
Equivalent: Closing stock at selling price × (1 − Gross margin %).
Closing stock at selling price (when not given)
Goods available at selling price − Sales
Goods available = Opening stock at selling price + Purchases at selling price. Adjust for markdowns and returns where given.
Final valuation rule
Inventory = Lower of (cost by technique) and NRV
AS 2 still requires the lower of cost and NRV test.

How to solve Techniques of Cost Measurement: Standard Cost and Retail Method questions

Use this order for any question on standard cost or retail method. Show each line so you earn step marks.

  1. 1Identify the technique asked: standard cost or retail method.
  2. 2For standard cost, list the quantity on hand and the standard cost per unit. Check whether standards are based on normal levels and reviewed. Note any variance information.
  3. 3For retail method, find closing stock at selling price. If it is not given, compute: opening stock at selling price + purchases at selling price − sales.
  4. 4Find the gross margin percentage on selling price. Use the given percentage, or compute gross margin ÷ selling price × 100.
  5. 5Convert to cost: closing stock at selling price × (100 − margin %) ÷ 100. For standard cost, multiply quantity by standard rate.
  6. 6Compare the result with NRV if the question gives it. Take the lower.
  7. 7Write the final answer with a one-line conclusion, for example 'Closing inventory to be shown at ₹...'.

Quickest way: Selling-price-to-cost shortcut

When to use it: Use when a retail question gives selling-price figures and a margin percentage, and you are short of time.

  1. Read whether the margin is on sales or on cost. Convert to a percentage of selling price if needed: margin on cost of 25% means 25 ÷ 125 = 20% of selling price.
  2. Compute the cost ratio: 100% − margin %. For a 20% margin it is 80%.
  3. Multiply closing stock at selling price by the cost ratio.
  4. Do a quick check: cost must always be less than selling price.
  5. Finish with the lower of cost and NRV line if NRV is given.

Common mistakes in Techniques of Cost Measurement: Standard Cost and Retail Method

  • Applying the gross margin percentage on cost instead of selling price.

    Students are used to mark-up on cost from other chapters.

    Fix: Under the retail method, margin is a percentage of selling price. If the question gives mark-up on cost, convert: mark-up ÷ (100 + mark-up).

  • Valuing closing stock at selling price and forgetting to convert it to cost.

    The figure looks like the final answer after subtracting sales.

    Fix: Always write a separate line for 'less: margin' and show stock at cost as the final line.

  • Using standard cost without checking if it approximates actual cost.

    Students treat standard cost as automatically acceptable.

    Fix: State that standards are based on normal levels and are reviewed regularly. If the question shows large unexplained differences, standard cost is not suitable.

  • Ignoring the lower of cost and NRV rule after using the technique.

    The technique feels like a complete valuation.

    Fix: These are only ways to measure cost. Always compare with NRV if given.

  • Forgetting to adjust selling-price stock for markdowns or returns given in the question.

    Students rush to apply a single formula.

    Fix: Read all data lines. Adjust goods available and sales for returns and markdowns before finding closing stock at selling price.

Worked examples

Example 1

A retailer's stock at selling price on 31 March is ₹2,40,000. The average gross margin on selling price is 25%. Net realisable value of the stock is ₹2,00,000. Find the value of closing inventory under AS 2.

Show the solution
  1. Closing stock at selling price = ₹2,40,000.
  2. Gross margin = 25% of ₹2,40,000 = ₹60,000.
  3. Cost of closing stock = ₹2,40,000 − ₹60,000 = ₹1,80,000.
  4. Compare with NRV of ₹2,00,000. Cost ₹1,80,000 is lower.

Answer: Closing inventory = ₹1,80,000 (lower of cost ₹1,80,000 and NRV ₹2,00,000).

Example 2

A store has opening stock at selling price ₹1,50,000 and purchases at selling price ₹6,50,000. Sales for the year are ₹5,50,000. Its usual gross margin is 20% of selling price. Estimate the cost of closing stock. Also, a unit-wise standard cost check: 800 units are on hand with a standard cost of ₹90 per unit. Find their value under the standard cost method.

Show the solution
  1. Goods available at selling price = ₹1,50,000 + ₹6,50,000 = ₹8,00,000.
  2. Closing stock at selling price = ₹8,00,000 − ₹5,50,000 = ₹2,50,000.
  3. Margin = 20% of ₹2,50,000 = ₹50,000.
  4. Cost of closing stock = ₹2,50,000 − ₹50,000 = ₹2,00,000.
  5. Standard cost method: 800 units × ₹90 = ₹72,000.

Answer: Cost of closing stock under the retail method = ₹2,00,000. Value of the 800 units under standard cost = ₹72,000.

Exam tips

  • Write the technique name and its condition first: it must approximate actual cost. This usually earns a mark in theory questions.
  • In retail problems, show the selling-price table (opening + purchases − sales) before applying the margin.
  • Check whether the question gives margin on sales or on cost before you start calculating.
  • Close every answer with the lower of cost and NRV statement when NRV is given.
  • For short notes, mention that standard costs are based on normal levels and reviewed regularly, and that the retail method suits many items with similar margins.

Practice questions from Inventories

Techniques of Cost Measurement: Standard Cost and Retail Method: frequently asked questions

What is the retail method of inventory valuation under AS 2?

It is a technique to approximate cost by reducing the selling price of closing stock by an appropriate gross margin percentage. It is used in retail trade with many fast-moving items having similar margins. The result must approximate actual cost.

When can standard cost be used to value inventory?

AS 2 allows it when the result approximates cost. Standards should be set on normal levels of materials, labour, efficiency and capacity. They must be reviewed regularly and revised when conditions change.

Is the margin in the retail method on selling price or cost?

It is on selling price. If a question gives mark-up on cost, convert it first. For example, 25% on cost equals 20% on selling price.

Do I still apply lower of cost and NRV after these methods?

Yes. These methods only estimate cost. You compare that cost with net realisable value and value inventory at the lower figure.