How retail accounting could distort profitability as tariffs take effect

While there's debate over who pays that tariff — the manufacturer, the retailer, the consumer or some combination — the hit will ly show up in retailers' bottom lines.But a specific accounting practice, called retail inventory method accounting, or RIM, can make fitability appear stronger than it is in the short term."Retail inventory method accounting (RIM) is less responsive to initial duct cost changes compared to cost accounting, and can initially overstate fitability," said Ali Furman, PwC U.S. consumer industry leader. "This would normalize once tariffs stabilize, depending on how much of the cost retailers absorb." Because RIM uses an average cost-to-retail price ratio across a broad group of items, rather than the actual cost of every item, in cost accounting, RIM does not entirely capture the immediate impact of rising costs

Zoom In IconArrows pointing outwardsThe retail method of accounting.CNBC US sourceNearly a quarter of U.S. retailers use the retail inventory method of accounting, according to PwC

Walmart, Target and Depot are among them

All three retailers report quarterly earnings this week, and their results may not fully show how tariffs have cut into their fitability so far.Take Walmart, the largest U.S. retailer, which will post fiscal second-quarter earnings Thursday.TD Cowen analyst Or Chen estimated half of Walmart's quarter will include the impact of levies, as the company brought in inventory at different cost levels before and after new tariff rates took effect

That could temporarily distort gross margin fitability, Chen said.Walmart's accounting has in part informed its strategy in recent months as it navigates President Donald Trump's unpredictable tariff policy.A week after Trump's April 2 announcement of so-called "recical tariffs" on a wide swath of trade partners, Walmart withdrew its guidance for operating income in its first fiscal quarter

However, the company maintained its annual forecast, citing in part the influence of RIM accounting.Walmart employee Losing Spicer helps transport bikes on Friday, Dec. 8, 2023, in Conroe.Jason Fochtman | Houston Chronicle | Hearst Newspapers | Getty ImagesThen when it reported its fiscal first-quarter earnings in May, Walmart said it would mitigate higher costs as much as possible, but would ly have to increase some prices at the current tariff rates

In response, Trump wrote on his Truth Social platform that Walmart should "just eat" the tariffs.Doing so could actually benefit a retailer's bottom line, at least initially, according to Furman."The more costs retailers absorb in retail accounting, the greater the risk of overstating fitability during periods of increasing costs, such as tariff increases," she said.Walmart management briefed Trump this spring the impact its accounting method may have on results in a high-tariff environment, according to a person familiar with the discussion, who asked to remain unnamed while speaking private conversations.Still, James Bowie, managing director in EY's nical accounting advisory group, warned "all of the inventory costing methodologies will be affected in some ways."An employee folds towel at a Manhattan retail store on July 15, 2025 in New York City

Spencer Platt | Getty ImagesIt typically takes a large, non-fast fashion retailer using RIM roughly two to four quarters for cost volatility to settle and fitability to get closer to its true level, according to PwC

The method could make fitability look higher initially, then lower in a subsequent quarter, before it has time to stabilize."It's kind of you've got a speed boat on the price," he said. "I can turn pretty quickly, but I've got a cruise liner that is carrying all my average of my inventory

It takes a little longer for it to turn and so even though they might ultimately be able to go the same speed, it takes a little bit of time for that one turn to take place."While RIM is more ly to lead to a temporary overstating of fitability, it can also wind up understanding fits if tariffs are negotiated lower.Bowie said if a retailer responds to lower tariff rates by cutting retail prices, under RIM accounting, "it looks my margin has eroded, but it's only because I now am waiting for the cost relationship to catch back up, so [it] might look there's margin compression even in a period of decreasing tariffs."Furman added that PwC is seeing "a disconnect" for companies that use RIM accounting."Companies might be doing all the right things: navigating sourcing challenges, managing suppliers, and even mitigating tariffs," she said. "But, those efforts often aren't reflected in the financials

That misalignment between operational execution and reporting for those using RIM is exacerbating the challenges retailers face." Why use RIM?The retail inventory method of accounting is an older method that was most useful for retailers when they had many items from a range of without an easy, or nological, way to track inventory. "Inventory accounting methods existed before this thing called Excel," said Bowie. "[A retailer] had an abacus and a dream trying to figure out what you're going to do."Over time, nology made it easy to use actual costs rather than averages, so cost accounting became more common.People shop at Macy’s department store in Manhattan in New York City, U.S., August 11, 2025

Eduardo Munoz | ReutersAs retailers grow and accounting methods become ingrained, it's difficult, though not impossible, to switch tactics

Macy's and Nordstrom recently made the change to cost accounting.PwC said it takes an average of two to three years to make the transition from one accounting method to another and can require millions of dollars and a restatement of previous years' financials to vide apples-to-apples comparisons

Still, the accounting firm said half of retailers that use RIM have considered switching.A case studyCNBC worked with PwC's Furman and Suni Shamapande, the firm's U.S. retail customer experience and operations leader, to develop a simplified example demonstrating the difference between RIM and weighted average cost accounting in how they affect gross fit margins.The example demonstrates how RIM accounting can "overstate" true fitability at a moment in time when costs increase quickly.Zoom In IconArrows pointing outwardsListed gross fit margin can change based on accounting methods in various tariff scenarios.CNBC US sourceFor the purposes of this example, PwC and CNBC used weighted average cost accounting, which takes a SKU-level weight average and blends all costs together, regardless of purchase date

A SKU is a stock-keeping unit, which retailers use to track inventory of specific items.Base case: No tariffsThe base case, which does not include tariffs, uses three different T-shirts types 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

CNBC US sourceTariff case 1: Retailer's costs increase, all else remains the sameIf the retailer's cost for each T-shirt goes up as a result of tariffs, but everything else — units bought, units sold and retail price — remains the same, gross margin falls if calculated using cost accounting and RIM

But it would still be higher under RIM than if the company used cost accounting.Here's the math for our simplified example:Zoom In IconArrows pointing outwardsThe retail accounting method if the retailer's costs increase but prices and demand stay the same.CNBC US sourceTariff case 2: Retailer raises prices to offset higher costsIf the retailer passes on the full dollar value of the tariff cost to the customer, and units bought and sold stay the same, gross margin imves under both accounting methods

Zoom In IconArrows pointing outwardsThe retail accounting method if a retailer raises prices and the units bought and sold both fall.CNBC US source— CNBC's Jodi Gralnick contributed to this report.