Parkhurst Auto Parts Ltd. sells over 4,000 types of car parts, ranging in cost from just a few dollars to hundreds of dollars each. Six employees work in the warehouse accepting inventory purchases and shipping out products sold. Each one of these employees can adjust the perpetual inventory records if they discover any damaged inventory in the warehouse. All six employees have keys to the building. Because the building has a large loading bay, most of the employees, who love to tinker with their cars, will often use the loading bay at night, after all of the other employees have gone home, to work on their cars. All six employees count inventory once each year and then they adjust the inventory records to ensure they equal amounts on hand. Sometimes count errors occur because one type of inventory may be stored in different locations in the warehouse. The owners noticed after the last annual inventory count that the company’s gross profit margin had fallen due to a sharp increase in cost of goods sold, even though costs of inventory items that the company purchases have not risen this year.

Instructions

a. What are three major types of internal control activities over inventory?

b. For each type of internal control activity, assess the quality of the company’s internal controls.

c. What is the most likely cause of the decrease in the gross profit margin?