You are recently hired as a staff accountant for a small finished goods manufacturing company. Part of
Question:
You are recently hired as a staff accountant for a small finished goods manufacturing company. Part of your duties include doing the month end inventory of finished goods. After a few months you do not look forward to this as the amount of inventory seems to be increasing. In order to satisfy your thoughts on this increase of inventory you decide to review the financial information for the last few months.
Looking over the Income Statement you see the profits have been steady, but the gross profit percentage has increased, and the cost of goods sold have decreased. This does not seem possible as the company has increased the amount of inventories.
Identify why this situation could exist, providing an explanation which can be given to the CFO.
In order to assist in controlling the costs and providing a lower inventory carrying cost, select a costing system and explain why it should be utilized.
Expert Answer:
Explaining the Inventory Increase with Decreasing COGS and Increasing Gross Profit This seemingly contradictory situation can have several explanations 1 Price Increases If the company has raised its selling prices due to inflation or increased demand while keeping production costs relatively stable it could lead to a higher gross profit percentage and decreased COGS as a percentage of revenue even with increased inventory 2 Product Mix Change If the company has shifted production towards highermargin products it could decrease overall COGS as a percentage of revenue despite an inventory increase This wouldnt impact profit much if the total production cost remains similar 3 Inventory Valuation Method Different inventory valuation methods can impact reported values If you switched from FIFO FirstIn FirstOut to LIFO LastIn FirstOut COGS could decrease in periods of inflation even with inventory growth 4 Efficiency Gains Its possible that the company has achieved production efficiencies reducing perunit costs leading to lower COGS despite higher inventory levels 5 Accounting Error Although rare accidental errors in inventory or cost calculations could skew the results Recommended Costing System for Inventory Control ActivityBased Costing ABC ABC allocates indirect costs based on activity driversproviding a more accurate picture of product costsThis helps identify areas for cost reduction and optimize inventory levels based on true profitability By understanding costs per activityyou can identify unnecessary activities affecting inventory holding costs Benefits of ABC for Inventory Control Improved cost visibility for accurate product costing and pricing decisions Identifying nonvalueadding activities leading to unnecessary inventory Supporting justintime JIT inventory management by optimizing production based on actual demand Explanation ... View the full answer
