The Fashion Palace Inc. sells a variety of home decorating merchandise, including pictures, small furniture items, dishes, candles, and area rugs. The company uses a periodic inventory system and counts inventory once a year. Most customers use the option to purchase on account and many take more than a month to pay. The company does not have any specific credit terms for its regular customers.

The general manager of The Fashion Palace, Rebecca Sherstabetoff, believes the company needs a bank loan because the accounts payable have to be paid long before the accounts receivable are collected. The bank manager is willing to give The Fashion Palace a loan but wants monthly financial statements.

Rebecca has also noticed that, while some of the company's merchandise sells very quickly, other items do not. Sometimes she wonders just how long some of those older items have been in stock. She has observed that the company seems to run out of some merchandise items on a regular basis. And she is wondering how she is going to find someone with the time to count the inventory every month so that monthly financial statements can be prepared for the bank. She has come to you for help.

Instructions

(a) Explain to Rebecca what an operating cycle is and why the company is having problems paying its bills.

(b) Make a recommendation about what inventory system the company should use and explain why.

(c) Explain to Rebecca the reasons for conducting an inventory count and advise her on the required frequency of counts.