Chapter 5, Problem 2BTN

1.

To determine

Compute inventory turnover for each company for the most recent years shown.

Explanation of Solution

Inventory turnover:

This is the ratio which analyzes the number of times inventory is sold during the period. This ratio gauges the efficacy of inventory management. Larger the ratio, more efficient the inventory management.

Calculate inventory ratio for Company A’s current year as follows:

$\begin{array}{c}\text{Inventory turnover = }\frac{\text{Cost of}\text{Goods sold }}{\text{Average Inventory}}\\ =\frac{\$140,089}{\left(\$2,349+\$2,111\right)÷2}\\ =62.8\text{Times}\end{array}$

Calculate inventory ratio for Company A’s one year prior as follows:

$\begin{array}{c}\text{Inventory turnover = }\frac{\text{Cost of}\text{Goods sold }}{\text{Average Inventory}}\\ =\frac{\$112,258}{\left(\$2,111+\$1,764\right)÷2}\\ =57.9\text{Times}\end{array}$

Calculate inventory turnover ratio for Company M’s current year as follows:

$\begin{array}{c}\text{Inventory turnover = }\frac{\text{Cost of}\text{Goods sold }}{\text{Average Inventory}}\\ =\frac{\$33,038}{\left(\$2,902+\$2,660\right)÷2}\\ =11.9\text{Times}\end{array}$

Calculate inventory turnover ratio for Company M’s one year prior as follows:

$\begin{array}{c}\text{Inventory turnover = }\frac{\text{Cost of}\text{Goods sold }}{\text{Average Inventory}}\\ =\frac{\$27,078}{\left(\$2,660+\$1,938\right)÷2}\\ =11.8\text{Times}\end{array}$

2.

To determine

Compute days’ sales inventory for each company for three years shown.

Explanation of Solution

Days’ sales Inventory:

Days’ sales in inventory are used to determine number of days a particular company takes to make sales of the inventory available with them.

Calculate days’ sales inventory for the Company A’s current year as follows:

$\begin{array}{c}\text{Days' sales inventory = }\frac{\text{Ending inventory}}{\text{Cost of goods sold}}\times 365\\ =\frac{\$2,349}{\$140,089}\times 365\\ =6.12\text{Days}\end{array}$

Calculate days’ sales inventory for the company A’s one year prior as follows:

$\begin{array}{c}\text{Days' sales inventory = }\frac{\text{Ending inventory}}{\text{Cost of goods sold}}\times 365\\ =\frac{\$2,111}{\$112,258}\times 365\\ =6.86\text{Days}\end{array}$

Calculate days’ sales inventory for the Company A’s two year prior as follows:

$\begin{array}{c}\text{Days' sales inventory = }\frac{\text{Ending inventory}}{\text{Cost of goods sold}}\times 365\\ =\frac{\$1,764}{\$106,606}\times 365\\ =6.04\text{Days}\end{array}$

Calculate days’ sales inventory for the Company M’s current year as follows:

$\begin{array}{c}\text{Days' sales inventory = }\frac{\text{Ending inventory}}{\text{Cost of goods sold}}\times 365\\ =\frac{\$2,902}{\$33,038}\times 365\\ =32.06\text{Days}\end{array}$

Calculate days’ sales inventory for the Company M’s one year prior as follows:

$\begin{array}{c}\text{Days' sales inventory = }\frac{\text{Ending inventory}}{\text{Cost of goods sold}}\times 365\\ =\frac{\$2,660}{\$27,078}\times 365\\ =35.86\text{Days}\end{array}$

Calculate days’ sales inventory for the Company M’s two year prior as follows:

$\begin{array}{c}\text{Days' sales inventory = }\frac{\text{Ending inventory}}{\text{Cost of goods sold}}\times 365\\ =\frac{\$1,938}{\$20,385}\times 365\\ =34.70\text{Days}\end{array}$

3.

To determine

Comment and interpret your findings from parts 1 and 2. Assume an industry average for inventory turnover of 15.

Explanation of Solution

Interpret and Comment:

• Company A’s inventory turnover ratio is more efficient than Company M.
• Company A’s days’ sales inventory is fewer than company M.
• Company A’s  inventory turnover ratio is more than the industry average of 15 for inventory turnover for both the current year and prior year, but Company M is slightly below the industry average in both the current year and prior years.
• Company M’s days’ sales inventory seems a bit too high comparing with the Company A.