(a)
Inventory turnover ratio: Inventory turnover ratio is used to determine the number of times inventory used or sold during the particular accounting period. The formula to calculate the inventory turnover ratio is as follows:
To determine: the inventory turnover for Company T and Company A
(a)
Answer to Problem 6.1MAD
Explanation of Solution
The inventory turnover ratio for Company T is calculated as follows:
Working notes:
The average inventory is calculated as follows:
The inventory turnover ratio for Company A is calculated as follows:
Working notes:
The average inventory is calculated as follows:
The inventory turnover ratio is calculated by dividing cost of goods sold by average inventory during the period. The average inventory is calculating by dividing beginning inventory and ending inventory by 2. The inventory turnover ratio is an important measure as to how efficient is the management is good at managing inventory and achieving sales from it.
Therefore, the inventory turnover of Company T is 6.2 Times & the inventory turnover of Company A is 7.7 Times.
(b)
Days’ sales in 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. The formula to calculate the days’ sales in inventory ratio is as follows:
To determine: the Days’ sales in inventory ratio Company T and Company A.
(b)
Answer to Problem 6.1MAD
Explanation of Solution
The Days’ sale in inventory ratio for Company T is calculated as follows:
The Days’ sale in inventory ratio for Company A is calculated as follows:
The Days’ sales in inventory ratio are calculated by dividing days in accounting period by inventory turnover ratio. The Days’ sale in inventory ratio is an important measure to know how long the company is holding the inventory before selling when compared to its peers.
Therefore, the Days’ sales in inventory of Company T are 58.8 days, & the Days’ sales in inventory of Company A is 47.4 days.
(c)
Inventory turnover ratio: Inventory turnover ratio is used to determine the number of times inventory used or sold during the particular accounting period. The formula to calculate the inventory turnover ratio is as follows:
To state: the company that has better inventory efficiency.
(c)
Answer to Problem 6.1MAD
Explanation of Solution
The company A has higher inventory turnover ratio of 7.7 and lesser number of days’ sales in inventory of 47.4 days when compared to company T’s inventory turnover ratio of 6.2 and number of days’ sales in inventory of 58.8 days.
(d)
Inventory turnover ratio: Inventory turnover ratio is used to determine the number of times inventory used or sold during the particular accounting period. The formula to calculate the inventory turnover ratio is as follows:
Days’ sales in 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. The formula to calculate the days’ sales in inventory ratio is as follows:
To explain: the difference in inventory efficiency between two companies.
(d)
Explanation of Solution
The main difference in the inventory efficiency between both the companies is that merchandising strategy followed. The Company A uses internet as medium for selling goods and direct shipping of merchandise inventory is not handled as company A’s inventory, whereas company T uses traditional retail store method which makes them to stock more level of inventory in retail outlet. The company T’s strategy requires a significant investment in inventory as it can be seen in its inventory turnover and number of days’ sales in inventory
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Chapter 6 Solutions
Corporate Financial Accounting - W/CENGAGENOW
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We negotiated an agreement earlier in the year with our manufacturing division in Philadelphia for a price of 5.00 for the entire year. I called the manager of that division. He said that the original price was still acceptablethat the increase was a directive from headquarters. Thats why I wanted to meet with you. I need some explanations. When I was hired, I was told that pricing decisions were made by the divisions. This directive interferes with this decentralized philosophy and will lower my divisions profits. Given current market conditions, there is no way we can pass on the cost increase. Profits for my division will drop at least 600,000 if this price is maintained. I think a midyear increase of this magnitude is unfair to my division. Jeff: Under normal operating conditions, headquarters would not interfere with divisional decisions. But as a company, we are having some problems. What you just told me is exactly why the price of your product has been increased. We want the profits of all our European marketing divisions to drop. Debbie: What do you mean that you want the profits to drop? That doesnt make any sense. Arent we in business to make money? Jeff: Debbie, what you lack is corporate perspective. We are in business to make money, and thats why we want European profits to decrease. Our U.S. divisions are not doing well this year. Projections show significant losses. At the same time, projections for European operations show good profitability. By increasing the cost of key products transferred to Europeto your division, for examplewe increase revenues and profits in the United States. By decreasing your profits, we avoid paying taxes in France. With losses on other U.S. operations to offset the corresponding increase in domestic profits, we avoid paying taxes in the United States as well. The net effect is a much-needed increase in our cash flow. Besides, you know how hard it is in some of these European countries to transfer out capital. This is a clean way of doing it. Debbie: Im not so sure that its clean. I cant imagine the tax laws permitting this type of scheme. There is another problem, too. You know that the companys bonus plans are tied to a divisions profits. This plan could cost all of the European managers a lot of money. Jeff: Debbie, you have no reason to worry about the effect on your bonusor on our evaluation of your performance. Corporate management has already taken steps to ensure no loss of compensation. The plan is to compute what income would have been if the old price had prevailed and base bonuses on that figure. Ill meet with the other divisional managers and explain the situation to them as well. Debbie: The bonus adjustment seems fair, although I wonder if the reasons for the drop in profits will be remembered in a couple of years when Im being considered for promotion. Anyway, I still have some strong ethical concerns about this. How does this scheme relate to the tax laws? Jeff: We will be in technical compliance with the tax laws. In the United States, Section 482 of the Internal Revenue Code governs this type of transaction. The key to this law, as well as most European laws, is evidence of an arms-length price. Since youre a distributor, we can use the resale price method to determine such a price. Essentially, the arms-length price for the transferred good is backed into by starting with the price at which you sell the product and then adjusting that price for the markup and other legitimate differences, such as tariffs and transportation. Debbie: If I were a French tax auditor, I would wonder why the markup dropped from last year to this year. Are we being good citizens and meeting the fiscal responsibilities imposed on us by each country in which we operate? Jeff: Well, a French tax auditor might wonder about the drop in markup. But, the markup is still within reason, and we can make a good argument for increased costs. In fact, weve already instructed the managers of our manufacturing divisions to legitimately reassign as many costs as they can to the European product lines. So far, they have been very successful. I think our records will support the increase that you are receiving. You really do not need to be concerned with the tax authorities. Our tax department assures me that this has been carefully researchedits unlikely that a tax audit will create any difficulties. Itll all be legal and above board. Weve done this several times in the past with total success. Required: 1. Do you think that the tax-minimization scheme described to Debbie Kishimoto is in harmony with the ethical behavior that should be displayed by top corporate executives? Why or why not? What would you do if you were Debbie? 2. 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