Chapter 6, Problem 6.12E

(a)

To determine

Inventory turnover ratio: This is a financial measure that is used to evaluate as to how many times a company sells or uses its inventory during an accounting period. It is calculated by using the following formula:

$\text{Inventory turnover = }\frac{\text{Cost of goods sold}}{\text{Average inventory}}$

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.

$\text{Days' sales in inventory}=\frac{\text{Days in accounting period}}{\text{Inventory turnover}}$

Gross profit rate is the financial ratio that evaluates the money left over out of the total revenues after deducting the cost of goods sold. Thus, it shows the relationship between the gross profit and net sales. It is calculated by using the following formula:

$\text{Gross profit rate}=\frac{\text{Gross profit}}{\text{Net sales}}\times 100$

To Calculate:

• The inventory turnover for 2016, and 2017 of Company Z.
• The days in inventory of Company Z for 2016, and 2017.
• The gross profit rate of Company Z for 2016, and 2017.

Explanation of Solution

Calculate the inventory turnover of Company Z for 2016.

Cost of goods sold = $1,288,000

Average inventory = $450,000 (1)

$\begin{array}{c}\text{Inventory}\text{turnover for 2016}\}=\frac{\text{Cost}\text{of}\text{goods}\text{sold}}{\text{Average Inventory}}\\ =\frac{\$1,288,000}{\$450,000}\\ =2.86times\end{array}$

Calculate the inventory turnover of Company Z for 2017.

Cost of goods sold = $1,552,000

Average inventory = $560,500 (2)

$\begin{array}{c}\text{Inventory}\text{turnover for 2017}\}=\frac{\text{Cost}\text{of}\text{goods}\text{sold}}{\text{Average}\text{Inventory}}\\ =\frac{\$1,552,000}{\$560,500}\\ =2.77\text{times}\end{array}$

Working Notes:

Calculate the average inventory for 2016.

Beginning inventory = $332,000

Ending inventory = $568,000

$\begin{array}{c}\text{Average Inventory}=\frac{\text{Beginning Inventory}+\text{Ending Inventory}}{2}\\ =\frac{\$332,000+\$568,000}{2}\\ =\frac{\$900,000}{2}\\ =\$450,000\end{array}$ (1)

Calculate the average inventory for 2017.

Beginning inventory = $568,000

Ending inventory = $553,000

$\begin{array}{c}\text{Average Inventory}=\frac{\text{Beginning Inventory}+\text{Ending Inventory}}{2}\\ =\frac{\$568,000+\$553,000}{2}\\ =\frac{\$1,121,000}{2}\\ =\$560,500\end{array}$ (2)

Calculate days in inventory of Company Z for 2016.

Total number of days = 365

Inventory turnover, 2016 = 2.86 times (a)

$\begin{array}{c}\text{Days}\text{in}\text{inventory for 2016}\}\text{=}\frac{\text{Total}\text{number}\text{of}\text{days}}{\text{Inventory}\text{turnover}}\\ =\frac{365}{2.86}\\ =128\text{Days}\end{array}$

Calculate days in inventory of Company Z for 2017.

Total number of days = 365

Inventory turnover, 2016 = 2.77 times (a)

$\begin{array}{c}\text{Days}\text{in}\text{inventory for 2017}\}\text{=}\frac{\text{Total}\text{number}\text{of}\text{days}}{\text{Inventory}\text{turnover}}\\ =\frac{365}{2.77}\\ =132\text{Days}\end{array}$

Calculate gross profit rate of Company Z for 2016.

Gross profit = $437,000 (3)

Sales revenue = $1,725,000

$\begin{array}{c}\text{Gross}\text{profit}\text{rate of 2016}\}=\frac{\text{Gross}\text{Profit}}{\text{Sales}\text{revenue}}\times 100\\ =\frac{\$437,000}{\$1,725,000}\times 100\\ =25.33\%\end{array}$

Calculate gross profit rate of Company Z for 2017.

Gross profit = $396,000 (4)

Sales revenue = $1,948,000

$\begin{array}{c}\text{Gross}\text{profit}\text{rate of 2017}\}=\frac{\text{Gross}\text{Profit}}{\text{Sales}\text{revenue}}\times 100\\ =\frac{\$396,000}{\$1,948,000}\times 100\\ =20.33\%\end{array}$

Working Notes:

Calculate the gross profit for 2016.

Sales revenue = $1,725,000

Cost of goods sold = $1,288,000

$\begin{array}{c}\text{Gross}\text{profit of 2016}\}=\text{Sales revenue}-\text{Cost of goods sold}\\ =\$1,725,000-\$1,288,000\\ =\$437,000\end{array}$ (3)

Calculate the gross profit for 2017.

Sales revenue = $1,948,000

Cost of goods sold = $1,552,000

$\begin{array}{c}\text{Gross}\text{profit of 2017}\}=\text{Sales revenue}-\text{Cost of goods sold}\\ =\$1,948,000-\$1,552,000\\ =\$396,000\end{array}$ (4)

Conclusion

Therefore, the inventory turnover of Company Z for 2016, and 2017 are 2.86 times, and 2.77 times respectively.

Therefore, the days in inventory for 2016, and 2017 are 128 days, and 132 days respectively.

Therefore, the gross profit rate of Company Z for 2016, and 2017 are 25.33%, and 20.33% respectively.

(b)

To determine

To Explain: Whether the liquidity and profitability of Company Z improve or deteriorate in 2017

Explanation of Solution

Based on the inventory turnover ratio and days’ in inventory are fluctuating in nature. Therefore, the liquidity of the company has deteriorated in the year 2016 and improved in the year 2017.

Based on the gross profit ratio, the profitability of the company has decreased.