Chapter 7, Problem 7.6CP

a.

To determine

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:

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

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. The formula to calculate the days’ sales in inventory ratio is as follows:

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

The inventory turnover for Company C, Company W and Company JCP.

Answer to Problem 7.6CP

The inventory turnover ratio for Company C is calculated as follows:

$\begin{array}{c}\text{Inventory turnover}=\frac{\text{Cost of goods sold}}{\text{Average inventory}}\\ =\frac{\$86,823}{6,867\left(1\right)}\\ =12.6\text{ Times}\end{array}$

Working notes:

The average inventory is calculated as follows:

$\begin{array}{c}\text{Average inventory}=\frac{\left(\begin{array}{l}\text{Inventory, beginning of the year + }\\ \text{Inventory, end of the year}\end{array}\right)}{2}\\ =\frac{\left(6,638+7,096\right)}{2}\\ =\frac{\text{\$13,734}}{2}\\ =\text{\$6,867}\end{array}$ (1)

The inventory turnover ratio for Company W is calculated as follows:

$\begin{array}{c}\text{Inventory turnover}=\frac{\text{Cost of goods sold}}{\text{Average inventory}}\\ =\frac{\$335,127}{38,575.5\left(2\right)}\\ =8.7\text{ Times}\end{array}$

Working notes:

The average inventory is calculated as follows:

$\begin{array}{c}\text{Average inventory}=\frac{\left(\begin{array}{l}\text{Inventory, beginning of the year + }\\ \text{Inventory, end of the year}\end{array}\right)}{2}\\ =\frac{\left(36,437+40,714\right)}{2}\\ =\frac{\$77,151}{2}\\ =\$38,575.5\end{array}$ (2)

The inventory turnover ratio for Company JCP is calculated as follows:

$\begin{array}{c}\text{Inventory turnover=}\frac{\text{Cost of goods sold}}{\text{Average inventory}}\\ \text{=}\frac{\text{\$11,042}}{\text{3,064}\text{.5}\left(\text{3}\right)}\\ \text{=3}\text{.6 Times}\end{array}$

Working notes:

The average inventory is calculated as follows:

$\begin{array}{c}\text{Average inventory}=\frac{\left(\begin{array}{l}\text{Inventory, beginning of the year + }\\ \text{Inventory, end of the year}\end{array}\right)}{2}\\ =\frac{\left(3,213+2,916\right)}{2}\\ =\frac{\text{\$6,129}}{2}\\ =\text{\$3,064}\text{.5}\end{array}$ (3)

Explanation of Solution

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.

Conclusion

The inventory turnover of Company C is 12.6 Times, for Company W is 8.7 Times & for Company A is 3.6 Times.

b.

To determine

The number of Days’ sales in inventory for all three Companies.

Answer to Problem 7.6CP

The Days’ sale in inventory ratio for Company C is calculated as follows:

$\begin{array}{c}\text{Days' sales in inventory}=\frac{\text{Days in accounting period}}{\text{Inventory turnover}}\\ =\frac{365}{12.6}\\ =28.\text{97 days}\end{array}$

The Days’ sales in inventory ratio for Company W are calculated as follows:

$\begin{array}{c}\text{Days' sales in inventory}=\frac{\text{Days in accounting period}}{\text{Inventory turnover}}\\ =\frac{365}{8.7}\\ =\text{42 days}\end{array}$

The Days’ sales in inventory ratio for Company JCP is calculated as follows:

$\begin{array}{c}\text{Days' sales in inventory}=\frac{\text{Days in accounting period}}{\text{Inventory turnover}}\\ =\frac{365}{3.6}\\ =101.4\text{ days}\end{array}$

Explanation of Solution

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.

Conclusion

The Days’ sales in inventory of Company C, Company W and Company JCP are 28.9 days, 42 days and 101.3 days.

c.

To determine

To Interpret: The results based on each company’s merchandise concept.

Explanation of Solution

• The inventory turnover ratio and number of days’ sales in inventory of all the three companies reflect the merchandising approaches of all companies. Company C is a club warehouse and it has approach of holding only items which are quickly sold. Most of the items are sold in bulk at very attractive prices.
• In case of company W, it has a traditional discounter approach. Even though it has attractive pricing, the inventory movement is slower than in the case of company C.
• In the case of company JCP, it is a traditional department store. It offers a wide collection of specialty and unique goods that are specifically designed and it will not necessary appeal to the mass market. Therefore, the movement is slower than other two companies yet it has highest margin.