Intermediate Accounting - Essay Example

Module: Management Science “Accounting is a necessary and useful function, but it actually adds expense to the organization” (Schwartz, 2007, 30) and “the retail inventory method has become an important method of inventory determination” (Nelson et al, 1992, 451). Inventory, on the other hand, represents the most significant assets for the company. Any changes in the basis of valuation that was used in the previous period, it would likely affect the net income for the same period. Accounting for inventory or stock in retail operation such as MHS presents several challenges (Kieso et al, 1997). Even though its method can be used for financial accounting and tax purposes, it “provides only an estimate of the ending inventory” (Nelson et al, 1992, 451) at cost. It requires physical inventory count each year to ensure that the physical count matches with the value at cost. The company has 880 different items and the fairest method is “matching the cost against revenues regardless of whether or not the method corresponds to the physical flow of goods” (Kieso et al, 1997, 401). Small companies with less merchandise and ones that are not purchased by pound such as nuts and bolts, this inventory system may have no effect much but to MHS with 880 items, of which some have relatively low unit cost this is very challenging and inefficient, even time consuming when internal report or adjustment is required. In fact, classifying nuts and bolts into per unit cost can be time consuming and ineffective especially when it comes to year end where you need to do physical inventory. In practice, nuts and bolts and small items of this kind tend to be classified under weighted average system which makes the system to be more effective and less time consuming in times of physical evaluation. In addition, this method requires analysis because there is always discrepancy, which MHS inventory record does not indicate. The discrepancy may represent “loses due to breakage, loss or theft; incorrect application of the retail method; failure of departmental managers to correctly report markdowns, additional markups or cancellations; errors in the inventory records; errors in the physical inventory; inventory manipulation” (Nelson et al, 1992, 451). MHS is a retail store and in valuation of retail stores, “perpetual inventory procedures may be impractical, and it is unusual to take a complete physical inventory count more often than annually” (Ibid, 445). Generally, retail inventory method has two advantages. First, it is easy to use and second, it reduces the detail in record keeping. However, this method requires that items sold, as identified by bar code, should be marked up at the same rate, and items “purchased for resale should be priced immediately and the sales prices displayed” (Ibid). According to Nelson et al (1992), this retail inventory method is based only on dollar amount. It uses both retail value and actual cost data, which is not shown in MHS record, in order to compute the ratio of cost to retail. It allows the staff to calculate the ending inventory at retail value, and convert the retail value to a cost by using the computed ratio. The primary usage of retail inventory method is “to provide estimates on inventory cost for interim period… when it is not practical to physically count the inventory and a perpetual inventory system is not used; to provide a means for converting inventory amounts determined by a physical count of inventory, priced at retail, to cost basis; to eliminate the necessity of marking the cost on the merchandise, or referring to invoices; to provide basis for control of inventory, purchases, theft, markdowns, and additional markups when neither a traditional periodic nor a perpetual inventory system is used for these interim purposes; to provide inventory cost data for external financial reports; to provide inventory cost data for income tax purposes; to provide a test of the overall reasonableness of a physical inventory costed in the normal manner” (Ibid, 451 – 452). MHS inventory system indicates a retail method but it does not explain the entire process of the retail method. This method associates with purchases and sales or any other returns or disbursement accounts. In its application, this method requires that the company should keep all records associate with these accounts for internal purposes and control. For example, sales revenue, beginning inventory valued at both cost and retail, purchases during the period, which is also valued at cost, and retail, adjustment for markups and markdown, cancellation or discounts, and data related to damaged goods, returns, transfer, breakage, or because of other reasons. The objective of using the retail inventory method is “to find the ending inventory value at cost” (Ibid). For MHS to use bar code with the products are recorded and classified by the cost value makes the physical count time consuming and difficult. This type of unit cost inventory method is unsatisfactory. Goods on stock or inventory are related to accounts payable and affect sales. If they are not properly recorded, they can cause ending inventory to be overestimated and pretax income to be overestimated by the same amount. Similarly, ending inventory can be underestimated and pretax income be underestimated by the same amount. Conversely, the beginning inventory would be overstated or understated. Purchases would likely be affected, either overestimated or underestimated, so do cost of goods sold and pretax income by the same amount. Indeed, overstates or understates inventory may affect income statement and balance sheet. Too often, said Nelson et al (1992), errors in recording inventory would be reflected in accounts payable and purchases. This method also makes it difficult for the company management to evaluate which items cause problem in stock out or over stock. It reduces its ability to conduct inventory liquidation either voluntarily or involuntarily. Management may want to, voluntarily, liquidate the existing items because the demand is declining or that the company is anticipating a decline in inventory replenishment cost or improvement in the product. In other instances, the company may have to liquidate the items because of uncontrollable causes such as strikes at the manufacture, a delayed in delivery dates, or other unexpected customer demand. They may use retail inventory method. This method enables the company to estimate inventory anytime they need and take physical inventory at retail prices. At any time, consistently, the company can covert inventory at cost by keeping the record of the total cost and retail value of goods purchased, the total cost and retail value of the goods in stock, and the total sales for the period (Kieso et al, 1997). While using this method, according to Kieso et al, in order “to avoid a potential misstatement of the inventory, periodic inventory count” should be made because the possibility of loss due to shoplifting and breakage is common. Using this method, the physical count would be adjusted to the amount at retail and the “discrepancy between the retail value and physical count would require an adjustment to make the records agree with the count” (Ibid, 437). One advantage of this method is that the “inventory balance can be approximated without a physical count. This makes the method particularly useful for the preparation of interim reports… insurance claims... act as a control device because any deviations from a physical count at the end of the year have to be explained… expedites the physical inventory count at the end of the year” (Ibid, 437-438). Another advantage of using this method is that during the physical count, the clerk does not need to look up at each invoice to check the cost of each item. Thereby, saves time and expenses. No additional person requires conducting investigation that is not necessary. As well, it helps the company to keep an excellent record of perpetual inventory of its 880 items, gives easy information concerning goods on hand, their cost, their availability for sales, and the clerks’ can even serve several customers simultaneously. Alternatively, the company may follow the current trend of using point-of-sale system. Some of this system is affordable and others are quite expensive. However, in general, this system creates a seamless pathway between the suppliers, distributors, and retailers. It allows the company to manage very component of its retail management. It gives up-to-date sales transaction information. The “retail quote, sales, layaway, workorder, backorder and return documents are automatically integrated into the suppliers and distributors’ system,… eliminating delays and errors associated with manual data entry. Management now has access to a central database with valuable data across an entire organization providing a clear, comprehensive picture of enterprise wide retail operations” (Retail Advantage). It gives a precise inventory control. You can increase sales because you have better access to inventory, track its movement, maintain the level of inventory level you have on stock. Because you have quick access to locate the inventory, quick tracking of inventory, and your chance of increasing sales is improving. Point-to-point sales also promote easy transfer from one retail to another which makes it possible for the company not to lose sales opportunity. It also gives the opportunity for the company to transfer the goods from one outlet to another, from one warehouse to another, or from one distributor to another. By using this system, it is easy to identify customers’ buying patterns and preferences, the company’s service to the customers is more personalized, the company has better chance of learning about customers’ purchasing histories, changing demographics, can set target pricing effectively, and can improve sales, and offer sales promotion. Point-of-sale system also allows the company to anticipate quick response to customers’ demand and thereby provide customers’ satisfaction, and quick reconciliation between accounts. Thereby, it “eliminates the inefficiency and expenses of manual, time-consuming reconciliation methods” (Ibid). The automatic transfer of inventory between locations can speed up the response time and reduces the possibility of misstatement. Finally, it increases the turnover time and eventually sales and profits. Pareto Analysis, which is also referred to as the 80/20 rule, helps the company to quickly scan the number of inventory identify the causes of a problem in inventory management system. It allows the company to focus on issues that will give the greatest potential in return on investment. Using ABC Analysis, the inventory system is grouped according to annual sales volume. Through this classification, it is easy to identify the number of items sold the most in volume. Most importantly, it helps to control the effectiveness of the inventory management system. There are some benefits associates with using Pareto analysis. For example, the company can focus on items that generate the most sales. In taking inventory account, for example, Pareto analysis helps the company to identify the criteria of certain items that contribute to the significant sales or generate problem in over stock. They may use the usage rate or the turn over value and its unit value. This Pareto cure will indicate that the items that generate significant sales volume would be classified at the top of the list. It eases the yearly analysis as the amount is accumulated and it helps in controlling cost and quality. For example, the company wants to keep the order processing cost and the storage cost to be below 20% and 10% respectively, this analysis helps the company in monitoring these expenses. Quality control and quality of services are another benefit of using Pareto analysis. Any discrepancy can be prioritize for faster fixing and increase the system’s performance, or any significant order can be prioritized to meet and increase sales demand. References Active Shelf System: RFID Tracking for Retail Inventory. Retrieved April 21, 2007 from http://www.barcoding.com/rfid/active-shelf.shtml. Kieso, Donald; Weygandt, Jerry J.; Irvine, Bruce, V.; Sylvester, Harold W. & Young, Nicola (1997). Intermediate Accounting. Fifth Edition. Toronto: John Wiley & Sons Canada, Ltd. Nelson, Morton; Zin, Michael; Conrod, Joan E. D.; Cyckman, Dukes and Davis. (1992). Intermediate Accounting. Sixth Canadian Edition. Homewood, IL: Irwin Pareto Analysis - in brief. Retrieved April 22, 2007 from http://thequalityportal.com/q_know03.htm Pareto Analysis/ABC Analysis. Retrieved April 21, 2007 from http://www.lmu.ac.uk/lis/imgtserv/tools/pareto.htm Retail Advantage. Improve The Efficiency of Every Component of Your Retail Operation. Nodus Technologies. Retrieved April 22, 2007 from http://www.nodus.com/Retail_Advantage.pdf Read More