Merchandising Operations and the Accounting Cycle - Pearson

WORKING IT OUT
Calculate inventory turnover from
the following data:
Beginning inventory $2,350
Ending inventory 1,980
Cost of goods sold 15,310
A:
Inventory turnover =
Cost of goods sold
(Beginning inventory + Ending
inventory)/2
Inventory turnover is
$15,310
($2,350 + $1,980)/2
= $15,310
$2,165
= 7.1 times per year
246 Part One The Basic Structure of Accounting
Accounting and the -World
Varsitybooks.com: A Textbook Case on the Fulfillment Cost Issue
If you were to order this edition of Accounting from Varsitybooks.com, the company
arranges for Baker & Taylor, a book distributor, to ship it to you immediately.
Varsitybooks.com does not have a warehouse or any inventory, but it does have
to pay Baker & Taylor to deliver the texts from the publishers to you. How does
Varsitybooks.com, a fledgling company, account for these significant fulfillment
costs?
E-commerce has revolutionized business and has “bent” certain accounting
rules in the process. One such rule is that the cost of goods sold to customers is reported
on the Cost of Goods Sold line on the income statement. Yet, online companies
like Amazon.com and Etoys Inc report some of this cost as Sales and
Marketing Expenses because the companies never own the inventory. By including
these fulfillment costs on the Marketing Expenses line, these companies do not subtract
the considerable costs from their gross margin.
Varsitybooks.com wanted to follow this practice, arguing that mail-order companies
have always done this. Also, investors would understand that increased
marketing costs are necessary for start-up companies to build a solid customer
base. This practice would also protect already-thin gross margins. For instance, if
Amazon.com accounts for fulfillment costs on the Cost of Goods Sold line, gross
margins for the last quarter of 1999 would go from 15% to -3%. The company’s
sales and net profit or net loss amounts would remain the same, but analysts and
investors look at the gross margin figure to see how well a company can make
money from basic business operations.
This approach is controversial. The auditors of Varsitybooks.com advised that
fulfillment costs be reported as cost of goods sold, and Varsitybooks.com finally
followed their advice.
Based on: Shannon Henry, “An E-Tail Identity Crisis,” The Washington Post, May 4, 2000,
p. E01. Anonymous, “Web Retailers’ ‘Gross Profit’ Questioned; The SEC may make some
firms account for distribution costs, possibly turning their profits into losses,” The Los
Angeles Times, February 19, 2000, p. 2.
Inventory turnover varies from industry to industry. Grocery stores, for example,
turn their goods over faster than automobile dealers do. Drug stores have a higher
turnover than furniture stores do. Retailers of electronic products, such as Austin
Sound Centre Inc., have an average turnover of 3.6 times per year. Austin Sound’s
turnover rate of 2.3 times per year suggests that Austin Sound is not very successful.
Exhibit 5-11 compares the inventory turnover rate of Austin Sound and Wal-Mart
Stores, Inc.
Exhibits 5-10 and 5-11 tell an interesting story. Wal-Mart sells lots of inventory at
a relatively low gross profit margin. Wal-Mart earns its profits by turning its inventory
over rapidly—7.0 times during the year. Austin Sound Centre Inc., a small business,
prices inventory to earn a higher gross margin on each dollar of sales and only
turns over its inventory 2.3 times during the year.
Gross margin percentage and rate of inventory turnover do not provide enough
information to yield an overall conclusion about a merchandiser, but this example
showed how owners and managers may use accounting information to evaluate
a company.