Question

32. What does an inventory turnover of 3.5 mean?

Answer 1

32)

It means that it is a measure that states 3.5 times, the inventory is sold or used in a period particular period of time.

The inventory turnover ratio is calculated by dividing the cost of goods sold by the average inventory and the average inventory is calculated by adding the beginning and ending inventory balances and divided by 2.

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37)

The ending inventory in period one will be the beginning inventory in period two so the cost of goods sold will increase due to overstating the beginning inventory. It is explain with the below example -

Original Data
	Period 1	Period 2
Beginning inventory	$9,000	$10,000
Add: Purchases	$13,000	$15,000
Goods available for sale	$22,000	$25,000
Ending inventory	$10,000	$8,000
Cost of Goods Sold	$12,000	$17,000

Overstating the Ending Inventory in period 1
	Period 1	Period 2
Beginning inventory	$9,000	$12,000
Add: Purchases	$13,000	$15,000
Goods available for sale	$22,000	$27,000
Ending inventory	$12,000	$8,000
Cost of Goods Sold	$10,000	$19,000

From original data, the ending inventory of $10,000 in period 1 is overstated to $12,000 so the cost of goods sold in period 2 is increased from $17,000 to $19,000.

Therefore, when ending inventory is overstated in period 1, the cost of goods sold in period 2 will also increase. When cost of goods sold increases, the gross profit decreases because the gross profit is calculated by deducting the cost of goods sold from the sales revenue.

When gross profit decreases, the net income also decreases because the net income is calculated by deducting the selling and administrative expenses from the gross profit.