Question

00 Decision Case 6-1 Assume you are opening a Bed Bath & Beyond store. To finance the busi- ness, you need a $500,000 loan, and your banker requires a set of forecasted financial state- ments. Assume you are preparing the statements and must make some decisions about how to do the accounting for the business. Requirements Answer the following questions (refer to Chapter 5 if necessary): 1. Which type of inventory system will you use? Perpetual or Periodic? Give your reason. 2. Show how to compute net purchases (see the vocabulary list in Chapter 5 for the definition of "net purchases") and net sales. How will you treat the cost of freight in? 3. How often do you plan to do a physical count of inventory on hand? What will the physi- cal count accomplish? 4. Inventory costs are rising. Which inventory costing method would have the effect of a. maximizing net income? b. paying the least amount of income tax?

Answer 1

(1): I will use the perpetual inventory system because sales volume at the store will likely to be high and hence there will be a need to keep a track of inventory balances continuously. Each product will be bar coded and will be updated in the inventory records whenever it is received or sold. This will ensure that inventory related errors are minimized and all individual unit level information is available. This will also enable ordering of goods at the right time when their inventory level falls.

(2): Net purchases = purchases – purchase returns and allowances – purchases discounts.

Net sales = gross sales – sales returns, allowances and discounts.

Net purchases + freight in = cost of goods purchased.

(3): You should do a cycle count of your inventory on a continuous basis rather than doing a full physical count of inventory at year end. Cycle count of your inventory on a continuous basis will entail doing partial counts on a continuous basis. This can be accompanied by doing a full physical count at the end of every quarter, or end of every six months or end of every year depending on the size of inventory that you carry. The purpose that inventory count will serve is that it will ensure that records are accurate and the physical count matches the book record or computerized records. It will ensure that errors are also minimized.

(4): (a): To maximize net income the cost of goods sold has to be minimized. This can be possible when FIFO method is used i.e. the first in first out method. As per the FIFO method earlier units will be considered and these would have been purchased at lower costs as the costs are rising and so costs of latest purchases will be higher.

(b): To pay the least amount of income tax LIFO method should be used i.e. last in first out. LIFO method takes into consideration the latest units purchased and in an environment of rising costs the latest units will be more costly. As such cost of goods sold will be highest thus minimizing the net profit amount and hence minimizing the amount of income tax.