Discussion: Inventory Controls

Scenario

Bonanza, Inc. globally sells tumble stones (polished rocks), amethyst, fossils, and a variety of other gemstones and minerals, including Himalayan salts, Australian musgravite, opals, and turquoise.

Bonanza management became concerned about two things: (1) a high rate of customer dissatisfaction and (2) a decreasing gross profit ratio. The rate of sales (based on transactions) seems to be higher than ever, but the company is struggling to pay bills because of poor cash flow. They have done their best to cut back on operating expenses, but they are still losing money.

You were hired to do a year-end inventory count and an analysis of the profit and loss (P&L) and here is what you found:

1. Sales returns and allowances are posted directly to the Sales Revenue account, as are sales discounts.

2. The company uses a periodic inventory system.

3. Some expensive, authentic products, like Himalayan salts, had been replaced with a lower-grade counterfeit.

4. A comparison of sales records to purchasing records and other data analysis showed there was probably a significant amount of inventory missing, and management acknowledged that some of that inventory had been traced to private sales on internet auction sites.

5. The owners do their own accounting, but their backgrounds are in geology and sales.

Discussion Questions

• How would you explain the inverse relationship between sales revenue and sales activity? In other words, why do you think the gross profit percentage is dropping as the number of sales transactions is increasing?

• What systematic changes would you suggest to management, if any, and how would you explain those changes? Dont ignore a cost-benefit analysis.

• If management could only implement one of your suggestions, which one would you encourage them to choose and why?