Acc1002X CP-W08

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CP-W08: Inventories and Cost of Sales

Karmaine Kong A0100508X Le Hoang Van A0098100N Mahati Sridhar A0117809Y

Ong Lishan A0103485J

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Question 1

1. Compute the amount of merchandise inventorypurchased for the fiscal year 2012. Since Cost ofgoods sold reported in the income statementincludes cost of merchandise, and other relatedexpenses, assume 90% of the costs listed under cost of goods sold are cost of merchandise. Comparepurchases to cost of goods sold and state anyconclusions about the companys operations.

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Definition of Merchandise Inventory

Goods that a company owns andholds for sale

Take note of goods in transit,consignment goods, damaged/obsolete goods

Annual Report, Pg 53: Inventory in transit is considered tobe all merchandise owned by Abercrombie & Fitch that hasnot yet been received at an Abercrombie & Fitch distribution

center

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Question 1

Cost of Goods Sold for 2012 = $1,694,096

Cost of Merchandise Sold for 2012 =0.90 x $1,694,096 = $1,524,686.40

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Question 1

Beginning Inventory (2012) = $679,935 Ending Inventory (2012) = $426,962 Cost of Merchandise = $1,524,686.40

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Question 1 Beginning Inventory + Purchases

= Ending Inventory + Cost of Merchandise

Rearranging: Purchases= Ending Inventory + Cost of Merchandise -

Beginning Inventory= $426,962 + $1,524,686.40 - $679,935

= $1,271,718.40

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Question 1

Compare purchases to cost of goods sold Purchases = $1,271,718.40

Cost of goods sold = $1,694,096 Purchases is 75.1% of the cost of goods sold

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Question 1

Conclusions about A&Fs Operations Cost of goods sold > Purchases Ending inventory < Beginning inventory A&F is selling more than it purchases Inventory (Asset - Stt. of Financial Position)

depletes Purchase more inventory to ensure a healthy

inventory amount to match cost of goodssold

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Question 22. Estimate the inventory turnover ratio in the last two

years. What can you conclude from the trend in thisratio?

Inventory turnover ratio= Cost of Goods Sold / Average Inventory

Average Inventory= (Beginning Inventory + Ending Inventory) / 2

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Question 2In general Measures how many times a company sells its inventory

during a period Determines ability to pay short-term obligations

High ratio: Inventory moves more quickly through a business

Less money is tied up in inventory Excess money for can be invested

Rapid turnover is generally favourable, but problems canarise if turnover is too fast /slow.

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Question 2

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Question 2

Decreased slightly Company is not converting itsinventory into cash as quickly as before.

Figure(thousands) 2011 2012

Cost of Goods

Sold1,607,834 1,694,096

AverageInventory

( 385,857 + 569,818)/2= 477,837.50

(679,935 + 426,962)/2=553,448.50

Inventory

Turnover3.36 3.06

Days Sales inInventory

569,818/ 1,607,834 * 365=129.4

679,935/1,694,096* 365= 146.5

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Question 2 Decrease in inventory turnover rate

Company has planned and purchased a certainlevel of inventory based on sales forecasts thatdo not materialize

Look at several sequential periods of thecompanys financial statements to identify whether the decrease is temporary or a long-term problem.

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Question 2

However, decrease is not very large (9%)

Annual Report, Pg 5:The Company strives to maintain sufficient

quantities of inventory in its retail stores...TheCompany attempts to balance in-stock levels

and inventory turnover, and to takemarkdowns when required to keep merchandise

fresh and current with fashion trend

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Question 3

3. On Page 41 of the Annual Report, itmentioned that the company changed itsmethod of accounting for inventories fromthe retail method to the cost method. Explainthe difference between the retail and the costmethod.

The Company elected to change its method of accounting for inventory from the lower of cost or market utilizingthe retail method to the weighted average cost method

effective February 2, 2013.

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Question 3 Annual Report, Page 57 Reasons for change to Cost Method

Better aligns with the A&Fs focus on realizedselling margin

Improves comparability of financial results with competitors

Improves matching of cost of goods sold withthe related net sales Reflects acquisition cost of inventory

outstanding at each balance sheet date

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Question 3 Abercrombie and Fitch follows the GAAP

accounting standards as opposed to IFRS Way of accounting for inventory shrinkage for

the past 3 fiscal years is the same Shrinkage: Estimate made in each period for

lost or stolen goods

Markdown reserveunder the retailmethod

Lower of Cost orMarket (LCM)reserve under cost

method

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Question 3 - Retail Method Substitute measure used to approximate

inventory value (IV) on hand when taking aphysical count of inventory is impractical.

Requires that a record be kept of:1. Value of ending inventory goods purchased at

cost and at retail .2. Value of goods available for sale (GAFS) at

cost and at retail .3. Sales for the period.

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Question 3 - Retail Method

1.

2.

GAFS(Retail)IV(Retail) Sales

Cost-to-retail ratio GAFS(Cost) GAFS(Retail)

IV(Retail)IV(Cost) Cost-to-retail ratio

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Question 3

Retail method Inventory valuation

using projected retail value of goods

Applies markdown

reserve

Cost Method Inventory valuation

according to weightedaverage cost

Applies LCM reserve

More conservative

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Question 3- Retail methodMarkdown Reserve

Recording a valuation reserve that representsestimated future permanent markdowns required

to sell-through the inventory

Reduces inventory value by:

Valuation reserve can fluctuate depending onthe timing of markdowns previously recognized

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Question 3- Cost method Weighted Average Cost Average cost = Cost of Goods Available for Sale

Units on hand on the date of Sale

Cost of inventory items > Amount expected to berealised from sale of goods

Lower of Cost or Market (LCM)

Reduce inventory value only when:

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Question 4

4. If the ending inventory of the company isreported $1 million higher because of thechange from the retail method to the costmethod, what is the effect of such anaccounting policy change on income beforeincome taxes for the current fiscal year?

Effective February 2, 2013, the Company changed itsmethod of accounting for inventories from the retailmethod to the cost method.

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Question 4

Beginninginventory

PurchasesGoods available

for sale

Goods availablefor Sale

EndingInventory

Cost of GoodsSold

Net SalesCost of

Goods Sold Gross Profit

Gross Profit Expenses Net income

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Question 4

Goods availablefor Sale

EndingInventory

Cost of GoodsSold

Overstated by $1 million

Understated by $1 million

Actual ending inventory is $1 million lower than reported

Actual Cost of Goods sold is $1 million higher than

reported

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Question 4

Net SalesCost of

Goods SoldGross Profit

Understated by $1 million


Actual Gross Profit is $1 million lower than reported

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Question 4

Gross Profit Expenses Net income



Actual net income of Abercrombie and Fitch is $1 millionlower than reported in the current fiscal year

Leads to an understatement of income tax

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Thank you

Documents

Acc1002X CP-W08