Question

A small firm has an ending inventory of $52,000 as at December 31, 2012 and the following accounting information.

Month	Ending Inventory	Cost of Goods Sold
January 2013	$75,000	$225,000
February	$56,000	$325,000
March	$25,000	$240,000
April	$85,000	$325,000
May	$125,000	$460,000
June	$95,000	$220,000
July	$72,000	$85,000
August	$45,000	$156,000
September	$52,500	$220,000
October	$120,000	$265,000
November	$162,500	$100,000
December	$255,000	$350,000

a) Compute the monthly inventory turnover ratio for each of the twelve months. Do you see any trend in the monthly inventory turnover ratio? (4 points)

Hints: the average inventory level = (ending inventory of previous period + ending inventory of current period)/2. Use Excel to do all calculations and copy/paste the result to Word file.

b) What are the annual cost of goods sold and the average inventory for the year? (3 points)

Hint: the annual cost of goods sold = summation of cost of goods sold of 12 months; the average inventory for the year = summation of average inventory of 12 months / 12.

c) Compute the annual inventory turnover ratio. What can the purchasing department do to improve the firm’s performance? (3 points)

Problem 2 (10 points)

You are given the following information:

Costs	Make Option	Buy Option
Fixed Cost	$25,000	$3,000
Variable Cost	$8	$12

1. Find the break-even quantity and the total cost at the break-even point. (4 points)
2. If the requirement is 4,500 units, is it more cost-effective for the firm to buy or make the components? What is the cost savings for choosing the cheaper option? (3 points)
3. If the requirement is 6,000 units, is it more cost-effective for the firm to buy or make the components? What is the cost savings for choosing the cheaper option? (3 points)

Answer 1

1.
a. Inventory Turnover = Cost of Goods Sold / Average Inventory

Month	Ending Inventory	Cost of Goods Sold	Average Inventory	Inventory Turnover
Jan-13	75,000	2,25,000	63,500	3.54
February	56,000	3,25,000	65,500	4.96
March	25,000	2,40,000	40,500	5.93
April	85,000	3,25,000	55,000	5.91
May	1,25,000	4,60,000	1,05,000	4.38
June	95,000	2,20,000	1,10,000	2.00
July	72,000	85,000	83,500	1.02
August	45,000	1,56,000	58,500	2.67
September	52,500	2,20,000	48,750	4.51
October	1,20,000	2,65,000	86,250	3.07
November	1,62,500	1,00,000	1,41,250	0.71
December	2,55,000	3,50,000	2,08,750	1.68
Total		29,71,000	10,66,500

b. Annual Cost of Goods Sold = $2,971,000
Annual Average Inventory = $1,066,500 / 12 = $88,875

c. Annual Inventort Turnover = $2,971,000 / $88,875 = 33.43 times
To improve the same, company should try to increase the sales.

Problem 2
Break Even Quantity = ($25000-3000)/(12-8) = 5500
Cost at Break Even Point = 5500 x $8 + $25000 = $69,000

For 4500 units,
Buy Option should be chosen, as quantity is lower than break even point.
Cost Savings = ($25000+4500*8) - ($3000+4500*12) = $4000

For 6000 units,
Make Option should be chosen, as quantity is greater than break even point.
Cost Savings = ($3000+6000*12) - ($25000+6000*8) = $2000