Question

Exercise 9-10 [Financial/Theory] Your boss, John Creedy, is a partner in the small local CPA firm for which you work. One morning a client, Jeff Altman, the owner of Alt- man Manufacturing, storms into Mr. Creedy's office and delivers a complaint. An edited version follows: This morning at my breakfast Club I spoke with my competitor, Tony Dodd. He uses the LIFO inventory method just as I do. He boasted that his accountant had told him that by speeding up his purchases of raw materials at year-end he could significantly increase reported profits. If he can do that, why can't 1? And why haven't you discussed this gim- mick with me? I don't expect to rely on Dodd for financial advice; I pay you for that. After Altman's departure, Mr. Creedy calls you, the accountant-in- charge of the Altman account, into his office to discuss Mr. Altman's complaint. You explain to your boss that your concern is your client's very large raw material inventory and slow turnover rate caused by years of over-buying. Mr. Creedy advises you that Altman needs new capital in his business and is trying to interest another local businessper- son in becoming a limited partner. An increase in reported profits could be advantageous to Mr. Altman's plans and, therefore, left to his own devices, Mr. Altman would likely follow Mr. Dodd's accountant's advice. Mr. Creedy asks you to draft a letter to Mr. Altman. The letter should discuss the problems of maintaining an overly large inven- tory as well as the disadvantage of a low tumover rate. Although you are not familiar with Mr. Dodd's company, you are reasonably cer- tain his accountant would not have made the comment he did if Mr. Dodd's company had the same existing inventory problems as Alt- man Manufacturing. Use the proper format, effective organization, and

Answer 1

To

Jeff Altman

Altman Manufacturing

Subject: Inventory Keeping Policy

Respected Sir,

Thanks for sharing your advice in respect of Inventory management policy dealt by competitors, Well the churn out of working capital is very high due to low turnover of inventory, means it is taking more no. of days to convert our finished goods inventory into sale. While if following LIFO will enhance the profitability is no longer supporter because it will block your majority of capital in inventory itself and secondly the inventory not get chance to move out will be later on discarded as scrap i.e Loss and not wise steps.

It is advisable the corporate tycoons engaged in manufacturing required to follow such method of inventory recording system which will not only block the funds in inventory but also reduce the scrap rate in the inventory department, Turnover rate policy will go parallel with the inventory policy. If Turnover rate is low, purchase of Inventory will block the fund, Turnover rate is high and following LIFO will also handicapped the system of working capital.

Hence from above the policy insights blindly following rival policy without knowing the impact on our business environment are not wiser decision. Need of Capital can be driven from various source but the main eye should be on its utilization of such capital will also play major role, because you are struggling with capital requirement and laying the capital funding with old policy will not helps to overcome the churn out situation, its required to complete.

Advise not to follow rival policy, but follow the own business environment and made specific changes as required to develop a sense of confidence in achieving the objectivity of profitability.

Your Sincerely

CPA Firm Assistant