[Anonymous]

From AICPA practice, I had 1 SIM that I didn’t understand one of the explanations for this change in ratio:

Days Sales in Inventory

Y2=> 82

Y1=> 70

Explanation#1

The company has experienced rising costs of raw materials since December Year 1.

With this change in ratio, cost of sales decreased while inventory increased. I am lost how this flow relates to the rising costs of raw materials since Dec Y1.

Please help!

[Anonymous]

If I'm understanding the situation right…

For the ratios to change in that manner, it requires that either cost of sales decreased or inventory increased, or both. Inventory can increase either due to rising costs of materials/labor, or due to having more items in inventory…right?

So, it looks like for some reason they're making the assumption that the reason was due to rising costs of raw materials. I'm not sure why this is the right option, but I can see how it would be an option. (If sales were $1,000k both years, and the cost of a single unit was $1 in Y1 and $2 in Y2, then if they'd had 100 units in average inventory both years, then inventory value Y1 would be $100 and Y2 would be $200…so days' sales in inventory in Y1 would be 36.5 and Y2 would be 73. Obviously this isn't the actual inventory etc numbers for them, but I thought laying out the numbers might help it make more sense…and made me a bit more confident in my answer!)

[wizards8507]

What are the other options?

Rising raw materials cost lead to an increase in either raw material inventory or WIP. This will eventually flow through to Finished Goods and COGs.

NY CPA

[Anonymous]

Thanks Elisabeith & Wizards for replying quick. I got this question from SIM from AICPA practice. I got it right with the second possible explanation of mistakenly including sales in Y1's consigned goods that were not sold until the first week of January of Y2.

There are no other figures given on the problem. So assuming numbers for this change of ratio is the method we use to come up with how cost of sales and inventory accounts increase or decrease.

Okay, I think I understood it (just now) how the rising costs of RM affect the inventory turnover.

Hmmmm

BI + Purchase = Goods Available for Sale – EI = COS

Increase of costs of ending inventory (RMs) would be equal to decrease in COS.

[Mia]

I've come across a similar MCQ, I don't think it was that.

But the explanation was that rising costs of raw materials would be passed on to the customers through higher prices. And so inventory would move slowly because less people would buy.

I think Elisabeth and wizards are right too.

BEC 82 Nov 2012 | REG 80 Feb 2013 | FAR 76!!! Apr 2013 | AUD 69 May 2013 | AUD 83!!! Aug 2013

Done!! Thanks Jeff & A71 friends!

Ad maiorem Dei gloriam - For the greater glory of God!

[Anonymous]

Thanks Mia for your feedback Your simple explanation of rising cost of RM makes it easier for me to understand it better.

At least I don't anymore doubt the final answer for this question.

I am not good in explaining things in English so using the formula for GAFS and COS adds confusion to others. But overall, I understood the explanation better now.

Thanks again.

[Author]

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