Inventory Control Methods Discussion 1: Jason Archer is the CEO of JC Penney® (a United States retailer). Because Jason’s bonus is based on the company’s earnings, he has directed the controller to use FIFO as the inventory costing method. Jason did not tell the controller his real reason for the directive; instead, he stated that he thought FIFO better reflected the actual flow of inventory costs. Please review the following links and company websites then answer the questions. http://www.ur.umich.edu/0304/Jan19_04/10.shtml
http://ir.jcpenney.com/phoenix.zhtml?c=70528&p=irol-irHome
http://www.searsholdings.com/invest/financial_info.htm
Jason’s decision to select FIFO appropriate? Is it ethical? Is Jason wrong if this will help the company and also benefit him too?
What are some of the pitfalls of a company basing a manager’s or CEO’s compensation on the company’s earnings?
Jason’s Decision to Select FIFO:
The decision of JC Penny to use the FIFO method for inventory valuation will yield greater tax burden and a greater net income during inflationary times. Even though the profit seems to be greater with this method, however these phantom profits do not reflect accurately upon the actual earnings and profits of the business. The material which was bought first was bought in a currency which was valued highly. With the decline in the value of the currency, the material cost is expected to get higher. The price difference is reflecting upon inflation and not actual income. Therefore, it would not be ethical to report it as income. The changing of systems to incline the net income value is considered to be unethical even if the business profits from it.
Pitfalls:
The dependence of the CEO compensations on the earnings of the company offers some pitfalls as well. It can be in the form of the likelihood of alteration of the actual financial statements of the earnings because of the reason that compensation depends on it. It can raise concerns as CEO’s priority would be to increase earnings no matter what as their compensations depend on it. A recent study has found this (DeGroat, 2004).
Inventory Turnover:
The inventory turnover rate of JC Penny was computed as.
8174/2762=2.95
The inventory turnover rate of Sears was computed as.
13175/3959=3.32
These inventory turnover ratios show that Sears has turned over its inventory into sales one more time than the company PC Jenny (JC Penny, 2018). The inventory of JC Penny is better managed as compared to Sears with 109.9 days of inventory.
Number of Days in Inventory:
PC Jenny= 365/2.95=123.7 days
Sears= 365/3.32=109.9 days
As the inventory turnover ratio is better for Sears, the inventory in days is also better for it as compared to PC Jenny. The inventory stayed 13 days less on the shelves for Sears as compared to PC Jenny. The inventory in days for JC Penny is 123.7 days and for Sears is 109.9 days (Sears Holdings Corporation, 2018).
References:
DeGroat, B. (2004, January 9). CEO pay, earnings manipulation linked. Retrieved from Record: http://www.ur.umich.edu/0304/Jan19_04/10.shtml
JC Penny. (2018). Investors. Retrieved from http://ir.jcpenney.com/phoenix.zhtml?c=70528&p=irol-irHome
Sears Holdings Corporation. (2018). Sears Holdings Corporation Annual 10 K 2018. Retrieved from http://searsholdings.com/docs/investor/SHC_2017_Form_10-K.pdf
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