In comparison of 2014 to 2013 performance, Weir Company's inventory turnover decreased substantially, although sales and inventory amounts were essentially unchanged. Which of the following statements best explains the decreased inventory turnover ratio? Explain your answer choice.
A. Cost of goods sold increased.
B. Total asset turnover decreased.
C. Gross profit percentage increased.
D. Accounts receivable turnover decreased.
Gross Profit Margin:
The gross profit margin is the ratio of the gross profit earned during the period relative to the net sales generated, expressed as a percentage. The gross profit is the difference between the sales and cost of goods sold. Any change in the cost of goods sold, assuming sales to be constant, affects the gross profit margin.
Answer and Explanation:
Correct answer: Option C) Gross profit percentage increased.
As we know that:
Inventory turnover = Cost of goods sold / Average inventory
Therefore, for inventory turnover to decrease, either the cost of goods sold should decrease or the average inventory should increase.
Given, the inventory and the sales level are almost unchanged, so assuming them to be constant, if the cost of goods alone decreases, as a result, the gross profit percentage increases, because the difference between the sales and cost of goods sold represents gross profit.
Therefore, if the gross profit percentage increased, it indicates a decreased inventory turnover.
Why other options are incorrect?
Option A: An increase in cost of goods sold increases the inventory turnover.
Option B: The decrease or increase in asset turnover affects the total assets if sales are constant and not inventory.
OPtion D: The decrease or increase in accounts receivable turnover affects the receivable balance if sales are constant and not inventory.
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from Financial Accounting: Help and ReviewChapter 5 / Lesson 17