Question

Question One (Total mark: 11 marks, word limit: 900 words)

Jordan Fit is a leading shoe retailer in the UK. During the last two years Jordan Fit has experienced considerable financial pressures: its performance has been declining, along with its share price. The accountants of the company have been ordered by their executives to review various aspects of their business and recommend some fundamental changes to improve the company’s financial performance.

One area of the business that has become very costly is holding stocks of saleable products in the stores. Storage and handling of stock is identified as an expensive operation for Jordan Fit. The accountants want this aspect of the business to be better controlled than it has been to date.

            As a new and more immediate mechanism for control within the business, the accountants decide to introduce a charge into the profit statements of individual stores. Every store has its own profit statement which broadly speaking records revenues and costs attributable to that store. These are internal management reports, compiled by the management accountants, and constituting an important part of how executive and divisional managers assess store performance over time. Importantly, the senior managers in each store, including the store manager, have a significant proportion of their salary and annual bonus based on a percentage of their store’s net profit figure. The new charge is to be based on the amount of stocks being held on average, over a year, by a particular store. The higher the average stocks held, the higher the charge in a store’s profit statement and, consequently, the lower the net profit. All other employees of a store (retail assistants, administrators and storeroom staff) also receive an annual ‘Christmas bonus’ that is calculated in relation to their store’s net profitability.

The accountants will implement the changes to stores’ reporting within two months, in time for the start of the new financial year. The changes, approved recently by majority vote at executive level, will be ‘sold’ to employees mostly via memos and email on the basis that the organization is facing a serious crisis, costs must be cut drastically, and that the introduction of a charge for holding stocks in stores was a sensible way to improve control over this particular element of business costs. No further consultation was planned, and the accountants intended to run brief training courses for their store managers, at which the technicalities of calculating the new charges for stock-holding (but not much else) would be explained.

Required:

You are a senior management accountant in Jordan Fit, although you are not actually leading this particular change programme. You have serious reservations about what is being proposed. Write a memo to the CFO of Jordan Fit explaining the reasons why you have serious reservations about the proposed changes, and describe alternative options (not just accounting related) that might be considered during this extremely testing time for the organization.

Answer 1

Hello Sir,

This is with respect to the approved proposal for introduction of charge to Profit statement based on level of stocks as per respective stores that I wish to state my reservations.

The profit of each store is the factor determining the employee pay including bonus. Any charge against the profit will directly impact the pay of the employees, which will be demotivating them to deliver efficient performance. Also, this will not result in reduction of stocks since the charge is only a provision against the profit. Thus, nothing will be achieved as far as the stock reduction is concerned. On the contrary, we will enrage our employees.

To liquidate the stock better option is to offer incentives to our employees to support their sale. We can release additional discounts in market to liquidate these stocks. The cost incurred via these measures will reduce the stock levels and also help us to maintain our goodwill with our employees.

From accounting point of view, any provision can be made only if there is a probable event in near future. In case of inventories, they are valued at lower of replacement cost or historical cost whichever is lower. Thus, any reduction in inventory value is provided as of balance sheet date. We cannot make any provisions without any suitable basis.

To summarize my views, charge against profits of the company will only result in artificial reduction in profits without liquidating the stocks. Thus, it is not a healthy measure. Incentivizing the sale of stores via employees and market participants is a better option.

With Regards,

ABC