Question

Early in your first audit of Star Corporation, you notice that sales and year-end inventory are almost unchanged from the prior year. However, cost of goods sold is less than in the preceding year, and accounts payable also are down substantially. Gross profit has increased, but this increase has not carried through to net income because of increased executive salaries. Management informs you that sales prices and purchase prices have not changed significantly during the past year, and there have been no changes in the product line.   Star Corporation relies on the periodic inventory system. Your initial impression of internal control is that several weakenesses may exist.  

Suggest a possible explanation for the trends described, especially the decrease in accounts payable while sales and inventory were constant and gross profit increased. EXPLAIN THE RELATIONSHIPS INVOLVED.

Answer 1

Cost of goods sold (COGS) is the direct costs attributable to the production of the goods sold in a company. This amount includes the cost of the materials used in creating the good along with the direct labor costs used to produce the good. It excludes indirect expenses such as distribution costs and sales force costs.

COGS = Beginning Inventory + Purchases during the period – Ending Inventory.

In the Above scenario possible reason could be COGS can decrease if the cost per product purchased is decreased which can be through improvements in cost controls, productivity or the adoption of new technology can bring the COGS down or the other reason could be there is huge stock lying with the company in the begining of the year. Both situations will result in a larger gross profit as there is no change in Sales and closing inventory during th year.

Both the above reasons will lead to less materials being purchased during the current period and accordingly there is decline in accounts payable during the year as less material will be purchased during the current year.