a merchandising company wants to include the cost of operating its warehouse in the cost of inventory. The company’s controller argues that the cost of the warehouse is a reasonable and necessary cost of getting the inventory ready for sale and, therefore, should be included in the cost of the inventory. what impact will this descision have on the firm's income stement and balance sheet? Do you think the controller is justified in his actions? WHY
If the merchandising company decides to include the cost of operating its warehouse in the cost of inventory, it will have both income statement and balance sheet implications.
1. Income Statement: The inclusion of warehouse costs in inventory will increase the cost of goods sold (COGS) on the income statement. As a result, the company's gross profit will decrease, leading to a lower net income.
2. Balance Sheet: Including warehouse costs in inventory will increase the value of inventory on the balance sheet. This increase in inventory value will affect various financial ratios, such as the current ratio and inventory turnover ratio.
Now, whether the controller's decision is justified or not depends on the specific accounting principles and guidelines followed in the company's jurisdiction. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) provide guidance on determining the cost of inventory.
Under these guidelines, the warehouse costs are not usually included in the cost of inventory. Instead, the costs directly associated with purchasing and preparing the inventory for sale, such as purchase costs, transportation, and handling costs, are included. Warehouse costs are typically considered as operating expenses, as they are not directly related to the acquisition or production of inventory.
However, it's worth noting that there may be exceptions or alternative accounting treatments allowed in certain circumstances or industries. For example, if the warehousing costs directly relate to the production process or customization of inventory, they might be capitalized as part of the inventory cost.
Ultimately, it is important for the controller to consult with the company's accountants, auditors, or seek professional advice to ensure compliance with relevant accounting standards and guidelines.