Accounting Case – Angela Kellett Issue – 1 : Profit Margin Issues
The new owner that is buying the business is doing so because of its complementary nature – the components that will be made by Inuvik will then be bought by his own pre existing firms – The new owner may choose to mark the selling prices of the components to his own business and his incur a lower margin – which might not be detrimental to his wealth considering he can potentially mark up the prices of subsequent finished products. However there are implications of this for Mr Jones – his net income will be affected by such a strategy and he will not be paid as much as he could have based on the proper selling price. This bias can be avoided – if the selling price is the same for all the companies that deal with Inuvik to undo any bias that the new owner may have towards his own pre owned businesses to which he will supply the components.
Issue 2 : A large amount of inventory of parts used to construct its products and for repairs and maintenance of products sold. There has been no set way of evaluating this inventory that has been described.
Assumption –Management will have discretion on deciding which way to evaluate inventory by. Therefore – it might choose the option which maximized the amount of COGS , thereby making net income smaller – due to the bias that exists between the two parties.
There can exist a clause in the agreement that allows for the evaluating the inventory in the same way as it has been done previously in the business for at least a period of 2 years (till the time Mr Jones is receiving his payment for the company he sold). This helps insure that any undue bias is avoided from the side of the new owner.
Sub issue 2: Old inventory Assumption: in technology based firms there is steady decline in the amount for inventory that is old or obsolete. Hence