You are a staff accountant for Pearce, Pearce, and Smith, CPAs, and have worked for several years on the audit of a major client of the firm, Flexcom, Inc. Flexcom sells its products in a highly competitive market and relies heavily on the careful management of inventory because of the unique nature of the products sold and the importance of minimizing the company’s investment in inventory. Flexcom sells cellular phones, personal handheld computers, and other communications devices that are particularly sensitive to changes in consumer demands and changes in technology, which are both frequent and significant in terms of their impact on the attractiveness of Flexcom’s products to buyers.
In the course of your work, you have noticed several trends related to inventory that interest you and that have caused you to explore further the underlying details. Specifically, you have determined the following:
Despite sluggish sales volume, the company’s net income has steadily increased for each of the last three years.
Inventory has been increasing at a higher-than-normal rate.
The allowance to reduce inventory for obsolescence has dramatically declined during the last three years, going from nearly 10 percent of inventory three years ago to approximately 2 percent at the end of the most recent year.
You are aware that, within Flexcom, profitability is a major factor in the evaluation of management and has been cited in at least two recent situations as the basis for replacing individuals in leadership positions.
Prepare a brief report to your supervisor explaining why you are bothered by these trends and offer one or more explanations that may underlie what is actually going on within Flexcom.