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An executive in a merchandising company receives an annual bonus equal to 5% of net income. Historically, the company has calculated the cost of goods sold and ending inventory using LIFO and has maintained 30,000 units in inventory for the last 10 years. The executive is recommending the company reduce the number of units in year-end inventory to 1,000. Over the 10-year period, the cost per unit of inventory has increased from $60 per unit to $110 per unit.
Problem 1: Inventory is costed is a big deal and would require a lot of work in addition to looking back and maybe restating financial statements. It is important to keep in mind both the short term and long term consequences of this decision. Also, whether or not the executive's bonus structure is congruent with the companies goals. In other words, does the bonus encourage behavior which is beneficial to the company.
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