Can You Afford Not to Invest in Inventory Controls?

An internal auditor examines inventory control with projected losses of 2%. If controls costing $35,000 can reduce losses to .5%, should these controls be recommended?

• A. Yes, because the projected saving exceeds the cost of the added controls.
• B. No, because the cost of the controls exceeds projected savings.
• C. Yes, because the ideal internal control system is the most extensive.
• D. Yes, regardless of cost, due to employee theft.

Answer: (B)

The identified answer asserts that the cost of implementing the controls exceeds the projected savings, which is fundamental in evaluating internal control systems. To determine whether the controls should be recommended, it's pivotal to perform a cost-benefit analysis. First, let's break down the projected losses without the new controls. If inventory control losses are expected to be 2%, we can analyze the potential impact of the new controls. Assuming that the controls will reduce losses to 0.5%, that’s a reduction of 1.5% in projected losses. If we consider the cost of the inventory being evaluated, the savings from reducing the losses by 1.5% needs to exceed the $35,000 cost of the controls for them to be deemed a good investment. If the inventory amount is relatively small, say less than $2,333,333, the projected savings from the reduced loss may not cover the control costs (1.5% of $2,333,333 is approximately $35,000). The correct rationale focuses on whether the economic benefits from the controls will outweigh their costs. If the costs of implementing these controls surpass the savings derived from the enhancement of inventory control, then it is indeed logical not to recommend the controls based on financial grounds

When it comes to an internal auditor’s world, decisions often boil down to numbers. You might find yourself staring at a set of figures and wondering, “Am I making the right choice here?” Take the case of inventory control losses, for instance. An initial projected loss of 2% might prompt thoughts of risk management and controls to mitigate these losses. But when the cost of implementing those controls comes in at a whopping $35,000, the question arises: should these controls really be recommended?

Let’s wrap our heads around this. If those fancy new controls can drop the loss down to a mere 0.5%, we’re looking at a hearty 1.5% reduction in projected losses! Sounds good, right? But here’s the catch—the savings from that reduction need to eclipse the cost of those controls. So, what’s the magic number here?

Imagine we’re evaluating inventory that totals about $2,333,333. To break even, that 1.5% decline in losses—approximately $35,000—needs to stack up against the $35,000 it’ll cost us to roll out the controls. If our inventory is a bit lighter, say under $2,333,333, those projected savings might not cover control costs. Then what? We’re left at a crossroads.

Now, here’s where the internal auditor’s toolkit really shines: the cost-benefit analysis. This is where the rubber meets the road and economic sense takes the reins. Assessing whether the economic benefits from those shiny new controls outbalance their costs is pivotal. If the balance tips the wrong way, it’s time to reconsider and perhaps even put the brakes on the proposal. So, what do we do?

Let’s put it this way: if implementing controls results in a net loss, you probably don't want to push that button. After all, the best internal controls aren’t just about being ideal or elaborate; they’re about being effective and financially sensible.

So, “yes” may tempt you, especially considering employee theft whispers in the background. But we’ve got to listen to the numbers, folks. Without a solid financial strategy, investing in these controls could lead to tighter budgets and perhaps regrettable choices down the line.

At the end of the day—well, not literally—what’s critical is to weigh all angles. Sure, you want the best possible defensive measures against inventory losses, but do you really want to spend more than what you would potentially save? Perspective, folks, it’s all about perspective.