An internal auditor is examining inventory control in a merchandising division with annual sales of $3,000,000 and a 40 percent gross profit rate. Tests show that 2 percent of the dollar amount of purchases does not get into inventory due to breakage and employee theft. Adding certain controls costing $35,000 annually could reduce these losses to 0.5 percent of purchases. Should the control be recommended?
ANSWER: No, because the cost of the added controls exceeds the projected savings.
REASON: Annual cost is US $35,000, but the cost savings is only US $27,000 {(2.0%-0.5%) x [$3,000,000 sales x (1.0-0.4 gross profit rate)]}.This is a self-study exam model. Please break down this formula.