In 2008, the McQueen Company purchased from Chris Padgett the right to be the sole distributor in the western states of a product called Halenol. In payment, McQueen agreed to pay Padgett 20% of the gross profit recognized from the sale of Halenol in 2009.
McQueen uses a periodic inventory system and the LIFO inventory method. Late in 2009, the following information is available about the Halenol inventory:
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Beginning inventory, 1/1/09 (10,000 units @ $30)
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$300,000
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Purchases (40,000 units @ $30)
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1,200,000
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Sales (35,000 units @ $60)
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2,100,000
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By the end of the year, the purchase price of Halenol had risen to $40 per unit. On December 28, 2009, three days before year-end, McQueen is in a position to purchase 20,000 additional units at the $40 per unit price. The supplier guarantees the units will leave its warehouse on December 30, FOB (free on board) shipping point, and will take 3 days to reach McQueen's warehouse. Due to market demand for Halenol, McQueen can easily pass on the increased cost to its customers by raising its prices in 2010 to $80 per unit. Inventory on hand at December 28 is 15,000 units and is sufficient to meet sales demand for the next 6 months. The company doesn't expect the purchase price of Halenol to change during 2010.
a. Determine the effect of the purchase of the additional 20,000 units of Halenol and the payment due Chris Padgett.
b. Discuss briefly the ethical dilemma that McQueen faces in deciding whether or not to purchase the additional units.
c. Make a suggestion as to how McQueen and Padgett could have written the contract to avoid this ethical dilemma.
d. What does FOB shipping point mean to McQueen's inventory records? What would be the effect if the shipment was FOB destination?