Book Description

This case recounts an actual sequence of events that unfolded in the early 1990s. The facts of this case were drawn primarily from two enforcement releases issued by the Securities and Exchange Commission (viz., AAER Nos. 1015 and 1037) and from the 1991-1994 annual reports of Perry Drug Stores, Inc. in 1992, Perry Drug Stores ranked as the 14th largest drug store chain in the nation. During that year, Perry's management discovered that the company's inventory was significantly overstated. Physical inventories of Perry's more than 200 retail outlets revealed a $20.3 million inventory shortage, representing 14 percent of the company's book inventory. The company's year-end book inventory figure was an estimate yielded by the gross profit method. Perry's executives decided not to record a book-to-physical inventory adjustments to recognize the shortage during fiscal 1992. Perry's independent auditors were aware of this decision and did not object to it. When the company's 1993 physical inventory confirmed the inventory shortage, Perry wrote off the $20.3 million shortfall, treating it as a change in accounting estimate. Perry's audit firm approved this financial statement treatment of the write-off. This case focuses on inventory accounting and control issues, in particular application of the gross profit method. In addition, the case introduces auditing issues relevant to inventory.