A Comparative Analysis of the Impact of Inventory Valuation Methods on Financial Report Statement

Chapter One of A Comparative Analysis of the Impact of Inventory Valuation Methods on Financial Report Statement

BACKGROUND OF THE STUDY

Inventory valuation allows companies to provide a monetary value for items

that make up their inventory (stock).

Inventories are usually the largest current asset of a business and are as

important as funds (cash). It is a form of fund tied up in assets (current assets). It‟s

proper or accurate measurement or valuation cannot be overlooked as it forms a

greater percentage of an enterprise‟s current assets in particular and a total asset in

general.

For manufacturing companies, inventories usually represent

approximately 20 to 60 percent (%) of their assets. If inventory is not properly

valued, it may result that expenses and revenue may as well not be properly

matched and a company could make poor business decisions that will affect the

company‟s profit. It is essential the way assets are valued because it could be

attributable to the numerous benefits which an organization stands to gain by

keeping an accurately valued stock that meet shareholders needs, demands for

financial information and also the relevant specification of a particular

organization. However, it will be a waste of time if the record accuracy is poor.

Inventory in manufacturing company or concern comprises of the following

components:

§ Raw materials inventory

§ Work- in- progress (semi- finished goods) inventory

§ Finished goods inventory

These components show the relationship between production and sales, and

it enables an organization to offer better service to its customers at a reasonable

price.

However, the technique or method used in the valuation of inventories varies

and the values placed on inventories vary in time with the prevailing economic

parameters (inflation, deflation or static economy) and it can also be influenced by

the management policy of the organization. For instance, if the objective of an

enterprise is that of profit maximization, it may result to the use of a particular

method so as to disclose lower profit, thereby using excess fund at its disposal to

expand its operations. This type of organization may discard other methods of

valuing inventories in favour of the method that suit it objectives.

According to Nwoha (2006:69), no area of accounting has produced wider

difference in practice than the computation of amount at which inventories (stocks)

and work-in-progress as stated in financial account.

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Inventory valuation method used by an enterprise is determined by a number

of reasons. These include inflation, differences in quantity discounts, frequent

changes in prices of commodity, buying from different suppliers and also the

nature of items or product. For instance a company that deals on perishable goods,

let‟s say a grocery store, prefers an inventory valuation method that recognizes the

out flow of goods that were first in stock. This arises as a result of the perish ability

of the items treated and the high turnover rate could also be accounted for this

choice of method FIFO (first-in, first-out). The level of the three component of the

inventory stated earlier differs among organizations depending on the nature and

volume of operation undertaken. Manufacturing companies have a high level of

raw material inventory and semi-finished goods inventory as it is found in the

grocery stores. Considering the large sums of money tied up in inventory as earlier

stated, Horngren and Foster (2004:756) pointed out that it is pertinent to have an

“information model” as a result of the obvious fact that if stock matters (receipts,

issues and controls) are not properly handled, it would go a long way to jeopardize

the financial status (liquidity) as well as the profitability position of the firm.

Hence, this research work is a step in the right direction to address and highlight

the role of account professional towards the achievement of choosing and adopting

appropriate inventory valuation methods for each group of industry.

STATEMENT OF THE PROBLEMS

For a long time now the accounting profession has not been able to come up

with any particular techniques to be used uniformly in valuing inventories. Various

accounting bodies strongly recommend one method or the other. As each method

used has its effect on profits and closing inventory figures. This paves way to

differing tax assessments and brings about a situation whereby some organizations

are over assessed (overtaxed) while others are under assessed. This also bedevils

the comparability of one firm‟s performance with that of another though they may

be in the same line of business when an investor is attempting to invest his capital

in a firm.

However, each body or organization purports being consistent with the use

of certain valuation methods yet some companies adopt the method which gives

them advantage over any other recommended method or method accepted by the

Board of Internal Revenue, or Federal Board of Inland Revenue for tax assessment

purposes. The method adopted by the companies enables them to pay less tax to

the government. The problem in achieving a statutory consensus compliance

method in the administration of inventory valuation by Nigerian manufacturing

industry has persisted. An appropriate forum of diverse accounting professional

bodies is required to reach a consensus on the issues of choosing and adopting

appropriate inventory valuation methods for each group of industry.