Impact of Inventory Valuation Methods on Financial Report Statement

CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

Inventory refers to the stock of the resources which are held for sales and/or future production. It can be also viewed as an idle resource that has an economic value. So, better management of the inventories would release capital productively. Inventory control implies the coordination of materials controlling, utilization and purchasing. It has also the purpose of getting the right inventory at the right place at the right time with the right quantity because it is directly connected with the production. This implies that the profitability of the firm is directly or indirectly affected by inventory management.

The inventory valuation method used by an enterprise is determined for several reasons. These include inflation, differences in quantity discounts, frequent changes in prices of commodities, buying from different suppliers, and also the nature of items or products. For instance, a company that deals in perishable goods, let’s say a grocery store, prefers an inventory valuation method that recognizes the outflow of goods that were first in stock.

This arises as a result of the perishability 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 components 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 is found in the grocery stores.

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). Its 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 an 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.

The way assets must be valued could be attributable to the numerous benefits which an organization stands to gain by keeping an accurately valued stock that meets 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 a manufacturing company or concern comprises the following components:

Raw materials inventory, Work-in-progress (semi-finished goods) inventory, and 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 in the use of a particular method to disclose lower profit, thereby using excess funds at its disposal to expand its operations. This type of organization may discard other methods of valuing inventories in favor of the method that suits its objectives.

According to Nwoha (2006), no area of accounting has produced a wider difference in practice than the computation of the amount at which inventories (stocks) and work-in-progress as stated in the financial account.

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 professionals in the achievement of choosing and adopting appropriate inventory valuation methods for each group of industries.

1.2 Statement of the Problems

The techniques used in inventory valuation have for long been an issue for the accounting profession. This has become a problem for the accounting profession – the lack of no particular techniques to be used uniformly in valuing inventories. Various accounting bodies strongly recommend one method or the other. Each method used has its effect on profits and closing inventory figures. This paves the way for 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 to be consistent with the use of certain valuation methods yet some companies adopt the method which gives them an 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 the 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. Hence, this research work is a step in the right direction to address the role of accounting professionals in the achievement of the objective.

1.3 Research Questions

The following questions are formulated for this study;

1. Does an inventory valuation method have any impact on the assessable income tax of a Nigerian manufacturing company?
2. What influence does the prevailing economic parameter have on the inventory valuation method used by Nigerian manufacturing companies?
3. To what extent does the variance in the inventory valuation method affect the financial reporting positions of Nigerian manufacturing companies?

1.4 Objectives of the Study

The aim of this research work includes the following:

To determine whether inventory valuation methods have any impact on the assessable income tax of Nigerian manufacturing companies.

To ascertain whether the prevailing economic parameters influence the inventory valuation method used by Nigerian manufacturing companies.

To determine whether variances in inventory valuation methods affect financial reporting positions of Nigerian manufacturing companies.

Other headings in chapter one include the followings.