The Impact of Inventory Valuation Methods on Financial Report Statement

Abstract

This research work was conducted with special reference to the impact inventory valuation methods have on the financial report statements of manufacturing companies. For a long time now the accounting profession has not been able to come up with any particular technique or method to be used uniformly in valuing inventory. This research work examined if the method used was a result of the prevailing economic circumstances. A survey research design was adopted for the study; data collected were gotten from both primary and secondary sources. An infinite population of over 3000 was used and a finite population of 220. Three hypotheses were tested at a 5 percent level of significance. Tables and percentages were employed to answer the questionnaires while the statistical regression coefficient analysis and Z- test were used to test the hypotheses. It was found amongst others that the prevailing economic parameter influences the decision of choice of an inventory valuation method used. The Accounting professional bodies should try as much as possible to adopt a particular method of inventory valuation and the weighted average method was recommended as a method that can withstand any economic challenges.

CHAPTER ONE

1.0 INTRODUCTION

1.1 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 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
• 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 (2006:69), 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.

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 by 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. 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

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. 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 OBJECTIVES OF THE STUDY

The aim of this research work includes the following:

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

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

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

4. To provide an acceptable basis for valuing inventory on hand.

5. To evaluate certain limiting factors faced by accountants in inventory valuation.

6. To make recommendations based on findings.

1.4 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?

1.5 HYPOTHESES

The following hypotheses are formulated to help achieve the purpose of the study:

HYPOTHESIS ONE

H0: inventory valuation methods do not have any impact on the assessable income tax of Nigerian manufacturing companies.

H1: inventory valuation methods have an impact on the assessable income tax of Nigerian manufacturing companies.

HYPOTHESIS TWO

H0: the prevailing economic parameters do not influence the inventory valuation methods used by Nigerian manufacturing companies.

H1: The prevailing economic parameter influences the inventory valuation methods used by Nigerian manufacturing companies.

HYPOTHESIS THREE

H0: the variance in inventory valuation methods does not affect the financial reporting positions of Nigerian manufacturing companies.

H1: the variances in inventory valuation methods affect the financial reporting positions of Nigerian manufacturing companies.

1.6 SIGNIFICANCE OF THE STUDY

The proper valuation of stock (inventory) cannot be overlooked. This research work is significant in the following ways:

1. It will determine if inventory valuation methods play any significant role in ensuring the firm’s accountability.

2. It will determine the role of the accounting department in a firm‟s inventory valuation.

3. It will x-ray what true and fair means about inventory valuation.

4. It will determine the causes of misrepresentation of true and fair views of financial statements of firms and usher useful suggestions to stop the practice.

5. It will offer useful suggestions for making the store manager more efficient in preparing or advancing adequate data that will lend credibility to a true and fair view of a firm’s operation and financial statement.

6. It shall serve as an aid to companies that want to change their methods but are unable to identify the impact of the different methods on their financial statements under the prevailing economic situation.

7. It will be meaningful to other researchers and businesses for it will serve as reference material and the recommendation will be very useful for organizations that have problems in their application of inventory valuation methods.

1.7 SCOPE OF THE STUDY

This research work will be limited to the use of questionnaires and oral interview where appropriate and to a review of related literature (relevant books, journals, etc.) that would provide an adequate and lasting solution to the problem of inventory valuation. Data collection will be restricted to three manufacturing companies which are Emenite limited, Innoson industrial and a technical company limited, and Alo aluminum manufacturing company all in Enugu state.

Furthermore, the study is equally limited to the study of the impact of the different methods on inventory valuation on a company‟s financial statement with particular reference to its effect on:

Tax assessable profits on companies.

Amount of tax payable by firms under the different methods,

The cost of goods sold value reported under the methods,

Closing stock values reported under these methods,

The decision of the potential and actual investors in the companies is based on available divisible profits.

1.8 LIMITATIONS OF THE STUDY

In carrying out this research project, the researcher encounters problems that may be attributed to;

1. Unreliable or irrelevant information obtained from oral interviews. This was based on the degree of the respondent‟s truthfulness in answering the questions asked during the oral interview. Some respondents thought the research was to expose their company and thus were unwilling to give adequate and relevant information.

2. As a result of time the researcher was restricted to just the LIFO (Last-In, First-Out), FIFO (First-In, First-Out), and the WAM (Weighted Average method) of inventory valuation.

3. The researcher encountered the problem of not getting back all the questionnaires administered to respondents for responses.

REFERENCES

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Adeniyi, A.A(2009).Cost Accounting; A managerial approach. El –Toda ventures ltd.

Horngren, E.T(1982).Cost Accounting. A managerial emphasis (5th Edition) London: Prentice-Hall.

Lucy, T (1984). Costing; An instructional manual, Eastleigh Hants: D. P publications

Nweze, A. U (2004). A quantitative approach to management accounting (3rd Edition) Enugu: Computer edge publishers.