A COMPARATIVE ANALYSIS OF THE IMPACT OF INVENTORY VALUATION METHODS ON FINANCIAL REPORT STATEMENT IN SOME MANUFACTURING COMPANIES
CHAPTER ONE
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 enterprises 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:
1. Raw materials inventory
2. Work- in- progress (semi- finished goods) inventory
3. 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. 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.
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. 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. Hence, this research work is a step in the right direction to address the role of accounting professional towards 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 accessible income tax of Nigerian manufacturing company.
2. To ascertain whether the prevailing economic parameters influences the inventory valuation method used by Nigerian manufacturing company.
3. To determine whether variances in inventory valuation methods affect financial reporting positions of Nigerian manufacturing company. 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 the purpose of this study;
1. Does an inventory valuation method have any impact on the assessable income tax of Nigerian manufacturing company?
2. What influence does the prevailing economic parameter have on the inventory valuation method used by Nigerian manufacturing company?
3. To what extent does the variance in inventory valuation method affect 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 accessible income tax of Nigerian manufacturing companies.
H1: inventory valuation methods have an impact on the accessible 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 financial reporting positions of Nigerian manufacturing companies.
H1: the variances in inventory valuation methods affect financial reporting positions of Nigerian manufacturing companies.
1.6 SIGNIFICANCE OF THE STUDY
The proper valuation of stock (inventory) cannot be over looked. This research work is significant in the following ways:
1. It will determine if inventory valuation methods play any significant role in ensuring the firms accountability.
2. It will determine the role of account department of a firm‟s inventory valuation.
3. It will x-ray what true and fair means with regard to inventory valuation.
4. It will determine the causes of misrepresentation of true and fair view of financial statement of firms and usher useful suggestions to stop the practice.
5. It will offer useful suggestions towards making the store manager more efficient in preparing or advancing adequate data that will lend credibility to a true and fair view of a firms 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 prevailing economic situation.
7. It will be meaningful to other researchers and business 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 questionnaire and oral interview where appropriate and to a review of related literature (relevant books, journals, etc.) that would provide 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 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 company‟s financial statement with particular reference to its effect on:
1. Tax assessable profits on companies.
2. Amount of tax payable by firms under the different methods,
3. The cost of goods sold value reported under the methods,
4. Closing stock values reported under these methods,
5. The decision of the potential and actual investors in the companies based on available divisible profits.
1.8 LIMITATIONS OF THE STUDY
In carrying out this research project, the researcher encounters problems which 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 respondent 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.
1.9 DEFINITION OF TERMS
INVENTORY
This is also known as stock. These are assets held for sale in the ordinary course of business, in the process of production for such sale; or in the form of materials or supplies to be consumed in the production process or in rendering of services.
FINANCIAL STATEMENTS
These are statements produced at the end of accounting periods, such as income statement, cash flow and statement of financial position. They are reports which summarize the financial position. They are reports which summarize the financial position and operating results of a business.
CONSISTENCY IN INVENTORY VALUATION
This is an accounting standard which demands for the use of the same method of inventory pricing (valuation) from year to year, with full disclosure of the effect of any change in method to enhance the comparability of financial statements presented in the annual report.
MANUFACTURING COMPANIES
These are establishments that combine men, materials and machinery in an effective manner with the aim of producing goods for human consumption and also to make profit for the on going of the business.
BUFFER STOCK
It is an additional inventory held in excess of that needed to meet normal demand and which leads to avoidance of stock out. It could also be referred to as safety stock.
WORK- IN- PROGRESS
This is part of a manufacturer‟s inventory that is in the production process and has not yet been completed and transferred to the finished goods inventory.
STOCK OUT
This refers to when the stores department of a manufacturing company, or a store runs out of a type of stock before the next order arrives.
ACCESSIBLE INCOME
This is the amount of income (after charging expenses against the gross income) from each source in the year immediately preceding the year of assessment.
