Comparative Analysis Of The Impact Of Inventory Valuation Methods On Financial Report Statement In Some Manufacturing Companies
Inventory valuation methods play a crucial role in shaping the financial statements of manufacturing companies. The chosen valuation method significantly influences the reported value of inventory and, consequently, impacts financial metrics. The use of methods such as FIFO (first-in, first-out), LIFO (last-in, first-out), or weighted average directly affects the cost of goods sold and, by extension, the company’s profitability. Companies employing FIFO tend to reflect higher inventory values on their balance sheets, potentially portraying a healthier financial position. Conversely, those utilizing LIFO may report lower taxable income due to assigning the most recent costs to goods sold. The choice of inventory valuation method becomes particularly pertinent in times of fluctuating prices, directly influencing a company’s reported earnings and tax liabilities. The financial statements, thus, mirror the financial health and tax implications of manufacturing entities, illustrating the intricate interplay between accounting methods and the portrayal of financial standing.
This research work was conducted on with special reference to the impact inventoryvaluation methods has on financial report statements of manufacturing companies. For a longtime 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 as a result ofthe prevailing economic circumstances. A survey research design was adopted for the study; data collected weregotten from both the primary and secondary sources. An infinite population of over 3000 was used and a finite population of 220. Three hypotheses were tested at 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 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
Title Page
Approval Page Dedication
Acknowledgments Abstract
Table Of Contents
Chapter One:
Introduction
1.1 Background Of Study
1.2 Statement Of The Problem
1.3 Objectives Of Study
1.4 Research Questions
1.5 Hypotheses
1.6 Significance Of The Study
1.7 Scope Of The Study
1.8 Limitation Of The Study
1.9 Definition Of Terms
Chapter Two:
Literature Review
2.1 History Perspective
2.2 The Problem Of Inventory Management
2.3 Inventory Valuation
2.4 Inventory Valuation Methods
Reference
Chapter Three:
Research Methodology
3.1 Introduction
3.3 Area Of The Study
3.4 Population Of The Study
3.5 Sample Size And Sampling techniques
3.6 instrument Of Data Collection
3.7 Validity Of The Instrument
3.8 Reliability Of Instrument
3.9 Method Of Data Collection
3.10 Method Of Data Analysis
CHAPTER FOUR:
Data Presentation, Analysis And Interpretation 4.1 Data Analysis
4.2 Testing Of Hypotheses
CHAPTER FIVE:
Summary Of Findings, Recommendations And Conclusion
5.1 Summary Of Findings
5.2 Recommendations
5.3 Conclusion
Bibliography
Appendix A
Appendix B
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 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.
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
assessable 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 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 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:
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 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
A. 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.
B. 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.
C. 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.
D. 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.
E. 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.
F. 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.
G. 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.
H. ASSESSABLE 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.
Impact Of Inventory Valuation Methods On Financial Report Statement In Some Manufacturing Companies:
The choice of inventory valuation methods can have a significant impact on the financial statements of manufacturing companies. The primary inventory valuation methods include:
- First-In, First-Out (FIFO): This method assumes that the first items added to inventory are the first ones sold. As a result, the cost of goods sold (COGS) is calculated based on the cost of the oldest inventory items, while the ending inventory is valued at the cost of the most recently acquired items.
- Impact on Financial Statements:
- Higher COGS: FIFO tends to result in a higher cost of goods sold, which can lead to lower gross profits and net income.
- Higher Ending Inventory: The balance sheet reflects ending inventory at a higher cost compared to other methods, leading to higher total assets and shareholders’ equity.
- Impact on Financial Statements:
- Last-In, First-Out (LIFO): LIFO assumes that the most recently acquired items are the first ones sold. Consequently, the cost of goods sold is calculated based on the cost of the most recent inventory items, and the ending inventory is valued at the cost of older items.
- Impact on Financial Statements:
- Lower COGS: LIFO often results in a lower cost of goods sold, leading to higher gross profits and net income.
- Lower Ending Inventory: The balance sheet shows ending inventory at a lower cost compared to other methods, resulting in lower total assets and shareholders’ equity.
- Impact on Financial Statements:
- Weighted Average Cost: This method calculates the average cost of all items in inventory, and this cost is used to determine both the cost of goods sold and the value of ending inventory.
- Impact on Financial Statements:
- Stable and Moderate Effects: The weighted average cost method generally has a more moderate impact on the financial statements compared to FIFO and LIFO. It results in COGS and ending inventory values that fall between those of FIFO and LIFO.
- Impact on Financial Statements:
- Specific Identification: This method individually identifies and values each item in inventory, often used for unique or high-value items.
- Impact on Financial Statements:
- Variable Impact: The impact on financial statements depends on the specific identification of items and their costs. It can result in varying COGS and ending inventory values.
- Impact on Financial Statements:
The choice of inventory valuation method can impact various aspects of a manufacturing company’s financial statements:
- Profitability: Different methods can result in different levels of reported profitability. FIFO typically leads to higher reported profits in periods of rising costs, while LIFO can lead to higher profits when costs are falling.
- Taxation: LIFO may result in lower taxable income and, therefore, lower tax expenses in times of rising costs, which can benefit a company’s cash flow. However, it may not be allowed under certain accounting standards or tax regulations.
- Balance Sheet: The choice of method affects the reported value of inventory on the balance sheet, which in turn affects total assets, shareholders’ equity, and financial ratios.
It’s essential for manufacturing companies to carefully consider the choice of inventory valuation method and ensure consistency in its application, as changes in method can impact comparability between financial statements of different periods. Companies should also consider the accounting standards and regulations applicable in their jurisdiction when selecting an inventory valuation method.