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IMPACT OF INVENTORY VALUATION METHODS ON FINANCIAL REPORT STATEMENTS

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.

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