Financial Accounting 6 - Inventories

dexazuxo's version from 2018-01-13 21:00

Section 1

Question Answer
What is inventories?IAS 2: inventories defines this as an asset that is held for sale in the ordinary course of business, in the process of production of such sale, in the form of materials that will be consumed in the production process or the rendering of services.
What does the valuation of inventories involve? determination of unit costs, establishment of physical existence and ownership, calculation of provisions to reduce NRV (try to keep closing inventory as high as possible)
Why is inventory valuation a controversial area?Inventory is usually a multiple rather than a fraction of profit. crucial element in profit in SoCI, and total assets is SoFP
- The valuation of inventory affects the earnings per share (eps) and the current ratio (liquidity indicator; can make you appear more profitable).
- Current assets/current liabilities, therefore if current assets are boosted, will increase the figure.
- Closing inventory is a much larger number, therefore has a bigger impact on the profit
What is profit smoothing? to take a profit figure and smooth it to be more even. Investors like evenness but don’t like erratic movements. To smooth it and make it more even, can find a way to value inventory to make it a more pessimistic value

Section 2

Question Answer
Inventory valuationIAS 2 requires inventory to be stated at the lower of cost and NRV. Can use FIFO, AVCO, Standard cost, retail cost (selling price - estimated profit margin)
Are these methods meant to stipulate the flow of inventory?These methods are NOT meant to simulate the physical flow of inventory; they are merely an accounting assumption.
Appropriate overhead: Some can be in COS, some are expensed. There are 5 types.COS - Direct overheads: subcontract work, royalties. Non routine subcontract may be expensed.
COS - Indirect overheads: Factory rent, rates, power, depreciation of plant and property
Expensed – Admin overheads: can only place them to inventory if can trace then directly to a product.
Expensed – Selling and distribution overheads
Expensed - Finance overhead
Net realisable value (NRV)Estimated selling price – any additional selling costs (repackaging, advertising, delivery). PRUDENCE requires that inventories be valued at the lower cost or NRV (e.g. What you buy for, not what you will sell for). May sell for an amount lower than costs recover a part of the amount spent.
Occasions when NRV may be lower than cost includePermanent fall in market price
Excessively priced stock
High stock levels and liquidity problems
Inventory controlith inventory, discrepancies between the books and physical existence of the inventory. Causes may include theft, improper accounting, lack of inventory management systems. Management may have incentives to inflate the closing inventory value.
Opportunities for creative accounting in inventory valuationThe valuation of inventory provides the most opportunities for subjectivity and creative accounting. - Use strategies to reduce cost of goods sold and inflate closing inventory figures. May be: Inaccurate records, inaccuracies in the physical inventory count.
Creative accounting techniquesStrategies used to reduce the Cost of Goods Sold and inflate the closing inventory figure include, among others:
Keeping inaccurate inventory records / failing to record material shrinkage due to loss and theft
Subjective use of NRV rule (a possible smoothing device)
Inaccuracies in the physical inventory count (exploiting auditor’s lack of expertise)