A COMPARATIVE ANALYSIS OF THE IMPACT OF INVENTORY VALUATION METHODS ON FINANCIAL REPORT STATEMENT IN SOME MANUFACTURING COMPANIES IN ENUGU STATE
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A COMPARATIVE ANALYSIS
OF THE IMPACT OF INVENTORY VALUATION METHODS ON FINANCIAL REPORT STATEMENT IN
SOME MANUFACTURING COMPANIES IN ENUGU STATE
ABSTRACT
This research work was conducted on with special reference to
the impact inventory valuation 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 of the 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
TABLE OF CONTENTS
TITLE PAGE…………………………………………….…………………i
APPROVAL PAGE………………………………………………………..ii
DEDICATION…………………………………………………..…………iii
ACKNOWLEDGMENTS…………………………………………….……iv
ABSTRACT………………………………………………………………...v
TABLE OF CONTENTS…………………………………………………..vi
CHAPTER ONE: INTRODUCTION
1.1BACKGROUND OF STUDY………………………………………1
1.2STATEMENT OF THE PROBLEM……………………………..…4
1.3OBJECTIVES OF STUDY……………………………………….....5
1.4RESEARCH QUESTIONS………………………………………….5
1.5
HYPOTHESES……………………………………………………...6
1.6 SIGNIFICANCE OF
THE STUDY………………………………...7
1.7 SCOPE OF THE
STUDY……………………………………..........8
1.8 LIMITATION OF
THE STUDY.....................................................9
1.9 DEFINITION OF
TERMS……………………………………..…..10
CHAPTER TWO:LITERATURE REVIEW
2.1 HISTORY
PERSPECTIVE………………………………..………..13
2.2 THE PROBLEM OF
INVENTORY MANAGEMENT………..…..14
2.3 INVENTORY
VALUATION………………………………………..16
2.4 INVENTORY
VALUATION METHODS…………………….……20
REFERENCE……….......................................................................37
CHAPTER THREE: RESEARCH METHODOLOGY
3.1
INTRODUCTION.……………………………………….……………39
3.3 AREA OF THE
STUDY……………………………….……………...40
3.4 POULATION OF
THE STUDY………………………………………41
3.5 SAMPLE SIZE AND
SAMPLINGTECHNIQUES……………….…41
3.6 INSTRUMENT OF
DATA COLLECTION……………………….…44
3.7 VALIDITY OF THE
INSTRUMENT …….………………………....45
3.8 RELIABILITY OF
INSTRUMENT ……………………………...…..45
3.9 METHOD OF DATA
COLLECTION………………………………..46
3.10 METHOD OF DATA
ANALYSIS…………………………………...46
CHAPTER
FOUR:DATA PRESENTATION, ANALYSIS AND INTERPRETATION
4.1DATA ANALYSIS………………………………..………………….....49
4.2 TESTING OF HYPOTHESES ……………………….………………...66
CHAPTER FIVE:SUMMARY OF FINDINGS, RECOMMENDATIONS AND
CONCLUSION
5.1 SUMMARY OF
FINDINGS…………………………………………..82
5.2
RECOMMENDATIONS……………………………………………....84
5.3
CONCLUSION…………………………………………………...........86
BIBLIOGRAPHY………………………………………………………88
APPENDIX A…………………………………………………...……...90
APPENDIX B…………………………………………………………….9
CHAPTER ONE
1.0INTRODUCTION
1.1BACKGROUND 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). Its 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 respondents 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 ongoing 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.
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