3 In general :Creative accounting refers to ways used by entities to ‘change’ or ‘window dress’ figures to achieve their desired result. The desired result may be to achieve a profit or loss position, as desired by management.There are ways to ‘window dress’ the Financial Statements. ‘Window dressing’ inventory or other current assets remain a common way.
4 Objectives After finishing this chapter, you should be able to: define inventory in accordance with IAS 2;explain why valuation has been controversial;describe acceptable valuation methods;describe procedure for ascertaining cost;calculate inventory value;explain how inventory could be used for creative accounting;explain IAS 41 provisions relating to agricultural activity;calculate biological value.
5 Inventory defined IAS 2 Inventories defines inventories as assets held for sale in the ordinary course of business;in the process of production for such sale;in the form of materials or supplies to be consumed in the production process or in the rendering of services.
6 Inventory defined (Continued) The valuation of inventory involvesthe establishment of physical existence and ownership;the determination of unit costs;the calculation of provisions to reduce cost to net realisable value, if necessary.
11 Inventory valuation methods (Continued) Average cost method (AVCO)
12 Methods rejected by IAS 2 LIFO and (by implication) replacement cost are rejected by IAS 2.Last-in-first-out (LIFO)The cost of the inventory most recently received is charged out first at the most recent ‘cost’, that is the inventory value is based upon an ‘old cost’, which may bear little relationship to the current ‘cost’.
13 Extract from the Wal-Mart 2012 Annual Report InventoriesThe Company values inventories at the lower of cost or market as determined primarily by the retail method of accounting, using the last-in, first-out (‘LIFO’) method for substantially all of the Wal-Mart Stores segment’s merchandise inventories…Inventories of foreign operations are primarily valued by the retail method of accounting, using the first-in, first-out (‘FIFO’) method. On January 31, 2008 and 2007, our inventories valued at LIFO approximate those inventories as if they were valued at FIFO.
15 Procedure to ascertain cost Direct materialDirect labourAppropriate overhead
16 Five types of overhead Direct Indirect Subcontract, royalties Non-routine subcontract might be expensed.IndirectFactory rent, ratesPowerDepreciation of plant and machineryWarehouse cost of finished goods.
17 Five types of overhead (Continued) AdministrationOffice costs easily identifiable to productionApportion wages department on head countProduction-specific admin – canteen.Selling and distributionAdvertising, delivery, sales salariesNot normally included in inventory valuationSale or return basis incurs delivery costsIncluded in inventory valuation.FinanceCost of borrowing, fees for letters of creditMay be a case for including in inventory.
18 How much of total overhead to include Important to use normal activity basis.Numerical example – normal activity
19 How much of total overhead to include (Continued) Numerical example – normal activity (Continued)
20 Net realisable value (NRV) Prudence requires lower of cost and NRVPermanent fall in market priceExcessively priced stockHigh stock levels and liquidity problemsDeterioratingObsolescenceMarketing strategy to penetrate a market.
21 Net realisable value (NRV) (Continued) Numerical example
22 Inventory controlProblem when inventory is taken at different date to year-endAdjusted inventory figure
23 Creative accounting Year-end manipulation Ineffective cut-off proceduresSuppression of invoicesWindow dressingSubjective use of NRV ruleLoad overheads onto inventory in low profit periodsOptimistic view of obsolescenceInaccuracies in the physical inventory count.
24 Inventory count Audit attendance Identification of inventory items Ownership of inventory itemsPhysical condition of inventory items.
25 IAS 41 AgricultureIAS 41Basic problem is that biological assets, and the produce derived from them (referred to in IAS 41 as ‘agricultural produce’), cannot be measured using the cost-based concepts in IAS 2 and IAS 16.This is because biological assets, such as cattle, for example, are not usually purchased; they are born and are developed into their current state.
26 The recognition and measurement of biological assets and agricultural produce IAS 41 states that an entity should recognise a biological asset or agricultural produce whenthe entity controls the asset as a result of a past event;it is probable that future economic benefits associated with the asset will flow to the entity;the fair value or cost of the asset can be measured reliably.
27 An illustrative example A farmer owned a dairy herd. At the start of the period the herd contained 100 animals that were 2 years old and 50 newly born calves. At the end of the period, a further 30 calves were born. None of the herd died during the period. Relevant fair value details were as follows:Start of period End of period$ $Newly born calvesOne-year-old animalsTwo-year-old animalsThree-year-old animals
28 An illustrative example (Continued) The change in the fair value of the herd is $3,400, made up as follows:Fair value at end of the year = (100 × $80) + (50 × $65) + (30 × $55) = $12,900Fair value at start of the year = (100 × $70) + (50 × $50) = $9,500
29 An illustrative example (Continued) IAS 41 requires that the change in the fair value of the herd be reconciled as follows:$Price change of opening newly born calves: 50 ($55 − $50)Physical change of opening newly born calves: 50 ($65 − $55)Price change of opening two-year-old animals: 100 ($75 − $70)Physical change of opening two-year-old animals: 100 ($80 − $75)Due to birth of new calves: 30 × $ ,650Total change ,400
30 End of LessonPlease complete all theory and practice questions