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INTRODUCTION
1.0
Accounting policies are defined as the specific accounting bases selected and
consistently followed by an entity as being, in the opinion of the management,
appropriate to its circumstances and best suited to present fairly its results and
financial position. Statement of Accounting Standard (S.A.S) No. 1, issued by
the Nigerian Accounting Standards Board (N.A.S.B) defines accounting policies
as those bases, rules, principles, conventions and procedures adopted in
preparing and presenting financial statements(p. 25).
Accounting policies deal specifically with matters such as consolidation of
accounts, depreciation methods, goodwill, inventory pricing/valuation, and
research and development costs and they must be disclosed in the annual
financial statements. Accounting policies can be divided into three categories
namely: policies for revenue and expense recognition (profits and losses); assets,
investments, liabilities and provisions recording, under which inventory
valuation policies fall; and general financial reporting.
According to Ball (1972), changes in accounting policies are believed to deceive
the general public because of the effects they have on the reported incomes of
firms. He further observes that:
1
Apart from the real factors that influence firms incomes, there exist accounting factors that
permit firms to select from a variety of possible incomes to report (Ball, 1972, p. 1).
This means that if the various economic agents of society are uninformed of the
intricacies of accounting, part of which the choice of inventory valuation policy
falls under, they will not be able to distinguish between the real influences and
the accounting influences on the reported income of a firm.
Generally, inventory can be defined as the stock of items present with the
company which are to be used in the process of production, that is, a company's
merchandise, raw materials, and finished and unfinished products which have
not yet been sold. Inventory can therefore be seen as the items which are held
for sale in the ordinary course of business or which are in the process of
production for the purpose of sale, or which are to be used in the production of
goods or services which will be for sale. Inventories exist at all levels of
production, be it at the pre-production stage, work-in-progress stage and postproduction and for sale stage. Inventory valuation then, is a very important part
of cost accounting because at any given time, the company needs to know what
the value of the inventory is, to enable them to manage it better based on the
demand and supply conditions in the market.
The inventories of manufacturing companies include raw materials, goods in
process and finished goods. The purchase prices of goods and raw materials
vary. It has been argued that keeping up records of numerous purchases is
tedious and identifying the cost of specific product or goods sold is cumbersome
if not impossible for companies engaged in manufacturing (Ibarra, 2008).
Inventory valuation is an important part of the accounting function in any
manufacturing business. Apart from being a vital factor that affects the
companys cash flow, balance sheet and income statement, a big part of the
capital of the business is tied to or invested in its inventory. In fact, inventories
are perhaps the largest current asset of a business, and proper measurement of
them may be necessary to guarantee accurate financial statements. The cost of
the inventory at the end of an accounting period is crucial because of its effect
on the cost of goods sold and ultimately, on the computation of profits. The
lower the cost of ending inventory, the higher is the cost of goods sold, and vice
versa. Higher cost of goods sold will result in lower gross profit and vice versa.
Therefore, the choice of inventory costing method has a significant effect on
reported income.
For many companies, inventory represents a large portion of current assets and
becomes one of the most necessary parts. The accounting method that a
company decides to use to determine the costs of inventory can directly impact
the balance sheet, income statement and the statement of cash flow. It may
perhaps also affect the earnings per share and other financial indices, and the
investment plans. It is therefore important for all the corporations because while
the costs of inventories sold affect the income statement, the costs of the unsold
3
inventories affect the balance sheet and the value of the company at the end of
the financial year.
The casual reader will equally benefit by gaining fresh knowledge in this aspect
of accounting.
The kind of inventory valuation method chosen to determine the costs of ending
inventory has therefore been said to be one of the basic decisions all companies
engaged in the manufacturing and distribution of goods needs to make (Ibarra,
2008). Ideally, the method chosen should result in the best measure of a
company's income and financial condition.
1.1
It is a pertinent question if one were to ask the rationale behind there being
different inventory valuation methods. This is because; at the outset it would
seem that the items would be purchased and then sold all at a good price. But
therein lays the problem. The prices of inventory items rarely stay steady over
the assessment period over which the bookkeeping for a company is done and
so, valuation becomes a little tricky. Suppose, an inventory item is purchased in
bulk at the start of the year, it costs the company N10 per piece and the company
purchases inventory at different times during the year, if the price of that
inventory item increases at 10per cent each month, there would be difficulty in
understanding the value of the inventory at the end of the financial year. Has the
N10 per piece been used or the N11 per piece? This would lead to a lot of
confusion, had it not been for the scientifically and logically devised inventory
valuation methods.
But how is the right inventory valuation method selected for any firm? Many
studies have been carried out based on this question, but a complete and
exhaustive answer may not be put forward yet. This is because an average firm
in each of the industries that make up the manufacturing sector of the economy
manages different types of inventory peculiar to their production process. Since
the values of the inventory at each stage of the production process (i.e. raw
material, work-in progress, finished goods) will be used either directly or
indirectly in the determination of the gross profit and by extension the reported
income of the firm, the managers are faced with the task of selecting the
inventory valuation policy that adequately fits the nature of the production
process and therefore precisely places value on each type of inventory at each
stage.
There are various types of inventory valuation methods, but statutory and
regulatory provisions have reduced the number of methods available for use by
any firm to a select few based on their impact not only on the firms in question,
but also on the stakeholders of the firms. The main thrust of this study is
therefore the process of selecting one of these valuation policies in view of their
respective impacts in the Nigerian setting and how managers are able to make a
decision on which policy to choose or follow.
1.2
1.4
RESEARCH QUESTIONS
The study will attempt to provide answers to the following research questions:
What are the inventory valuation policies available to a manufacturing
company?
Do inventory valuation policies affect the reported incomes of manufacturing
companies?
What are the factors a manager should consider when selecting an inventory
valuation policy?
1.5
RESEARCH HYPOTHESES
H1
HYPOTHESIS II
H0
H1
HYPOTHESIS III
H0
H1
1.6
RESEARCH METHODOLOGY
For the purpose of this study, the descriptive research design will be adopted.
This design focuses on the description of the state of affairs of a situation or
particular phenomenon as it exists at present. In the context of this study, the
phenomenon is the inventory valuation selection process.
The population, for the purpose of the study comprises of all manufacturing
firms listed in the Nigerian Stock Exchange which consists of firms from the
following industries: beverages, building materials, chemicals, food, healthcare,
manufacturing & industrial, and textiles, making a total of 72 companies. The
primary focus of the study is on companies that are situated within Lagos State,
thus limiting the number of eligible companies to 35 companies.
9
10
result of the devices of design or method that establish internal and external
validity.
The purpose of this research is to investigate the inventory valuation policies
employed by manufacturing companies in Lagos State. The scope of the study
shall cover the process of selecting the inventory valuation policy used by
companies belonging to different industries, which are located within the state.
It shall also be concerned with the factors that come into play in the choice of
such inventory valuation policies and in changes of inventory valuation policies.
The study shall also be concerned with the interrelationships between the
policies and underlying factors and their impacts on the companies.
The inventory policies under consideration in this study shall be limited to
inventory policies used for valuing the finished goods, as the value assigned to
the finished goods also covers the costs of raw materials and work-in-progress,
along with other direct costs and factory overheads incurred. Also, many studies
carried out by Nigerian authors previously in this field of accounting research
were not particularly related to inventory policies in manufacturing companies,
studies like Adeyemi et al (2010) examined the use of EOQ theory in inventory
management in a manufacturing company (Coca-Cola, Ilorin Plant),focusing
mainly on the importance of inventory management in manufacturing
companies.
11
1.8
This study is structured into five chapters. The first chapter introduces the
research topic, gives its background, and states the problem to be researched
upon, the objectives of the study, the research questions and the research
hypotheses put forward. It also provides the scope, limitations and methodology
to be used in carrying out the study.
The second chapter reviews the existing literature on the choice of inventory
valuation methods by manufacturing companies. It also considers the relevant
concepts in the development of a model of the use of inventory valuation policy
in a manufacturing company.
Chapter three describes the planned research methodology which details out the
ways in which the research will be conducted. It contains the research design,
data collection method, population, sample and sampling techniques and the
techniques used in analysing the data collected by the researcher.
Chapter four provides the required analysis and presentation of data collected
through the methodology adopted for the research.
Chapter five contains the summary, conclusions and recommendations based on
the results of the data analysed.
12
1.9
DEFINITION OF TERMS
raw materials and finished goods which must be accounted for when valuing
inventory for accounting purposes. The opening and closing balances of work-
13
in-progress are shown in the cost of goods produced/ cost of production section
of the manufacturing, trading, and profit and loss account. The closing balance
is shown as a current asset in the balance sheet.
Finished goods inventory:
hand that is available for sale to customers. The closing balance is shown as a
current asset in the balance sheet, while both the closing and opening balances
are shown in the trading account when the cost of goods sold is presented.
14
REFERENCES
JOURNALS
Adeyemi S. L. and Salami A. O. (2010) Inventory Management: A Tool of
Optimizing Resources in a Manufacturing Industry. A Case Study of
Coca-Cola Bottling Company, Ilorin Plant, Journal of Social Sciences,
Vol. 23(2); pp. 135-142.
Ball, R. (1972) Changes in Accounting Techniques and Stock Prices, Journal
of Accounting Research, Vol. No. 10, pp. 1-38
Ibarra, V. (2008) Choice of Inventory Costing Method of Selected Companies
in the Philippines, Journal of International Business Research, Vol.
7(1), pp.1-8.
Sunder, S. (1973) Relationship between Accounting Changes and Stock Prices:
Problems of Measurement and Some Empirical Evidence, Journal of
Accounting Research, Vol. No. 11; pp. 1-45
INTERNET
Codjia,
M.
(2011)
Types
of
Accounting
Policies
online
http://www.ehow.com/list_6717572_types-accounting-policies.html
accessed on 3rd August, 2011.
online
at
F.W
(2011) available
online
at
www.social research
methods.net/tutorial/Mugo/tutorial.htm accessed on 25th July, 2011.
15
CHAPTER TWO
LITERATURE REVIEW
2.0
INTRODUCTION
2.1
THE
CONCEPT
OF
INVENTORY
AND
INVENTORY
VALUATION
The word inventory is defined from the Middle French word inventaire,
which means a detailed list of goods. It can therefore be defined as the stock of
items present with the company which are to be used in the process of
production, that is, a company's merchandise, raw materials, and finished and
unfinished products which have not yet been sold. This means that the items
which are held for sale in the ordinary course of business or which are in the
process of production for the purpose of sale, or which are to be used in the
production of goods or services which will be for sale can be defined by the
16
word inventory. According to Ibarra (2008), inventories are the life of the
business because they are necessary in order to generate sales and, in return,
sales generate profit for the business, stressing that cost of the inventory at the
end of an accounting period is crucial because of its effect on the cost of goods
sold and ultimately on the computation of profits. Inventory is also reflected as a
current asset on the balance sheet, and the way in which a company accounts for
its inventory can have a dramatic effect on its financial statements. Therefore,
the valuation of inventory directly affects the inventory, total current assets, and
total assets balances. Companies intend to sell their inventory, and when they
do, it increases the cost of goods sold, which is often a significant expense on
the income statement. Therefore, how a company values its inventory will
determine the cost of goods sold amount, which in turn affects gross profit
(margin), net income before taxes, taxes owed, and ultimately net income. It is
clear, then, that a company's inventory valuation approach can cause a ripple
effect throughout its financial picture. The use of different accounting policies
on inventory can cause different effects on the quality of information presented
in the profit and loss accounts and the balance sheet, and where there is no clear
regulation as to how these policies are used, the directors of these companies
therefore have the free rein to manipulate these policies to suit their own needs
and give false impressions and distorted pictures of the state of affairs of these
companies. We will now look at the efforts made to put regulations in place and
17
set standards for the use of inventory valuation policies in Nigeria, the United
Kingdom and the United states.
2.1.1 HISTORICAL BACKGROUND ON ACCOUNTING STANDARDS
FOR INVENTORY VALUATION
Standards were first set for inventory valuation policies in the early 1940s, when
the Taxation and Financial Relations of the Institute of Chartered Accountants
of England and Wales (I.C.A.E.W) was established and given the mandate of
considering and making recommendations of certain aspects of the accounts of
companies; and publishing approved recommendations for the information of
members. At that time, the importance of the members of companies being
informed of the practices and policies of the companies was being brought to
light. The accounting standard for inventory valuation was contained in the first
collection of recommendations for accounting principles, issued as the standard
for the valuation of stock-in-trade (Recommendation No. 10). In October 1960,
recommendation No. 10 was replaced by No. 22 (Treatment of stock-in-trade
and work in progress in financial accounts) which includes not only the
valuation of stock in trade, but also of work- in- progress, making the standard
applicable to manufacturing companies, not just merchandising/retailing
companies. It also recommends how these valuations should be reflected in the
financial statements.
18
However, it was within this period (1942-1969) that questions were being raised
as to the quality of information presented by the companies, perhaps owing to
the fact that the recommendations, though influential in directing how
companies should carry out financial reporting, did not require strict
compliance. This was because they were, as Robert G. Day (Day, 2000) put it,
non-mandatory but did express an authoritative statement on accounting
which improved existing practices at that time. Added to this problem was the
incidence of the failure of two large companies in the UK, and other major
incidents involving major companies where accounting practice was suspected
to be a major, if not primary cause of these incidents. This entails that the
recommendation may not have been followed, or may have been manipulated to
suit the directors needs.
Therefore in December 1969, as an attempt to remedy these problems, the
English Institute of Chartered Accountants published A Statement of Intent on
Accounting Standards, leading to the creation of the Accounting Standards
Steering Committee (A.S.S.C) in January 1970, and the setting of accounting
standards beginning in 1971. It was in May 1975 that recommendation No.22
was replaced by Statement of Standard Accounting Practice (SSAP) No. 9
(Stocks and Long Term Contracts).
Another accounting standard that has been issued with respect to inventory
valuation policies is International Accounting Standard (IAS) No. 2 (revised),
19
20
accounting process. SAS 4 also states that stocks should be valued at the lower
of cost or net realisable value (p. 44). It also permits the use of FIFO, Average
Cost, Specific Identification, Standard Cost and the adjusted selling price
methods for the valuation of stock, leaving out the Latest Purchase Price, LIFO,
and base stock methods for selection. In compliance with the standards,
companies are required to state the accounting policies in respect of inventory in
their financial statements.
2.2
THEORETICAL FRAMEWORK
22
between all the variables so the reader can understand the theorized relationships
between them.
Since 2007, the cost of inventories is determined on the FIFO, the specific
identification method or weighted average basis by the newest accounting
standards. Many studies have been conducted and published regarding inventory
costing methods used by companies in the United States and in Europe, putting
forward various theories as regards the reasons why managers select certain
inventory valuation methods for their finished goods inventory.
Chung and Narasimhan (2003) proposed that the managers selected the
inventory valuation policies based on the financial characteristics of the
companies, which included the materiality of the inventory held as per the
current assets in total, which is important in assessing the efficiency of the
inventory management capability of the firm, and the leverage ratio of these
firms, which is important in assessing the stability of these companies (i.e. the
proportion of the firm which is exposed to external debt). However the authors
were only determining the rationale behind the choices of inventory valuation
methods chosen by these companies based on whether or not these companies
can use the LIFO method for their international operations.
Although Chung and Narasimhan (2003) concluded that most multinational
companies chose the LIFO method, they stated that these companies will
continue to do so only if the value of their sales increased, otherwise they were
23
most likely to change to non-LIFO policies if any changes were to occur in the
financial structure of the companies, as shown by their financial characteristics
(increased exposure to external debt, increased inventory materiality, increased
capitalised costs incurred on fixed assets). They however did not consider the
nature of business that these firms belong to, which is supported by Ibarra
(2008) who discovered that the choice of ending inventory valuation is not
affected or dictated by the company's nature of business. Rather the two
variables seemed independent of each other.
Ibarra (2008) however discovered that the type of inventory managed by a
company has a significant relationship with the choice of using FIFO, though
some care has to be taken in extending this relationship to the use of the
weighted average method, because companies whose inventory costs are
unstable, and whose inventories are varied, are the primary users of this method,
and this includes pharmaceutical companies and oil companies. Companies in
the Food and Beverage industry make use of this method due to the perishability
of their products and the fluctuations in the costs of acquiring their products.
It is however important to note that though Chung and Narasimhan (2003) had
successfully determined why most multinational companies used a particular
method, financial ratios and indices are mere indicators, which are subject to
error, both implicit (i.e. the definitions of these ratios, the variables to be
considered in their computation) and explicit (i.e. errors that may occur from the
24
computation itself). So these ratios may not present an accurate picture of the
situation within those companies.
Cushing and LeClere (1992) created a multivariate model comprising of a
comparison of long-time FIFO and LIFO users which they used in testing
variables that influence inventory valuation policy choice. They included a tax
savings variable in their analysis, along with other factors like the physical
characteristics of the inventory they manage, such as the variability/variation of
their inventory and the rate of obsolescence of their inventory.
They discovered that tax savings is the dominant reason why firms use LIFO,
and that other firms use FIFO for a combination of reasons which include LIFO
bookkeeping costs, contradictory tax and reporting rules on accounting for
inventory obsolescence, effects on debt covenants, and the requirements of FIFO
for government contracts, though no singular reason was prevalent. They
therefore concluded that both tax and non-tax considerations influenced the
choice of an inventory costing system, which supports Chung and Narasimhan
(2003), who considered mainly non-tax aspects of the inventory valuation
policies, even though they did not consider the differences in the reported
incomes of these companies.
Notably, all these authors did not include differences in reported income as a
variable to include in their research, a factor which is considered by most
managers, as argued by Bar-Yosef and Sen (1992). They claimed that inventory
25
accounting rules may have a production repercussion on the firm that affects
shareholders wealth because managers, paid by an accounting-income based
contract, can potentially distort the operation while maximising their payoffs.
Thus, shareholders can use these rules either directly or indirectly to implement
their preferences and control the managers.
Bar-Yosef and Sen (1992) explained that the absence of taxes and inflation
highlights FIFO as the first-best decision rule, as it results in the highest reported
income, compared to other methods. However, the introduction of taxes causes a
divergence of the preferences of the shareholders and managers which may lead
to operating distortions (resulting in distortions of operating income and
reported income). Out of these distortions, an inventory valuation policy
decision must be made and this decision must optimise the trade-off between the
operating distortions (known as the incentive effect) and the tax gain derivable
from the use of LIFO. It must also align the managers interest as much as
possible with those of the shareholders.
Most of these studies focused on two inventory methods- FIFO and LIFO. Very
little research has been carried out on the other methods, namely weighted
average method and specific identification. Also, the studies under review have
focused on the choices being based on the nature of the inventory managed by
the firms as well as the nature of their businesses, ignoring the changes in
reported income caused by the use of these methods. In spite of the tax benefits
26
that accrue to companies that use LIFO, most of the companies that have been
studied still choose to use non-LIFO methods, and this cuts across industries.
This study therefore aims to find out if this is the same case in the Nigerian
manufacturing sector and to find out the reasons for this behaviour among the
companies, and to determine whether the reported incomes of these firms are a
factor considered by their managers. It must be pointed out that for financial
reporting purposes, LIFO is no longer allowed in Nigeria, so this method will
not be considered in this study.
2.3
CONCEPTUAL FRAMEWORK
According to Ibarra (2008), most companies believe that the method will match
the actual flow of goods from the warehouse to the stores. This method costs
less to implement as it simply reflects the actual flow of goods along the chain
of production and distribution.
However, Banerjee (2006) claims that FIFO is more suitable in times of falling
prices. Schroeder et al (2010) explains this claim in this way:
Including older and lower unit costs in cost of goods sold during a period of inflation causes
a an inflated net profit figure that may mislead financial statement users could also result in
the payment of additional income taxes. (p.266)
But since most companies turn over their inventory fairly rapidly, this argument
may be doubtful in most instances.
Weighted Average Method
This method is one type of a set of various styles of techniques, known as
averaging techniques/average price techniques (Banerjee, 2006). Schroeder et al
(2010) describes averaging as a compromise position between FIFO and LIFO
(Last-In-First-Out). The weighted average inventory valuation method assumes
the weighted average cost of all inventory purchased and then the items going
out of the inventory are valued at that rate.
According to Schroeder et al (2010), the use of averaging affects both inventory
valuation and the cost of goods sold, therefore it does not result in either a good
match of costs with revenues or a proper valuation of inventories, especially in
fluctuating market conditions, though this claim is refuted by Banerjee, who
29
states that the use of the weighted average method smoothens out fluctuations in
prices, though it can be quite tedious to calculate (Banerjee, 2006).
Schroeder et al (2010) expands further on his claim, stating that though a claim
can be made on the use of the Weighed Average method that the cost of goods
sold is reflective of the total periods operations; the resulting inventory
valuation is not representative of the expected future cash flows. This is
supported by Banerjee (2006), who affirms that there is some difficulty attached
to verifying the value of the closing stock figure since the identity of the
products in inventory disappear under the use of this method (Banerjee, 2006, p.
94).
Specific Identification Method
This method identifies the cost of each item of inventory, i.e. it concentrates on
the physical identification and linking of the particular items sold. An obvious
way to account for inventory through this method is via physical observation or
the labelling of items in stock with individual numbers or codes. Such an
approach is easy and economically justifiable for relatively expensive
merchandise. The specific identification method, however, is cumbersome in
situations where a company owns a great deal of inventory and each specific
inventory item is relatively indistinguishable from each other.
30
Schroeder et al (2010) explains that most companies find that the required
record-keeping associated with the procedure outweighs any expected benefits.
This method is therefore feasible when the volume of sales is low and the cost of
individual items is high, for example, with items like jewellery, automobiles,
yachts and works of art. Therefore, companies in the automobile industry will be
expected to use this method.
Mussa (2009) asserts that the specific identification method is a 100per cent
accurate method of stock valuation because of two reasons: (i) the cost of sales,
and gross and net profit are accurate; (ii) the value of stock and owners equity
(due to profit impact) are accurate as well. This, in effect, makes the information
contained within the reports generated reliable. Hence the specific identification
method promotes the reliability characteristic of the financial statements.
However Schroeder et al (2010) disproves this claim, stating that this method
has low informational content to balance sheet readers because the valuation of
inventories at original cost generally has little relation to future expectations.
It is important to note that these methods exist on simply the one assumption
that the prices of inventory increase and decrease. If they were to remain the
same throughout, then there would be no inventory valuation methods
whatsoever.
31
FIGURE 2.1 Diagram of the Manufacturing, and Trading, Profit and Loss Accounts,
Showing the Effect of Inventory Valuation on the Reported Income of Firm A
32
Cost of
production/valuation
of finished goods
inventory
Gross
Profit
Reported
Income
Sales
Relevant
costs/expenses
Flow of cost/profit
Matching of
sales with
cost
33
made; and in the absence of any other income generating venture, the lower the
reported income generated by the firm.
34
35
In addition, the manager also must consider the nature of the production
processes engaged by the firm, which could be in batches, by jobs, or
continuously (mass production), and the cost of implementing any of these
policies. The Specific identification policy is more expensive to implement
relative to the other policies, especially in economies where the cost of labour is
high, because this method is more manually intensive than the other two
methods.
Because FIFO increases reported net income in a period of rising prices, FIFO
may also increase the compensation of managers who have bonuses based on
reported income. This could boost managements motivation to adopt FIFO.
EXTERNAL FACTORS
These include effects on loan agreements, the quality of financial information
produced, the effects of reported results on investors and taxes and other
environmental conditions.
In preparing tax returns for the government, the type of inventory valuation used
will determine the cost of goods sold, thus affecting the income reported by the
firm and affecting the tax liability of the firm. FIFO assigns the older and lower
costs to inventory, which results in a higher reported income by the firm.
Therefore, the tax liability of the firm will be higher than if it used other
policies.
36
It is important to note that the effects described above occur only during a period
of rising prices, or inflation. The effects will be different during periods of
deflation or stability.
38
REFERENCES
Banerjee, B. (2006) Cost Accounting Theory and Practice (12th ed.); India:
PHI Learning Pvt. Ltd.
Bar-Yosef, S. and Sen, P. K. (1992) On Optimal Choice of Inventory
Accounting Method The Accounting Review, Vol. 67(2), pp. 320-336.
Retrieved from http://www.jstor.org/stable/247727 on 25/08/2011.
Carnes, G.A. and Englebrecht, T.D. (1992) The Internal Revenue Service's
increasing power with the clear reflection of income standard Tax
Executive, Vol. 6, pp. 1-8. Accessed from
http://findarticles.com/p/articles/mi_m6552/is_n6_44/ai_13096933/pg_3
/?tag=content;col1 on 10/08/2011.
Chung, S. and Narasimhan, R. (2003) An Empirical Analysis of the Inventory
Methods OF U.S. Multinational Companies: Segment effects. Paper
presented at the Seventh International Conference on Global Business
and Economic Development, Bangkok, Thailand; January, 2003.
Cushing, B. E. and LeClere, M. J. (1992) Evidence on the determinants of
Inventory Accounting Policy Choice The Accounting Review, Vol.
67(2), pp. 355-366.
Day, R.G. (2000) UK Accounting Regulation: An Historical Perspective
Being Working Paper No. 20 in the Working Paper series presented in
the School of Finance and Law, Bournemouth university, Dorset,
London.
Ibarra, V. (2008) Choice of inventory costing method of selected companies in
the Philippines. Journal of International Business Research, Vol.
7(1), pp.1-8.
Knight R.F., Affleck-graves J.F. and Hamman W.D. (1985) The Effect of
Inventory Valuation Methods on Share Prices: Some New Evidence for
the JSE. Investment Analysts Journal, Vol. 26, 45-47.
Schroeder R.G., Clark M.W. and Cathey J.M. (2010) Financial Accounting
Theory and Analysis: Text and Cases; New York: John Wiley & Sons.
INTERNET
Mussa (2009) "FIFO" online at http://www.docstoc.com/docs/5070221/FIFO ,
accessed on 07/09/2011.
39
CHAPTER THREE
RESEARCH METHODOLOGY
3.0
INTRODUCTION
This chapter focuses on the research methodology to be carried out in the course
of this study, the research design, population characteristics, sample size and
sampling techniques, the sources of data, research instruments used, and the
methods of data analysis employed, with the decision rules to be followed at the
completion of the analysis.
3.1
40
3.1.1
H1
HYPOTHESIS II
H0
H1
HYPOTHESIS III
H0
H1
41
3.2
RESEARCH DESIGN
The research design adopted for this study is the descriptive survey design. This
means that the relevant data collected for the research through this method were
through the researchers personal fieldwork by the use of questionnaires,
observations and personal interviews of the respondents.
3.2.1
SOURCES OF DATA
Responses generated from the questionnaire will serve as the primary source of
data for the study. The secondary sources of data for this study consist of journal
articles, articles published on the internet and textbooks.
3.3
POPULATION
The population, for the purpose of the study comprises of all manufacturing
firms listed in the Nigerian Stock Exchange which consists of firms from the
following industries: Beverages, Building Materials, Chemicals, Food,
Healthcare, Manufacturing & Industrial, and Textiles, making a total of 72
companies. The primary focus of the study is on companies that are situated
within Lagos State, thus limiting the number of eligible companies to 35 in
number.
3.4
The sampling technique used in this study is the stratified sampling technique
where a stratified sample is obtained by independently selecting a separate
42
The data collection instrument to be used for the study is the questionnaire,
which will be self-administered and collected directly. The questionnaire will be
a structured questionnaire, designed to deal with comprehensively on inventory
valuation policies. The questionnaire will be divided into 3 parts. Part A
requiring the bio-data of the respondents and Part B requiring information about
the company and testing the respondents knowledge of inventory and inventory
valuation, and Part C containing carefully worded questions relating to the study
and testing the respondents understanding of the topic and questions about the
respondents opinion of the inventory valuation policy selected.
43
3.5.1
ADMINISTRATION OF INSTRUMENTS
DATA ANALYSIS
This study utilizes the highly dependable statistical software called Statistical
Package for Social Scientists (SPSS). The Likert scale is used in drafting the
questionnaire made so that it is made adaptable to SPSS. The following
statistical techniques were used:
Simple percentage
This statistical tool will essentially help in categorising the responses given by
the respondents into the different groups as contained in the questionnaire and
express each groups figures in percentages terms to determine the agreement or
otherwise with the research questions by the respondents.
Chi-square
For the purpose of this study, the chi-square test of independence and
homogeneity will be applied to determine if there is any relationship between
the managers choice of inventory valuation policy and the reported incomes of
44
the firms they manage. The following formula is used in computing the chisquare value for the data:
(O
=
2
- Ei )
Ei
DEFINITION OF VARIABLES
For the purpose of this study, the independent variable X shall be defined as the
inventory valuation policy selected by the firm, while the dependent variable Y
shall be the reported income of the firm.
3.6.2
DECISION RULE
The null hypothesis will be tested at the 5per cent level of significance with
95per cent confidence level. If the calculated value is greater than the table
value, the null hypothesis shall be rejected. But if the table value is greater than
the calculated value, the null hypothesis shall be accepted.
3.7
45
followed before meeting the respondents, will result in delays in responses from
the respondents.
In addition to this, the unwillingness and general reluctance of company
reluctance of company employees to release information for fear of letting out
trade secrets may further limit the truthfulness and consistency of the responses
generated using this methodology.
Finally, the locations of these firms may also cause imperfections in the
methodology as these firms are spread over the Lagos metropolis, therefore
causing some difficulty in gaining access to these firms.
46
CHAPTER FOUR
DATA PRESENTATION AND ANALYSIS
4.0
INTRODUCTION
This chapter of the research study entails a clear representation and analysis of the
data collected from sampled respondents using the methods and tools discussed in
chapter three. The objective of this analysis is to allow for the testing of the
hypotheses earlier formulated in chapter one, in order to validate or reject the
various assumptions made. A total of thirty-six (36) copies of questionnaire were
administered to the sample size selected, and all the questionnaires were returned,
indicating 100per cent response rate.
4.1
Percent
MALE
26
72.2
FEMALE
10
27.8
Total
36
100.0
Table 4.1 shows that 26 respondents representing 72.2 per cent are male while
which far exceeds the female respondents which are 10 respondents representing
27.8 per cent. This suggests that the population of respondents required for the
study is male-dominated.
Table 4.2
Frequency
Percent
UNDER 21 YEARS
2.8
21-30
11.1
31-35
10
27.8
36-40
14
38.9
19.4
Total
36
100.0
48
Table 4.3
Frequency
Percent
SSCE/OND
11.1
B.SC/HND
25
69.4
M.SC
19.4
Total
36
100.0
Table 4.4
Frequency
Percent
ACCOUNTING/FINANCE
18
50.0
STORES MANAGEMENT
18
50.0
Total
36
100.0
49
This is also good for the purposes of the validity of the data gathered from the
respondents.
4.2
Table 4.5
Percent
BREWERIES
5.6
BUILDING MATERIALS
13.9
19.4
FOOD
5.6
HEALTHCARE
16.7
MANUFACTURING/INDUSTRIAL
25.0
TEXTILES
13.9
Total
36
100.0
50
4.3
YES
Frequency
Percent
36
100.0
51
Table 4.7
Frequency
Percent
RAW MATERIALS
19.4
2.8
ALL THREE
11
30.6
19.4
WORK-IN-PROGRESS
5.6
FINISHED GOODS
22.2
Total
36
100.0
52
Table 4.8
Percent
RAW MATERIALS
16.7
2.8
ALL THREE
22.2
11.1
WORK-IN-PROGRESS
11.1
FINISHED GOODS
13
36.1
Total
36
100.0
Percent
NO
2.8
YES
35
97.2
Total
36
100.0
53
Table 4.9 shows that 35 respondents representing 97.2 per cent are familiar with
inventory valuation policies, while 1 respondent representing 2.8 per cent is not
familiar with inventory valuation policies.
TABLE 4.10 INVENTORY POLICIES FAMILIAR TO RESPONDENTS
Frequency
Percent
NONE
2.8
SPECIFIC IDENTIFICATION
16.7
ALL THREE
5.6
WEIGHTED AVERAGE
5.6
FIRST-IN-FIRST-OUT
15
41.7
8.3
19.4
Total
36
100.0
However, 2 respondents
representing 5.6per cent in total are familiar with all three policies and 1
respondent representing 2.8 per cent is not familiar with any of the policies, ,
suggesting that the respondents knowledge on inventory valuation policies is
limited to either one or two policies.
54
Table 4.11
INVENTORY VALUATION
POLICIES
GOODS
Frequency
Percent
SPECIFIC IDENTIFICATION
19.4
WEIGHTED AVERAGE
16.7
FIRST-IN-FIRST-OUT
23
63.9
Total
36
100.0
55
Table 4.12
BY RESPONDENTS COMPANIES
Frequency Percent
NATURE OF INVENTORY MANAGED
13.9
COSTS OF IMPLEMENTATION
2.8
2.8
2.8
16.7
11.1
2.8
INVENTORY
COST OF SALES, GROSS PROFIT & TAX LIABILITY & NATURE OF 1
2.8
INVENTORY
EFFECTS ON COST OF SALES, GROSS PROFIT & REPORTED INCOME
16.7
8.3
INVENTORY
EFFECTS ON COST OF SALES, GROSS PROFIT & REPORTED INCOME & 2
5.6
COST OF IMPLEMENTATION
ALL EXCEPT TAX LIABILITY
8.3
2.8
2.8
INVENTORY
Total
36
100.0
respondents representing 8.3 per cent chose effects on cost of sales, gross profit,
reported income and nature of inventory managed and 3 respondents
representing 8.3 per cent chose all other reasons except tax liability. This
suggests that chief among the reasons for the use of the policies for finished
goods is its effects on the cost of sales and gross profit, which is the primary
reason given by 26 respondents, representing 72.3 per cent. The nature of
inventory managed is also a major reason given by 20 respondents representing
55.6 per cent. The effects of the inventory valuation policies on reported income
is another major reason given by 16 respondents representing 44.5 per cent. 5
respondents representing 14 per cent chose the costs of implementation, while 3
respondents representing 8.4 per cent chose the effects of inventory valuation
policies on tax liability. This suggests that the respondents believe that
inventory valuation policies are selected based primarily on their effects on cost
of sales, gross profit, the nature of the inventory managed by the company and
the effects on the companys reported income.
Table 4.13
Frequency
Percent
NO
8.3
YES
33
91.7
Total
36
100.0
57
Table 4.13 shows that 33 respondents, representing 91.7 per cent believe that
inventory valuation policies affect the appraisal of a companys financial
performance. However, 3 respondents representing 8.3 per cent do not believe
that inventory valuation policies affect the appraisal of a companys financial
performance.
Table 4.14
ASPECTS
OF
FINANCIAL
PERFROMANCE
AFFECTED
BY
11.1
2.8
25.0
8.3
30.6
INCOME
ALL THREE
13.9
8.3
Total
36
100.0
tax liability. 4 respondents representing 11.1 per cent believe that none of these
aspects of financial performance appraisal will be affected by inventory
valuation policies.
The overall analysis of the responses to questions in this section shows that the
respondents are familiar with inventory and inventory valuation as well their
categories. It also shows that 15 respondents representing 42 per cent are aware
of the effects of inventory valuation policies on their companys financial
performance, though their knowledge of this is limited to the policies in use in
their companies.
4.4
RESEARCH FINDINGS
59
Frequency
Percent
STRONGLY DISAGREE
5.6
DISAGREE
8.3
UNDECIDED
13.9
AGREE
16
44.4
STRONGLY AGREE
10
27.8
Total
36
100.0
60
Frequency
Percent
STRONGLY DISAGREE
2.8
UNDECIDED
5.6
AGREE
12
33.3
STRONGLY AGREE
21
58.3
Total
36
100.0
Percent
STRONGLY DISAGREE
2.8
UNDECIDED
13.9
AGREE
10
27.8
STRONGLY AGREE
20
55.6
Total
36
100.0
61
Table 4.17 shows that 20 respondents representing 55.6 per cent strongly agreed
and 10 respondents representing 27.8 per cent agreed that the use of inventory
valuation policies affects the reported incomes of manufacturing companies.
However, 1 respondent representing 2.8 per cent strongly disagreed and 5
respondents representing 13.9 per cent were neutral in their opinion. It can
therefore be concluded that the use of inventory valuation policies affects the
reported incomes of manufacturing companies.
Table 4.18
Percent
DISAGREE
2.8
AGREE
24
66.7
STRONGLY AGREE
11
30.6
Total
36
100.0
62
Table 4.19
THE
NATURE
OF
INVENTORY
MANAGED
SHOULD
BE
Percent
DISAGREE
2.8
AGREE
15
41.7
STRONGLY AGREE
20
55.6
Total
36
100.0
Table 4.20
REPORTED INCOME
Frequency
Percent
STRONGLY DISAGREE
2.8
DISAGREE
2.8
UNDECIDED
8.3
AGREE
12
33.3
STRONGLY AGREE
19
52.8
Total
36
100.0
63
Table 4.20 shows that 19 respondents representing 52.8 per cent strongly agreed
and 12 respondents representing 33.3 per cent agreed that the knowledge of
inventory valuation policies and their effects on reported income will enhance
the investors evaluation of the company. However, 1 respondent representing
2.8 per cent strongly disagreed, and 1 respondent representing 2.8 per cent
disagreed with this statement, while 3 respondents representing 8.3 per cent
were neutral in their opinion. It can therefore be concluded that the knowledge
of inventory valuation policies and their effects on reported income will
enhance the investors evaluation of the company.
Table 4.21
Percent
DISAGREE
5.6
UNDECIDED
5.6
AGREE
16
44.4
STRONGLY AGREE
16
44.4
Total
36
100.0
64
Percent
STRONGLY DISAGREE
5.6
UNDECIDED
19.4
AGREE
19.4
STRONGLY AGREE
20
55.6
Total
36
100.0
HYPOTHESES TESTING
This section tests the hypotheses developed for the purpose of this study using a
non-parametric tool called the chi-square test of independence and homogeneity
and decisions will be reached based on the findings. The analysis will be carried
65
out at 5per cent significant level and 95per cent confidence level i.e. this test
will only accommodate a maximum probability of risking a type 1 error of 0.05
while the confident level is 95per cent.
4.5.1 HYPOTHESIS I
Restatement of Hypothesis I
H0
H1
Expected N
Residual
SPECIFIC IDENTIFICATION
12.0
-5.0
WEIGHTED AVERAGE
12.0
-6.0
FIRST-IN-FIRST-OUT
23
12.0
11.0
Total
36
Chi-Square
Df
Asymp. Sig.
.001
66
From the above result, the calculated value is greater than the tabulated value
i.e. the calculated value of 15.167 is greater than the tabulated value of 5.99.
Here the null hypothesis should be rejected and the alternative hypothesis that
states that First-In-First-Out, Weighted Average and Specific Identification are
the methods available to manufacturing companies should be accepted.
Conclusion: First-In-First-Out, Weighted Average and Specific Identification
are the methods available to manufacturing companies.
4.5.2 HYPOTHESIS II
Restatement of Hypothesis II
H0
H1
Expected N
Residual
STRONGLY DISAGREE
9.0
-8.0
UNDECIDED
9.0
-4.0
AGREE
10
9.0
1.0
STRONGLY AGREE
20
9.0
11.0
Total
36
67
Chi-Square
22.444
Df
Asymp. Sig.
.000
From the above result, the calculated value is greater than the tabulated value
i.e. the calculated value of 22.444 is greater than the tabulated value of 7.82.
Here the null hypothesis should be rejected and the alternative hypotheses that
state that The reported income of a manufacturing company affects its
selection of an inventory valuation policy should be accepted.
Conclusion: The reported income of a manufacturing company affects its
selection of an inventory valuation policy.
4.5.3 HYPOTHESIS III
Restatement of Hypothesis III
H0
H1
68
Table 4.27
Observed N
Expected N
Residual
DISAGREE
12.0
-11.0
AGREE
24
12.0
12.0
STRONGLY AGREE
11
12.0
-1.0
Total
36
Chi-Square
Df
Asymp. Sig.
.000
From the above result, the calculated value is greater than the tabulated value
i.e. the calculated value of 22.167 is greater than the tabulated value of 5.99
Here the null hypothesis should be rejected and the alternative hypotheses that
state that The tax liability of a manufacturing company affects its selection of
an inventory valuation policy should be accepted.
Conclusion: The tax liability of a manufacturing company affects its selection
of an inventory valuation policy.
69
CHAPTER FIVE
SUMMARY, CONCLUSION AND RECOMMENDATION
5.0
INTRODUCTION
This chapter summarizes the findings of the study and also makes deductions
from those findings. It also makes recommendations based on the deductions
derived from the study.
5.1
SUMMARY
This study was carried out to achieve the objectives developed for the purpose
of the study. In order to achieve the stated objective of investigating the
inventory valuation policies employed by manufacturing companies in Lagos
State and providing answers to the research questions and hypotheses, a survey
instrument (questionnaire) was administered on respondents to generate and
examine their opinions. The study also sought to establish a relationship
between inventory valuation policies and the reported incomes of the
companies. In doing this, several literatures were reviewed for the purpose of
the study and findings revealed that extensive study have been conducted in
many countries into the effects of inventory valuation policies and their effects.
These literatures, alongside the findings in this study, revealed that inventory
valuation policies have a significant effect on the companies where they are put
to use. Studies also revealed that the financial characteristics of the company,
70
the types of inventory it manages, the tax savings/liability derivable, and its
reported income are all factors that must be considered in the selection of an
inventory valuation policy.
5.2
CONCLUSION
This study examined the perceptions of store managers and financial officers of
manufacturing companies in Lagos state regarding the choice of inventory
valuation policies and the factors to be considered in the source of making such
a decision.
The study found that the awareness of inventory valuation policies and their
effects on companies is too low in Nigeria. It also found that the use of
inventory valuation policies affects the reported incomes of the companies.
Furthermore, the study revealed that the knowledge of inventory valuation
policies and their effects is of critical value to Nigerian investors and
shareholders of companies, and that the knowledge of these policies and their
effects will enhance an investors evaluation of a company.
Finally, the findings of the study also revealed that the nature of inventory
managed by a company, its tax savings/liability derivable, and its reported
income are factors that should be considered by a manager when selecting an
inventory valuation policy.
71
5.3
RECOMMENDATIONS
72
BIBLIOGRAPHY
Adeyemi S. L. and Salami A. O. (2010) Inventory Management: A Tool of
Optimizing Resources in a Manufacturing Industry. A Case Study of
Coca-Cola Bottling Company, Ilorin Plant, Journal of Social Sciences,
Vol. 23(2); pp. 135-142.
Ball, R. (1972) Changes in Accounting Techniques and Stock Prices, Journal
of Accounting Research, Vol. No. 10, pp. 1-38
Banerjee, B. (2006) Cost Accounting Theory and Practice (12th ed.); India:
PHI Learning Pvt. Ltd.
Bar-Yosef, S. and Sen, P. K. (1992) On Optimal Choice of Inventory
Accounting Method The Accounting Review, Vol. 67(2), pp. 320-336.
Retrieved from http://www.jstor.org/stable/247727 on 25/08/2011.
Carnes, G.A. and Englebrecht, T.D. (1992) The Internal Revenue Service's
increasing power with the clear reflection of income standard Tax
Executive, Vol. 6, pp. 1-8. Accessed from
http://findarticles.com/p/articles/mi_m6552/is_n6_44/ai_13096933/pg_3
/?tag=content;col1 on 10/08/2011.
Chung, S. and Narasimhan, R. (2003) An Empirical Analysis of the Inventory
Methods OF U.S. Multinational Companies: Segment effects. Paper
presented at the Seventh International Conference on Global Business
and Economic Development, Bangkok, Thailand; January, 2003.
Cushing, B. E. and LeClere, M. J. (1992) Evidence on the determinants of
Inventory Accounting Policy Choice The Accounting Review, Vol.
67(2), pp. 355-366.
Day, R.G. (2000) UK Accounting Regulation: An Historical Perspective
Being Working Paper No. 20 in the Working Paper series presented in
the School of Finance and Law, Bournemouth university, Dorset,
London.
Ibarra, V. (2008) Choice of inventory costing method of selected companies in
the Philippines. Journal of International Business Research, Vol.
7(1), pp.1-8.
Knight R.F., Affleck-graves J.F. and Hamman W.D. (1985) The Effect of
Inventory Valuation Methods on Share Prices: Some New Evidence for
the JSE. Investment Analysts Journal, Vol. 26, 45-47.
73
Schroeder R.G., Clark M.W. and Cathey J.M. (2010) Financial Accounting
Theory and Analysis: Text and Cases; New York: John Wiley & Sons.
Sunder, S. (1973) Relationship between Accounting Changes and Stock Prices:
Problems of Measurement and Some Empirical Evidence, Journal of
Accounting Research, Vol. No. 11; pp. 1-45
74
APPENDIX
Department of Accounting,
Faculty of Business Administration
University of Lagos
Akoka-Yaba
16th September, 2011.
Dear Sir/Ma,
SECTION A: BIODATA
Instruction: Please tick [] in the appropriate box as provided.
1. Sex:
Male [
Female [
2. Age:
Under 21 years[
21-30[
]
]
31-35[
36-40[
M.Sc. [ ]
Ph.D. [
3. Educational background:
SSCE/OND [ ]
B.Sc./HND [ ]
Stores management [
]Building materials [
Textiles [
Healthcare [
Yes [
No[ ]
7. If yes, kindly indicate the categories of inventory that you are familiar with (you may
pick more than one):
Raw Materials inventory [
] Work-in-progress inventory [
] Work-in-progress inventory [
Yes[
] No[
10. If yes, which of these policies are you familiar with (you may tick more than one
option, please):
First-In-First-Out (FIFO) [
Specific Identification [
Weighted Average [
76
11. Do these policies have any effects on the appraisal of your companys financial
performance? Yes [
No [
12. Please indicate the aspects of this appraisal that these policies affect (you may tick
more than one option):
Computation of cost of goods sold and gross profit [
income [
computation of reported
13. Which of these inventory valuation policies is used for the finished goods inventory of
your company?
First-In-First-Out (FIFO) [
Specific Identification [
Weighted Average [
14. Kindly state the reasons why your company is using this inventory valuation policy:
15. Are your reasons related to any of the following (you may pick more than one)
Effects on cost of sales and gross profit
[ ]
[ ]
[ ]
Costs of implementation
[ ]
[ ]
PART C
Instruction: please indicate the extent to which you agree or disagree with the following
statements by ticking in the appropriate column
Key: Strongly Agree [SA] Agree [A] Undecided [U] Disagree [D] Strongly Disagree [SD]
S/N
16
ITEM
SA
77
SD
17
18
19
20
21
22
23
24.
Please make recommendations that will enhance the managers choice of inventory
valuation policies.
78