Regulating Inventory Essay Example

align="justify">According to AASB 102, paragraph 12, fixed production and manufacturing overheads, like factory depreciation or rent, must be allocated to the cost of inventories as conversion costs. This is done in the same way as direct labour and other variable costs using the "absorption costing" method, which is required by AASB 102. However, if attainable and regularly reviewed, "standard costs" based on prior planning can be used instead.

Paragraph 13 of the text states that in order to ensure consistent cost figures, costs should be allocated based on "normal capacity," which refers to the expected production levels minus any reductions caused by planned maintenance. However, if the actual production levels are close to the normal capacity, they can be used instead. AASB 102 also permits different methods of measuring cost for service providers, agricultural produce harvested from biological assets, and retailers. Furthermore, paragraph 19 mandates that service providers include labor costs, other costs related to personnel directly involved in providing the service, and relevant overhead expenses.

When measuring agricultural inventories, paragraph 20 refers to AASB 141, which states that the cost of harvested inventories should be measured at their fair value less the costs to sell at the point of harvest. Paragraph 22 outlines the retail method, which determines the cost of inventory by subtracting an average gross margin (mark-up) percentage for each relevant department from the sales value of the inventory, considering any mark-ups or mark-downs applied. An example of costs can be seen in Table 10.

In the given example, AASB 102 mandates that the cost of purchasing and transporting raw materials must be included in the overall cost of acquiring finished

goods, as these expenses are directly linked to the procurement process. Conversely, the expenses related to renting and depreciating the factory premises, as well as the salaries of factory workers, should be accounted for as costs of conversion since they are incurred during the transformation of materials into finished products. As per paragraph 16, expenses such as salaries of administrative staff, administration building rent, and office furniture depreciation should not be considered in the calculation as they are not relevant to bringing the inventories to their current location.

The cost of shipping to customers is not included in the purchase or production of goods and does not affect the overall cost of inventory. Expenses related to late payment, although they may occur during the purchase or production process, are mainly a result of mismanagement of accounts payable and are also excluded from the cost of inventory (Deegan, 2010 pp. 227). According to paragraph 10 of AASB 102, each unit of inventory has a total cost of $52. Therefore, the total cost for 10,000 units is $52,500 or $5.25 per unit.

The net realisable value of the inventory is determined by subtracting the estimated cost of completion and the cost necessary to make the sale ($5.30 per unit) from the selling price ($15 per unit), resulting in a value of $9.70 per unit. Paragraph 9 ensures accurate reporting by stating that the lower value between the net realisable value and the cost ($5.25 per unit) should be used. AASB 102 allows assumptions about cost-flow and valuation of ending inventory, avoiding impracticality.

This text explores different methods for determining the cost of inventories, such as "specific identification,"

"weighted average," and "first-in-first-out (FIFO)." Originally, the International Accounting Standard IAS 2 permitted the use of the "last-in-first-out (LIFO)" technique. However, in 2004, this standard was modified to prohibit LIFO due to its exploitation of tax benefits. Additionally, paragraph 25 emphasizes that entities must consistently apply a consistent cost method to inventories with similar nature and purpose.

The weighted-average approach calculates the average cost of goods by combining the opening inventory cost and the cost of goods purchased during the period. This average cost is used to value the ending inventory. The FIFO method assumes that the first goods purchased are sold first, and values the ending inventory based on the costs of more recent purchases. On the other hand, the LIFO method values the ending inventory using the costs of earlier purchases instead (Deegan, 2010 pp. 234).

When it comes to reporting, if the chosen cost-flow method aligns with the assumptions made for physical inventories, there are no significant issues. However, difficulties arise when the cost-flow method only appears in accounting figures and not in actual inventory flow. In situations where prices tend to rise over time due to inflation, the LIFO method assumes that the most recent purchases, which are generally more expensive, are sold first. As a result, the cost of goods sold increases, leading to a lower profit and an understatement of ending inventory if the newest physical goods were not actually sold first.

LIFO was a popular tool for reducing income tax due to its ability to lower profit. However, it also distorts major ratios like current, debt-to-equity, and turnover ratios. Additionally, the valuation process of LIFO cannot run consistently

throughout the year; it is primarily a year-end calculation. This reliance on future price forecasts rather than current inventory increases the need for adjustments, raises the possibility of errors occurring, and incurs higher costs in overseeing the system (Gibson, 2002).

In 2004, the International Accounting Standards Board prohibited LIFO due to problems it caused. However, the FIFO method, favored by the IASB and AASB over LIFO, is also not without flaws. The assumption that the first goods purchased are the first to be sold can lead to an inflated figure for profit, as the cost of goods sold remains at a historical level while the cost to replace those goods has risen (Miller, 2004).

According to AASB 102, adjustments to inventory values are allowed in paragraphs 32 and 33. However, these adjustments are only permitted for write-downs of net realisable value and the subsequent reversal of those write-downs. The AASB Framework for the Preparation and Presentation of Financial Statements establishes the objective of financial statements as providing understandable, relevant, reliable, and comparable information that is useful to a wide range of users when making economic decisions (AASB, 2004).

The purpose of AASB 102 is to ensure understandability by disclosing the accounting policies used in measuring inventories, such as cost formulas and methods. The financial statements should also include information on the total carrying amount of inventories, how they are classified for the entity, the carrying amount of inventories at fair value less costs to sell, the expenses recognized from inventories during the period, and any write-downs conducted under paragraphs 32 and 33 (2009), along with their associated circumstances, results, and reversals.

Standardization and regulation

pose challenges in achieving comparability and reliability. Different organizations with varying needs may benefit from alternative inventory management methods, such as specific-identification, weighted-average, and FIFO. However, regulators must carefully balance the risk of embezzlement against the goal of achieving easy and absolute comparability.

Paragraphs 9 to 22 focus on addressing the components of comparability and reliability, specifically discussing the methods for measuring inventory. Additionally, paragraphs 23 to 33 outline the methods for valuing inventory. To prevent profit manipulation, the standard does not include LIFO as an acceptable inventory valuation method. Reliability is also addressed in paragraph 13, where it stipulates that total inventory costs should be allocated based on "normal capacity," which refers to the average expected production value.

In situations where production is low or idle, unit costs may seem higher because fixed production costs are included. To address this issue, the figure for normal capacity considers any decrease in production caused by planned maintenance. Currently, the AASB allows three methods of inventory valuation and five techniques for measuring inventories, although ideally only one set of methods would be needed in a standardized environment.

These provisions cover various types of businesses, which enables a certain level of comparability in inventory. However, this emphasis on comparability can result in challenges stemming from inconsistencies between accounting practices and physical inventory movement. These discrepancies may cause profits and asset balances to be greatly over or under-reported, distorting users' perception of an organization's financial state.