Mr. A was a junior accountant of Fine Company Limited (FCL) which is involved in the manufacturing and marketing of homogeneous products with the brand name of Dry Milk while facing the period of inflation. He had left his job due to his domestic issues and Mr. B has been hired as his replacement. While reviewing the company’s accounting records, Mr. B has come to know that there has been no consistent stock valuation policy in the past for valuing the company’s stocks. This had lead towards an inappropriate impact on the financial reporting in terms of inconsistent profitability and financial position.
He has discussed the matter with the chief accountant – Mr. C who told him that the company is in the process of implementation program of related IASs on various accounting issues. As there has been no application of IAS’s in the company, therefore, the inventory has been treated on many valuation techniques including LIFO, FIFO, weighted average, and some others keeping in view the convenience to the accountant.
Mr. B suggested applying an appropriate valuation policy so as to produce consistency in the financial reporting. He emphasized that it will let the company to present fair reporting of the company’s operation and performance in the coming financial statements. He argued that this will also match the inventory costs as per the current market prices, and the inventory will reflect fairly current market prices in the company’s balance sheet. After going through this meeting, Mr. B has been asked to prepare a preliminary report on the inventory valuation of the present stock held with the company while using the appropriate stock valuation method.
- What was the stock valuation method used by Mr. A in past that cased a lower profitability and huge difference of market price of stock with its reported cost in balance sheet? (Just write the name of asked method)?
Solution: LIFO method is used. This method assumes that the last goods purchased are the first sold. This approach charges cost of goods sold with the latest acquisition costs and ending inventory is valued at the cost of the first goods purchased. LIFO produces a better measure of net income than FIFO because the most recent (and accurate) inventory prices are charged against current revenues in cost of goods sold.
- Recommend Mr. B the most appropriate stock valuation method to use in his preliminary report for inventory valuation? (Just write the name of recommended method)
FIFO method should be used. In this method assumes that the first goods acquired are the first goods sold. This results in cost of goods sold being charged with the earliest cost and ending inventory stated in terms of the most recent cost.
- Upon what grounds did you recommend the method in question 2 above?
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LIFO is recommended by International Financial Reporting Standards