# MGT401 Financial Accounting II GDB 2 Solution Fall 2013

MGT 401

“Measurement of Inventories IAS-2”

SWAN Shoes Ltd. was established in 1980. Initially, company was engaged in leather processing, manufacturing of shoes and its trade in local market. In 1998, it expanded its business internationally & started exporting shoes. Main target of the company were European countries. In today’s competitive environment, companies across industries are emphasizing on inventory valuation. Management of the company is interested in changing its inventory valuation technique from FIFO to weighted average. Prices of leather are increasing day by day. Selection of method used for inventory valuation does not change the reality of economic transactions, that have occurred but it is taken into consideration for financial reporting propose.

Accountant of SWAN Shoes Ltd. reported following differences if company switches to weighted average method from First-In-First-Out method.

 Year Inventory First-In-First-Out (Rs.) Weighted Average Method (Rs.) 2002 Opening 34,000 30,000 2002 Closing 45,000 51,000 2003 Closing 65,000 60,000 2004 Closing 60,000 66,000

Requirements:

Q1. What will be the effects of above figures on the profits of the respective years due to change in the basis of valuation? Give arguments to justify your answer.    (Marks 4)

Solution: HIGHER VALUE OF STOCK LEADS TO LOWER COST OF SALES, THEREFORE HIGHER PROFITS.OVERALL PROFIT IS MORE BY USING WEIGHTED COST METHOD

Q2. In the year 2004, 1/3rd of the inventory was damaged. It has been estimated that it will now be sold at 10% less than the normal selling price which is 25% above the weighted average cost. To fetch this sale, the company has to incur Rs. 1,500 on rework of the inventory. Determine the value of the damaged inventory to be presented in the balance sheet.(Mark 1)

Solution: VALUE REPRESENTED IN BALANCE SHEET AT COST OR NRV, which ever IS LOWER.

COST 22,000, NRV 23,250, SO LOWER VALUE IS 22,000

NRV= (22000*125/100)*90/100 = 23,250