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CHAPTER ONE

INTRODUCTION

1.0 BACKGROUND OF THE STUDY

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:

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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 post-

production 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

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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

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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 STATEMENT OF THE PROBLEM

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

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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

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respective impacts in the Nigerian setting and how managers are able to make a

decision on which policy to choose or follow.

1.2 PURPOSE OF THE STUDY

The primary objective of this study is to investigate the inventory valuation

policies employed by manufacturing companies in Lagos State. Therefore, this

study is designed to achieve the following objectives:

To highlight the various inventory valuation policies available to a

manufacturing company.

To establish a relationship between the inventory valuation policy used by a

manufacturing company and the reported income of that company;

To identify the factors a manager should consider when selecting an inventory

valuation policy;

1.3 SIGNIFICANCE OF THE STUDY

Generally accepted accounting principles allow alternative treatments of several

types of accounting events. Financial accounting policy-making bodies such as

the Nigerian Accounting Standards Board (N.A.S.B) and the Securities and

Exchange Commission rule on the admissibility of various accounting

procedures and on changes from one procedure to another. For this purpose,

they need information about the effect of accounting procedures and changes in

accounting procedures on the interest of various economic agents in society.

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Admissibility of alternative procedures implies that corporate managers must

select one of the available procedures for their use. For making such selection,

managers need information about the relationship of accounting procedures with

corporate objectives.

In making their investment decisions, investors too need information not only

about the meaning of various accounting procedures but also about the

relationship of these procedures with stock prices. Likewise, tax authorities will

also need information about the effects that these accounting procedures have on

the reported incomes of these firms which have a direct bearing on the tax that

these firms are liable to.

Finally, shareholders of manufacturing firms also need this information as it

helps them understand the relationship of these accounting procedures with the

reported income and the share prices of the firms so that they can determine

whether a change in the reported income or share price of a firm is caused either

by a change in accounting procedure or by improved trading activities/a newly

discovered advantage or strength.

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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

The research hypotheses for this study are stated as follows:

HYPOTHESIS I

H0 The inventory policies available to a manufacturing company are the

First-In-First-Out, Weighted Average and the specific identification

methods.

H1 First-In-First-Out, Weighted Average and Specific Identification are not

the methods available to manufacturing companies.

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HYPOTHESIS II

H0 There is no relationship between the inventory valuation policy used by a

manufacturing company and its reported income.

H1 The reported income of a manufacturing company affects its selection of

an inventory valuation policy.

HYPOTHESIS III

H0 There is no relationship between the inventory valuation policy used by a

manufacturing company and its tax liability.

H1 The tax liability of a manufacturing company affects its selection of an

inventory valuation policy.

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.

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The sampling technique to be used will be the stratified sampling technique

where a stratified sample is obtained by independently selecting a separate

simple random sample from each population stratum. A population can be

divided into different groups based on some characteristics or variables, which,

in the context of this study, are the industries which these firms belong to. A

total of 18 companies will be selected as the sample size for the study.

The data collection instrument to be used for the study is the questionnaire,

which will be self-administered and collected directly. The questionnaire will

serve as the primary source of data for the study. The secondary sources of data

for this study consist of journals, articles published on the internet and

textbooks.

The respondents for this study are the financial managers/directors of each

company, as they have a knowledge of the accounting and financial policies of

the companies within which they serve. Therefore they will be able to provide

information that will be relevant to the study.

1.7 SCOPE AND LIMITATION OF THE STUDY

The limitations of the study are those characteristics of design or methodology

that set parameters on the application or interpretation of the results of the study;

that is, the constraints on generalizability and utility of findings that are the

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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.

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1.8 ORGANIZATION OF THE STUDY

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.

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1.9 DEFINITION OF TERMS

Inventory: This is defined as a detailed, itemized list, report, or record of

things in one's possession, especially a periodic survey of all goods and

materials in stock. Inventories are the life of the business and are essential for

manufacturing businesses. This is because inventories are necessary in order to

generate sales and, in return, sales generate profit for the business. For the

purpose of this study, inventory will be considered with relation to the

manufacturing sector.

Inventory valuation: This is defined as the determination of the cost

assigned to raw materials inventory, work-in-progress, finished goods and any

other inventory item. It is the lower of cost or market value applied on an item

by item basis, a category basis or a total basis.

Raw material inventory: This is the opening or closing balance of raw

materials on hand for an accounting period. It represents items that will be a

component of a produced good. The opening and closing balances are shown in

the manufacturing account, when the cost of goods manufactured is presented,

while the closing balance alone is reported in the balance sheet.

Work- in-progress: This is defined as inventory that is at a stage between

raw materials and finished goods which must be accounted for when valuing

inventory for accounting purposes. The opening and closing balances of work-

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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: This is the amount of manufactured products on

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.

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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.

Kulkarni, A. (2010) Inventory Valuation Methods, online at http://www.buzzle.com/ accessed on 15th February, 2011.

Mugo, F.W (2011) available online at www.social research methods.net/tutorial/Mugo/tutorial.htm accessed on 25th July, 2011.

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CHAPTER TWO

LITERATURE REVIEW

2.0 INTRODUCTION

This chapter focuses on the history of accounting standards on inventory

valuation, the review of prior literature and of studies previously carried out in

the aspect of accounting relating to inventory valuation policies. It also

considers the relevant concepts in the development of a model of the use of

inventory valuation policy in a manufacturing company, their importance, and

the factors to consider in selecting an inventory valuation policy.

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

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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

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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.

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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),

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issued in December 1993 and replacing I.A.S 2- Valuation and Presentation of

Inventories in the context of the historical cost system, which was issued in

October 1975. I.A.S 2 is the most recent development in the setting of

accounting standards, as it is part of the accounting standards to be followed by

companies adopting the International Financial Reporting Standards (I.F.R.S) in

the preparation and presentation of their financial statements.

Under S.S.A.P No. 9, a company can adopt the Last-In-First-Out (LIFO) policy

of inventory valuation; however, this is not the case with companies adopting

International Financial Reporting Standards (I.F.R.S) in the context of I.A.S 2

revised. Under I.A.S 2, goods/services produced/segregated for their specific

projects and inventories of items not ordinarily interchangeable are valued using

specific identification of individual costs (paragraph 23). For inventories

meeting either of these criteria, the specific identification method is mandatory

and alternative methods cannot be used (paragraph 23). In addition, other goods

apart from those mentioned in paragraph 23 shall be assigned using the First-In-

First-Out or Weighted Average methods, stating that the same cost formula shall

be used for all inventories of similar nature and use to the entity, though

different cost formulas can be used for inventories with a different nature/use.

This standard expressly states that it does not permit the use of LIFO to measure

the cost of inventories (paragraph IN13) so as to serve the goals of achieving

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convergence among accounting standards, and of promoting uniformity across

entities reporting under the IFRS.

It is important to note that IAS 2 revised and S.S.A.P No. 9 state that cost should

be valued at the lower of cost or net realisable value.

In the United States, Generally Accepted Accounting Practices (GAAP) requires

that inventory be valued at the lower of cost or market. Market is usually equal

to current replacement cost; however it cannot be greater than the net realisable

value or the net realisable value less a normal profit margin. GAAP also permits

the use of LIFO, just like S.S.A.P No. 9. However, initial valuation is at cost

when it is first recognised.

In Nigeria, the relevant accounting standard issued to address inventory

valuation was the Standard Accounting Standard No. 4 (on stocks), which

became operative in January 1987. The standard explains that the use of several

methods for valuing and reporting stocks gives rise to wide differences in the

results of the operations of enterprises in the same line of business, and that it

seeks to narrow such differences by setting a standard for the valuation and

presentation of items of stock, doing this in the context of the historical cost

concept. The historical cost concept holds that cost is the appropriate basis for

the initial accounting recognition of all assets acquisitions, services rendered or

received, expenses incurred, and creditors and owners interests. It also holds

that subsequent to acquisition, cost values are retained throughout the

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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

A theoretical framework is defined as a frame of reference that serves to guide a

research study and is developed from theories, findings from a variety of other

studies, and the researchers personal experiences.

A theoretical framework is a collection of interrelated concepts, like a theory but

not necessarily so well worked-out. A theoretical framework guides your

research, determining what things you will measure, and what statistical

relationships you will look for.

The theoretical framework is supposed to help the reader make logical sense of

the relationships of the variables and factors that have been deemed

relevant/important to the problem. It provides definition of relationships

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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

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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

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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

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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

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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

A conceptual framework can be defined as a theoretical structure of

assumptions, principles, and rules that holds together the ideas comprising a

broad concept.

2.3.1 INVENTORY VALUATION POLICIES

Different methods of inventory valuation will directly affect the manufacturing,

trading, profit and loss accounts as a whole, and the current asset schedule of the

balance sheet which includes indicators, investment decisions, financing plans;

enterprises can also use this for tax planning, earnings management, crucial to

the suitability or otherwise of their choice. Based on accounting standards, the

inventory valuation policies available for selection by manufacturing companies

are discussed, namely:

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First- In- First- Out Method (FIFO)

The FIFO method of inventory valuation requires that the inventory which came

in first will be used first, which sounds like a fairly logical and plausible

situation. Hence the inventory which comes in first will be used or resold first.

So if we have 4 different inventory prices at say N1, N1.30, N1.90 and N2 and

the company follows the FIFO inventory valuation method, then the N1

inventory will be used up first and so on.

According to Schroeder et al (2010), FIFO is based on assumptions about the

actual flow of merchandise throughout the enterprise i.e. it is an approximation

of the specific identification method. The FIFO method satisfies the historical

cost and matching principles since the amount for cost of goods sold is similar to

the amount that would have been recorded under specific identification if the

actual flow of goods were on a FIFO basis. Moreover the valuation of the unsold

inventory reported on the balance sheet more closely resembles the replacement

cost of the items on hand and thereby allows financial statement users to

evaluate future working capital flows more accurately.

This method of inventory valuation is generally looked at as the better indicator

of the inventory position (Ibarra, 2008). By using up the inventory items which

came in first and selling them, there is no risk of loss due to spoilage or

obsolescence, which is why this method is used by most companies, especially

those, whose inventory comprises of consumables and perishable products.

29

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

30

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.

31

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.

32

2.3.2 THE IMPACT OF INVENTORY VALUATION POLICIES ON

REPORTED INCOME

As earlier mentioned, inventory valuation policies are used to determine the cost

of goods produced by a firm, starting from the cost of raw materials, to the cost

of work in progress, and finally to the total costs assigned to the finished goods,

all other things being equal. To describe the effects of the inventory valuation

policies used by a particular firm A on its reported income, the following

assumptions will be made:

The sole business carried out by firm A is the manufacture and sale of one

product;

It purchases its raw materials from several suppliers and makes its sales to a

several buyers/customers;

Its tax liability is determined based on the reported income for each accounting

period;

In view of these, the use of inventory valuation policies in the course of costing

Firm As production process and determining its reported income is seen below:

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

33

Source: The Researcher, designed for the current study

From the diagram above, the values of raw materials and work-in-progress

inventories have a part to play in determining the total cost of the goods

manufactured by firm A. however the value of the cost of the finished goods

consists of these two values, as well as all other costs incurred in the course of

production. When sales are made over the firms accounting period and the

income generated from carrying out the firms ordinary business (which, in this

case is the manufacture and sale of products) is to be determined, the revenues

received during the period are matched with the cost of production (which is

derived based on the inventory valuation method used by the firm). At this point

it will be noted that the higher the cost of production, the lower the gross profit

Valuation of raw materials inventory

Sales

Other direct costs and factory overheads

Relevant costs/expenses

Flow of cost/profit

Matching of sales with cost

Cost of production/valuation

of finished goods inventory

Admin & Selling (operational) expenses

Valuation of Work-in-progress inventory

Gross Profit

Reported Income

34

made; and in the absence of any other income generating venture, the lower the

reported income generated by the firm.

2.3.3 IMPORTANCE OF AN EFFECTIVE INVENTORY VALUATION

POLICY

An effective inventory valuation policy is one which correctly and accurately

determines the costs of inventory managed by a firm. Carnes et al (1992)

describes an effective inventory valuation policy as one which (i) conforms to

the best accounting practice in the trade or business i.e. it can serve as a

surrogate for GAAP; and (ii) clearly reflects income. This implies by extension

that it also clearly states the tax liability of the firm, as well as a clear picture of

the firms cash flow. This is because clearly stating income will derive an

accurate determination of the tax liability of the firm. Proper inventory valuation

also enhances the accuracy and reliability of the financial statements of the firm,

helping the firm to gain credibility with creditors (in situations where loan

agreements and debt covenants are based on accounting ratios), the government,

shareholders, the relevant tax authorities, and the general public.

The basic function of inventories whether they are raw materials, work-in-

progress or finished goods, is that they facilitate decoupling the operations

involved in converting inputs into outputs. This allows the successive stages in

35

the purchasing, manufacturing and distribution process to operate reliance on the

schedule of output, of prior activities in the production process. Therefore, an

effective inventory valuation policy implies a proper costing of each stage in the

production process.

2.3.4 THE SELECTION PROCESS OF AN INVENTORY VALUATION

POLICY: FACTORS TO CONSIDER

It is important to note here that GAAP does not require that the assumed costs

correspond to the actual flow of goods. Therefore firms are given the freedom to

select from the permitted inventory valuation policies (FIFO, Weighted average,

and Specific identification). However, any inventory valuation policy selected

by a firm can affect the firm in significantly diverse ways; therefore the

managers have to be careful in selecting a policy to use. These factors can be

divided into two categories: internal and external factors.

INTERNAL FACTORS

Firstly, the manager has to consider the shelf life/rate of obsolescence of the

product(s). The shelf life of a product is defined by the length of time before the

product becomes unsuitable for use. Therefore, the FIFO policy would be best

suited for perishable goods. However, firms that engage in mass production of

durable products would prefer the other two methods.

36

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.

37

Also a firm that reports higher incomes consistently will be perceived as

lucrative by most investors, motivating them to invest more in such firms. In this

same vein, a firm that reports lower incomes will most likely divert investors

from such firms.

Many firms have loan agreements that require them to maintain certain levels of

financial ratios. The current ratio is one example. Given that during a period of

rising prices, FIFO results in a higher inventory figure, current assets will also

be higher. This results in a higher current ratio and a lower likelihood of loan

agreement violations. A number of other ratios will be similarly affected. When

adopting any inventory policy, managers must be confident that the use of such

policies will not result in levels of financial ratios that violate existing loan

agreements.

FIFOs ending inventory calculation is based on a firms most recent acquisition

costs. Thus, the inventory amount on the balance sheet is likely to be very close

to current value, though the profit and loss figures are more historical than

current. However, the average cost policy spreads the costs over all the units

produced so both the balance sheet value and the profit and loss figures are

neither historical nor current value. So the inventory valuation policy selected

affects the quality of information produced by the firm.

Finally, other factors to consider include the policies used by other firms within

the industry, as described by Carnes et al (1992); and government regulations.

38

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.

39

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.

40

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 RESTATEMENT OF RESEARCH QUESTIONS

The research questions are restated here as follows:

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?

41

3.1.1 RESTATEMENT OF RESEARCH HYPOTHESES

The research hypotheses are restated here as follows:

HYPOTHESIS I

H0 The inventory policies available to a manufacturing company are not the

First-In-First-Out, Weighted Average and the specific identification

methods.

H1 First-In-First-Out, Weighted Average and Specific Identification are the

methods available to manufacturing companies.

HYPOTHESIS II

H0 There is no relationship between the inventory valuation policy used by a

manufacturing company and its reported income.

H1 The reported income of a manufacturing company affects its selection of

an inventory valuation policy.

HYPOTHESIS III

H0 There is no relationship between the inventory valuation policy used by a

manufacturing company and its tax liability.

H1 The tax liability of a manufacturing company affects its selection of an

inventory valuation policy.

42

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 SAMPLING AND SAMPLING TECHNIQUES

The sampling technique used in this study is the stratified sampling technique

where a stratified sample is obtained by independently selecting a separate

43

simple random sample from each population stratum. A population can be

divided into different groups based on some characteristics or variables, which,

in the context of this study, are the industries which these firms belong to. A

total of 18 companies from each industry will be selected. Key personnel is

made up of at least 2 from each of the aforementioned companies will be

interviewed.

The sample size therefore consists of 36 employees from the following

departments in each company: Finance, Supply/Warehouse.

3.5 DATA COLLECTION INSTRUMENT

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.

44

3.5.1 ADMINISTRATION OF INSTRUMENTS

The questionnaire will be administered by the researcher in person. The

respondents for this study are the financial managers/directors of each company,

as they have a knowledge of the accounting and financial policies of the

companies within which they serve. Therefore they will be able to provide

information that will be relevant to the study.

3.6 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

45

the firms they manage. The following formula is used in computing the chi-

square value for the data:

2 = ( )i

ii

EEO - 2

where Oi = observed frequency, Ei = expected frequency

3.6.1 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 LIMITATION OF THE RESEARCH METHODOLOGY

Limitations can be defined as extraneous circumstances that can cause

imperfections in the application of the methodology. In view of this, the

bureaucratic nature of most of manufacturing firms, requiring that protocol is

46

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.

47

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 ANALYSIS OF RESPONDENTS CHARACTERISTICS

This section presents the findings on the characteristics of the stakeholders in a

tabular form. Attempts have been made to classify the respondents according to

their demographic characteristics such as sex, age, educational background, and

area of specialization.

Table 4.1 SEX DISTRIBUTION OF RESPONDENTS

Frequency Percent

MALE 26 72.2

FEMALE 10 27.8

Total 36 100.0

Source: Field survey, 2011

48

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 AGE DISTRIBUTION OF RESPONDENTS

Frequency Percent

UNDER 21 YEARS 1 2.8

21-30 4 11.1

31-35 10 27.8

36-40 14 38.9

40 YEARS AND ABOVE 7 19.4

Total 36 100.0

Source: Field survey, 2011

Table 4.2 shows that 14 respondents representing 38.9 per cent are within the

age range of 36 to 40 years, closely followed by 10 respondents representing

27.8 per cent within the age range of 31 to 35 years, 7 respondents representing

19.4 per cent are 40 years and above, 4 respondents representing 11.1 per cent

are within the age range of 21 to 30 years while 1 respondent representing 2.8

per cent is below the age of 21 years. This suggests that majority of the

respondents are in their thirties. However, the data gathered covers all the major

working age groups within the organization.

49

Table 4.3 EDUCATIONAL BACKGROUND OF THE RESPONDENTS

Frequency Percent

SSCE/OND 4 11.1

B.SC/HND 25 69.4

M.SC 7 19.4

Total 36 100.0

Source: Field survey, 2011

Table 4.3 shows that 25 respondents representing 69.4 per cent have a

B.SC/HND, 7 respondents representing 19.4 per cent have a M.Sc., and 4

respondents representing 11.1 per cent have a SSCE/OND, suggesting that

majority of the respondents have gone through the higher institutions of

learning. This is good for the purposes of the study.

Table 4.4 SPECIALIZATIONS OF THE RESPONDENTS

Frequency Percent

ACCOUNTING/FINANCE 18 50.0

STORES MANAGEMENT 18 50.0

Total 36 100.0

Source: Field survey, 2011

Table 4.4 suggests that there is an even distribution of the respondents

specialization, with 18 respondents specializing in accounting/finance and 18

respondents specializing in stores management, both representing 50 per cent.

50

This is also good for the purposes of the validity of the data gathered from the

respondents.

4.2 ANALYSIS OF THE RESPONDENTS INDUSTRIES

Table 4.5 DISTRIBUTIONS OF THE RESPONDENTS INDUSTRIES

Frequency Percent

BREWERIES 2 5.6

BUILDING MATERIALS 5 13.9

CHEMICALS & PAINTS 7 19.4

FOOD 2 5.6

HEALTHCARE 6 16.7

MANUFACTURING/INDUSTRIAL 9 25.0

TEXTILES 5 13.9

Total 36 100.0

Source: Field survey, 2011

Table 4.5 shows that 9 respondents representing 25 per cent work in the

manufacturing/industrial sector, 7 respondents representing 19.4 per cent work

in the chemical/paints industry, 6 respondents representing 16.7 per cent work

in the healthcare industry, 5 respondents representing 13.9 per cent work in the

building materials and 5 respondents representing 13.9 per cent work in the

textiles industry and 2 people representing 5.6 per cent work in the food

industry. This suggests that all the respondents work in industries engaged in

the manufacturing sector which is in line with the focus of this study.

51

4.3 ANALYSIS OF THE RESPONSES TO QUESTIONS ON THEIR

KNOWLEDGE OF INVENTORY AND INVENTORY VALUATION

POLICIES

This section was designed to analyse the responses to questions based on the

knowledge of inventory, inventory valuation, inventory valuation policies and

their effects on financial performance appraisals. It was also designed to analyse

the policies in use by the respondents companies and their reasons for the use

of these policies.

Table 4.6 FAMILIARITY WITH THE WORD INVENTORY

Frequency Percent

YES 36 100.0

Source: Field survey, 2011

Table 4.6 shows that all the respondents are familiar with the word inventory.

This is good for the validity of the responses given to the questions in the

questionnaire.

52

Table 4.7 CATEGORIES OF INVENTORY FAMILIAR TO RESPONDENTS

Frequency Percent

RAW MATERIALS 7 19.4

RAW MATERIALS & WORK-IN-PROGRESS 1 2.8

ALL THREE 11 30.6

RAW MATERIALS & FINISHED GOODS 7 19.4

WORK-IN-PROGRESS 2 5.6

FINISHED GOODS 8 22.2

Total 36 100.0

Source: Field survey, 2011

Table 4.7 shows that 11 respondents representing 52.8 per cent are familiar with

the three categories of inventory, while 8 respondents representing 22.2 per cent

are familiar with finished goods category, 7 respondents representing 19.4 per

cent are familiar with the raw materials category only and 7 respondents

representing 19.4 per cent are familiar with the raw materials and finished

goods categories, 2 respondents representing 5.6 per cent are familiar with the

work-in-progress category and 1 respondent representing 2.8 per cent is familiar

with only the raw materials and work-in-progress categories. In all, 28

respondents category representing 77.8 per cent are familiar with the finished

goods, while 26 respondents representing 72.2 per cent are familiar with the raw

materials category. This suggests that majority of the respondents have adequate

knowledge of inventory, as well as its categories.

53

Table 4.8 INVENTORY MANAGED BY RESPONDENTS

Frequency Percent RAW MATERIALS 6 16.7

RAW MATERIALS & WORK-IN-PROGRESS 1 2.8

ALL THREE 8 22.2

RAW MATERIALS & FINISHED GOODS 4 11.1

WORK-IN-PROGRESS 4 11.1

FINISHED GOODS 13 36.1

Total 36 100.0

Source: Field survey, 2011

Table 4.8 shows that 13 respondents representing 36.1 per cent manage finished

goods for their companies, 8 respondents representing 22.2 per cent manage all

three categories of inventory, while 6 respondents representing 16.7 per cent

manage raw materials for their companies, 4 respondents representing 11.1 per

cent manage work-in-progress for their companies, and 4 respondents

representing 11.1 per cent manage raw materials and finished goods for their

companies. Also, 25 respondents representing 69.4 per cent manage finished

goods on behalf of their companies, which is good for the purposes of this

study.

Table 4.9 FAMILIARITY WITH INVENTORY VALUATION POLICIES

Frequency Percent NO 1 2.8

YES 35 97.2

Total 36 100.0

Source: Field survey, 2011

54

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 1 2.8

SPECIFIC IDENTIFICATION 6 16.7

ALL THREE 2 5.6

WEIGHTED AVERAGE 2 5.6

FIRST-IN-FIRST-OUT 15 41.7

FIFO & SPECIFIC IDENTIFICATION 3 8.3

FIFO & WEIGHTED AVERAGE 7 19.4

Total 36 100.0

Source: Field survey, 2011

Table 4.10 shows that 15 respondents representing 41.7 per cent are familiar

with the first-in-first-out (FIFO) policy and 6 respondents representing 16.7 per

cent are familiar with the specific identification policy. It also shows that 2

respondents representing 5.6 per cent are familiar with the weighted average

policy, while 7 respondents representing 19.4 per cent are familiar with both

FIFO and weighted average policies, 3 respondents representing 8.3 per cent are

familiar with FIFO and specific identification. 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.

55

Table 4.11 INVENTORY VALUATION POLICIES USED FOR FINISHED

GOODS

Frequency Percent SPECIFIC IDENTIFICATION 7 19.4

WEIGHTED AVERAGE 6 16.7

FIRST-IN-FIRST-OUT 23 63.9

Total 36 100.0

Source: Field survey, 2011

Table 4.11 shows that 23 respondents companies representing 63.9 per cent use

the FIFO policy to value their finished goods inventory, and 7 respondents

companies representing 19.4 per cent use the specific identification policy for

their inventory. Also, 6 respondents representing 16.7 per cent use the weighted

average policy to value their finished goods. All the respondents manage

inventory for their companies.

56

Table 4.12 THE USE OF RESPECTIVE INVENTORY VALUATION POLICIES

BY RESPONDENTS COMPANIES

Frequency Percent NATURE OF INVENTORY MANAGED 5 13.9

COSTS OF IMPLEMENTATION 1 2.8

EFFECTS ON TAX LIABILITY 1 2.8

TAX LIABILITY& NATURE OF INVENTORY 1 2.8

EFFECTS ON COST OF SALES & GROSS PROFIT 6 16.7

COST OF SALES, GROSS PROFIT & NATURE OF INVENTORY 4 11.1

COST OF SALES, GROSS PROFIT & IMPLEMENTATION & NATURE OF

INVENTORY

1 2.8

COST OF SALES, GROSS PROFIT & TAX LIABILITY & NATURE OF

INVENTORY

1 2.8

EFFECTS ON COST OF SALES, GROSS PROFIT & REPORTED INCOME 6 16.7

COST OF SALES, GROSS PROFIT, REPORTED INCOME & NATURE OF

INVENTORY

3 8.3

EFFECTS ON COST OF SALES, GROSS PROFIT & REPORTED INCOME &

COST OF IMPLEMENTATION

2 5.6

ALL EXCEPT TAX LIABILITY 3 8.3

EFFECTS ON REPORTED INCOME & NATURE OF INVENTORY 1 2.8

REPORTED INCOME & COSTS OF IMPLEMENTATION & NATURE OF

INVENTORY

1 2.8

Total 36 100.0

Source: Field survey, 2011

Table 4.12 shows that 6 respondents representing 16.7 per cent chose the effects

on cost of sales alone as the reasons why their companies use inventory

valuation policies, 6 respondents representing 16.7 per cent chose the effects on

cost of sales, gross profit and reported income, 5 respondents representing 13.9

per cent chose the nature of inventory managed alone, 4 respondents

representing 11.1 per cent chose the cost of sales and the nature of inventory, 3

57

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 THE EFFECTS OF INVENTORY VALUTION POLICIES TO THE

APPRAISAL OF A COMPANYS FINANCIAL PERFORMANCE

Frequency Percent

NO 3 8.3

YES 33 91.7

Total 36 100.0

Source: Field survey, 2011

58

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

INVENTORY VALUATION POLICIES

Frequency Percent

NONE 4 11.1

COMPUTATION OF TAX LIABILITY 1 2.8

COMPUTATION OF COST OF SALES & GROSS PROFIT 9 25.0

COMPUTATION OF COST OF SALES, GROSS PROFIT & TAX LIABILITY 3 8.3

COMPUTATION OF COST OF SALES, GROSS PROFIT AND REPORTED

INCOME

11 30.6

ALL THREE 5 13.9

COMPUTATION OF REPORTED INCOME 3 8.3

Total 36 100.0

Source: Field survey, 2011

Table 4.14 shows that 11 respondents representing 30.6 per cent believe that

inventory valuation policies affect the computation of cost of sales and reported

income, while 9 respondents representing 25 per cent believe the policies affect

only the computation of cost of sales alone. 5 respondents, representing 13.9 per

cent believe that inventory valuation policies affect the computation of cost of

sales; reported income and tax liability and 3 respondents representing 8.3 per

cent believe the policies affect the computation of cost of sales, gross profit and

59

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

This section was designed to analyse the findings on the statements

administered to the respondents to examine their opinion on the awareness of

inventory valuation policies and their effects on the company, the effects of the

knowledge of inventory valuation policies on investors and shareholders, and

the factors that a manager should consider in the selection of inventory

valuation policies.

60

Table 4.15 THE AWARENESS OF THE EFFECTS OF INVENTORY

VALUATION POLICIES IS TOO LOW IN NIGERIA.

Frequency Percent

STRONGLY DISAGREE 2 5.6

DISAGREE 3 8.3

UNDECIDED 5 13.9

AGREE 16 44.4

STRONGLY AGREE 10 27.8

Total 36 100.0

Source: Field survey, 2011

Table 4.15 shows that 10 respondents, representing 27.8 per cent, strongly

agreed, and 16 respondents, representing 44.4 per cent agreed that the

awareness of the effects of inventory valuation policies is too low in Nigeria. 2

respondents representing 5.6 per cent strongly disagreed, and 3 respondents

representing 8.3 per cent disagreed with this statement, while 5 respondents

representing 13.9 per cent were neutral in their opinion. It can therefore be

concluded that the awareness of the effects of inventory valuation policies is too

low in Nigeria.

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Table 4.16 INVENTORY VALUATION POLICIES: A CRITICAL VALUE TO INVESTORS AND SHAREHOLDERS.

Frequency Percent

STRONGLY DISAGREE 1 2.8

UNDECIDED 2 5.6

AGREE 12 33.3

STRONGLY AGREE 21 58.3

Total 36 100.0

Source: Field survey, 2011

Table 4.16 shows that 21 respondents representing 58.3 per cent strongly agreed

and 12 respondents representing 33.3 per cent agreed that the knowledge of

inventory valuation policies and their effects is of critical value to investors and

shareholders. However, 1 respondent representing 2.8 per cent strongly

disagreed, and 2 respondents representing 5.6 per cent were neutral in their

opinion. It can therefore be concluded that the knowledge of inventory valuation

policies and their effects is of critical value to investors and shareholders.

Table 4.17 THE USE OF INVENTORY VALUATION POLICIES ON THE

REPORTED INCOMES OF MANUFACTURING COMPANIES.

Frequency Percent

STRONGLY DISAGREE 1 2.8

UNDECIDED 5 13.9

AGREE 10 27.8

STRONGLY AGREE 20 55.6

Total 36 100.0

Source: Field survey, 2011

62

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 MANAGERS SHOULD CONSIDER THE EFFECTS OF INVENTORY

VALUATION POLICIES ON THEIR TAX LIABILITY BEFORE SELECTING A

POLICY.

Frequency Percent

DISAGREE 1 2.8

AGREE 24 66.7

STRONGLY AGREE 11 30.6

Total 36 100.0

Source: Field survey, 2011

Table 4.18 shows that 11 respondents representing 30.6 per cent strongly agreed

and 24 respondents representing 66.7per cent agreed that managers should

consider the effects of inventory valuation policies on their tax liability before

selecting a policy. However, 1 respondent representing 2.8 per cent strongly

disagreed with this statement. It can therefore be concluded that managers

should consider the effects of inventory valuation policies on their tax liability

before selecting a policy.

63

Table 4.19 THE NATURE OF INVENTORY MANAGED SHOULD BE

CONSIDERED BEFORE SELECTING AN INVENTORY VALUATION POLICY.

Frequency Percent

DISAGREE 1 2.8

AGREE 15 41.7

STRONGLY AGREE 20 55.6

Total 36 100.0

Source: Field survey, 2011

Table 4.19 shows that 20 respondents representing 55.6 per cent strongly agreed

and 15 respondents representing 41.7 per cent agreed that the nature of

inventory managed should be considered before selecting an inventory

valuation policy. However, 1 respondent representing 2.8 per cent disagreed

with this statement. It can therefore be concluded that the nature of inventory

managed should be considered before selecting an inventory valuation policy.

Table 4.20 INVENTORY VALUATION POLICIES AND THEIR EFFECTS ON

REPORTED INCOME

Frequency Percent

STRONGLY DISAGREE 1 2.8

DISAGREE 1 2.8

UNDECIDED 3 8.3

AGREE 12 33.3

STRONGLY AGREE 19 52.8

Total 36 100.0

Source: Field survey, 2011

64

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 THE COST OF IMPLEMENTATION SHOULD BE CONSIDERED

BEFORE SELECTING AN INVENTORY VALUATION POLICY.

Frequency Percent

DISAGREE 2 5.6

UNDECIDED 2 5.6

AGREE 16 44.4

STRONGLY AGREE 16 44.4

Total 36 100.0

Source: Field survey, 2011

Table 4.21 shows that 16 respondents representing 44.4 per cent strongly agreed

and 16 respondents representing 44.4 per cent agreed that the cost of

implementation should be considered before selecting an inventory valuation

policy. However, 2 respondents representing 5.6 per cent disagreed with this

statement, while 2 respondents representing 5.6 per cent were neutral in their

65

opinion. It can therefore be concluded that the cost of implementation should be

considered before selecting an inventory valuation policy.

Table 4.22 MANAGERS SHOULD CONSIDER THE EFFECTS OF INVENTORY

VALUATION POLICIES ON REPORTED INCOME BEFORE SELECTING A

POLICY.

Frequency Percent

STRONGLY DISAGREE 2 5.6

UNDECIDED 7 19.4

AGREE 7 19.4

STRONGLY AGREE 20 55.6

Total 36 100.0

Source: Field survey, 2011

Table 4.22 shows that 20 respondents representing 55.6 per cent strongly agreed

and 7 respondents representing 19.4 per cent agreed that managers should

consider the effects of inventory valuation policies on reported income before

selecting a policy. However, 2 respondents representing 5.6 per cent strongly

disagreed, while 7 respondents representing 19.4 per cent were neutral in their

opinion. It can therefore be concluded that managers should consider the effects

of inventory valuation policies on reported income before selecting a policy.

4.5 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

66

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 The inventory policies available to a manufacturing company are not the

First-In-First-Out, Weighted Average and the specific identification

methods.

H1 First-In-First-Out, Weighted Average and Specific Identification are the

methods available to manufacturing companies.

Table 4.23: HYPOTHESIS I Observed N Expected N Residual

SPECIFIC IDENTIFICATION 7 12.0 -5.0

WEIGHTED AVERAGE 6 12.0 -