Question Tag: Inventory Adjustment

Search 500 + past questions and counting.
Professional Bodies Filter
Program Filters
Subject Filters
More
Tags Filter
More
Check Box – Levels
Series Filter
More
Topics Filter
More
  • 5 Marks

FA – May 2024 – L1 – SB – Q5b – Accounting for Inventories (IAS 2)

Calculates the total lower of cost and NRV adjustment required for Bala PLC’s inventory and prepares the necessary journal entry.

b. Bala PLC prepares its financial statements on December 31, 2023. At the end of the year, Bala PLC holds three different inventory items. The following information is available for each item:

  • Item A:
    Cost as at December 31, 2023: ₦1,500,000
    Estimated selling price: ₦1,800,000
    Estimated costs of completion, disposal, and selling expenses: ₦200,000
  • Item B:
    Cost as at December 31, 2023: ₦2,250,000
    Estimated selling price: ₦2,000,000
    Estimated costs of completion, disposal, and selling expenses: ₦300,000
  • Item C:
    Cost as at December 31, 2023: ₦3,000,000
    Estimated selling price: ₦3,200,000
    Estimated costs of completion, disposal, and selling expenses: ₦400,000

Required:

i. Calculate the total lower of cost and NRV adjustment required for inventory of Bala PLC. (2 Marks)

ii. Prepare the necessary journal entry to adjust the inventory to its lower of cost and NRV. (3 Marks)

i. Lower of Cost and NRV Adjustment for Bala PLC:

Item Cost (₦) Net Realisable Value (₦) Lower of Cost and NRV (₦)
A 1,500,000 1,600,000 1,500,000
B 2,250,000 1,700,000 1,700,000
C 3,000,000 2,800,000 2,800,000

Total Lower of Cost and NRV = ₦6,000,000

The adjustment required is calculated as:
Total Cost – Total NRV = ₦6,750,000 – ₦6,000,000 = ₦750,000

ii. Journal Entry for Inventory Adjustment:

Account Debit (₦) Credit (₦)
Cost of Sales 750,000
Inventory 750,000
Narration: Being reduction of inventory to the lower of cost and NRV.
  • 10 Marks

CR – May 2018 – L3 – Q5b – Regulatory Framework and Ethics

Identify the ethical issue related to inventory adjustment and explain the Finance Manager’s course of action.

The Finance Manager of Integrity Sports, a Takoradi-based manufacturer and retailer of sporting goods, prepares quarterly accounts for his boss, the Finance Director. At the end of the first quarter of 2017, the Finance Manager identified that net assets were below the level required by a bank covenant that the company had entered into with Unique Bank. He therefore alerted the Finance Director to this. The following week, the Finance Manager identified that amended quarterly accounts had been sent to the bank by the Finance Director, in which the inventory figure had been increased. The same issue arose at the end of the second quarter of 2017, and again the Finance Manager noted that the accounts sent to the bank included a different inventory figure from those that he had prepared the previous week. The Finance Manager is sure that cut-off procedures and valuation were correctly adhered to and this was done under his supervision. He therefore asked the Finance Director why the figures had changed, and the Finance Director responded:

“The adjustment is just for some goods held at one of our customer’s retail premises – we missed it out from the stock count. Don’t worry, I’ve got it all in hand!”

The Finance Manager then reviewed the contract with the customer in question and noted that it clearly states that the customer will be supplied with goods as ordered and has no right of return in the case of unsold goods. He also noted that Integrity Sports has sold goods to this customer for a number of years on the same terms, and no adjustment has ever been made before. Both the Finance Manager and Finance Director are Chartered Accountants.

Required:
i) Explain why the inventory adjustment suggests an ethical issue. (6 marks)
ii) Explain FOUR courses of action that the Finance Manager should take in respect of the issue that he has identified. (4 marks)

i) Ethical Issue in Inventory Adjustment:
The inventory adjustment made by the Finance Director raises a significant ethical concern because it appears to violate accounting principles and ethical standards. Here’s why:

  1. Violation of Revenue Recognition Principles:
    Under IAS 18, revenue is recognized when the significant risks and rewards of ownership are transferred to the buyer, which in this case, happens when the goods are delivered. The Finance Manager reviewed the contract and found that the customer had no right of return on unsold goods. This implies that the goods had been sold, and any inventory adjustment is inappropriate since it would inflate the closing inventory figure and reduce the cost of sales. This misrepresentation results in an artificially increased profit.
  2. Breach of Bank Covenant:
    The inventory adjustment seems to have been made deliberately to meet the net asset requirement of the bank covenant. Inflating inventory to avoid breaching the covenant is a form of financial manipulation and misrepresentation, which is unethical and could lead to legal consequences if discovered.
  3. Professional Integrity and Objectivity:
    As both the Finance Director and Finance Manager are Chartered Accountants, they are bound by the Code of Ethics for Professional Accountants (issued by IFAC), which requires accountants to act with integrity and objectivity. Manipulating inventory values to meet external covenants compromises the integrity of financial reporting and misleads stakeholders, including the bank, shareholders, and regulators.
  4. Potential Personal Gain:
    The Finance Director may be attempting to manipulate the financial statements to present a healthier financial position for personal or corporate gain, such as avoiding penalties from the bank or preserving the company’s credit facilities. This type of action is in direct conflict with ethical standards and fiduciary responsibilities.

(6 marks for explaining the ethical issues)

ii) Courses of Action for the Finance Manager:
As a qualified Chartered Accountant, the Finance Manager is obligated to act ethically and professionally. Here are four courses of action he should take:

  1. Gather All Relevant Facts:
    The Finance Manager should first ensure that he has all the facts regarding the inventory adjustment. This may involve reviewing contracts, invoices, and the original stock count to confirm that the adjustment is indeed improper. It is essential to have a clear understanding before taking further steps.
  2. Discuss the Issue with the Finance Director:
    The Finance Manager should have a direct conversation with the Finance Director to express his concerns about the ethical and financial reporting implications of the inventory adjustment. This discussion should emphasize the professional and legal consequences of manipulating financial statements, including potential breaches of accounting standards and bank covenants.
  3. Escalate the Issue to a Higher Authority:
    If the Finance Director does not respond appropriately, the Finance Manager should escalate the issue to a higher authority within the company, such as the Board of Directors or the Audit Committee. These parties have oversight responsibilities and can intervene to ensure that the financial statements are prepared in accordance with ethical standards and accounting principles.
  4. Consult External Auditors or Regulatory Bodies:
    If internal escalation fails to resolve the issue, the Finance Manager should consider informing the company’s external auditors or relevant regulatory bodies. External auditors have a duty to ensure that financial statements are fairly presented and may take corrective action if they discover financial manipulation. In extreme cases, regulatory bodies may need to be informed of the unethical practices.
  • 20 Marks

FA – July 2023 – L1 – Q4 – Preparation of limited liability company financial statements

Prepare the statement of profit or loss and statement of financial position for a limited liability company using the provided trial balance and adjustments.

The following trial balance relates to Pakro Ltd at 31 July 2022:

The following matters remain to be adjusted for in preparing the financial statements for the year ended 31 July 2022:

  1. The cost of inventory of GHȼ 38,400 for the year ended 31 July 2022 was based on an inventory count on 4 August 2022. Between 31 July 2022 and 4 August 2022, the following transactions took place:
Item GHȼ
Purchases of goods 8,000
Sales of goods (profit margin 20% on sales) 12,000
Goods returned by Pakro Ltd to a supplier 800
  1. Trade receivables totaling GHȼ24,000 are to be written off and allowance for receivables is to be adjusted to GHȼ8,000. The irrecoverable debt expense is to be included in administrative expenses.
  2. Pakro Ltd receives rent for subletting part of its building. The rent, which is receivable quarterly in advance, was received as follows:
Date of receipt Period covered GHȼ
1 July 2021 3 months to 30 September 2021 7,200
1 October 2021 3 months to 31 December 2021 7,200
30 December 2021 3 months to 31 March 2022 9,000
4 April 2022 3 months to 30 June 2022 9,000
1 July 2022 3 months to 30 September 2022 9,000
  1. The loan of GHȼ60,000 was taken out on 1 January 2022 with annual interest of 12%. The interest is payable in equal instalments on the first day of April, July, October, and January in arrears. The loan is repayable in full during the financial year ended 31 July 2026.
  2. Depreciation is to be provided for as follows:
    • Buildings 2.5% per year on cost
    • Plant and equipment 25% per year on cost
    • 70% of the depreciation is to be charged in cost of sales, and 15% each in distribution costs and administrative expenses.
  3. Current year income tax charged was GHȼ18,105.

Required:

a) Prepare the Statement of Profit and Loss for the year ended 31 July 2022. (10 marks)
b) Prepare the Statement of Financial Position as at 31 July 2022. (10 marks)

a) Pakro Ltd:

Workings:

  1. Closing inventory:
Item GHȼ
Inventory count value 38,400
Less purchases (8,000)
Add sales (12,000 x 80/100) 9,600
Add goods returned 800
Adjusted inventory figure 40,800
  1. Depreciation:
Item GHȼ
Buildings (100,000 x 2.5%) 2,500
Plant and equipment (128,000 x 25%) 32,000
Total 34,500
70% to cost of sales: 24,150, 15% to distribution cost: 5,175, and 15% to administrative expenses: 5,175.
  1. Non-current assets:
Item GHȼ
Land: Carrying amount per trial balance 30,000
Building: Carrying amount per trial balance (100,000 – 28,000) 72,000
Less depreciation for the year (2,500)
Carrying amount at 31 July 2022 69,500
Plant and equipment: Carrying amount per trial balance (128,000 – 32,000) 96,000
Less depreciation for the year (32,000)
Carrying amount at 31 July 2022 64,000
  1. Cost of sales:
Item GHȼ
Per trial balance 84,600
Add back inventory count value 38,400
Add depreciation (W2) 24,150
Deduct adjusted inventory figure (W1) (40,800)
Total 106,350
  1. Irrecoverable debts expense:
Item GHȼ
Allowance for receivables 8,000
Previous allowance (12,000)
Reduction (4,000)
Debts written off 24,000
Irrecoverable debts expense 20,000

Take control of your business data with insight and in-depth understanding by taking this course. 

Services

Contact Info

  • +233203701923
    +233543919232
  • info@noohrabusiness.com

Get In Touch

Follow us on our social media and get daily updates.

Facebook-f Twitter Linkedin-in Envelope