Question

Explain some of the practical problems encountered by companies when valuing inventories.

Set out two circumstances in which it may be necessary to complete financial statements from incomplete records and discuss the risks involved in preparing these financial statements.

Explain what is meant by the "elimination method" of accounting for depreciation when a revaluation occurs?

Explain why the profit on a disposal of property, plant and equipment is removed from the Operating Cash Flows under the indirect method and explain how the disposals of such assets are recorded in the Statement of Cash Flows.

Answer 1

1.Valuation of inventories is complex problems faced by company while undergoing valuation. Some of the practical problems encountered by companies when valuing inventory are

• There are different method that can be adopted for valuation of inventory . Methods are FIFO, LIFO, weight average method .Consideration of method that should be adopted is one of the most difficult task for the company . Consideration of method requires judgment and evaluation of nature of cost associate with inventory, different types of element compromising inventory as each method has its own advantage and disadvantage . The method adopted should clearly indicate that it is best approach and financial statements shows fair view of the financial statements.
• Cost that need to be included in the inventory, that is products cost as well as perodic cost. Consideration of cost that need to be included in inventory will have effect on current as well as future financial statement.

2. Circumstances 1- If there is an retrospective amendment in law for preparation and maintaince of financial statements to certain class of company and before amendment class of company was not required to prepare the statements hence due to legal obligation they are required to prepare the statements from incomplete record and risk for company would be that financial statements does not show accurate financial position.

Circumstances 2 - If company met with unexpected fire accident and companies all record was destroyed, in such situation the company would required to prepare financial statements with incomplete record. The risk for company would be that financial statements does not show fair view of financial position.

3. Revaluation model under depreciation gives company an option to revalue it's fixed asset at fair value. Elimination method is one of method adopted to revalue the fixed asset at its fair value. Under elimination method accumulated depreciation is adjusted to gross value of revalued asset to show the carry value of fixed asset at fair value.

4. The profit on a disposal of property, plant and equipment is removed from the operating cash flow under indirect method as disposal of property plant and equipment is not an operating activities which is carried on day to day business . The disposal of such asset should be included in financing activities in cash flow statements.