Question

When answering the provided questions, you must ensure that your answers address the questions, that your answers have an Australian accounting/financial reporting focus, that your answers are internally consistent, and that the individual components of your answers provide a well-rounded argument that is easy to follow.

The Chief Financial Officer (CFO) of Large Mart has been unable to find answers for two accounting problems. He has asked you to investigate the following questions and to write a report (including relevant references to source materials and accounting standards) that will provide him with a sufficient understanding of these issues to allow a well-supported decision to be made. To achieve this, the CFO seeks you to answer specific questions, but also to outline the development of your answers sufficiently to allow a reader to understand why you have developed your answers.

Question:

The Chief Executive Officer (CEO) of Large Mart has asked the CFO if it is possible to change the cost flow assumption that is used to value Large Mart’s inventory. At the moment, Large Mart is using the First-In-First-Out (FIFO) cost flow assumption (in a perpetual inventory accounting system) and although the CEO would like to retain a perpetual inventory accounting system, she would prefer the application of a different cost flow assumption. The CEO would like to make this change because she believes that this could potentially improve Large Mart’s financial position in the balance sheet.

The CFO asks you to investigate, and write a report about, the following questions:

a)     What are the legal requirements in relation to changes in inventory cost flow assumptions for reporting entities in Australia? In your answer, you should discuss (1) whether or not changes to cost flow assumptions are permissible in principle and why, and (2) what valuation options (other than FIFO) may be available to Large Mart. (500 Words)

b)     What are the legal limitations to changes in cost flow assumptions for reporting entities in Australia? In your answer, you should discuss (1) what legal restrictions would limit Large Mart’s ability to make changes to their inventory cost flow assumptions, and (2) whether or not the reason why the CEO would like to make this change may have any impact on Large Mart’s ability to make such a change. (500 Words)

Answer 1

Ans: a)

1) changes to cost flow assumptions are permissible if it is required for compliance of law, reporting framework & if it results in better (True & fair) presentation of financial statements.

2) If the cost of inventories of items that are not ordinarily interchangeable and goods or services produced and segregated for specific projects shall be assigned by using specific identification of their individual costs. In other cases weighted average cost formula can be used.

Ans b:

1)  A change in inventory cost flow assumptions is required to be disclosed by retroactively restating the results of prior periods. It will limit Large Mart’s ability to make changes to their inventory cost flow assumptions.

2) Such a change may result in good financial position of Large Mart in case there is quite fluctuaton in inventory prices. For instance, if initially the prices of inventory were higher and in recent times if prices are lower weighted average cost formula will show profitability more.