Question

(c) Due to Covid-19, the company has not been performing well. Thus, the CEO asked the accountant to change the inventory method to report better financial performance. The CEO explained that the accounting standards allow companies to change inventory methods. The CEO added that the accountant can always switch back the inventory method when things return to normal after Covid-19. Explain whether you agree or disagree with the CEO to change the inventory method for earnings management purpose. You should also discuss the impacts on the users of the financial statements. (15 marks)

Answer 1

I disagree with the CEO Statement. Inventory valuation method is an accounting policy. Accounting policy should be consistently applied from one accounting period to another accounting period since it materially impacts the financial statements and the end users of the financial statements. An Inventory valuation can be done on various methods like FIFO, LIFO, weighted average methods and closing inventory valued impacts the profit or loss reported in Income statement and also the Balance sheet of the entity. Hence there has to be consistency in valuation of Inventory and it cannot be changed year on year basis.

A change in accounting policy has to be accounted retrospectively that is the material impact on profit or loss account has to be re-stated by adjusting the Retained earnings balance and proper disclosures should be given in the notes to the accounts. A user of financial statements should be well informed of following information

· Method of inventory valuation

· Change of method of inventory valuation

· Impact of difference in inventory valuation on company’s current year profits or losses

· The total changes in profits or losses in past years based on new inventory valuation method.