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.
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)
"Cost flows" are paths taken by costs in a complete business cycle. In manufacturing businesses costs go into the inventory for raw materials, process stocks and finished goods. The cost flow assumption assumes costs change right from the production of goods till transformed to sale.
Answer and Explanation:
1)Cost flow assumptions include FIFO and average. In Australia LIFO is not allowed.The costs in a cost flow assumption is quantified as in raw materials, work in process and finished goods. The costs are assigned till they transition to a saleable commodity.
2)Large Mart can go for the average method. In the average method the costs are accumulated and the product costs are divided by the number of units manufactured. Till a good is produced, and then sold, the entire process involves cost flows. The unit is valued in a particular way and the price per unit is derived.
a) FIFO is not allowed in Australia
b)Large Mart's ability to make the change is based on the functions of technical specialists like cost accountants who can make the change.The CEO making the change is a positive one and this impacts Large Mart's ability as well. Average costs are recommended when prices are stable, and in this case perpetual inventory system overrules any negative cost impacts.
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from Accounting 102: Intro to Managerial AccountingChapter 4 / Lesson 3