Impact of Average Cost Method on Profit and Loss Statement of Automotive Holdings Group Limited

This article discusses the impact of average cost method on the profit and loss statement of Automotive Holdings Group Limited. It also covers the selection of inventory valuation method and its effect on closing stock and net profit. The article is relevant for ACCG101 students studying inventory management.

ACCG101

ACCG101: 1
Executive summary
With the growing risk of recession, most companies try to deliver profitable business
performances even during recession. While examining the crucial factors affecting the
operations of the company, inventory management is a topic, which is raised every time.

ACCG101: 2
Contents
Executive summary...............................................................................................................................1
Introduction...........................................................................................................................................3
Answer 1-..............................................................................................................................................3
Answer 2-..............................................................................................................................................4
Conclusion.............................................................................................................................................4
References.............................................................................................................................................5

ACCG101: 3
Introduction
Automotive holdings group limited is an Australia`s leading automotive retailing and
logistics group. The company operates 180 automotive retail franchises at nearly 110 dealers.
The company has 29 manufacturer passenger vehicle and 12 commercial vehicle and truck
manufacturers. Automotive holdings group inventory system follows perpetual and average
cost system to maintain its inventory. Under the average cost method, both inventory and the
cost of goods sold is calculated based on average cost of all the units during a particular
period (Automotive holdings group limited, 2017). When inventory is sold out, the situation
of Average cost is more or less similar to FIFO or LIFO. Automotive holdings group deals in
motor vehicles.
Answer 1-
Impact on profit and loss statement-
The Average cost method will not affect fiscal P&L statement. Whereas, the annual P&L
statement is formed by three quarterly profit and loss statement. The average cost method
generates difference in quarterly profit and loss statement. Suppose- during 2rd quarter, the
company invests and purchases a stock of 100 motor vehicles in which two vehicles has the
maximum cost price. When the average cost method is applied, the cost of two vehicles,
which has the maximum price, is absorbed and distributed in the price of all the remaining 98
motor vehicles. The average cost of motor vehicles in 2nd quarter has been raised due to
reflection of two costly motor vehicles in all the vehicles. However, in the annual profit and
loss statement, the cost of all the vehicles remains same because all the vehicles purchased
during the year absorbs and overprices the price of inflated and deflated cost of vehicle
(Nisha, 2015).
Any discount and rebate on the selling price of motor vehicles will not be reflected. During
determination of net realisable value or written down value, it may differ on the reporting
date due to use of average cost method rather than any other cost method (Automotive
holdings group limited, 2016). Cost is assigned to each vehicle ignoring the date of purchase
of goods rather than specific identification.
When compared to any one method of calculating the cost of closing stock such as FIFO.
FIFO is inventory valuation method in which the first goods purchased are sold first. The
average cost method reflects less amount of closing stock resulting in less profit. For
example- let the company follows FIFO, it is generally considered that the price is inflated in
the last days of the month. Therefore, the selling price of the remaining stock will be
calculated on the basis on cost price of current stock purchased. However, the price of closing
stock remain inflated in the last days of the month (Chen et al., 2016).
FIFO
Quantity price cost
100 10 1000
200 9 1800
300 15 4500
By applying FIFO to sell 300 units,
The units, which are purchased at the price of 10 and 9, will be sold first…

ACCG101: 4
The remaining stock is priced of 300 units priced at 15 is the closing stock.
Closing stock- 4500
Average cost
Quantity price cost
100 10 1000
200 9 1800
300 15 4500
By applying the average cost method to sell 300 units, the average cost will be 12
The quantity of 300 units is to be sold at 12
The remaining stock of 300 units is priced at 12 is the closing stock.
Closing stock-3600
From the above example it can be interpreted that by using average cost method, the cost
closing stock remains low.
Answer 2-
An accountant should consider various accounting policy related to manage the inventory
such as-
Selection of inventory valuation method. The accountant should consider market trends and
fluctuation while selecting the method. LIFO will result in low closing stock because of high
purchase cost and low net profit. Whereas, FIFO will result in high closing stock because the
last stock which is inflated is sold at high price (Lawson et al., 2015).
In order to manage the inventory, the accountant should decide the safety stock and re-order
point. The accountant has to separate the goods, which have early leakage and spoilage
problems because these goods need to be sold as soon as possible (Pomerleau, 2016).
Conclusion
From the above discussion, it can be concluded that accountant should make appropriate
policies regarding selection of inventory valuation method. As stock is a current asset, which
is an essential part of balance sheet. The manager has to take appropriate measures and adopt
methods to minimise the loss of demand from the consumers, linkages and spoilages.

ACCG101: 5
References
Automotive holdings group limited, (2017) ANNUAL REPORT 2017. [online] Available on:
http://www.ahgir.com.au/download/2017-annual-report-to-shareholders.pdf [Accessed on
04/09/18]
Automotive holdings group limited, (2016) ANNUAL REPORT 2016. [online] Available on:
http://www.ahgir.com.au/download/2016-ahg-annual-report-to-shareholders.pdf [Accessed
on 04/09/18]
Nisha, N. (2015) Inventory valuation practices: A developing country
perspective. International Journal of Information Research and Review, 2(7), pp. 867-874.
Lawson, R.A., Blocher, E.J., Brewer, P.C., Morris, J.T., Stocks, K.D., Sorensen, J.E., Stout,
D.E. and Wouters, M.J. (2015) Thoughts on competency integration in accounting education.
Issues in Accounting Education, 30(3), pp. 149-171.
Pomerleau, K. (2016) the Tax Treatment of Inventories and the Economic and Budgetary
Impact of LIFO Repeal. [online] Available on: https://taxfoundation.org/tax-treatment-
inventories-and-economic-and-budgetary-impact-lifo-repeal/ [Accessed on 04/09/18]
Chen, X., Hu, P., Shum, S. and Zhang, Y. (2016) Dynamic stochastic inventory management
with reference price effects. Operations Research, 64(6), pp. 1529-1536.