Analysis of Adairs Ltd's Inventory Accounting and Costing Systems

Desklib provides past papers and solved assignments for students. This report analyzes Adairs Ltd.'s accounting practices.

Accounting
1

Table of Contents
Introduction:....................................................................................................................................3
Question 1:.......................................................................................................................................4
Question 2:.......................................................................................................................................6
Question 3:.......................................................................................................................................8
Question 4:.....................................................................................................................................10
Conclusion:....................................................................................................................................11
References:....................................................................................................................................12
2

Introduction:
This assessment is based on the accounting theories and practices that are applicable to the
corporate companies and going to be created to explain different accounting applications of
inventory and cost management. Inventory is one of the most crucial assets for each organization
because it is related to sales operations and financial strength. This report will concentrate on the
inventory management practices of Adairs Ltd and explain the concepts of inventory accounting.
Also, the report will present the merits of inventory management practices that are applicable in
Adairs Ltd. Costing practices of a company are another vital matter that is going to be
elucidated here. The report will examine the costing methods of Adairs Ltd and provide the
explanatory view of merits included in the costing practice of Adairs Ltd.
3

Question 1:
AASB 2 ‘inventories’ is a regulatory set of guidelines that are issued for the Australian
companies to correctly evaluate the value of inventory. This standard is accountable with IFRS 2
and provides descriptive guidelines regarding the inventory valuation process (IFRS, 2019).
Also, AASB 2 describes the cost formulas which are available to correctly measure the final cost
of inventory items.
The scope of AASB 2:
This standard is applicable to all those items that are held by a business entity was final goods,
WIP goods or raw inventory. Some items like WIP construction contracts (AASB 11), biological
assets (stated in AASB 41) are not covered by AASB 2.
As per the requirements of para 5.2 of AASB 2, inventory items are required to be measured by
considering NRV and cost of the product. If NRV is lower than cost, inventory will be valued at
NRV. Similarly, if the cost is lower than NRV, inventory will be valued at cost (AASB, 2002).
AASB-2 refers that companies that are working in a retail industry like Adairs Ltd can apply
retail inventory framework if it is expected that final value of inventory will be lower than NRV
or Cost (IFRS, 2019).
Analysis of Adairs Ltd is stating that the company is following the AASB 2 completely and
evaluating the inventory on the basis of the NRV method. From note 2 (m) and 7 of financial
statements, it is outlined that stock items are valued at lower of NRV or cost.
In 2016, the cost of inventory was $ 26272 which reached to $ 32992 in 2017 and attained the
level of $ 33568 in 2018 (Adairs, 2018). Disclosure made by the auditor is stating that the
appropriate level of personal judgement was applied by the managers during the determination of
4

NRV. Utilization of managerial judgment is necessary because the fair value of many final
products changes as per the fashion and industry trends. Similarly, Adairs Ltd adopted
departmental costing to evaluate the cost of inventory that is associated with each department. It
is considerable that the cost of insurance duties, fare and other associated costs that are allowed
under AASB 2 are included while determining the cost of inventory.
5

Question 2:
Inventory is one of the most crucial factors for each entity which demands efficient management
to ensure the wellness of profit conditions and financial position. Adairs Ltd is a retail selling
company which is engaged in production activities also and producing different type of
furnishing products. In 2016, the value of inventory was $ 26272 which stretched to $ 32992 in
2017 (Adairs, 2018). An elucidated image of a company’s inventory practices is provided
below:
From the financial disclosures of Adairs Ltd, inventory items are evaluated on the basis of the
Cost-NRV method. As per this method, the value of available inventory will be least of the
following:
 NRV (net realizable value): the net amount that is expected to be received from the available
inventory Cost of inventory
NRV of a product includes all amounts that are expected to be received from the sale of
considered inventory and excludes all costs that are associated with the distribution of inventory.
Adairs Ltd is engaged in the production and retail sale of furnishing items so NRV of closing
inventory gets influenced by the rapid changes in customer interest and fashion trends (CFI,
2019). During the evaluation of NRV value, a significant level of judgment was made by the
management of Adairs Ltd. Cost centre costing is utilized by Adairs Ltd to evaluate the final
cost of inventory and all fright, insurance, duties are included in it.
For the valuation of inventory, Adairs Ltd is utilizing the weighted average method which is
allowed by the AASB board for the Australian companies. Average cost method refers to that the
valuation of inventory should be made on the basis of average values. This method considers the
sum of all costs or products and attributes such costs on the basis of a final number of units
(Johnston, 2019). Following advantages are associated with the Average method:
 Simple and easy:
6

It is one of the easiest methods of inventory valuation which helps to reduce the complexities
that are associated with inventory valuation. As prices of material components vary every time,
it ensures the utilization of the average rate and reduces the impact of price fluctuation on the
final value of inventory.
 Consistency:
It is another merit that is contained by the average method of inventory valuation. Per unit cost
that is determinate through the average method can be utilized for the calculation of COGS,
beginning inventory or closing inventory which is not available with the FIFO method (Johnston,
2019). Thus, the average method contains consistency.
 Cost effective:
If the cost of FIFO, average and other methods compared, the Average method will show the
highest cost-effectiveness because it is useable with less paperwork and human efforts. For
instance, different rates for the valuation of opening, closing and COGS are required under
FOFO meth but only one rate can be used under the average cost method (Johnston, 2019). Thus,
WDV is more cost-effective for Adairs Ltd.
7

Question 3:
costing can be explained as the set of some practices and techniques that are utilized to correctly
measure and classified the different type of expenses to correctly determinate the cost of the final
product and manage the expenditure at most mitigated level. Adairs Ltd is a retail company
which is engaged in the production and sales of furnishing items. From the analysis of Adairs
Ltd, it is outlined that the standard costing system is adopted by the company to correctly
evaluate and manage the costs of production and operations.
Standard costing:
It can be explained as the set of some estimation practices that are utilized to correctly evaluate
the most appropriate level of each associated cost as standard so that real outcomes of efforts can
be compared against these standards and steps of improved can be performed (Karmakar, 2019).
As per CIMA, standard costing is a process of projection of standards, comparison among real
v/s projected figures and analysis of results to maximize the efficiency and gains.
There are several types of costs that are associated with the production process of Adairs Ltd. for
instance; the company is producing furnishing items so the cost of material, labour and
overheads are part of company’s total cost. Similarly, it is engaged in retail selling also, so there
are several operational costs are associated with the company (Adairs, 2018). In this situation,
Adairs Ltd adopted standard costing to set an appropriate standard level for each expense so that
spending can be controlled at the most mitigated stage.
Through the adoption of this method, Adairs Ltd is receiving several competitive advantages and
some of them are explained below;
Elimination of deficiency:
Standard costing provides a facility of comparison among pre-defined standard figures and real
results of efforts. Through this comparison, areas of deficiency that are demanding improvement
can be identified at a regular basis and practices of continuous improvement can be executed to
remove such deficiency (Karmakar, 2019). Adairs Ltd is focused to improve efficiency because
8

it is helpful in the reduction of per unit cost. Due to the same, Adair Ltd adopted standard costing
so that problematic issues can be eliminated for target attainment.
Improved profitability:
A good thing with standard costing is that it is an effective tool to establish control on expenses
which works to improve final profitability. As per Adairs Ltd, standard costing indicates an
acceptable level of expenditure for each process and, helps to mitigate the consumption of extra
funds (Tobi, et al., 2015). Thus, standard costing works to improve final profitability by forming
control of spending.
Evaluation of performance:
For retail companies, performance always remains an issue of concern because it makes a direct
impact on profitability. Standard costing comes with variance analysis and Adairs Ltd is using
this technique to compare the real performance against pre-defined level so that performance and
profits can be improved (Karmakar, 2019).
9

Question 4:
There are several costing methods that can be adopted by a company like Adairs Ltd to correctly
evaluate and manage the spending of the organization. Each costing method comes with some
advantages and limitations so the selection of costing method should be made with elucidated
analysis. Alteration in costing method creates a considerable impact on the figures of financial
statements and the same is explained below:
Marginal costing:
This method is highly utilized by the production companies to correctly measure, classified and
allocated the occurred costs. As per the marginal concept, all variable costs that are part business
process should be allocated as the primary cost of the product and all fixed expenditures should
be absorbed as a period cost (Lacoma, 2017). Adairs Ltd can adopt this method to get the
descriptive image of associated costs.
Utilization of marginal costing will increase the net incomes with each reduction in closing
inventory. As marginal costing refers that only variable expenses are part of the product’s
primary cost, closing inventory contains a high value which reduces the profits (Lacoma, 2017).
It is considerable that the decrease or increase in profits will reflect in the financial statement
also because closing inventory is required to b reported in balance-sheet.
ABC costing:
As per the concept of the ABC method, each expense that is made by the entity should be
allocated to those activities which are consuming the advantage of such expense. This method
leads to the identification of each activity so that occurred cost can be allocated to each
operational activity as per consumption structure (Cooper and Kaplan, 2019).
ABC costing method refers to the set of cost drivers so that occurred costs can be allocated to
each process in the proportion of consumption. It delivers a descriptive image of allocated costs
and helps to eliminate the factor of additional cost from each process (ȘUTEU, et. al., 2016)
Adairs Ltd is engaged in the production of different products and utilization of this method will
improve the figures that are shown in profit statement.
10

Conclusion:
Above report is considering the accounting arrangements of Adairs Ltd and presenting a
descriptive image of accounting practices of the company. Discussion included in the above
report is focused on the practices of inventory valuation and costing and, prepared so that the
diplomatic image of Adairs Ltd.’s accounting and costing system can be presented in front of the
user. In the first question of the report, practices of AASB-2 has been explained in respect of
Adairs Ltd which is concluding that the inventory valuation process of the company is
accountable with AASB-2. In the second question of this assessment, inventory valuation system
of Adairs Ltd is evaluated which is explaining that company is using WDV method for inventory
valuation and, receiving advantages in the form of consistency and cost-effectiveness. In the
ending questions of this assessment, the costing system of Adairs Ltd is evaluated which is
concluding that the company is using a standard costing system to mitigate the costs.
11

References:
 AASB (2002). Inventories [online] Aasb.gov.au. Available at:
https://www.aasb.gov.au/admin/file/content102/c3/AAS02_3-98.pdf [Accessed 12 Feb.
2019].
 Adairs (2018). Annual report and review. [Online] investors.adairs.com.au. Available at:
http://investors.adairs.com.au/FormBuilder/_Resource/_module/51fbMLwe2UG-
5KJ3qHCF4w/file/Adairs-2018-Annual-Report.pdf [Accessed on 12 Feb 2019].
 CFI (2019). Net Realizable Value - Definition, How to Calculate, Example. [online]
Corporate Finance Institute. Available at:
https://corporatefinanceinstitute.com/resources/knowledge/valuation/net-realizable-value-
nrv/ [Accessed 12 Feb. 2019].
 Cooper, R. and Kaplan, R. (2019). Profit Priorities from Activity-Based Costing. [online]
Harvard Business Review. Available at: https://hbr.org/1991/05/profit-priorities-from-
activity-based-costing [Accessed 12 Feb. 2019].
 IFRS (2019). IFRS. [online] Ifrs.org. Available at: https://www.ifrs.org/issued-standards/list-
of-standards/ias-2-inventories/ [Accessed 12 Feb. 2019].
 Johnston, K. (2019). Advantages & Disadvantages of Average Cost Method. [online]
Smallbusiness.chron.com. Available at: https://smallbusiness.chron.com/advantages-
disadvantages-average-cost-method-63677.html [Accessed 12 Feb. 2019].
 Karmakar, R. (2019). Standard Costing: Meaning, Objectives, Advantages and
Disadvantages. [online] Your Article Library. Available at:
http://www.yourarticlelibrary.com/accounting/standard-costing/standard-costing-meaning-
objectives-advantages-and-disadvantages/66374 [Accessed 12 Feb. 2019].
 Lacoma, T. (2017). [online] Bizfluent.com. Available at: https://bizfluent.com/info-8424166-
advantages-disadvantages-marginal-costing.html [Accessed 12 Feb. 2019].
 Lodha, A. (2019). Profit Priorities from Activity-Based Costing. [online] Harvard Business
Review. Available at: http://www.yourarticlelibrary.com/cost-accounting/methods-and-
techniques-of-costing/55231 [Accessed 12 Feb. 2019].
12