The Directors of UW PLC are keen to attract internal investment to support the expansion of sales.
The company buys raw widgets and, using a complex machining process, produces finished widgets for world-wide consumption. Although demand for finished widgets has been falling during the last few years, UW has just secured a contract with a large company based in China, which will increase its turnover significantly for the foreseeable future. However, the company needs to invest in high-value production machinery to satisfy the increase in demand and will need to raise finance to fund this capital investment. Unfortunately, the company's bankers have declined to offer UW a loan until fully audited forecast accounts have been produced for the coming year.
The Financial Controller has produced forecast accounts for the current year as well as the following table, which compares performance for the past three years with the current year:
|
|
Y/E April 2009
£000s
|
Y/E April 2010
£000s
|
Y/E April 2011
£000s
|
Y/E April 2012
$000s
|
|
Turnover
|
17,076
|
16,419
|
15,780
|
13,200
|
|
Cost of Sales
|
7,982
|
7,675
|
7,380
|
6,150
|
|
Indirect Expenses
|
3,894
|
3,744
|
3,600
|
3,000
|
|
Net Profit
|
5,200
|
5,000
|
4,800
|
4,150
|
The Directors are certain that the bank will refuse a loan on this basis and have asked the Financial Controller to review his forecast to see if there is any way in which forecast profit can be improved.
The Financial Controller has suggested the following ways in which this objective might be achieved:
1. The company has used the First-In-First-Out FIFO) method of stock valuation for many years. However, rough calculations show that profit might be increased by adopting the Average Cost (AVCO) method of stock valuation. The justification for this is that all UW's main competitors use this method of stock valuation, and changing their method would make comparisons more meaningful.
2. The contract with the company in China requires delivery according to the schedule in the Appendix.
Although delivery of the first tranche of goods will take place in June of the following financial year, the Financial Controller believes that income for 120 widgets may be recognised in the year ending 30th April, 2012.
Required:
1. Produce UW's forecast accounts for the year ending 30th April 2012 on the following bases:
a. Without changing stockholding policy or including May sales to China.
b. Changing stockholding policy but excluding sales to China.
c. Without changing stockholding policy but including sales to China.
d. Changing stockholding policy and including sales to China.
2. Comment on the validity of the Financial Director's proposed treatment of stock valuation and revenue recognition, referring to relevant International Accounting Standards as appropriate.