As per the respective Annual reports (Consolidated financial statements) from FY 2016 until FY2020, the inventory valuation methods followed by the three major automobile companies i.e. Ashok Leyland Ltd, Tata Motors Ltd and Maruti Suzuki Ltd are detailed as follows, Companies Inventories Inventory Valuation Method Ashok Leyland Ltd Raw Materials Work in Progress Finished Goods Moving Weighted Average method since Perpetual inventory system is applied Maruti Suzuki India Ltd Raw Materials Work in Progress Finished Goods Weighted Average Cost Tata Motors Ltd Raw Materials Work in Progress Finished Goods First In First Out Full Absorption Cost All the three companies measure and state their inventories at Lower of Cost and Net Realizable Value. This principle is being used by all the three automobile companies because it allows companies to recognise the loss experienced due to factors such as damage, deterioration, obsolescence and so on. In such cases, the value of inventory will drop below its original cost and the company would have to write off or write down inventory to its net realizable value. In the case of Ashok Leyland, the moving weighted average method is used for evaluating raw materials, work in progress and finished goods. This along with the perpetual inventory system being applied by the company assists in maintaining up-to-date records of inventory. Tata Motors Ltd as a consolidated entity uses First In First Out (FIFO) method to ascertain the cost of its raw materials. Meanwhile, as a standalone entity Tata Motors uses the moving weighted average method to measure the cost of raw materials. Tata Motors’ work-inprogress and finished goods are evaluated on the basis of full absorption cost. Absorption Costing a Since Tata Motors Ltd. recognises manufacturing costs including both fixed and variable production overheads under Product costs, the full absorption cost basis is applied to evaluate the work in progress and finished goods. Maruti Suzuki uses weighted average cost method to determine the value of all of its inventories. The weighted average cost method is used here due to the homogeneous nature of the inventories. To understand the impact of inventory valuation methods on the financial position, a comparative analysis of the inventory turnover ratios of all three automobile companies Ashok Leyland Ltd, Tata Motors Ltd and Maruti Suzuki India Ltd for the last five financial years (ending 2016 - 2020) was undertaken. The results of which are as follows, Inventory Turnover Comparison COGS/AVERAGE INVENTORY 30 25 22.36 25.53 24.17 26.52 23.12 20 15 12.74 11.74 10.08 10 5 13.4 10.34 12.71 9.55 9.19 FY2016 FY2017 9.69 10.46 0 Ashok Leyland Ltd FY2018 Tata Motors Ltd FY2019 FY2020 Maruti Suzuki India Ltd As the only company to have used the Weighted Average Cost method for all inventories (including raw materials, work in progress, finished goods and stock in trade), the inventory turnover ratios of Maruti Suzuki for all five financial years on average was markedly higher than that of the inventory turnover ratios of the other two companies. Patterns in Inventory methods Ashok Leyland ➢ For all five years, inventories are valued at lower of cost and net realizable value. ➢ For the FY 2015-16, Stores, raw materials, components and working progress are measured based on monthly moving weighted average basis whereas for the next four years, they are valued at moving weighted average method. ➢ Spares and consumable tools follow weighted average method in FY15-16 period whereas they are calculated on moving weighted average method for the rest four years. ➢ Work made components cost shows an additional inclusion of applicable production overheads for the year 2015-16 and the finished/traded goods are calculated under absorption costing method. Work made components and finished/traded goods are calculated using weighted average method including appropriate share of overheads in cost for the rest four years. ➢ Ashok Leyland had a different pattern till FY 2015-16, and after that they were consistent in their inventory valuation methods and cost ascertainment. Maruti Suzuki ➢ For the last five years, Maruti Suzuki has been consistent in its inventory valuation method. ➢ Inventories were stated at the lower of costs, determined using Weighted Average basis and at net realizable value. TATA Motors ➢ Their inventories, other than those recognized consequent to the sale of vehicles subject to repurchase arrangements, are valued at the lower of costs and net realizable values for last five years. ➢ For the FY 2015-16, the cost of raw materials and consumables are ascertained on moving weighted average method/monthly moving weighted average basis, except for Jaguar and Land Rover which used FIFO method. From the FY 2016-17 onwards, the company is following a pattern on ascertaining the cost of raw materials, components and consumables using the FIFO (First In First Out) basis. ➢ For the last five years, the cost of work-in-progress and finished goods included the fixed and variable production overheads and is determined using full absorption cost basis. Significance of Financial Statement Analysis Knowing how a company’s inventory affects its financial statements is crucial to understand its operations. Higher inventory levels can incur large carrying costs and expenses, such as warehousing costs, insurance expense and interest on bank debt. While lesser levels of inventory denote stockouts and customer dissatisfaction. Inventory analysis helps determine the right amount of inventory required to foster well organised operations. Thus, it is vital to ensure that the inventory shown in the company’s financial statements is very accurate, which also helps them make better financial predictions. Moreover, the inventory valuation method has a direct impact on the profit margin. For example, if the business used LIFO method it will incur lowest profit margin because the inventory bought last are costlier compared to the ones bought early. The opposite is true for FIFO as the first bought inventory are the cheapest. And an error in the inventory evaluation in one year has an effect on the cost of cost of goods sold, gross profit, net profit, equity and current assets of the next year, because the closing inventory in year 1 is the opening inventory of year 2. So, it is important to use the correct method and implement it to avoid any discrepancy while reporting the financial statements.
