Reference no: EM132982326

Question: N Ltd is an independent company which manufactures clothing. For many years, N Ltd has worked exclusively for Store plc, a national group of department stores, manufacturing gloves. Store plc supplies the patterns for the gloves and specifies the fabric and colours that N Ltd must use. Store plc actively discourages its suppliers from manufacturing for other retailers and expressly forbids them from using its patterns or fabric colours for anything sold to another customer.

N Ltd manufactures gloves steadily throughout the year, building up stocks in advance of the major order that Store plc places every year in order to meet demand in the autumn and winter months.

Store plc used to order 500 000 pairs of gloves from N Ltd every year.

Store plc has suffered declining sales and has closed several of its stores. In April 2001, it warned N Ltd that it will reduce its annual purchases to 400 000 pairs of gloves. N Ltd took immediate steps to reduce its production capacity in response to this reduced order.

N Ltd has a year end of 30 September 2001. At that date, the company had 40 000 pairs of gloves in stock. It also had work-in-progress of 5000 pairs of gloves that were 100% complete in terms of fabric and were 50% complete in terms of labour and overhead. Raw materials stocks comprised £10 000 of fabric in Store plc's colours. N Ltd actually completed a total of 430 000 pairs of gloves during the year ended 30 September 2001.

The fabric content of a pair of gloves costs N Ltd £1.00 per pair. N Ltd has summarised expenses incurred during the year as follows:

                      Fixed overheads         Variable overheads         Labour

Manufacturing    20 000                      40 000                       400 000

Administrative    15000                       10000                       50 000

Distribution       8000                           6000                       12 000

                        43000                        56000                      462 000

Required

(a) SSAP 9 - Stocks and long-term contracts requires that stocks be valued at the lower of cost and net realisable value. Describe the problems associated with determining net realisable value for closing stocks.

You should describe the particular problems associated with determining the net realisable value of N Ltd's closing stocks.

(b) SSAP 9 defines the cost of stock as 'the expenditure which has been incurred in the normal course of business in bringing the product to its present location and condition'

(i) Calculate the cost of N Ltd's closing stocks.

(ii) Identify the accounting issues associated with calculating the cost of closing stocks for N Ltd and explain how you have dealt with them.

(c) Explain why the valuation of closing stock is particularly important in the preparation of financial statements.