The Wall Strret Journal reported that \"Valero Energy Corp. said it will take a

Question

The Wall Strret Journal reported that "Valero Energy Corp. said it will take a first-quarter charge of $37.7 million, or 43 cents per share, related to lower prices for crude oil and refined products. The energy-refining and marketing company characterized the write-down as an accounting 'to reduce the carrying value of our crude oil and refined products inventories to ther market value'. A. What exception to the principles of financial accounting is being followed by Valero when it writes down its inventories? B. How would the write down affect the financial statements? C. How would the write down affect the company's current ratio and its inventory turnover ratio? D. Explain how such a write down could be used to manipulate earnings and what two reporting strategies Valero could be following. E. If crude oil prices rebounded the following year, explain how Valero, which uses U.S. GAAP, would account for the rebound. What is Valero used IFRS instead of U.S. GAAP?

Explanation / Answer

a)It is using the lower of cost or market value to the historical cost principle that is applied to inventory. If the market value of inventory is lower than the cost of that inventory, it must be written down to the value at present

b)The write-down will lower reported income,equity,current assets

c)Valero’s current ratio will decrease because inventory will be carried at a lower value and there is no change to current liabilities. Valero’s inventory turnover ratio will increase because average inventory for the year will be lower.

d)By reducing the carrying value of inventory ,Valero is reducing earnings in the current quarter. As this inventory is sold in future periods Valero will report higher earnings than it would have with no write-down. Valero’s reporting strategy is to lower quarter’s earnings because may be it thinks it has produced greater earnings than it expected.

e)Under U.S. GAAP, inventory is written down, if required, but it is never written back up. Therefore, Valero would simply leave the inventory at the written-down carrying cost, even if market prices rebound. But in IFRS,the inventory writedowns can be recovered if market prices move back up. In that case, if Valero used IFRS, the company would book an Inventory Recovery (which would increase profits and equity) to balance out the increase in the carrying value of the asset

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