Hans Annan, CFA, a food and beverage analyst, is reviewing Century Chocolate’s inventory policies as part of his evaluation of the company.

Hans Annan, CFA, a food and beverage analyst, is reviewing Century Chocolate’s inventory policies as part of his evaluation of the company. Century Chocolate, based in Switzerland, manufactures chocolate products and purchases and resells other confectionery products to complement its chocolate line. Annan visited Century Chocolate’s manufacturing facility last year. He learned that cacao beans, imported from Brazil, represent the most significant raw material and that the work-in-progress inventory consists primarily of three items: roasted cacao beans, a thick paste produced from the beans (called chocolate liquor), and a sweetened mixture that needs to be “conched” to produce chocolate. On the tour, Annan learned that the conching process ranges from a few hours for lower-quality products to six days for the highest-quality chocolates. While there, Annan saw the facility’s climate-controlled area where manufactured finished products (cocoa and chocolate) and purchased finished goods are stored prior to shipment to customers. After touring the facility, Annan had a discussion with Century Chocolate’s CFO regarding the types of costs that were included in each inventory category.

Annan has asked his assistant, Joanna Kern, to gather some preliminary information regarding Century Chocolate’s financial statements and inventories. He also asked Kern to calculate the inventory turnover ratios for Century Chocolate and another chocolate manufacturer for the most recent five years. Annan does not know Century Chocolate’s most direct competitor, so he asks Kern to do some research and select the most appropriate company for the ratio comparison.

Kern reports back that Century Chocolate prepares its financial statements in accordance with IFRS. She tells Annan that the policy footnote states that raw materials and purchased finished goods are valued at purchase cost whereas work in progress and manufactured finished goods are valued at production cost. Raw material inventories and purchased finished goods are accounted for using the FIFO (first-in, first-out) method, and the weighted average cost method is used for other inventories. An allowance is established when the net realizable value of any inventory item is lower than the value calculated.

Kern provides Annan with the selected financial statements and inventory data for Century Chocolate shown in Exhibits A through E. The ratio exhibit Kern prepared compares Century Chocolate’s inventory turnover ratios to those of Gordon’s Goodies, a U.S.-based company. Annan returns the exhibit and tells Kern to select a different competitor that reports using IFRS rather than U.S. GAAP. During this initial review, Annan asks Kern why she has not indicated whether Century Chocolate uses a perpetual or a periodic inventory system. Kern replies that she learned that Century Chocolate uses a perpetual system but did not include this information in her report because inventory values would be the same under either a perpetual or periodic inventory system. Annan tells Kern she is wrong and directs her to research the matter.

Century Chocolate Income Statements (CHF millions)

For Years Ended 31 December

2009

2008

Sales

95,290

93,248

Cost of sales

-41,043

-39,047

Marketing, administration, and other expenses

-35,318

-42,481

Profit before taxes

18,929

11,720

Taxes

-3,283

-2,962

Profit for the period

15,646

8,758

Century Chocolate Balance Sheets (CHF millions)

For Years Ended 31 December

2009

2008

Cash, cash equivalents, and short-term investments

6,190

8,252

Trade receivables and related accounts, net

11,654

12,910

Inventories, net

8,100

7,039

Other current assets

2,709

2,812

Total current assets

28,653

31,013

Property, plant, and equipment, net

18,291

19,130

Other noncurrent assets

45,144

49,875

Total assets

92,088

100,018

Trade and other payables

10,931

12,299

Other current liabilities

17,873

25,265

Total current liabilities

28,804

37,564

Noncurrent liabilities

15,672

14,963

Total liabilities

44,476

52,527

Equity

Share capital

332

341

Retained earnings and other reserves

47,280

47,150

Total equity

47,612

47,491

Total liabilities and shareholders equity

92,088

100,018

Century Chocolate Supplementary Footnote Disclosures: Inventories (CHF millions)

For Years Ended 31 December

2009

2008

Raw Materials

2,154

1,585

Work in Progress

1,061

1,027

Finished Goods

5,116

4,665

Total inventories before allowance

8,331

7,277

Allowance for write-downs to net realizable value

-231

-238

Total inventories net of allowance

8,100

7,039

Century Chocolate Inventory Record for Purchased Lemon Drops

Nokia
(6 in millions)

Ericsson
(SEK in millions)

2008

2007

2008

2007

Short-term borrowings

3,578

714

1,639

2,831

Current portion of long-term interest bearing debt

13

173

3,903

3,068

Long-term interest bearing debt

861

203

24,939

21,320

Total shareholders’ equity

14,208

14,773

140,823

134,112

Total assets

39,582

37,599

285,684

245,117

SIT

4,966

7,985

16,252

30,646

Interest payments

155

59

1,689

1,513

Century Chocolate Net Realizable Value Information for Black Licorice Jelly Beans

2009

2008

FIFO cost of inventory at 31 December (CHF)

314,890

374,870

Ending inventory at 31 December (kilograms)

77,750

92,560

Cost per kilogram (CHF)

4.05

4.05

Net realizable value (CHF per kilogram)

4.20

3.95

While Kern is revising her analysis, Annan reviews the most recent month’s Cocoa Market Review from the International Cocoa Organization. He is drawn to the statement that “the ICCO daily price, averaging prices in both futures markets, reached a 29-year high in US$ terms and a 23-year high in SDRs terms (the SDR unit comprises a basket of major currencies used in international trade: US$, Euro, Pound Sterling and Yen).” Annan makes a note that he will need to factor the potential continuation of this trend into his analysis.

Ignoring any tax effect, the 2009 net realizable value reassessment for the black licorice jelly beans will most likely result in:

A. an increase in gross profit of CHF 9,256.

B. an increase in gross profit of CHF 11,670.

C. no impact on cost of sales because under IFRS, write-downs cannot be reversed.