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8/29/2017
1
Eliminating Standard Costing: A Step-by-Step Methodology
Nick Katko
COO & CFO
Tenmast Software Company
Lexington, KY
1. GAAP Principles
2. Lean Inventory Valuation & GAAP Compliance
3. Lean Inventory Valuation Examples
4. Wrap Up & Questions
Workshop Agenda
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2
GAAP Principles Inventory Valuation and Cost of Goods Sold
“Actual expenses incurred to get goods in condition for sale”
Inventory at Cost
Acquisition Costs
Production Costs
“ involves many
considerations”
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“A major objective of accounting for inventories is the proper determination of income through the process of
matching appropriate costs against revenues”
COGS
Expenses incurred to generate revenues
recognized
Difficulties in matching specific costs to revenue recognized
Continuous nature of
MFG
Products not sold in same
period as produced
Prices change over time
Production costs change over time
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GAAP: Use a Cost Flow Assumption
• Companies must use a consistent method Consistent:
• Cannot change year-to-year Over Time:
• In audit reports Disclosed:
• Change in cost flow assumption is a change in accounting method Change:
Codified Cost Flow Assumptions
• Most recent costs assigned to ending inventory FIFO:
• Most recent costs assigned to COGS LIFO:
• Inventory and COGS at average cost of all goods available for sale Average Cost:
• Exact specific costs of each product can be accumulated
Specific Identification:
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Lean Inventory Valuation GAAP Compliance
Lean Inventory Valuation
• Lean transformation is designed to reduce inventory levels in manufacturing companies
• 30 – 60 days is a good target
Inventory levels
• Financial risk of inaccurate inventory valuation decreases significantly, lowering materiality of misstated profits
Materiality
• Simpler valuation methods can be used to maintain GAAP compliance Methods
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Lean Inventory Valuation & GAAP
• Inventory and COGS at average cost of all goods available for sale
• But not individual product costs
Average Cost:
• 30-60 Days Low
Inventories:
Lean Inventory Valuation - Material
Quantity Monthly physical
Track in ERP
Cost VSP&L: average cost per unit or
per day
Individual part: average cost or last price paid
Few Parts Many Parts
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Lean Inventory Valuation: Production Cost Capitalization
• Actual costs from value stream income statements
Actual Production Costs
• Capitalize total costs, not individual products
• Use journal entry
Capitalization of Production Costs
• Labor & OH rates set to zero
• Auditor buy-in on methodology Requirements
Production Cost Capitalization Methods
• Count the inventory, calculate the days, calculate the value from the number of days. Days of Inventory
• Calculate the number of units in finished goods as a percentage of total production that month. Inventory value will be that percentage of the total value stream costs.
Units of Inventory
• Used when the company tracks inventory but maintains inventory value for the material content only. The conversion cost is then applied based upon the number of days of material.
Days of Conversion Cost
• Capitalize production costs to maintain historical standard margins, and re-calculate annually
Historical Margins
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Lean Inventory Valuation Examples
TOTAL
$2,048,686
$849,526
$312,984
$342,421
$116,550
$53,731
$41,200
$9,664
$1,726,076
$322,610
16%
$1,186,035
$963,148
($222,887)
$99,723
5%
Calculate the Inventory Value Using the “Days of Inventory Method”
REVENUE
Materials
Direct Labor
Support Labor
Machines
Outside process
Facilities
Other Costs
TOTAL COST
VALUE STREAM PROFIT
Return on Sales
Opening Inventory
Closing Inventory
Inventory Adjustment
NET PROFIT
1. Calculate the material cost per day. 2. Calculate the conversion cost per day 3. Calculate Raw Material value (#days * material cost per day) 4. Calculate the Finished Goods value (#days *( material + conversion
cost per day)) 5. Calculate WIP value (#days * material cost per day + #days/2 *
conversion cost per day) 6. Calculate total inventory value by adding the three together
TOTAL
$2,048,686
$849,526
$312,984
$342,421
$116,550
$53,731
$41,200
$9,664
$1,726,076
$322,610
16%
$1,186,035
Closing Inventory
Inventory Adjustment
Days in the month Total Material CostMaterial Cost per
Day
Total Conversion
Cost
Conversion cost
per day
20 $849,526 $42,476 $876,550 $43,828
Days Material Value Conversion Value Total Value
Raw Material 10 $424,763 $0 $424,763
Work in Process 3 $127,429 $65,741 $193,170
Finished Goods 4 $169,905 $175,310 $345,215
TOTAL INV VALUE 17 $722,097 $241,051 $963,148
Days in the month Total Material CostMaterial Cost per
Day
Total Conversion
Cost
Conversion cost
per day
20 $849,526 $876,550
Days Material Value Conversion Value Total Value
Raw Material 10
Work in Process 3
Finished Goods 4
TOTAL INV VALUE 17
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Total Units
Manufactured Total Material Cost
Average Material
Cost per Unit
Total Conversion
Cost
Average
Conversion cost
per Unit
22,861 $849,526 $37.16 $876,550 $38.34
Quantity Material Value Conversion Value Total Value
Raw Material 11,430 $424,744 $0 $424,744
Work in Process 3,430 $127,460 $65,758 $193,218
Finished Goods 4,573 $169,898 $175,341 $345,276
TOTAL INV 19,433 $963,238 $722,140 $241,098
TOTAL
$2,048,686
$849,526
$312,984
$342,421
$116,550
$53,731
$41,200
$9,664
$1,726,076
$322,610
16%
$1,186,035
$963,163
($222,872)
$99,737
5%
Calculate the Inventory Value Using the “Number of Units Inventory Method”
REVENUE
Materials
Direct Labor
Support Labor
Machines
Outside process
Facilities
Other Costs
TOTAL COST
VALUE STREAM PROFIT
Return on Sales
Opening Inventory
Closing Inventory
Inventory Adjustment
NET PROFIT
1. Calculate average material cost and average conversion cost 2. Calculate Raw Material value (#units * material cost per unit) 3. Calculate the Finished Goods value ((#units * material +
conversion cost per unit)) 4. Calculate WIP value (#units * material cost per unit + #units/2 *
conversion cost per unit) 5. Calculate total inventory value by adding the three together
TOTAL
$2,048,686
$849,526
$312,984
$342,421
$116,550
$53,731
$41,200
$9,664
$1,726,076
$322,610
16%
$1,186,035
Closing Inventory
Inventory Adjustment
Total Units
ManufacturedTotal Material Cost
Average Material
Cost per Unit
Total Conversion
Cost
Average
Conversion cost
per Unit
22,861 $849,526 $876,550
Quantity Material Value Conversion Value Total Value
Raw Material 11,430
Work in Process 3,430
Finished Goods 4,573
TOTAL INV 19,433
Calculate the Inventory Value Using the “Days of Conversion Cost Method”
Inventory Value
Materials Only
Number of Days in
the Month
Number of Days of
Inventory
$474,036 20 11.16
Inventory Value
Materials Only
Number of Days in
the Month
Number of Days of
Inventory
$474,036 20
This method is used when the company tracks inventory but maintains inventory value for the ,material content only. The conversion cost is then applied based upon the number of days of material.
1. Calculate the number of days of inventory. (Days in the month *
Inventory value / Monthly Material Cost) 2. Calculate the Conversion Cost Applied. (Number of days of
inventory * total conversion cost / Number of Days in the Month) 3. Calculate total inventory cost. (Add materials value plus
conversion cost applied)
Opening Inventory
Closing Inventory
Inventory Adjustment
NET PROFIT
TOTAL
$2,048,686
$849,526
$312,984
$342,421
$116,550
$53,731
$41,200
$9,664
$1,726,076
$322,610
16%
$1,186,035
$963,152
($222,883)
$99,726
5%
TOTAL
$2,048,686
$849,526
$312,984
$342,421
$116,550
$53,731
$41,200
$9,664
$1,726,076
$322,610
16%
$1,186,035
Closing Inventory
Inventory Adjustment
REVENUE
Materials Direct Labor Support Labor Machines Outside process Facilities Other Costs
TOTAL COST
VALUE STREAM PROFIT Return on Sales
Total Conversion
Cost
Conversion Cost
Applied
Total Inventory
Cost
$876,550 $489,115 $963,151
Total Conversion
Cost
Conversion Cost
Applied
Total Inventory
Cost
$876,550
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1. Calculate Labor & Overhead as a % of Material Cost
2. At FYE or any month end, set Labor & OH rates to zero
3. Revalue inventory in ERP system ( will be material cost)
4. AJE to recapitalize Production Costs prior to revaluation
5. Open new accounting and manufacturing period in ERP
6. Next month end: calculate change in capitalized production costs
Historical Margin Process Steps
FYE 12/31/16
Standard Costing Stand Calibration Measurement Optical Tooling Total
Material Cost 345,472 28,360 82,901 440,350 897,084
Labor & Overhead 152,008 5,105 73,782 325,859 556,754
Total Inventory 497,480 33,465 156,683 766,209 1,453,837
Labor & OH as a % of Material Cost 44% 18% 89% 74% 62%
Cost of Goods Sold Capitalized Production Costs Inventory
DR CR DR CR DR CR
Ending Balance - Standard Costing 1,453,837
#1 - Revalue Inventory (L&OH = 0) 556,754 556,754
556,754 897,084
#2 - Recapitalize Production Costs FYE 556,754 556,754
Ending Balance - Lean Inventory Valuation 0 556,754 897,084
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01/31/17 Stand Calibration Measurement Optical Tooling Total
Beginning Inventory 345,472 28,360 82,901 440,350 897,084
Ending Inventory 344,803 124,784 51,257 476,671 997,514
Labor & OH as a % of Material Cost 44% 18% 89% 74% 62%
Ending Capitalized Production Costs 151,713 22,461 45,618 352,736 572,529
Beginning Capitalized Production Costs 556,754
Increase (Decrease) Capitalized Production Costs 15,775
Cost of Goods Sold Capitalized Production Costs Inventory
DR CR DR CR DR CR
Beginning Balance 556,754 897,084
Month End AJE 15,775 15,775 100,430
Ending Balance - 15,775 572,529 997,514
Wrap Up Practical Advice on achieving Lean Inventory Valuation
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The Journey to Lean Inventory Valuation
Beginning Lean
Use Current Methods
VSP&L (Internal Use
Only)
In-Between
Simplify Current Methods
VSP&L (Internal Use
Only)
30-60 Days
Inventory
Lean Inventory Valuation
using VSP&L
VSP&L (Internal & External)
Lean Accounting GAAP
Practical Advice
• Design a lean inventory valuation methodology which works for your company
Company-Specific
• Macro Valuation method rather than Micro Valuation method
• This is the key to success
Capitalization of Production Costs
• Use ERP system with average actual cost Material Value
• Partner with them to create a methodology they can test Auditor Buy-In
8/29/2017
13
Thinking like a Lean Accountant
• Maintain GAAP compliance in the leanest way possible GAAP
• Simplest methodology to capitalize actual production costs for your company
• “Turn off standard costing”
The Goal
• Simplify current systems – eliminate waste
• Achieve the future state – your company’s goal
Continuous Improvement
• External Reporting: GAAP compliance
• Internal Reporting: usable financial information for Lean Operations
Customer Value
Question Time
Nick Katko Contact Information • [email protected]
• Lean Accounting Blog: www.theleancfo.com
• www.linkedin.com/in/nickkatko/