Inventory CostingLincy Rinil

INTRODUCTION

• Inventory-A physical resource that a firm holds in stock with the intent of selling it or transforming it into a more valuable state.

• Inventory is material that the firm obtains in advance of need, holds until it is needed, and then uses, consumes, incorporates into a product, sells or otherwise disposes it of .

Concept of Inventory

Inventory refers to the aggregate of those items owned by a firm that are held for the purpose of making sales to customers in the ordinary course of business; or are in the process of production for such sale; or are to be currently consumed in the production of goods to be available for sale

Types of Inventories

Raw materials Work-in- process

Types of Inventories

Spare parts inventories(Maintenance/repair/operating inventory)

Finished Products

Reasons for keeping Inventories

• To stabilise production

• To take advantage of price discounts

• To meet the demand during the replenishment period

• To prevent loss of orders(sales)

• To keep pace with changing market conditions

Types of Inventory Costs

• Ordering (purchasing) costs

• Inventory carrying (holding) costs

• Out of stock/shortage costs

• Other costs

Ordering Costs

• It is the cost of ordering the item and securing its supply.

• Includes-

– Expenses from raising the indent

– Purchase requisition by user department till the execution of order

– Receipt and inspection of material

Inventory Carrying Costs

• Costs incurred for holding the volume of inventory and measured as a percentage of unit cost of an item.

• It includes-– Capital cost

– Obsolescence cost

– Deterioration cost

– Taxes on inventory

– Insurance cost

– Storage & handling cost

Out-of-Stock Costs

• It is the loss which occurs or which may occur due to non availability of material.

• It includes-

– Break down

– delay in production

– Back ordering

– Lost sales

– Loss of service to customers, loss of goodwill, etc.

Other Costs

• Capacity Costs

– Over-time payments

– Lay-offs & idle time

• Set-up Costs

– Machine set-up

– Start-up scrap generated from getting a production run started

• Over-stocking Costs

Inventory control

Inventory control aimsat keeping track ofinventories. In otherwords, inventories ofgood quality and rightquantities should bemade available todifferent departmentsas and when theyneeded.

Objectives Of Inventory Control• To ensure smooth flow of production.

• To provide the required quantity of material

• To control Investment in stock

• Protection against Fluctuating demand

• Protection against Fluctuation in output

• Minimization Of Risk and Uncertainty

• To meet the customer requirement timely, effectively, efficiently, smoothly and satisfactorily.

• To minimize losses due to deterioration, obsolescence, damage, pilferage etc.

Benefits of Inventory Control

• Ensures an adequate supply of materials

• Minimizes inventory costs

• Facilitates purchasing economies

• Eliminates duplication in ordering

• Better utilization of available stocks

• Provides a check against the loss of materials

• Facilitates cost accounting activities

• Enables management in cost comparison

• Locates & disposes inactive & obsolete store items

• Consistent & reliable basis for financial statements

Inventory System

• Inventory System- A set of policies and controls that monitors levels of inventory and determines what levels should be maintained, when stock should be replenished, and how large orders should be placed.

There are two major systems of inventory accounting, they are;

1. Perpetual Inventory System

2. Periodic Inventory System

Inventory System1. Perpetual Inventory System

It is a widely used method of recording inventory which advocates the balancing of inventory after every receipt and issue to facilitate regular checking as well as obviate closing down for stock taking.

Thus, this system is not only provides a complete record of inventory quantities but also carries out valuation on a continuous basis.

2. Periodic Inventory SystemIt suggests to review the quantity

and value of inventory at a fixed timeinterval such as weekly, monthly,

quarterly, etc.

Methods of Inventory Valuation

• Historical Cost Method– First In First Out (FIFO) Method

– Last In First Out (LIFO) Method

– Average Cost Method

– Highest In First Out (HIFO) Method

– Next In First Out (NIFO) Method

– Base Stock Method

• Lower of Cost or Market Method

Definition of inventory control

Inventory control is the technique ofmaintaining the size of the inventory at somedesired level keeping in view the besteconomic interest of an organization.

Steps in Inventory control

• Deciding the maximum- minimum limits of inventory;

• Determination of Reorder point;

• Determination of reorder quantity;

• Perpetual inventory control;

• ABC analysis;

• Method of control through turn over.

Maximum stock level

• Quantity of inventory above which should notbe allowed to be kept. This quantity is fixedkeeping in view the disadvantages ofoverstocking;

Factors to be considered:

• Amount of capital available.

• Godown space available.

• Possibility of loss.

Continue….

• Cost of maintaining stores;

• Likely fluctuation in prices;

• Seasonal nature of supply of material;

• Restriction imposed by Govt.;

• Possibility of change in fashion and habit.

Minimum stock level

• This represents the quantity below whichstocks should not be allowed to fall .

• The level is fixed for all items of stores and thefollowing factors are taken into account:

1.Lead time-

2. Rate of consumption of the material duringthe lead time.

Re-ordering level

• It is the point at which if stock of the materialin store approaches, the store keeper shouldinitiate the purchase requisition for freshsupply of material.

• This level is fixed some where betweenmaximum and minimum level.

Inventory Control Techniques

• ABC Analysis

• Economic Order Quantity (EOQ)

ABC AnalysisIt is efficient control of stores requires greater in

case of costlier items. It is also known as ‘Always Better Control’

Item Quality Quantity order Checking

A Costlier Less Regular system to see

that there is no

overstocking as well as

that there is no danger

of production being

interrupted for

unwanted material.

B Less costlier than A Order may be on

review basis.

Position being viewed

in each month

C Economical Larger Order in large quantity

so that cost can be

avoided

Economic Order Quantity

• EOQ represents the size of an order for whichthe total cost is minimum.

• It is also known as standard order quantity ,optimum quantity or economic lot size.

Computation of EOQ

• The widely used formula is

EOQ = 2AB

C*SWhere ,

A = Annual units to be used in units.

B = Cost of placing an Order

C = Cost per unit

S = Carrying cost as a percentage of average inventory