INVENTORY (STOCK) CONTROL AND VALUATION

Inventory is an important asset to any business organization. It must be managed and

controlled to avoid cost that comes with keeping stock. To manage inventory it is
necessary to understand the following:

The functions and documents in inventory control

The different classifications of stock;

Why stock is kept;

The associated costs;

Management of stock levels and

Valuation of stock.

Inventory Control function

Inventory control is a process of managing the movement of stock and comprises the
following functions:

 Ordering/purchasing of stock

 Receiving/storage of stock

 Issuing/controlling stock levels

Classification of stocks:

 Raw materials,

 Work In progress(WIP),

 Finished goods and

 Consumables/spares

Inventory Control documents

To manage the movement of stock there is need for documentation that will ensure
that stock is accounted for through the entire process from ordering to storage and
issuing. There are various documents used in the accountability of stock which
include the following:
Purchase requisition: it is issued by stores to purchasing requesting that a particular
item be bought for a store that is not in stock.

Quotation/proforma Invoice: It is issued by the supplier to a customer and indicates

the items to be purchased as well the value. Three or more quotations are normally
collected from different suppliers to help the customer make a decision on which
supplier to choose. Quality, cost and reliability are essential considerations in the
choice of supplier.

Purchase order: When a supplier is selected a purchase order is raised by the

customer to the supplier requesting that items be supplier as per order. The supplier
will supply on cash or credit basis.

Delivery Note: The is document issued by the supplier to the customer indicating that
items ordered have been delivered.

Goods Received Noted: This is a document issued by the customer to the supplier
indicated that goods have been received as ordered.

Material requisition note: This is issued by departments as they request for items
from stores.

Items received in store are recorded on a bin card or stored electronically using
a computerized stores system.

Objectives of Storage

i. It makes receiving and issuing of stock more efficient

ii. It ensure protection and safety of stock and person

iii. Makes identification easier particularly where items in stores are similar.

iv. Maintenance of stock levels is more effective

v. Record keeping is accurate

Stock Count (stock take):

Is the physical count of stock, to verify that what is on record matches the physical
stock available.

Stock count can be done periodically or continuously.

Periodic stock take is done at specific times e.g. End of day, week, month or
year.Continous stock take is done targeting the counting of certain items more
frequently at different time intervals in a day and repeating the process for all other
items in store.
Benefits of Stock takes:

It reveals stock that is obsolete, damaged, stolen, slow moving or needs to be

quarantined for safety.

A bin Card is manual system of record keeping for stock. It records stock as it is
recived, issued and records the balance held in store each day. Bin card are still used
as back up even where a computerized system is in place. Using storage application is
much more efficient and accurate and provides real time information on stock
movements.

Controlling Inventory levels:

Inventory is a cost to a business and therefore managing this cost requires that
management controls the stock levels. An optimal stock level needs to be determined
by knowing how much stock to keep, how much stock to order and when stock should
be ordered. In the process of managing stock levels a balance should be struck to
avoid having too much stock and too little stock (Stock out).The following critical
inventory levels need to be determined:

Reorder Level: This is the level of stock that indicates that an order has to be placed
to new stock to replenish what has been used up.

Re-order level = maximum daily usage x maximum lead time (LT)

Maximum level: This level of stock that indicates there is too much stock being held
and this could be costly and wasteful.

Maximum level = Re-order level + Re-order quantity –(minimum usage x minimum

Lead time.

Minimum Level: This is a stock level that indicates that stock levels are low. Low
stock levels may lead to stock outs.

Minimum level = Reorder level – (Average usage x Average lead time)

Example: Stock level control:

Average Usage 350 units per day

Minimum Usage 180 units per day

Maximum Usage 420 units per day

Lead time 11 – 15 days

Re-order Quantity 6,500 units

Solutions

Re order level = 420 x 15 = 6,300 units

Maximum level = 6,300+6,500-(180 x11) = 10,820 units

Minimum level = 6,300 –(350 x 13 ) = 1,750 units

Managing Inventory Costs using EOQ

The Economic Order Quantity (EOQ) model is used to determine the quantity of stock
to order each so as to reduce inventory cost. The total inventory cost is minimized at
the point where storage and ordering costs are equal. The major costs associated with
inventory are Ordering Cost and Storage Cost.

Ordering Cost

This is the cost bring the stock to the stores from the suppliers. It constitutes costs
such as procuring, freight (transport), and insurance, handling and administrative
paper work.

Storage Cost

This is the cost keeping the stock and includes costs such as stores wages,
maintenance, security, insurance, opportunity cost for capital invested in stock.

Managing inventory costs means minimizing the two costs. This is done determining
the right quantity to order. The EOQ is used to calculate this quantity.

1. Graphical approach to EOQ

Q* = Economic Order Quantity (EOQ)

 2. EOQ using formula

Example: EOQ calculation and Total Cost of Inventory

A = Annual demand in units can also be shown as D and Q is the EOQ and c x i is
Carrying cost, can also be shown as CH. the cost per order can also be shown as
C.
Example: EOQ

D = 120,000 unit

C = K10 per order

CH = 10% of unit cost

The unit price or cost is K20 per Unit.

Using the following information determines the following:

i. EOQ

ii. Total Inventory Cost

Solutions:

Valuation of Stock (Inventory)

Valuation of stock is the process of determine the unit cost stock that will be used to
charge cost to the income statement as well the statement of financial position. An
appropriate cost or value of stock should be used to ensure that the profit and loss
amounts represent a true and fair position. They should be under estimate or over
estimated. Stock is valued using different method but the following are the common
methods used to value stock:

First In first Out (FIFO) it values stock on the basis that the first stock to be received
is the first to be issued. Therefore closing stock will carry the most recent prices for
stock purchased.

Last in first Out (LIFO) it values stock on the basis that the last stock received is the
first to be issued out. Therefore the closing stock will carry earlier process for stock
bought.

Average method (AVCO) values stock using an average price which is re calculated
each time new stock batch is received. Stock being issued will be issued at this
average price until another new batch is received in stores.
Example: Stock Valuation

Date Units Received Price /unit(K) Units Issued

Sep 1 10 10

Sep 2 20 15

Sep 3 - - 15

Sep 20 10 20

Required: Calculate the value of closing stock using the three methods above.

Solution
Under/over Absorption of Overheads
The costs charged to the cost of sales in the income statement are based on budgets or
estimate figures. Predetermined Absorption Rates are calculated based on these
estimates. This is the cause of over and under absorption. Actual costs and activities
levels do not turn out to be exactly the same as the budgeted ones.

Over Absorption: Is when overheads charged to the income statement are more than
those actually incurred.

Under Absorption: Is when overheads charged to the income statement are less than
those actually incurred.

Income statements are normally adjusted to correct the profit or loss by adding and
subtracting the Over/Under Absorption respectively.

Reasons for Over/Under absorption:

1. Actual Activity level is different from budgeted.

2. Actual Overhead Cost is different from budgeted.

3. Both Actual Overhead Cost and Activity is different from budgeted.

Example:

Budgeted production overhead is ZMW50,000 and budgeted activity is 25,000 direct

labour hours.

a) Calculate the absorption rate

b) Calculate the under/over absorption and give reasons for it in each of the cases
below.

i. Actual cost ZMW47,000 and 25,000 direct labour hours.

ii. Actual cost ZMW50,000 and 21,500 direct labour hours.

iii. Actual Cost ZMW47,000 and 21,500 direct labour hours.

Under/Over absorption = Actual Overhead Cost – Absorbed overhead cost

Absorbed Overhead Cost = Actual Activity x Absorption Rate