[HWE Session 1 Inventory Policies axe Pe ULE Saree) ea Cod Eu oa osu ey errs en Sra Pc Participant Workbook © 2013 APICS Confidential and Proprietary APICS ‘The Association for Operations ManagementDelsiled Scheduling and Planning Course Objectives « Provide a review of — Inventory polices, planning concepts, and techniques that ‘supportthe detaled scheduling and planning of manufacing and services = Schedifing and planing techniques that tranelate end-tem ‘plans a the master planning level nfo requirements that can be procured and produced with the resources avalible to the ‘company = Project management techniques and supplier retaionships that help manage the supply of products end services Provide a basis for further study leading to APICS CPIM certification. Meike. Bonita ADIGA ng | 1f®ics Course Overview Session 1: Inventory Policies Since 1973, the Certified in Production and Inventory Management (CPIM) program has been recognized as the international standard for individual assessment in the field of production and inventory management. The CPIM program provides a common basis for individuals and organizations to evaluate their knowledge of this evolving field. The mission of CPIM is to educate the CPIM target audience in the concepts, tools, topics, terminology, and integration of operations issues. The CPIM program is designed to test candidates’ in-depth knowledge of a variety of subjects specific to production and inventory ‘management. APICS ensures that CPIM exams are consistently reliable and uses the highest professional standards when developing and administering the program. ‘The CPIM program incorporates a business-process orientation rather than individual techniques. The individual modules are integrated and follow a progression of inoreased understanding: Entry module—BSCM covers terminology and basic concepts related to managing the complete flow of materials from suppliers to customers. Business process modules—Three modules—MPR, DSP, and ECO—cover methodologies and techniques to drive processes, plus the application of these ‘techniques. Capstone module—SMR builds upon the entry and business process modules named above. It encourages higher-level thinking about the relationship between strategic business planning and the development and execution of a competitive operations strategy. DSP—This course focuses on inventory management, material and capacity scheduling and planning, and supplier relationships. It also reviews the influences of lean philosophies in these areas. It includes a detailed explanation of material requirements planning (MRP), a technique suitable for use in job shop and certain high-volume repetitive industries. The course also introduces another material planning technique, material-dominated scheduling (MDS), which is applicable to process industries and other mature production environments, The course explains capacity requirements planning in detail, introduces other capacity- planning techniques such as processor-dominated scheduling, and reviews the use of project, management techniques. ©2073 APICS 13 Participant Workbook Version 5.7Detailed Scheduling and Planning Fics Detailed Scheduling and Planning Participant Workbook Version 5.1 14 ©2013 APICS/éics Session 1: Inventory Policies ‘Session 1: Inventory Policies Purpose Inventory policies play an important role in manufacturing companies. ‘¢ Manufacturing is the business of transforming raw materials into finished goods. In the ‘process, companies use and produce large amounts of inventory, which often is the largest asset on a mannfacturing company's balance sheet. A company does not realize revenue, including profit, from its production activities until it sells finished products in inventory. This ultimately converts inventory on the balance sheet, including the value added to it by labor and capital, into cash. ¢ As the final priority and capacity planning stage in manufacturing planning and control, the detailed planning and scheduling process establishes the company’s detailed schedules and resource plans for end items and their components. 4 The detailed planning and scheduling process must balance a universal inventory management policy, which is o convert raw materials into finished products and sell ‘them as quiokly as possible, This must be within the company’s customer service and production efficiency objectives and policies. Inventory policies, especially as they relate to inventory investment, are the subject ofthis session. We will review the following topics: + iypes and classifications of inventory in manufacturing and services environments + influence of aggregate-level inventory policies, which affect and reflect tradeoffs among customer service, production efficiency, and inventory investment objectives + adoption or selection of inventory policies consistent with inventory investment goals, that 4 influence the scheduling and planning of manufacturing activities, as discussed in Sessions 2 through 7 + guide the development and management of supplier relationships, as discussed in Sessions 8 and 9. ©2013 APICS 15 Participant Workbook Version 5.1Detaled Scheduling and Planning oo Learning Objectives 3) 2» Recognize types and classifications of inventories = Recognize the maior typas and sub-classifications of inventory. — Explain how they affect inventory valuation and investment. — Compare the types end roles of inventory management and policies in manufacturing and service industries. « Understand aggregete inventory policies = Explain how aggregate inventory policy interretates with & ‘company's customer service and operations efficiency objectives, — Desciibe the mle of inventory valuation methods. — Explain the significance of aggregate and itemrinventory performance metic Learning Objectives (cont.) s* «Understand item inventory policies — Desaite how lo-sizing and safety stock policies support ‘aggregete love pofces in menufacturing and service industies. ~ Differenite among the major lot-sizing methods. — Explain the use of safety stock in managing inventory/éics Session 1: Inventory Policies Learning Objectives Types and Classifications of Inventories + Recognize the major types and subciassifications of inventory. «Explain how they affect inventory valuation and investment. Compare the types and roles of inventory management and policies in manufacturing, and service industries. Aggregate Inventory Policies ‘+ Explain how aggregate inventory policy interrelates with a company’s customer service and operations efficiency objectives. + Describe the role of inventory valuation methods. + Explain the significancejof aggregate and item-inventory performance metrics. + Hom Inventory Policies + Describe how lot-sizing and safety stock policies support aggregate-level policies in ‘manufacturing and service industries. + Differentiate among the major lot-sizing methods. + Explain the use of safety stock in managing inventory. ‘©2013 APICS 7 Parlicisant Workbook Version 5.1Detailed Scheduling and Planning apes References: Amold et al, Jniroduction lo Materials Management, 7th c., ch George, Lean Six Signa, chap. 13; Bicheno and Holweg, The Lean Toolbox, 4" ed chp. 9; Hakscver et al, Service Management ad Operations, 2nd ed. chap. 1 and 19% Tacabs et al, Mamufactiing Planning and Control for Supply Chain Managersent, ‘AVICS/CPIM Certification Edition (2011), chap. 8,9, and 16. TS Types and Classifications Overview Mejor types of manufacturing inventory « Sub-dlassifcations of manufacturing invehtory «+ Other types of manufacturing inventory «Service inventory Major Types of Manufacturing Inventory + Raw material ‘» Work in process (WIP) ‘« Finished goods an¢ distribution inventories = Maintenance, repair, and operating (MRO) supplies Participant Workbook Version 5.7 18 ‘©2015 APICS wt a C e i i my dkeics Types and Classifications of Inventory Session 1: Inventory Poficies In this seotion, we will address the major types and classifications of inventory in traditional, lean, and TOC manufacturing processes. We also will discuss service inventory. (Our goal is to help you understand how different types of inventories affect inventory investment or the value of inventory at all levels measured in monetary terms. ‘Remember that detailed scheduling and planning balances inventory investment objectives, with customer service and production efficiency objectives, and thal inventory strategy and policies both affect and reflect tradeofis among the three objectives. Major Types of Manufacturing Inventory Manufacturing inventory can be classified into four major types that are found in both ‘traditional and lean manufacturing process environments: ¢ caw materials + work in process (WIP) + finished goods and distribution inventories + maintenance, repair, and operating supplies (MRO) ‘The first three (raw materials, WIP, and finished goods), are based on the flow of materials from suppliers through manufacturing and into the distribution system. Is inventory considered an asset or a liability, and why? ©2013 APICS + Participant Workbook Version 5.4Detailed Scheduling and Planning fics Participant Workbook Version 5.1 10 ‘2013 APICSt Pics Session 1: Inventory Policies Raw Material wip Raw materials are purchased items or extracted materials that are converted into components and products during the manufacturing process. + Raw materials include components such as manufactured parts or subassemblies that are transformed into finished products. ‘+ They are the lowest-level components in a bill of material (BOM). ‘The procurement process and management of supplier relationships address the management of raw material supply requirements in both manufacturing and service industries. In lean manufacturing environments, raw material inventories typically are very low. Lean ‘manufacturing relies on relationships with suppliers that deliver raw materials, often directly to the factory floor. Suppliers do this in appropriate lot sizes to reduce the waste represented by inventory carrying costs. ' In some traditional manufacturing process environments such as intermittent (job shop) and batch, production transforms raw materials into finished products in a series of discrete steps. This results in what is called WIP inventory: goods in various stages of completion in a production process. WIP includes the following: + raw material that has been released for initial processing ‘+ semifinished stock and components + completely processed materials awaiting final inspection and acceptance as finished goods inventory. “Most manufacturing firms have some inventory that fits this classification. Production reporting communicates the completion status of products at each intermediate stage of production so that accounting can determine the value of WIP, This is based on direct ‘material and labor costs and allocated factory overhead costs. Ina pure lean manufacturing environment, WIP levels are significantly lower. Production layouts, such as continuous flow and cellular, and other methods facilitate a continuous one- piece flow of material from raw meterial to finished product that is synchronized with customer demand, or pull rate, Manufacturing lead times and WIP decrease by design. ‘201 APICS Tit Participant Workbook Version 5.1 i erDetailed Scheduling and Planning Parlicipant Workbook Version 5.1 12 © 2013 APICSPics Finished Goods and Distribution Inventories Session 1: Inventory Policies ‘A finished good, or end item, is « product sold by a company as a completed item. Note that a service part sold to customers as a spare or replacement part also is considered a finished good. Manufacturing companies may keep a stock of finished goods at a production facility, Central warehouse, or distribution centers to reduce delivery lead times and delivery costs, ‘How can using distribution centers lower overall distribution costs? ‘Because of the philosophy of producing to customer demand and not to forecast, finished g00ds inventories are minimized in lean manufacturing environments, MRO Supplies C MRO supplies support general operations and maintenance. They include such items as cutting and lubricating oils, machine spare parts, glue, tape, and office and janitorial supplies. ‘Machine maintenance supplies and spare parts are used to support uptime and availability requirements and may include items costing 2 small or large amount, ‘2013 APIGS 13 Participant Workbook Version 5.1Detailed Scheduling and Planning Participant Workbook Version 5.4 144 ©2073 APICSHUW BBE ee oe eee ee ee fics Sesion vero Poies Subclassifications of Manufacturing Inventory ‘Visual 1-9 shows edditional ways of classifying and analyzing the four major types of inventory we just discussed. This will provide additional understanding of their implications for inventory investment. What could cause these types of inventory, and what can be done about them? ‘Why should the target inventory level for expensive operating items be lower? Excess ‘There are two perspectives on excess inventory. Many authors define it as materials procured or manufactured in excess of current operational needs. Excess inventory may occur by plan in response to lot-sizing rules, seasonality considerations, ot anticipation builds. A price ‘break or discount for a part may give the purchasing department sufficient reason to buy & larger quantity than normal. Inaccurate inventory records could prompt premature replacement, Order cancellations may result in higher inventory, thus increasing carrying costs and risk of spoilage and obsolescence. In lean manufacturing, Just-in-Time (ITT) material deliveries and demand-pull scheduling reduce the incidence of excess inventory. One of the eight wastes of manufacturing in the lean phitosophy is overproduction. ‘A second perspective on excess inventory shows the influence of the theory of constraints, (TOC) production philosophy. excess inventory—Any inventory in the system that exceeds the minimum amount necessary to achieve the desired throughput rate at the constraint or that exceeds the minimum amount necessary to achieve the desired due date. Total inventory = productive inventory + protective inventory + excess inventory. —APICS Dictionary Examples include inventory held for production to buffer critical constraining resources to achieve the desired throughput rate, and finished goods inventory at the shipping point to protect promised shipping dates, See the discussion of buffers below under “Other ‘Manufacturing inventory.” ‘@R01S APICS 5 Paricipant Workbook Version 5.1Detailed Scheduling and Planning Other Manufacturing Inventory ° Buffers « loventory buffers © Retum goods Participant Workbook Version 5.1 146 ©2013 APICSPEBDWRUWHTeaTeee eee eee Fé ics Inactive Session 1: Inventory Policies, Inactive inventory is stock that has exceeded consumption, or demand, within a defined petiod of time or has not been used for a defined period. Like excess inventory and obsolete inventory discussed below, it is an asset from an accounting perspective but entails ongoing carrying costs. Inactive inventory often is the direct result of inventory not being used within ¥2to 18 months with no foreseeable future use, For proper asset reporting, this inventory should be valued at zero and the cost should be written off against current profits. Obsolete Obsolete inventory typically is not used or sold at full value because the products aré no longer produced or supported. Disposing of the inventory means that its costs cannot be recovered through revenues, which means lost revenue and reduced profit. Obsolete parts are removed from inventory by engineering change orders, Scrap ‘Scrap is material that is outside of specifications and is not practical to rework. Scrap can be a result of the nature of the materials and the manufacturing process. A scrap factor should be ‘built into determining material requirements. Other Manufacturing Inventory Buffer inventories in lean and TOC environments are examples of inventories that incur a cost, but ‘whose overall impact on inventory investment is positive. This is because their objective is to maintain desired throughput, reduce manufacturing lead time, and lessen the dependence on forecasts—thus reducing total inventory and production costs. Buffer Buffer is a quantity of raw materials or semifinished goods requiring further processing, often purposely maintained at a work center to achieve desired throughput. In TOC, the term strategic buffer is used for raw materials and semifinished products that arrive early, as with a time buffer, to ensure that a critical constrained resource or shipping point docs not run short of materials to process or ship. In TOC production philosophy, buffer levels are evaluated as often as daily to ensure they are not tao high or too low. Constant adjustments to minimize inventory investment costs are considered to be a good practice. Buffers, including safety stock, can be used to address fluctuations in customer demand and supply at each workstation or process and at the shipping point or finished goods level. Inventory Buffer ‘The definition of inventory buffer in the APICS Dictionary is similar to the definition of buffer. It applies to inventory used to protect the throughput of an operation or the schedule fiom delays in delivery, quality problems, and delivery of incorrect quantities. ‘2013 APICS 77 Participant Workbook Version 5.1Detailed Scheduling and Planning feics Return Goods Participant Workbook Version 6.1 748 ‘©2013 APICSFics Other Manufacturing Inventory (cont.) Return Goods Sossion 1: Inventory Policies Retum goods are a class of goods handled by reverse logistics. They are.returned and accepted for a number of reasons, such as failure to meet customer quality demands damaged or defective condition over-forecasting of demand seasonal nature of demand for inventory obsolete inventory repair and remanufacturing, Return goods can be disposed of ina number of ways: correct defects replace retum to inventory for resale repair or temanufacture (refurbish) for resale sale into other markets convert to reusable components reuse in current form we eeee Provide examples of the two types of recycling—convert to reusable components and reuse in current form, ‘©2015 APICS 9 Participant Workbook Version 5.1Detsiled Scheduling and Planning Service Inventory « Service industries = Do not typicaly transform raw materials into finished products = May customize products to sell fo consumers — Often provide ate-sele service « Goods and services = Service may facilitate sales of products (food sold at moves). = Products may faclitste sale of services (after-sale automatite service) Participant Workbook Version 5.1 1-20 ©2013 APICSService Inventory Inventory also exisis in service industries. However, unlike the manufacturing industry, the service industry generally is not in the business of transforming raw materials into finished products. But the line between manufacturing and service industries on this issue is not definitive. Many service organizations will customize products before selling them to consumers. Such companies include restaurants, automobile dealerships, and logistics companies that perform final assembly of personal computers for manufacturers. Many manufacturers will provide after-sales service for their products or outsource the service to third-party service companies. Goods and Services In some cases, the primary value provided by a services organization is intangible, such as an online educational course, and may not involve the transfer ofa tangible product to a ‘customer. In others, the value lies primarily in the sale of a tangible product, such as gesoline or books. ‘There is a continuum of service organizations based on whether they provide services to facilitate the sale of products, or provide products to facilitate the sale of services. US movie theaters are an example of service providers that use the sale of services to facilitate sale of products. They derive much of their revenue from the sale of food and beverages to moviegoers, An example of a product provider that uses the sale of a product to facilitate sale of services is automobile dealers, which rely on after-sales service for continuous income. List some examples of service industry goods and services in which (1) sales of products generate sales of services: @) sales of services generate sales of products: ©2018 APICS rat Participant Workbook Version 5.1Detailed Scheduling and Planning Problem 1.1 Goods Versus Services Goods Services Participant Workbook Version 5.1 1-22 ©2013 APICS wiSession 1: Inventory Policies Class Problem 1.1: Goods and Services Service organizations may rely on providing goods to create value for their customers. Think of 5 to 10 types of service organizations and how their services relate to sale of goods, In the Venn diagram below, write the types of organizations according to how important goods or services are in creating value for their customers. Include organizations that show a broad range of dependence on goods or services to create a continuum across the diagram. Goods Services ©2013 APICS 423 Participant Workbook Version 5.1Detailed Scheduling and Planning fics Hard, Perishable, and Distressed Inventory « Hard inventory = Malesalsransformed into gods (eetaurert mea ingtetiote) ~ Mater net ansformed lal store ms, ao parts) « Perishable goods = Newspapers = Evont brochures '* Distressed goods Products that are damaged or close to expiration date = Cannot be soldat full rice Participant Workbook Version 5.1 24 ©2013 APICS/éics Hard, Perishable, and Distressed Inventory ‘Session 1: Inventory Poticies ‘The nature of hard goods is implied in the discussion of tangible products above. They are part of a service provided. We can infer that two types of hard goods exist: + those that involve some raw material transformation, such as restaurant meals, custom clothing, and baked goods ‘+ materials that are not transformed during the service transaction, such as goods bought from a retail store, automobile parts installed by an automotive repair shop, or replacement parts used in a surgical transplant operation. Perishable inventory is found in both manufacturing and service industries, Haksever et al., in Service Management and Operations, 2° ed., chap. 19, uses the example of brochures for an athletic event as a perishable goods reorder model. ‘The key concept is that brochures ‘bought but not sold for the evenf are worthless from the service organization’s standpoint. Distressed goods also are found in both manufacturing and services. They include products that are damaged or close to their expiration dates and cannot be sold at full price. An example would be damaged paintings or other works of att, Distressed goods often are found at clearance sales. Give some examples of service inventory that are considered hard goods: Give some examples of service inventory that are considered perishable goods: Service Inventory Management and Costs Like inventory managers in manufacturing, service inventory managers are subject to the same variations and flichiations in enstamer demand for different tunes of nraducis, They face the same challenges with respect to balancing inventory costs with customer service and service efficienay. ‘The management of physical inventory in service industries is subject to the same principles and policies used in manufacturing when dealing with issues such as forecasting and demand management, order management, inventory performance, and accuracy. ‘2016 APICS +25 Parlicpant Workbook Version 5.1Detoled Scheduling and Planning fics “Refaences: Amold eta. Introduction fo Materials Management, 7th ed chap. 2,9; George, Lean Six Sigma, csp. 13, 14; Bicheno and Holweg, The Lean Toolbox, 4” ed., chap. 9, 17; Simchi-Levy et al., Designing and Managing the Supply Chain, chap. 1, 12; Jobs eta, Manufacturing Plarting ant Control for Supply Chain Managenien ‘APICS/CPIM Certification Edition (2011), chap. 5, 16; Garison et , Managerial Accounting, 12h ed, chap. 3,4; Willams, “Costing Inventory—Yes It Casts Money,” APICS CPIM DSP Reprints, January, 2010; Epstein, Making: Ststinability Work, chop. Aggregate Inventory Policies « Resolving sales and operational conficts + Inventory valuation + Performance metrics eran Hie Emergence of Conflicts + During the development of business strategy = Choice of manufacturing strategy: make-to-stock, make-1o-order, assemble-to-order, engineerto-order ~ Choice of manufacturing process to support strategy: intermittent, repetitive, continuous, project + During priority and capacity planning — Customer service levels — Efficient plant operations — Backlog and safety stock decisions » Minimum inventory investment = Low inventory levels — High inventory tums: . sores Mies Participant Workbook Version 5.1 4-26 (©2013 APICSUWWWUT eee eae aaa Féics Aggregate Inventory Policies Session 1: Inventory Policies Introduction The two types of inventory policies are aggregate and item-level. + Aggregate-level policies are associated with the impact of inventory management on the overall financial performance of the company. aggregate inventory management—Establishing the overall level (for example, dollar level) of inventory desired and implementing, controls to achieve this goal. —APICS Dictionary 4 In this section of Session 1, we will cover three topics that relate to aggregate inventory policy: | + resolving sales and operational conflicts + inventory valuation performance metrics + Ttemlevel policies are associated with materials and operations planning and execution. Later in this section, we will cover two important policies—lot sizing and safety stock, both of which constrain the inventory planning functions addressed in Session 2. Resolving Sales and Operational Conflicts Business Strategy Choices In any manufacturing organization, different functions have different objectives. Those different objectives emerge and are addressed as carly as when a manufacturer decides what to make and sell, and how to make it. The manufacturer must make choices relating to + manufacturing strategy or production environment, such as make-to-stock, make-to- order, assemble-to-order, engineer-to-order, and mass customization, + manufacturing process, such as intermittent, repetitive, continuous, and project. Decisions on these choices are influenced by product and process design, technology requirements, level of expected demand, product variety and volume, geographic scope of the market, life cycle and environmental cost of purchased materials, and customer expectations about order fatfillment speed and location. Ultimately, these choices and decisions need to balance a set of conflicting objectives: + high customer service levels—high product variety and quality, and shorter lead times and production flexibility to respond to customer orders + efficient plant operations—long production runs to minimize changeovers and reduce per-unit production costs; high raw material inventory levels at low costs + minimum inventory investment—low levels of inventory and high inventory turns, or inventory tumover. real cost of materials—lowest purchase price versus total life cycle and environmental costs ©2013 APICS 17 Participant Workbook Version 8.1Detaled Scheduling and Planning Resolving Conflicts Participant Workbook Version 5.1 +28 “© 201SAPICSBHEHEUTTeeeeT ee eeeTHeeaas #eics Priority and Capacity Planning Choices Ideally, the discussion of tradeoffs should occur often during the priority and capacity planning phases of manufacturing planning control, such as in regularly scheduled sales and ‘operations planning (S&OP) meetings. Resolving Conflicts Session 1: Inventory Policies ‘The resolution of conflicting objectives does not always have to be accomplished by tradeoffs. For example, lean and TOC production approaches enable more than one objective to be achieved by increasing supply chain velocity through a number of methods, including + eliminating wasteful movements and procedures in the production process and fostering a culture of employee empowerment ensuring a continuous flow of production from raw materials to finished products by buffering critically constrained resources to maintain full wtilization ‘establishing supplier relationships and supply management practices that synchronize dclivery of raw materials to the point of use at time of production. Ultimately, these result in faster throughput and shorter manufacturing lead times, which enable the company to lessen its dependence on forecasts and to produce to customer orders. This reduces the amount of inventory needed to support customer service objectives and lowers production costs. ‘2013 APICS 129 Participant Workbook Version 5.1Detailed Scheduling and Planning Inventory Valuation 1 nvantoryis considered » shor-term assot because itis ‘pected lo be used or slé vthin a relatively short period. «Inventory asc include raw materials, WIP, and fished goods oumed by the company, «RO supplies are notincuded as an asset they are considered expenses. — ks Purpose and Uses of inventory Vatuation « Determine the cost of aw materials, WP, and Fished goods «+ Determine the impact of inventory investment on the Fnancal condiion of the business «+ Cateulais inventory tums and performance matics: rnecassary for strategic. and polity decisions « lnluence operational decisions about err quantities, safaty sioc, and replenishment Participant Workbook Version 5.1 450 ©2013 APICSFics Inventory Valuation Session 1: Inventory Policies Inventory often is the largest asset on a company’s balance sheet. For most companies, inventory is considered a short-term current asset because itis expected to be used or sold within a relatively short period. Inventory includes raw materials, WIP, and finished goods ‘owned by the company. MRO supplies are not included es assets; they are considered expenses. Purpose and Uses of Inventory Valuation “We mentioned earlier that inventory investment represents costs. Therefore, it is iroportant to ‘know the value of raw materials, WIP, and finished goods inventory. ‘This enables you to determine the impact of inventory on the financial condition of the business. It also provides information necessary for strategic and policy decisions, such as inventory tupns and perftirmance metrics. + Italso is useful in determining operational approaches fo order quantities, safety stock, and replenishment. Cost Accumulation Methods ‘Manufacturing and service companies use various cost systems or models to accumulate costs for inventory valuation and decision making. In a manufacturing environment, the three most popular cost systems are project, process, and job order costing, The three types of costs, accumulated are labor, material, and factory overhead. Project costing Project costing is an accounting method of assigning valuations based on services performed ona project basis. It employs some special rules such as percentage of completion revenue recognition, as many projecis—such as shipbuilding, for example—take more than a year to complete. Job order costing Custom engineer-to-order and make-to-order job shop manufacturing companies tend to use job cost, because it is important to know the cost accumulation of each different job. Process costing ‘Companies with flow production tend to use a process costing system, which enables them to capture the cost to process a batch or group of items. ‘Note that retail and distribution environments do not need to accumulate cost to manufacture, ‘but do need to track inventory costs as they buy and sell goods, ‘2013 APICS 13T Participant Workbook Version 5.1Detziled Scheduling and Planning Types of Inventory Valuation © Specific identification # Average cost « Standard cost # Actual cost « Transfer cost «« First in, first out (FIFO) «Last in, first out (LIFO) Participant Workbook Version 5.1 +32 ©2013 APICSHEWRUPP eee oe eee eae ee feics Cost of Goods Sold (Cost of Sales) Retail stores generally sel! goods in the same physical form in which they are acquired, ‘Sometimes the freight costs are added to the acquisition costs to ereate “landed costs.” This ‘occurs when the freight costs can be tracked easily to the item being bought. Landed costs, are listed as an asset on the balance sheet until the item is sold. The acquisition costs become the cost of goods sold once the item is sold, thus reducing profit in the period sold. Service organizations carry material inventories as in the case of plumbers, personal-service “organizations, hospitals, hotels, beauty salons, educational organizations, banks, and other financial institutions. Examples of material inventories include the pipes and fittings of a plumbing company, and office supplies used by personal service and financial institutions. ‘These are consumed as operatiig supplies and are not tracked as cost of goods sold. Other service organizations provide tangible goods in addition to the service, such as automobile repair companies that sell parts;with the service. These parts usually are carried in inventory as an asset, issued to the job as required, and tracked as cost of goods sold when the service is provided. Session 1: Inventory Policies ‘A manufacturing company converts raw material and purchased components into finished goods. Its cost of sales includes the conversion costs, such as labor and overhead, as well as the raw materials and component costs of the goods it sells. A manufacturer has three types of inventory accounts: materials, WIP, and finished goods. After raw materials are transformed into finished products, they remain in inventory until they are sold, In a make-to- order environment, shipment usually is immediate upon completing production. Once sold, the materials are subtracted from inventory and ate included in a company’s income statement, along with labor and overhead costs, as the cost of goods sold. Note that the terms “cost of goods sold” and “cost of sales” are used interchangeably. Types of inventory Valuation ‘Shown in Visual 1-23 are various types of inventory valuation methods. The different methods are necessary when the cost of an item changes during the accounting period. These methods produce different inventory investment values. Once a company selects its inventory valuation method, itis difficult and time-consuming to change to another method. ‘Specific Identification ‘The specific identification method keeps track of the units from the beginning inventory and the units purchased, resulting in identification of the purchase cost of each item. Tracking can be done by coding or serial number identification. This method is best used for expensive items, rather than for low or frequently changing unit costs, and can be used to determine actual cost. Average cost ‘With the average cost method, the cost of goods sold and ending inventory are based on the average of the actual costs paid for each unit produced or purchased. The average cost __ applies to ali of the items available for sale during the period. ‘2018 APICS 133 arlleipant Warktook Version 6.1Detaled Scheduling and Planning CE Costing Method Example Data Source Record of purchases April 400 units $10 each May 400 units S12each June 100 units St4 each Ending first quarter inventory: units Second quarter usage: 210 units Costing Method—FIFO Calculation = Pen] 100 | 10 | x00 | too | 10 4900 May | 100 | 12 | 4200 [woo | 2 | 1.200 are |100_| 14 | 100 | 10 [14 40 r (Gest of goods old = $2,340 Ju starting inventory of 0 at $14= $1.260 —— Ae Participant Workbook Version 5.1 134 (©2013 APICSBUEHDHBHBHYHTePWTeeeewTwuTwaTwatins /éics Standard cost ‘Session 4: Inventory Policies With standard cost systems, a single value is selected for an inventory item that is reasonable and often based on historical or anticipated costs. The difference between actual costs inourred and standard costs then is reported in the form of a variance from the standard. This technique consistently reports the inventory asset and the cost of goods sold at the same value. Standard costs typically are reviewed and updated annually, Actual cost Actual costs can be used when there is a means of tracking the specific cost of each item, such as some form of lot control, to a specific purchase order or production run, This method is not used often except for custom items or unique items such as expensive jewelry, ‘Transfer cost and price ‘Transfer cost and price are important in the transfer of goods between sister companies or ivisions. Although management policy can set the transfer price, the net transfer effect is to move the inventory costs from the selling division to the buying division. They do not affect the valuation of assets, as do average, standard, and actual cost. First in, first out (FIFO) ‘The FIFO method assumes that the oldest items in inventory are the first ones issved from inventory, In a period of increasing costs, this tends to keep the total inventory value on the balance sheet close to the current market value, but would charge cost of goods sold at the ‘older and lower cost values, ‘Visual 1-25 shows the FIFO caloulation based on the data in Visual 1-24, ©2013 APICS 135 Participant Workbook Version 5.1Detailed Scheduling and Planning féics Problem 1.2 LIFO eo recelvet's c C Sly staring inventory of 90 al Participant Workbook Version 6.1 136 (©2013 APICSBUBB HEHPTT Tees Fics LIFO (last in, first out) ‘Session 1: Inventory Policies ‘The LIFO method assumes that the latest items in inventory are the fitst ones being issued to production or sales. This method assigns cost of goods sold based on the most recent cost incurred. In a period of rising costs, this would tend to understate the total inventory value on the balance sheet. However, it would charge cost of goods sold at values close to the current ‘market value, It should be noted that this is strictly an accounting method for valuing inventory and is not necessarily based on the physical movement of inventoty. Class Problem 1.2: Last In, First Out Calculate the LIFO valuation for this inventory: Pe iia fel cuntiN i ray eU ta REN May 100 12 1,200 June 100 14 1,400 Cost of goods sold | July starting inventory of 90 at Once you have calculated the answer, explain why this would result in a lower total inventory value on the balance sheet than with using FIFO. ‘©2013 APICS 137 Participant Workbook Version 5.1Detailed Scheduling and Planning RE Aggregate Inventory Metrics 2 Inventory tums « Days of supply « Cash-to-cash cycle «= Customer service Inventory Turns A measure of how effectively inventory is being used Annual cost of goods sold Inventory tums = Average inventory in dollars Parlicinant Workbook Version 5.1 438 ©2013 APICSfics Inventory Performance Metrics Aggregate Inventory Metrics Aggregate inventory measures indicate how well inventory is managed from an overall business perspective. Important financial measures include inventory turns, days of supply, and cash-to-cash cycle. Important sources of data for these measures are provided by the costing and inventory valuation activities discussed in the previous section. Inventory turns Session 4: Inv. ‘Two performance measures that relate inventory to sales are inventory tums and days of supply. The rule of thumb is that high inventory turns and low days of supply are desirable because they indicate lower levels of inventory relative to sales per period (annual, monthly, and so on). ‘The inventory turns ratio meastires the speed of inventory conversion into sales: annual cost of goods sald Inventory turns = average inventory in dollars For example, if the annual cost of goods sold is $1,000,000 and the average inventory is $500,000, then: $4,000,000 Inventory turns = ~ $500,000 ba! ‘The business is generating annual sales of $1 million in cost of goods sold with an average of $500,000 of inventory, which means it takes about a half a year to recover its cost, or cash. That is, inventory tums two times a year. What would the inventory tums ratio be in another company that generates the same level of annual sales with an average inventory of $20,000? How long will it take, on average, to recover the cost of inventory? ‘Most often used 2s a comparison from periad to period, inventory tumover is an aggregate indicator. It offers insight into the level of inventory investment available to sustain current business levels. An increasing trend in the inventory turns rate aver time shows that less inventory is required per dollar of cost of goods sold, Companies routinely use fiscal or actual month-end inventory levels to determine average inventory. Because this is not really an average level, it can falsely increase or decrease inventory turns. Inventory tums should be based on the company’s annual average inventory level. (2013 APICS 439 Participant Workbook Version 6.1tailed Scheduling and Planning rc Days of Supply «Days of supply measures the relationship between usage (sales) and inventory. « Inthis example, 6,000 units are sold over a period of 30 days at 200 units per day, on average. + Inventory tums every 30 days, or 12 times a year (inventory tums are 12). ‘The number of days between paying for the raw materials and getting paid for the product “ rms __ AaB Participant Workbook Version 5.7 1-40HPRWERHPHPe eee Haass Poic Days of supply ‘Session 1: Inventory Policies Companies also can use days of supply to evaluate sales-to-inventory performance—how many days of inventory are being carried to support annual sales. It measures the ratio of inventory on hand to average daily usage, or sales. Let’s assume 6,000 units on hand and annual sales of 73,000 units. The calculation of days of supply takes two steps: (1) Determine average daily usage. 73,000 Average daly usage = —"222"_ = 200 units (2) Calculate days of supply. inventory on hand Days of supply = average daily usage Note that usage can be expressed in sales dollars or physical units. ‘The days of supply in this example tells us that inventory on hand is 30 days. It also tells us that if we set a target inventory level of 6,000 units, we would have to replenish it every 30 days at a daily usage rate of 200 units. ‘What is the inventory tums ratio and how often does inventory turn? ‘The days of supply concept can be used to set an inventory policy for eycle stock, which is the most active component of inventory. For example, based.on an average daily sales or usage of 200 units, the target inventory level for finished goods would be 30 days of supply, or 6,000 units. Materials management personnel then can analyze the tradeoff between (1) lowering the days of supply to 15 days to reduce inventory investment, and (2) the loss of ‘production efficiency in producing in 3,000-unit lot sizes rather than 6,000-unit lot sizes. Cosh-to-cash cycle Cash-to-cash cycle is yet another measure of an integrated, businesswide supply chain ‘management approach to inventory management. It measures the timespan between paying for raw materials and getting paid for the product. ° Cash-to-cash cycle time = days’ supply of inventory + accounts receivable days — accounts ‘payable days. It also can be stated as: cash-to-cash cycle time = inventory days of supply + days of sales outstanding ~ days of payables outstanding. For example, ifa supply chain has 60 days of inventory, 45 days of accounts receivable, and 50 days of accounts payable, its cash-to-cash cycle time is 55 days: 60+ 45 —50=55 days Companies should use this measurement cautiously and realize that deliberate delay in paying for raw materials can artificially cause the cash-to-cash cycle time to be understated. ©2013 APICS Tat Participant Workbook Version 5.1Detaled Scheduling and Planning Customer Service Metrics Total cyela ime from order placement to receipt on dock at the customer site ‘A focus on the requested receipt date by the customer as opposed {othe commitment date Cycle time to respond to a customer request such as schedule change or material change ‘Total deliveries of units compared to retumed materials ‘authorizations (RMAs) due to qualty or incorrect shipments “Metrics that support the total customer experience, inchading responsiveness, design suggestions for cost reductions or cycle, time improvements, service, and warranty fi Participant Workbook Version 5.1 142 @ 2013 APICS