INVENTORY COSTING BY:- Dr.

Narendranath Sengupta

INVENTORY SYSTEM

PERPETUAL INVENTORY SYSTEM

PERIODIC INVENTORY SYSTEM

INVENTORY SYSTEM
Perpetual Inventory System:-This method is widely used. It is a method of recording inventory balances after every receipt & issue, to facilitate regular checking and to obviate closing down for stock taking. Thus, this system gives a complete record of inventory quantities & valuation on continuous basis. Periodic Inventory System:-Under this the quantity & value of inventory are reviewed at a fixed time interval, such as weekly, monthly, quarterly or the like. However, in the actual practice usually this review takes place at the end of the accounting period.

METHOD OF INVENTORY VALUATION

HISTORICAL COST METHOD

LOWER OF COST

SPECIFIC IDENTIFICATION

FIFO

LIFO

AVERAGE COST METHOD

HIFO

NIFO

BASE STOCK METHOD

First in first out (FIFO) method
This method uses the most recent price paid for the goods as a basis for valuation. The basis philosophy behind this approach of inventory valuation is that the first units purchased are considered the first units issued/consumed. Thus, according to FIFO method as it is frequently called the physical flow of the units follow a chronological order. This method is most appropriate for perishable products like milk, vegetables and fruits.

Advantages & disadvantages of FIFO
Advantages of FIFO:Its application is simple. It does not allow management to manipulate income. Its tend to produce an ending inventory cost valuation which approximates the current market value. It provides a reasonable approximation of the actual flow of good.

Disadvantage of FIFO:It attracts heavier tax burden if applied under inflationary income.

It involves complicated calculation and therefore, it is more sensitive to clerical errors.

Numerical of FIFO method
Following information is available regarding procurement and issue of an item for the month of February 2006:Feb 1 Opening inventory 150 units @ Rest.10 each. Feb 7 Purchased 700 units @ Rs. 12 each. Feb 13 Issued 400 units. Feb 21 Purchased 200 units @ Rs. 14 each. Feb 28 Issued 300 units. You are required to calculate the value of the inventory according to FIFO method.

Last in first out (LIFO) method
LIFO METHOD:- This inventory valuation method is based on the assumption that the last item purchased is the first item used or sold. Thus under this method the units of the earliest purchases form the ending inventory which results in matching of cost of current purchases against current sales in the profit & loss a/c. LIFO method is appropriate during the inflationary conditions as it shows inventory at a lower value in the balance-sheet and results in the reduction of profits & income-tax. The special feature of this method is that basis of valuation remains unchanged despite of price changes. It also tends to stabilize income by minimizing the effects on profits of inventory price changes.

Advantages and disadvantages of LIFO method Advantages of LIFO:LIFO attempts to reduce distortions in the profit and loss a/c attributable to inflation. It is appropriate method of involuntary valuation during inventory period.

Disadvantages of LIFO:It permits management to manipulate income. It is dramatically opposed to the flow of goods.

Numerical of LIFO method
Form the information for the year May 2006 relating to Seema & co. Ltd., calculate the value of inventory on 30th May as per LIFO method.:May 1 May 7 May 13 May 21 May 26 May 30 Opening stock 300 units @ Rs. 6 each. Purchased 300 units @ Rs. 8 each. Issued 400 units. Purchased 300 units @ Rs. 9 each. Issued 400 units. Issued 50 units.

ILLUSTRATION
‘AT’ Ltd. furnishes the following store transactions for September, 2006 : 1-9-06 Opening balance 25 units value Rs. 162.50 4-9-06 Issues Req. No. 85 8 units 6-9-06 Receipts from B & Co. GRN No. 26 50 units @ Rs. 5.75 per unit 7-9-06 Issues Req. No. 97 12 units 10-9-06 Return to B & Co. 10 units 12-9-06 Issues Req. No. 108 15 units 13-9-06 Issues Req. No. 110 20 units 15-9-06 Receipts from M & Co. GRN. No. 33 25 units @ Rs. 6.10 per unit 17-9-06 Issues Req. No. 12 10 units

19-9-06 Received replacement from B & Co. GRN No. 38 10 units 20-9-06 Returned from department, material of M & Co. MRR No. 45 units 22-9-06 Transfer from Job 182 to Job 187 in the dept. MTR 6 5 units 26-9-06 Issues Req. No. 146 10 units 29-9-06 Transfer from Dept. “A” to Dept. “B” MTR 10 5 units 30-9-06 Shortage in stock taking 2 units Write up the priced stores ledger on FIFO method and discuss how would you treat the shortage in stock taking.

HIGHEST IN FIRST OUT(HIFO) METHOD
The HIFO method is based on the assumption that the highest priced goods are sold first of irrespective of the date of their purchase. As its name implies the highest in, first out method (HIFO) assigns to goods sold the costs of highest priced material in store. By the closing time the highest priced material is exhausted &, therefore, ending inventory is valued at a lower cost than its current cost. This method of inventory valuation is appropriate for FLACTUATING MARKET as it tends to provide opportunity to management to recover the cost of heavily priced goods from the sales made at the earliest.

Replacement cost method
Replacement cost suggest to value the inventory at the replacement cost. The replacement cost represents the market at which, on the date of the issue of the material, the goods can be replaced by purchasing the identical goods from the market. Thus, goods issued are valued at the market price on the date of their issue. This method helps inflating profit in a period of rising prices & deflating it in a period of declining prices. It is an appropriate valuation method where management is interested to reflect current price condition in costs.

HOW MUCH TO ORDER?? EOQ
ECONOMIC ORDERING QUANTITY:- One of the major decisions in the area of inventory management is HOW MUCH (QUANTITY) TO ORDER AT ONE TIME. Number of techniques have been developed in which most popular method is EOQ which represent the size of an order for which total cost is minimum & thereby maximum economy in purchasing. There are two type of EOQ:ORDERING COST. CARRYING COST.

TYPES OF EOQ
TYPES OF EOQ

ORDERING COST

CARRYING COST

ORDERING COSTS
It is the cost of getting an item into the firm’s inventory. At the time of placing an order for stock replenishment, certain cost are involved which are known as known as ordering costs. They include costs like requisition & purchase costs, follow-up costs, inspection checking & handling costs &so on. Such costs vary with the number of orders placed and the number of items ordered. The more frequently the orders are placed, & fewer quantities purchased on each other, the greater will be ordering costs and vise-verse.

CARRYING COST
Carrying costs:- These are those cost which are incurred in maintaining an inventory including storage, warehousing, insurance, & interest on capital invested in inventory. There are two ways of calculating EOQ.:Mathematical approach. Graphic approach.
METHODS OF CALCULATING EOQ

MATHEMATICAL APPROACH

GRAPHIC APPROACH

ASSUMPTIONS FOR EOQ’S MODEL
The forecasted usage per demand for a given period is known. It is even throughout the year. Inventory can be replenished immediately. The cost per order is constant. The cost for carrying is fixed for average level of inventory.

Average level of inventory= Q+0 = Q 2 2 Ordering cost = UF Q U x F = UF Q Q Carrying cost = Q x P x C 2

MATHEMATICAL APPROACH
Under mathematical approach, it can be expressed as:-

EOQ =
(IN UNITS)

2 UF P*C

Where, U = Annual usage in units. F = Cost of placing an order/Fixed cost P = Cost per unit/Purchasing cost C = Carrying cost as a percentage of average inventory.

GRAPHIC APPROACH

TOTAL COST c o s t CARRYING COST

ORDERING COST E.O.Q Order size (quantity)

NUMERICAL ON EOQ
FROM THE FIGURES GIVEN BELOW, CALCULATE ECONOMIC ORDER QUANTITY.:TOTAL CONSUMPTION ON MATERIAL 1800 UNITS. ORDERING COST OF Rest. 20 PER ORDER. CARRYING COST 10% ON AVERAGE INVENTORY. PRICE PER UNIT Rs. 40

NUMERICAL
A company requires 10000 units of a certain item annually. The purchase price per order is Rs. 20 and the fixed cost per order is Rs. 150. The inventory carrying cost is 25% per year. a) Calculate EOQ. b) Suppose the supplier offers you following discount— if you order above 1000 units you will get a 2% discount. Now what decision should be taken.

SOLUTION
a) EOQ = 2UF PC
U=10000, F=150, P=20, C=25% or 0.25

EOQ = 2x10000x150 20 x 0.25

EOQ = 775 UNITS

Our EOQ = 775 Units Q1P2C = 775x20x0.25 = 1937.5 old

2 2 Q2P2C = 1000x19.6x0.25 = 2450 new 2 2 Increase in carrying cost = 512.50(24501937.5)

BENEFIT: Discount = 20X2 = 0.40 100 0.40 X 10000 = 4,000 Reduction in ordering cost UF = UF = 10000X150 = 1935.48 old Q EOQ 775 Reduction in OC = 1935.48(old)-1500(new) = 435.48 Total benefit = 4435.48 (Disc + Red in OC) Net benefit = 3923.48 (TBenefit – TCost) If somebody offers you 2% discount, it would be better to change EOQ. EOQ in manufacturing is not a ultimate final word.

STATEMENT OF INVENTORY
RECEIPTS DATES UNITS RATE VALUE (Rs.) (Rs.) UNITS ISSUES RATE (RS.) BALANCES VALUE RATE VALUE UNITS (Rs.) (Rs.) (Rs.)

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