Inventory Costing

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/operatin Finished Products
g inventory)
 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 aims
at keeping track of
inventories. In other
words, inventories of
good quality and right
quantities should be made
available to different
departments as and when
they needed.
 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 System

1. 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 System

It suggests to review the quantity
and value of inventory at a fixed time
interval 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 of

maintaining the size of the inventory at some
desired level keeping in view the best
economic 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 not

be allowed to be kept. This quantity is fixed
keeping in view the disadvantages of
overstocking;
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
belowwhich stocks should not be allowed to
fall .
• The level is fixed for all items of stores and the
following factors are taken into account:
1.Lead time-
2. Rate of consumption of the material
during the lead time.
 Re-ordering level

• It is the point at which if stock of the material

in store approaches, the store keeper should
initiate the purchase requisition for fresh
supply of material.
• This level is fixed some where between
maximum and minimum level.
Inventory Control Techniques

• ABC Analysis
• Economic Order Quantity (EOQ)
 ABC Analysis
It 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

Regular system to see

that there is no
overstocking as well as
A Costlier Less
that there is no danger
of production being
interrupted for
unwanted material.

Order may be on Position being viewed

B review basis. in each month
Less costlier than
A
C Economical Larger Order in large quantity
so that cost can be
avoided
 Economic Order Quantity

• EOQ represents the size of an order for which

the 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
i
EOQ = 2AB
C*S
Where ,
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