Ibrahim Sameer (MBA - Specialized in Finance, B.Com Specialized in Accounting & Marketing)
Introduction What is inventory control? Inventory control includes the function of inventory ordering and purchasing, receiving goods into store, storing and issuing inventory and controlling levels of inventory.
The Ordering, Receipt & Issue of Raw Materials Every movement of a material in a business should be documented using the following as appropriate: purchase requisition; purchase order; GRN; materials requisition note; material transfer note & material return note.
Storage of Materials Objectives of storing materials: Speedy issue & receipt of materials Full identification of all materials at all times. Correct location of all materials at all times. Protection of materials from damage & deterioration. Efficient use of storage space.
Bin Card A bin card shows the level of inventory of an item at a particular stores location. It is kept with the actual inventory and is updated by the storekeeper as inventories are received and issued.
Stores Ledger Account Accounts department keep similar document like bin card in the accounts department which include inventory values.
Bin Card Vs. Stores Ledger Account Cost details are recorded in the stores ledger account, so that the unit cost and total cost of each issue and receipt is shown. The balance of inventory after each inventory movement is also valued. The value is recorded as these accounts form part of the costing bookkeeping records.
Free Inventory Managers need to know the free inventory balance in order to obtain a full picture of the current inventory position of an item. Free inventory represents what is really available for future use and is calculated as follows:
Free Inventory Particulars $ Materials in inventory Add: Materials on order from suppliers Less: Material requisitioned, not yet issued Free Inventory XXX XXX (XXX) XXX
Identification of Materials: Inventory Codes (Material Codes) Materials held in stores are coded and classified. Advantages of using code numbers to identify materials are as follows: Ambiguity is avoided Time is saved Computerized processing is made easier.
Inventory Count (Stocktake) The inventory count (stocktake) involves counting the physical inventory on hand at a certain date, and then checking this against the balance shown in the inventory records. The inventory count can be carried out on a continuous or periodic basis.
Periodic Stocktaking Periodic stocktaking is a process whereby all inventory items are physically counted and valued at a set point in time, usually at the end of an accounting period.
Continuous Stocktaking Continuous stocktaking is counting and valuing selected items at different times on a rotating basis. This involves a specialist team counting and checking a number of inventory items each day, so that each item is checked at least once a year. Valuable items or items with a high turnover could be checked more frequently.
Advantages of Continuous Stocktaking Compared to Periodic Stocktaking The annual stocktaking is unnecessary and the disruption it causes is avoided. Regular skilled stocktakers can be employed, reducing likely errors. More time is available, reducing errors and allowing investigation.
Perpetual Inventory Perpetual inventory refers to a inventory recording system whereby the records (bin cards and stores ledger account) are updated for each receipt and issue of inventory as it occurs. It means that there is a continuous record of the balance of each item of inventory.
Obsolete, Deteriorating & Slow Moving Inventories & Wastage Obsolete inventories are those items which have become out of date and are no longer required. Obsolete items are written off and disposed off.
Inventory Control Levels Inventory costs include purchase costs, holding cost, ordering costs and cost of running out inventory.
Reasons for Holding Inventories To ensure sufficient goods are available to meet expected demand To meet any future shortages. To take advantages of bulk purchasing discount. To allow production process to flow smoothly and efficiently.
Holding Costs If inventories are too high, holding cost will incurred: Cost of storage and stores operation. Insurance cost Risk of obsolescence. Deterioration
Stockout Cost (Running out of Inventory) Loss of customers goodwill Loss of future sales due to disgruntled customers Labour frustration over stoppages. Cost of production stoppages.
Inventory Control Levels Inventory control levels can be calculated in order to maintain inventories at the optimum level. The three critical control levels are reorder level, minimum level and maximum level.
Reorder Levels When inventories reach this level, an order should be placed to replenish inventories. Maximum lead time is the time between placing an order with a supplier and inventory becoming available for use. Reorder Level = Maximum Usage x Maximum Lead time
Minimum Levels This is a warning level to draw management attention to the fact that inventories are approaching a dangerously low level and that stockouts are possible. Minimum Level = Reorder level (Average Usage x Average Lead time)
Maximum Levels This is also as a warning level to signal to management that inventories are reaching potentially wasteful level. Maximum Level = Reorder level + Reorder Quantity - (Minimum Usage x Minimum Lead time)
Reorder Quantity This is the quantity of inventory which is to be ordered when reaches the reorder level. If it is set so as to minimize the total costs associated with holding and ordering inventory, then it is known as the economic order quantity.
Average Inventory The formula for the average inventory level assumes that inventory levels fluctuates evenly between the minimum (or safety) inventory level and the highest possible inventory level. Average Inventory = Safety inventory + ½ Reorder quantity
Economic Order Quantity (EOQ) The economic order quantity (EOQ) is the order quantity which minimizes inventory costs. The EOQ can be calculated using table, graph or formula.
Economic Order Quantity (EOQ) EEE = 2CCC CC Where CC = cost of holding one unit of inventory for one time period CC = cost of ordering a consignment from a supplier (if carriage cost is given then add that to ordering cost) D = Demand during the time period
Economic Batch Quantity (EBQ) The economic batch quantity (EBQ) is a modification of the EOQ. EBQ is used to establish cumulative production quantity. EEE = 2CCC CC (1 D R ) (1 D ) represent rate at which the stock get increase. R
How to Calculate Annual Cost Purchase Cost (p x D) Ordering cost ( D EEE x Co) = XXX = XXX Holding Cost (Ch x EEE 2 ) = XXX Total Annual cost = XXX
Other Systems of Stores Control & Reordering Order Cycling Method Under the order cycling method, quantities on hand of each stores item are reviewed periodically (for 1,2 &3 months).
Other Systems of Stores Control & Reordering Two Bin System The two bin system of stores control (or visual method of control) is one whereby each stores item is kept in two storage bin. When the first bin is emptied, an order must be placed for re-supply; the second bin will contain sufficient quantities to last until the fresh delivery is received.
Other Systems of Stores Control & Reordering Classification of materials This is sometimes called ABC method whereby materials are classified A, B and C according to their expense group A being the expensive, group B the medium cost and group C the inexpensive materials.
Other Systems of Stores Control & Reordering Pareto (80/20) Distribution Pareto (80/20) distribution which is based on the finding that in many stores, 80% of the value of stores is accounted for by only 20% of the stores items, and inventories of these more expensive items should be controlled more closely.
Accounting for Materials Any increase in material inventory will result in a debit entry in the material control account whilst any reductions in materials inventory will be shown as a credit entry in the material
Inventory Valuation The correct pricing of issues and valuation of inventory are of the utmost importance because they have a direct effect on the calculation of profit. Several different methods can be used in practice.
FIFO (First in, First Out) FIFO assumes that materials are issued out of inventory in the order which they were delivered into inventory; issues are priced at the cost of the earliest delivery remaining in inventory.
FIFO (First in, First Out) Advantages of FIFO It is a logical pricing method which probably represents what is physically happening: in practice the oldest inventory is likely to be used first. It is easy to understand and explain to mangers.
FIFO (First in, First Out) In a period of rising purchase prices, the closing inventory valuation will be close to current purchase price
FIFO (First in, First Out) Disadvantages of FIFO FIFO can be cumbersome to operate because of the need to identify each batch of material separately. Managers may find it difficult to compare costs and make decisions when they are charged with varying prices for the same materials.
FIFO (First in, First Out) In a period of high inflation, inventory issue prices will lag behind current market value.
LIFO (Last in, First Out) LIFO assumes that material are issued out of inventory in the reverse order to which they were delivered; the most recent deliveries are issued before earlier ones, and issues are priced accordingly.
LIFO (Last in, First Out) Advantages of LIFO Inventories are issued at a price which is close to current market value. This is not the case with FIFO when there is a high rate of inflation. Managers are continually aware of recent costs when making decisions, because the costs being charged to their department or product will be current costs.
LIFO (Last in, First Out) Disadvantages of LIFO The method can be cumbersome to operate because it sometimes results in several batches being only part used in the inventory records before another batch is received.
LIFO (Last in, First Out) LIFO is often the opposite to what is physically happening and can therefore be difficult to explain mangers As with FIFO, decision making can be difficult because of the variation in prices.
AVCO (Cumulative Weighted Average Pricing) The cumulative weighted average pricing method (or AVCO) calculates a weighted average prices for all units in inventory. Issues are priced at this average cost, and the balance of inventory remaining would have the same unit valuation. The average price is determined by dividing the total cost by the total number of units.
AVCO (Cumulative Weighted Average Pricing) A new weighted average price is calculated whenever a new delivery of materials is received into store. This is the key feature of cumulative weighted average pricing.
AVCO (Cumulative Weighted Average Pricing) Advantages of AVCO Fluctuation in prices are smoothed out, making it easier to use the data for decision making. It is easier to administer than FIFO & LIFO, because there is no need to identify each batch separately.
AVCO (Cumulative Weighted Average Pricing) Disadvantages of AVCO The resulting issue price is rarely an actual price that has been paid, and can run to several decimal places. Prices tend to lag a little behind current market values when there is gradual inflation.
Periodic Weighted Average This periodic weighted average pricing method calculates an average price at the end of the period, based on the total purchase in that period. Periodic weighted average = cost of opening inventory + total cost of receipts / Units of opening inventory + total unit receipt.
Q & A