Inventory mgmt

All About ACCOUNTING..!!
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ACCOUNTING

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What is accounting?
• The language of business.
• A means to communicate financial information.
• A way to convey information about a business to users.
What is ACCOUNTING…?

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What is Need of ACCOUNTING…?
Managers, investors, and other internal groups
want the answers to two important questions:
How well did the
organization perform?
Where does the
organization stand?

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What is Need of ACCOUNTING…?
Accountants answer these questions
with two major financial statements:
Income Statement
Balance Sheet

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Balance Sheet
The balance sheet (also called statement of
financial position or statement of financial
condition) is a snapshot of the financial status
of an organization at a point in time.
What is Balance Sheet…?

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Balance Sheet
What is Balance Sheet…?
Assets = Equities
Assets are economic resources that are expected
to benefit future activities of the organization.
Equities are the claims against, or interests in,
the assets of the organization.

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Income Statement
What is Income Statement…?
The income statement measures
the performance of an organization
by matching its accomplishments
(revenue from customers, which
is usually called sales) and its
efforts (cost of goods sold and
other expenses).

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Revenues
What is Revenue…?
Revenues are increases in ownership
claims arising from the delivery
of goods or services.
Revenues must be earned.
Revenues must be realized.

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What is Expenses
Expenses
Expenses are decreases in
ownership claims arising
from delivering goods or
services or using up assets.

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What is Profit
Profits
Profits (or earnings or income) are
the excess of revenues over expenses.

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Who users accounting information?
• Owners
• Managers
• Investors (including potential)
• Analysts on their behalf
• Creditors (including potential)
• Government (tax assessment)
• Regulators
• Customers
Who are Users of Accounting…?

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Accounting has two main divisions:
• Financial accounting
Primarily prepared for users external to the company.
Revenues, earnings, assets, etc.
• Management accounting
Primarily for internal purposes
Costing, budgeting, net present value, etc.
Types of ACCOUNTING…?

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Management Accounting is comprised of two words “ Management”
and “Accounting”.
It is the study of managerial aspects of accounting.
The emphasis of management accounting is to redesign accounting in
such a way that it is helpful to the management in formulation of
policy, control of execution and appreciation of effectiveness.
Management accounting is a system that helps management in
carrying out their functions more efficiently.
What is MANAGEMENT ACCOUNTING…?

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GAAP

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General Accepted Accounting Principle is a technical term that encompasses
the conventions, rules and procedures necessary to define accepted accounting
practices at a particular time.
GAAP are common set of accounting principles, standards and procedures that
companies use while preparing their financial statement.
Accounting Principle can be classified into two categories:
1. Accounting Concepts
2. Accounting Conventions
What is GAAP…?

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Accounting Concepts may be considered as traditions which guide the accountants
while preparing the accounting statements
Accounting Conventions:-
1. Consistency
2. Full Disclosure
3. Conservation
4. Materiality
What is Accounting Conventions…?

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Accounting Concepts may be considered basic assumptions or conditions upon
which the science of accounting is based.
Accounting Concepts:-
1. Separate Legal Entity 9.Realisation Concept.
2. Money Measurement
3. Going Concern
4. Cost Concept
5. Accounting Period
6. Dual Aspect
7. Matching Concept
8. Accrual concept
What is Accounting Concept…?

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Account :- Personal Account
:- Real Account
:- Nominal Account
Personal Account – Dr - The receiver – Cr – The Giver
Real Account – Dr – What comes in – Cr – What goes out
Nominal Account – Dr – Expenses/Losses – Cr – Income/Gain
What is Account…?

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Business transactions are recorded in Journal. Journal means a daily record of
business transactions. Journal is a book of original entry.
Jounalise the following transactions :
Jan 2 Commenced business with cash of 500000/-
Jan 4 Purchased furniture for cash of 20000/-
Jan 5 Goods purchased for cash of 29000/-
Jan 6 Deposited in bank 30000/-
Jan 8 Sold goods for cash 10000/-
Jan 10 Paid electricity bill by cheque 4000/-
Jan 14 Sold goods to AB Ltd on credit 9000/-
Jan 15 Paid salary in cash 25000/-
What is Recording ?

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Ledger :-
What is Posting?

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Inventory
Valuation

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Inventory is stock of goods, its includes raw material, work in progress,
consumables, finished goods, spares.
The investment in inventory is very high in a undertaking. About 90% of the
working capital is invested in inventory. Therefore a proper planning is
required for purchase, issue & vendor selection.
The purpose of inventory management is that neither there should be over-
stocking nor there should be under-stocking of inventory.
Overstocking=Reduction in liquidity
Under stocking = Stoppage in production cycle.
What is Inventory …?

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Inventory

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• Mueller Hardware has a storage barrel full of nails.
• The barrel was restocked three times with 100 pounds of
nails being added at each restocking.
• The first batch cost Mueller 100/-, the second batch cost
Mueller 110/-, and the third batch cost Mueller 120/-.
• The barrel was never allowed to empty completely and
customers have picked all around in the barrel as they
bought nails from Mueller
• At the end of the accounting period, Mueller weighs the
barrel and decides that 140 pounds of nails are on hand
What is the cost of the ending inventory?
Example of Inventory Valuating

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The methods from which to choose are varied, generally
consisting of one of the following:
• First-in, first-out (FIFO)
• Last-in, first-out (LIFO)
• Weighted-average
Example of Inventory Valuating

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CALCULATIONS: With first-in, first-out, the oldest cost is matched
against revenue and assigned to cost of goods sold. Conversely,
the most recent purchases are assigned to units in ending
inventory. For Mueller's nails the FIFO calculations would look like
this:
FIFO

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CALCULATIONS: Last-in, first-out is just the reverse of FIFO; recent
costs are assigned to goods sold while the oldest costs remain in
inventory:
LIFO

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CALCULATIONS: The weighted-average method relies on average unit
cost to calculate cost of units sold and ending inventory
Average Cost

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Valuation of inventory bears direct relation on the determination of income
of the company.
If all the material are purchased at same rate there will be no problem in
valuation of inventory. But because of different market condition the
valuation of inventory can be done in different ways.
There are many methods of valuing inventory, the most important being;
1. FIFO
2. LIFO
3. AVERAGE COST
4. BASE STOCK
What is Inventory Valuation

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First In First Out
• This method assumes that oldest material is issued first and at its
original rate at which it is received.
• Ie. Unit cost are apportioned to cost of production according to their
chronological order.
• This method is beneficial in case of falling price
What is FIFO…?

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First In First Out- Advantages
1. Rational
2. Material cost correctly ascertained
3. Useful when price are falling
4. Simple to understand
5. Closing stock value in balance sheet is more realistic
Advantages of FIFO…?

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First In First Out- Disadvantages
1. Possibility of more clerical error
2. Sometimes more than one price has to be use to value one issue
3. In case of frequent price fluctuation the pricing becomes different
Disadvantages of FIFO…?

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Last In First Out
• In this method issue is done in the reverse order of purchase.
• Material received last in the stores is issued first
• More appropriate in rising price
• Also known as replacement cost method
What is LIFO…?

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Last In First Out (Advantage)
• No profit No loss as material are issued at cost price
• Production Cost represents recent cost
• Suitable in rising price
What is LIFO…?

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Last In First Out (Disadvantage)
• May result in clerical error as every time issue is made price may be
revised
• Comparison between different jobs is difficult
• The stock in hand is valued at price which is not current market price
• More than one price can be used for valuing issue of material of single
requisitions.
What is LIFO…?

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Discuss the effect of adopting LIFO and FIFO on profit with the help of
following figures
Jan-1 Opening Balance-10 units @ 30/-
Jan 10 Purchased 10 unit @ 33/-
Jan 12 Issued 10
Jan 31 Closing Balance-10 unit
Feb-3 Purchase-10 unit @36/-
Feb-12 Issued-10 units
Feb-28 Purchased-10 units @ 40/-
Example

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following figures
Purchases Issue
May 3 500kgs @ 2/- per Kg May 19 600 kgs.
May 18 350kgs @ 2.10/- per kg May 26 450 kgs
May 25 600kgs@ 2.20/- per kg May 29 510 kgs
May 28 500kgs @ 2.30 per kg May 30 150 kgs
Example

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following figures
1.1.2010 Opening stock nil
1.1.2010 Purchase 100 units @30/- per unit
15.1.2010 Issue 50 units
1.2.2010 Purchase 200 units @ 40/- per unit
15.2.2010 issue 100 units
20.2.2010 issue 100 units
1.3.2010 Purchase 150 units @ 50/- per unit
15.3.2010 Issue 100 units
Example

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The principle on which average method is based is that all of
the material in the stores is mixed up and cannot be issued
from any particular lot
Types of Average Stock Method
1. Simple Average method
2. Weighted average method
Average Method

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Simple Average method
Price is calculated by dividing total of the prices of material in
the stock with the number of prices used in the total
Eg 1000units purchased @ 10/-
2000units purchased @ 11/-
Then the issue price of next issue will be
10+11+12/3 = 11
Simple Average Method

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Weighted Average method
Price is calculated by dividing total cost of material in the stock
with the total quantity of material
Eg 1000units purchased @ 10/-
Then the issue price of next issue will be
(1000*10)+(2000*11)+(3000*12)/(1000+2000+3000) =
11.33/-
Weighted Average Method

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Base Stock method
In this method some quantity of the material is assumed to be
necessary for keeping the concern going. This quantity is
not issued unless it is an emergency. This material which is
not issued and kept as stock is known as base stock.
The earlier material received are kept as a base and are valued
at the price on which they are acquired and that is why this
method is not independent method. Either it is clubbed with
FIFO,LIFO or Average Price Method.
Base Stock Method

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Standard Price method
In this method issue price of the material .
Standard Price Method

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AS-2

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AS-2 is Valuation of Inventory
What are covered ?
• Assets held for sale in the ordinary course of business
• Assets in the process of production for such sale
• Assets in the form of materials or supplies to be consumed in the
production process or in rendering services
AS-2

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AS-2 Application
AS-2 should be applied to all inventories, except:
• Contract WIP (covered by AS-7)
• WIP of service providers
• Financial instruments ( shares, debentures etc)
• Livestock, agricultural and forest products,
mineral oils, ores and gases (to the extent
measured at NRV, as per established industry
practices)
AS-2

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AS-2 Application
AS-2
AS-2

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Cost Of Purchase
• Purchase price including taxes & duties
• Taxes & duties recoverable from taxing authorities to be excluded
• Freight inwards included
• Exclude-trade discounts, rebates, etc
• Cash discount not considered
AS-2

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Cost Of Conversion
• Direct Labour
• Allocation of overheads:
– Variable: based on actual production
– Fixed: based on normal capacity of
production
– Unallocated : treated as period expenses
– Joint/By-Products: allocation may be done on a rational and consistent
basis (eg: sales value etc) if costs are not separately identifiable
AS-2

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Overheads
Usually exclude:
• Interest and borrowing costs (subject to applicability of AS-16)
• Abnormal waste-material, labour or others
• Storage costs- unless required in production process
• Administrative costs
• Selling and distribution costs
AS-2

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What is normal capacity ?
• Average production expected over a
number of periods/seasons under normal
circumstances
• Loss of production from normal
shutdown/maintenance to be factored
• Actual may approximate normal
AS-2

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Cost Formulae
• Specific identification
• If items not interchangeable and specifically identifiable
• FIFO
• Weighted average
• Standard costs – fixed on normal capacity levels may be used. Should
be reviewed and revised regularly
AS-2

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Net Realizable Value
To be assessed on each balance sheet date
• Usually written down to NRV on an item by item basis
• Sometimes-appropriate to group similar or related items
• Writing down not correct for a class as a whole (eg: all finished goods)
• Events after balance sheet date affecting balance sheet date position to
be considered
• Materials held for consumption-written down only if cost of finished
goods > it’s NRV.
• Replacement cost may be used as NRV
AS-2

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Illustration of NRV
• Traded goods – Market Price falls after purchase – new market price
less cost of sales will be NRV
• Raw materials held for manufacture – NRV will be calculated with
reference to sale price of finished goods and fall in price of raw
materials will not by itself impact it.
• Only variable costs to be incurred for sale after the reporting date to be
considered as costs of sales
AS-2

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Disclosure
• Accounting policies adopted
• Cost formula used
• Total and class-wise amount of inventory held
AS-2

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Inventory
Management

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Inventory Management:-
The investment in inventory in most of the manufacturing, wholesale, retail
trade is very high. In industries like sugar, the raw material cost is as
high as 68.75% and in steel industry also it count to about 65.33%.
About 90% of working capital is invested in inventory management.
Inventory Management will determine
• What to purchase
• How much to purchase
• From where to purchase
• When to purchase
• Where to store
What is Inventory Management…?

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Objectives of Inventory Management:-
1. To ensure continuous supply of materials, spares & finished goods so that
production should not suffer at any time & customer demand should also be
met.
2. To avoid over-stocking & under-stocking of inventory.
3. To maintain investment in inventory at optimum level
4. To maintain material cost at minimum, so that cost of production is minimum.
5. To eliminate duplication in ordering or replenishing stock.
6. To minimize losses due to wastage & damage.
7. To ensure perpetual inventory control
8. To facilitate furnishing of data for short-term & long-term planning & control of
inventory
Objective of Inventory Management…?

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Tools of Inventory Management:-
1. Determination of stock level.
2. Determination of safety stock.
3. Determination of EOQ.
4. A.B.C Analysis.
5. Preparation of inventory report
6. Perpetual Inventory system
7. JIT Control System
Tools of Inventory Management…?

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Determination of Inventory level:-
An efficient inventory management requires that a firm should maintain an optimum
level of inventory where inventory cost is minimum, at the same time there
should be no stock out. Various stock level are fixed for this.
(a) Minimum Level :- This represent the quantity which must be maintained in
hand at all times. Minimum level depends on:-
• Lead time
• Rate of consumption]
• Nature of material
MINIMUM STOCK LEVEL=REORDER LEVEL-(NORMAL
CONSUMPTION *NORMAL REORDER LEVEL)
Determination of Inventory level…?

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Re-order level -When the quantity of the material reaches a certain figure
then fresh order is sent to get the material again. The order is sent
before the material reaches the minimum level. Reorder level is fixed
between minimum & maximum level. It depends on following factors :-
• Rate of consumption
• Lead time
• Maximum quantity of material required in a day.
RE-ORDER LEVEL= (MAXIMUM CONSUMPTION * MAXIMUM
REORDER PERIOD)

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Maximum level –It is that quantity of the material beyond which a firm
should not exceed its stock. If stock reaches beyond this level it is over
stocking. Maximum level depends on following factors :-
• Rate of consumption
• Lead time
• Maximum quantity of material required in a day.
• Availability of capital for purchase of material.
• Availability of space for storing the material
• Cost of maintaining the stores.

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• Availability of material at any point of time.
• Restrictions imposed by the government.
• This possibility of change in fashions will also affect the maximum level.
MAXIMUM STOCK LEVEL = RE-ORDER LEVEL + RE-ORDER
QUANTITY – (MINIMUM CONSUPTION * MINIMUM RE-
ORDERING PERIOD)
Average stock level- The average stock level is average of minimum stock &
maximum stock.
Danger level-It is that level beyond which the material should not fall in any case.
DANGER LEVEL= (AVERAGE CONSUMPTION * MAXIMUM RE-ORDER
PERIOD FOR EMERGENCY PURCHASE)

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Safety Stock– Safety stock is a buffer to meet some unanticipated
increase in usage. The usage of inventory cannot be perfectly
forecasted. It fluctuates over a period of time. The demand for
material may fluctuate & delivery of inventory may also be delayed &
in such a situation the firm can face a problem of stock-out. The
stock out can prove costly by effecting in smooth working of
concern.
In order to protect against this situation firm usually maintains some
stock this stock is known as safety stock.
Determination of Safety Stock…?

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Inventory Order Cycle
DemandDemand
raterate
TimeTime
LeadLead
timetime
LeadLead
timetime
OrderOrder
placedplaced
OrderOrder
placedplaced
OrderOrder
receiptreceipt
OrderOrder
receiptreceipt
InventoryLevelInventoryLevel
Reorder point,Reorder point, RR
Order quantity,Order quantity, QQ
00

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From the following information, calculate minimum stock
level, maximum stock level and reorder level :-
• Max Consumption-200 units per day
• Min Consumption-150 units per day
• Normal Consumption-160 units per day
• Re-order period-10-15 days
• Re-order quantity-1600 units
• Normal re-order period-12 days
Determination levels…?

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Two material X and Y are used as follows:
Usage – 50-150units per day for both X and Y
Lead Time is 4-6 days for X and 2-4 weeks for Y
Reorder quantity is 600 units for X and 1000 units of Y
Calculate all the three levels
Determination levels…?

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Economic order quantity– is the level of inventory that minimizes the
total inventory holding costs and ordering costs. The framework
used to determine this order quantity is also known as Wilson EOQ
Model. The model was developed by F. W. Harris in 1913. But still
R. H. Wilson is given credit for his early in-depth analysis of the
model.
Ordering cost are the cost which is associated with the purchasing or
ordering of material. E.g. Cost of staff posted for ordering of goods,
transportation expenses, inspection cost. This cost is also called
buying cost. The planning commission of India has estimated these
cost between 10% to 20%.
Carrying cost are the cost of holding the inventory. E.g. Cost of
capital invested, storage cost, insurance cost, loss if material due to
deterioration, cost of spoilage
Determination of EOQ…?

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Underlying assumptions
(a) The ordering cost is constant.
(b) The rate of demand is constant
(c) The lead time is fixed
(d) The purchase price of the item is constant i.e. no discount is
available
EOQ is the level of the inventory where ordering cost and carrying
cost remains equal.
Determination of EOQ…?

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EOQ Cost Model
Order Quantity,Order Quantity, QQ
AnnualAnnual
cost ($)cost ($)
Ordering Cost =Ordering Cost =
CCooDD
QQ
Carrying Cost =Carrying Cost =
CCccQQ
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Total CostTotal Cost
Slope = 0Slope = 0
MinimumMinimum
total costtotal cost
Optimal orderOptimal order
QQoptopt

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cost function: EOQ is the level of the inventory where ordering cost and
carrying cost remains equal.
Total Cost = purchase cost + ordering cost + holding cost
Purchase cost=(purchase unit price × annual demand quantity.)
Purchase cost =(P×D)
Ordering cost: This is the cost of placing orders: each order has a fixed cost C,
and we need to order D/Q times per year.
Ordering cost=C × D/Q
Holding cost: the average quantity in stock (between fully replenished and
empty) is Q/2,
Holding cost = H × Q/2
Determination of Total Cost…?

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Find out EOQ from following information
Annual usage-6000units
Cost of material per unit-20/-
Cost of receiving and placing order-60/-
Annual carrying cost of one unit- 10% of inventory value
Determine EOQ

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A manufacturing company uses 6400unit of material per
year. The unit cost is 6/-, and the carrying cost is 25% of
unit cost. If the cost of procurement is 75/- determine
1. EOQ
2. Number of order per annum
3. Time period between two consecutive order.
EOQ Analysis…

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X ltd produces a product which has a monthly demand of
4000 units. The product requires a component X which is
purchased at 20/-.For every finished product, one unit of
the component is required. The ordering cost is 120/- per
order and the holding cost is 10%p.a
You are required to calculate
1. EOQ
2. If the minimum lot size to be supplied is 4000unit, what is
extra cost, the company has to incur
EOQ Analysis…

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An Enterprise requires 90000 units of a component in a
year. The cost per unit is 3/-.Ordering cost id 6/- per unit
1. What is EOQ
2. What should the firm do if the supplier offers discount as
below
At 4500 units – Discount offered is 2%
At 6000 units – Discount offered is 3 %
EOQ Analysis (Decision making)…

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Usually a firm has to maintain several types of inventories. It is not
desirable to keep the same degree of control on all the items. The
firm should pay maximum attention to those items whose value is
the highest. The firm should, therefore, classify inventories to
identify which items should receive the most effort in controlling. The
firm should be selective in its approach to control investment in
various types of inventories. This analytical approach is called the
ABC analysis and tends to measure the significance of each item of
inventories in terms of its value.
ABC Analysis…

Inventory mgmt

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