Continuous flow of inventory. Avoid excessive investment. Reducing carrying cost. To keep surplus & obsolete items minimum.

um. Helps the management in taking inventory decisions for various items of inventory from time to time.

 ABC

Analysis

EOQ
PERPETUAL

Inventory records & continuous stock verification. Use of control ratios and review of slow & non moving items. Setting of various stock levels.

The ABC analysis is a business term used to define an inventory categorization technique often used in materials management. It is also known as Selective Inventory

Control.

A ITEMS: very tight control and accurate records B ITEMS: less tightly controlled and good records C ITEMS: simplest controls possible and minimal records.

'A' items are very important for an organization. Because of the high value of these A items, frequent value analysis is required. In addition to that, an organization needs to choose an appropriate order pattern (e.g. Just- in- time) to avoid excess capacity. 'B' items are important, but of course less important, than A items and more important than C items. Therefore B items are intergroup items. C' items are marginally important.[

Minimum

levels Maximum levels Reorder levels Danger levels

The minimum level or minimum stock is that level of stock below which stock should not be allowed to fall. In case of any item falling below this level, there is danger of stopping of production and, therefore, the management should give top priority to the acquisition of new supplies. Minimum limit or level = Re-order level or ordering point Average or normal usage Normal reorder period . OR Minimum limit or level = Re-order level or ordering point Average usage for Normal period

The maximum stock limit is upper level of the inventory and the quantity that must not be exceeded without specific authority from management. In other words, the maximum stock level is that quantity of material above which the stock of any item should not normally be allowed to go. Maximum limit or level = Re-order level or ordering point Minimum usage Minimum reorder period + Economic order quantity

This is that level of materials at which a new order for supply of materials is to be placed. In other words, at this level a purchase requisition is made out. This level is fixed somewhere between maximum and minimum levels. The order point is reached when inventory on hand and quantities due in are equal to the lead time usage quantity plus the safety stock quantity.

 Ordering

point or re-order level = Maximum daily or weekly or monthly usage Lead time When safety stock is provided then the following formula will be applicable: Ordering point or re-order level = Maximum daily or weekly or monthly usage Lead time + Safety stock

When this level of stock is reached, then emergency steps are taken by the management to acquire material supplies. When danger level is reached, the try is made to purchase materials from the nearest possible source or place so that the workers and plant and machinery may not remain idle due to shortage of materials supplies. Danger level = Average daily requirement Time required to get emergency supply

Economic order quantity is the order quantity that minimizes total inventory holding costs and ordering costs. It is one of the oldest classical production scheduling models. Underlying assumptions: The ordering cost is constant. The rate of demand is known, and spread evenly throughout the year. The lead time is fixed. The purchase price of the item is constant i.e. no discount is available The replenishment is made instantaneously, the whole batch is delivered at once. Only one product is involved.

EOQ FORMULA
S = Annual Usage (sales) in units O = Order cost per order C = The carrying cost per unit per period Q = The order quantity

A document that records the status of a good held in a stock room. A typical retailing business with a large stock room will use a bin card to record a running balance of stock on hand, in addition to information about stock received and notes about problems associated with that stock item.

Store ledger is the book or file in which we contain the accounts of different stock items which is in the store. When store keeper gets or issues any items of inventory, he records it in the respective inventory item's account. So, every item account shows the total receipt, total issue and total balance. Both quantity and value of item is recorded in each account.

1.User

Bin card is maintained by the storekeeper. Store ledger is prepared by cost accounting department.

2. Nature 3. Period

Bin card is a record of quantity only. Store ledger is a record of quantities and values. In bin card, entries are made immediately after each transaction. In store ledger, entries are made periodically.

4. Posting

Postings are made before a transaction in bin card. Posting are made after a transaction in store ledger.

5. Using Department

Bin card is kept inside the store. Store ledger is kept outside the store.

Perpetual inventory or continuous inventory describes systems of inventory where information on inventory quantity and availability is updated on a continuous basis as a function of doing business. Generally this is accomplished by connecting the inventory system with order entry and in retail the point of sale system. In this case, book inventory would be exactly the same as, or almost the same, as the real inventory.

On the stores, a complete & reliable check is obtained. For the purpose of stock taking, the normal working of the company is not needed to be kept suspended. As stock figures are available from cost records, under financial accounting system, preparation of profit & loss account & balance sheet need not be delayed for stock figures. Detection & adjustment of discrepancies can be readily made. Where ever possible, measures to avoid such discrepancies should be taken.

It becomes possible to keep the stock within the prescribed limits, because to this aspect, the stores audit also extends. Since within the limits, the stocks are kept, the chances of capital being unnecessarily blocked, bottleneck in supply for production, loss due to deterioration, obsolescence etc., are not there. Assurance is given of timely stock replenishment because store audit also looks into the fact whether as soon as the stock reached the ordering level, initiative for purchase was taken or not. Detection of obsolete & slow moving materials can be achieved by systematic review of perpetual inventory.

It is costly. The work shall be hampered unless the bin cards & stores ledgers are kept up to date. The bin card balance & the stores ledger balance must be reconciled first if the two balances does not agree & then only physical verification of stock shall be feasible. This will require time.

Inventory Account and Cost of Goods Sold Account are used in both systems but they are updated continuously during the period in perpetual inventory system whereas in periodic inventory system they are updated only at the end of the period. Purchases Account and Purchase Returns and Allowances Account are only used in periodic inventory system and are updated continuously. In perpetual inventory system purchases are directly debited to inventory account and purchase returns are directly credited to inventory account.

Sale Transaction is recorded via two journal entries in perpetual system. One of them records the sale value of inventory whereas the other records cost of goods sold. In periodic inventory system, only one entry is made. Closing Entries are only required in periodic inventory system to update inventory and cost of goods sold. Perpetual inventory system does not require closing entries for inventory account.

Inventory turnover or stock turnover which is usually expressed as a ratio, indicates during a particular period, the number of times the inventory is turned over (i.e. bought & consumed). It measures the rate at which materials are consumed. The slow-moving, dormant & obsolete items are identified with the help of the ratio. By using the following formula, the calculation of the ratio can be done:

Inventory turnover ratio = Cost of materials consumed during a period Average inventory held during the period

Low stock is indicated by a high inventory turnover & high stock in relation to usage is indicated by low inventory turnover. Therefore, (a) danger of deterioration or obsolescence, (b) excessive holding costs, e.g. interest on capital, (c) excessive storage space, can be avoided by a high inventory turnover. On the other hand, accumulations of obsolete materials, carrying of too much stock etc. are indicated by a low inventory turnover. However, for holding high stocks, there may be good reasons, namely (a) at cheap prices, large forward purchases made, (b) uncertainty of supply, (c) cost of stock-outs, (d) high reordering costs.

(a) Deciding on how many ratios to calculate. Much work & materials may be involved for calculating a ratio for each item of materials; therefore, the ratios should be grouped. (b) Store price fluctuations may mean that, different unit values from those of average stock may be included in the cost of materials. Therefore, instead of values, number of units should be used. (c) Since average can be calculated in a number of ways, it can be misleading. The inventory turnover ratio is only one of a number of techniques available for inventory control & probably not as important as techniques used for determining the optimum order size & level of stock.

Objectives Identify costs associated with inventory Understand cost control levels calculate the most economical quantity to order

There are four types of inventory costs 1. Holding costs (Ch) 2. Ordering costs (Co) 3. Purchases cots (P) 4. Stock out costs

Costs incurred because the firm owns or maintains inventory. Examples. Cost of storage space Insurance Cost of capital interest tied up in inventory

Reasons for holding inventory To maintain sufficient inventory to meet anticipated demand To take advantage of bulk purchasing discount To meet possible shortage in future To provide buffer (safety stock) between production process Act as hedge against inflation

Annual holding cost = cost of holding the unit for one year average inventory throughout the year = Ch Q/2 Where: Ch = cost of holding a unit for one year Q = Order quantity

These are costs incurred every time an order is placed, e.g. Administrative costs, delivery costs, transport cost, insurance Annual ordering costs = cost per order number of orders pa = Co D/Q Where Co= Cost of making a single order D = Annual demand of materials

Amount paid to the supplier to acquire the item Annual Purchase cost = PD Where: P = Purchase cost per item

Costs associated with running out of stock e.g loss of profits due to loss of sales, loss of future sales.

Cash discount: purely financial in nature , so avoided in cost accounts. This discount is given when prompt payments are to collected. Trade discount: This is shown as a deduction from purchase price in the invoice . The net amount after deduction of trade discount is purchase price. Quantity discount: It is an incentive for bulk purchase, it is given by the supplier to the purchaser.

Should be easy & simple to operate. At the time of valuation of closing stock, the issue price should not necessitate heavy adjustments. The issue price must reflect current market price. The issue price should recover the cost of materials. The issue price should not cause major variation in cost from period to period & from job to job.

There are different methods of pricing materials issue. Cost Price Methods: First in First out (FIFO) Last in First out (LIFO) Base Stock Highest in first out (HIFO) Specific price

Average Price Methods: Simple Average. Weighted Average Periodic simple average Periodic weighted average Moving simple average Moving weighted average

Notional Price Method: Standard Price Inflated Price

Market price methods: Replacement price Net realizable value

Under this method materials are used in the order in which they are received. In other words, materials received first are issued first. This process is repeated throughout. The price of the earliest consignment is taken first and when that is exhausted, the price of the next consignment is adopted and so on. This method is most suitable for use where the material is slow moving and has comparatively high unit cost This method is also useful in times of falling prices because the issue price of material to the job will be high while the replacement cost of material will be below.

The main advantage of FIFO method is that it is simple to understand and easy to operate. This method is useful when prices are falling. Closing stock of materials will be valued at the market price as the closing stock under this method would consist of recent purchase of materials. This method is also useful when transactions are not too many and prices of materials are fairly steady.

This method increases the possibility of clerical errors, if consignments are received frequently at fluctuating prices as every time an issue of materials is made, the store ledger clerk will have to go through his record to ascertain the price to be charged. For pricing rise, the issue price does not reflect the market price as materials are issued from the earliest consignments. Therefore, the charge to production is low because the cost of replacing the material consumed will be higher than the price of issue.

The cost of materials issued will be either nearer to and or will reflect the current market price. Thus, the cost of goods produced will be related to the trend of the market price of materials. Over a period, the use of LIFO helps to iron out the fluctuations in profits. In the period of inflation LIFO will tend to show the correct profit and thus avoid paying undue taxes to some extent.

Calculation under LIFO system becomes complicated and cumbersome when frequent purchases are made at highly fluctuating rates. In time of falling prices, there will be need for writing off stock value considerably to stick to the principle of stock valuation, i.e., the cost or the market price whichever is lower. This method of valuation of material is not acceptable to the income tax authorities.

It is simple to operate, as it avoids calculation of issue price after every receipt. 2. This method can usefully be employed in costing processes where each individual order is absorbed into the general cost of producing large quantities of articles.

This method cannot be applied in jobbing industry where each individual job order is to be priced at each stage of its completion. 2. This method is unscientific as it does not take into consideration the quantities purchased at different prices. 3. This method also suffers from all those disadvantages of simple average cost method.

Smoothen out fluctuations in purchase price. Compared to FIFO or LIFO, this method is less cumbersome. Seems a logical method as it assumes the values of identical items will be equal. Issues may not be at current economic value As it based on average method, the issue price may run to a number of decimal places