Accounting for Materials

(Inventory)

Topic 2
Learning Objectives

1 Describe the different procedures and documents necessary

for ordering, receiving and issuing of materials from inventory.

2 Explain and calculate optimal reorder quantities.

3 Calculate the value of closing inventory and material issues

using LIFO, FIFO and AVCO.

2
Inventory

 Types of inventory:
• Raw Materials
• Work in progress
• Spare parts / consumables
• Finished goods
Inventory control system

Ordering Purchase Receipt Storage Issue

Inventory costs consist of:

• Lost sales • Storage

• Goodwill • Interest
• Production stoppages • Insurance
• Labour frustration • Obsolescence and
• Cost of urgent orders deterioration

Cost of
Holding
running
costs
out

Purchase Ordering
costs costs
• Admin
• Transport
• Production
costs

Inventory control is to minimise holding, ordering, and stockout costs

Aspects of Inventory Control

 Bin cards
 Level of stock on location
• Receipts, Date, Quatity
• Issues, Date, Quantity
• Balance
 Stocktake
 Periodic
 Continuous
 Advantages of continuous stocktaking
Inventory documents

STOCK IN

STORE DEPARTMENT PURCHASE DEPARTMENT

Purchase requisition Purchase order

SUPPLIER
Goods received note
Delivery note

ACCOUNNTING DEPARTMENT
Bin card
Store ledger account
Inventory documents

STOCK OUT

COST DEPARTMENT STORE DEPARTMENT

Materials/store Materials transfer note
requisition

ACCOUNTING DEPARTMENT

Store ledger account

Bin card
Quick check

The following relate to procedures for materials:

1. Check the goods received note
2. Raise a stores requisition note
3. Update the stores ledger account for the purchase
4. Raise a purchase order
What would be the correct order of the above when in the
process of purchasing and using materials?
A 4,2,1,3
B 2,1,3,4
C 4,1,3,2
D 1,4,3,2
Inventory control levels

Reorder Min. usage x + Reorder

-
level Min. lead time Quantify

Max. x Max. lead

usage time

Reorder - Avg. usage x Avg.

level lead time
Inventory control levels

 Reorder level
» Order to be placed at this level
• Reorder level = maximum usage x maximum lead time
 Minimum level
» Approaching stock-out levels
• = Reorder level – (average usage x average lead time)
 Maximum level
» Approaching wasteful level
• Maximum level= reorder level + reorder quantity-
(minimum usage x minimum lead time)
Exercise 1

A large retailer maintains a central warehouse. The

following information is available for item SF525:
Average usage 350/day
Minimum usage 180/day
Maximum usage 420/day
Lead time for replenishment 11 - 15 days
Reorder quantity 6,500 units
 Calculate Reorder level? buffer stock? Maximum
level?
Inventory control levels

Max.
10,820 level

Number of units

6,300 Reorder
usage point
during
order
lead
arrives
time
1,750 Min.
level

Working days
Economic order quantity

  EOQ is the order quantity which minimises inventory costs

 EOQ =
 = cost of ordering a consignment from a supplier
 D = demand during the time period
 Where = cost of holding one unit of inventory for one period
Relevant Costs

 Relevant Costs in EOQ considerations are:

 Total Ordering Costs

• Demand x ordering cost per order
EOQ

 Total Holding Costs

• EOQ x Holding Cost per unit per period
2
Economic Order Quantity graph
Annual costs
($)

Total costs

Holding costs

Ordering costs

Order quantity (units)

EOQ
CH = Cost of holding one unit of stock for
one time period
EOQ = 2COD
CO = Cost of ordering a consignment from a
CH supplier
D = Demand during the time period
Exercise 2

Jane plc purchases its requirements for component RB at a

price of $80 per unit. Its annual usage of component RB is
8,760 units. The annual holding cost of one unit of
component RB is 5% of its purchase price and the cost of
placing an order is $12.50.
Required:
 a)      Calculate the economic order quantity (to the nearest unit) for
component RB
 b)      Assuming that usage of component RB is constant throughout the
year (365 days) and that the lead time from placing an order to its receipt
is 21 days, calculate the stock level (in units) at which an order should be
placed.
Inventory Valuation

 Need Inventory Valuation for :

• Preparation of accounts
• Pricing of material issues to production

Financial Accounts Preparation

Inventories are valued at ‘lower of cost or net
realisable value’. This is undertaken at period end,
and inventory records are adjusted where necessary.
Charging inventory to production

 Goods may move physically from stores by:

• Oldest goods first
• Latest goods first
• Random choice
• Easiest to reach etc.

However the valuation of these issues must be on a

consistent basis. This means goods may be issued
not necessarily at the price paid for them.
Charging inventory to production

 Three popular methods of pricing inventories for issue to

production are based on the following assumptions:
 First in First Out (FIFO)
 Last in First Out (LIFO)
 Weighted Average Cost (AVCO)
 Example:
Units Date received Purchase cost
A June 20X1 $100
B July 20X1 $106
C August 20X1 $109
In September, one unit is issued to production. (The physical unit
actually issued was B). The accounting department must put a
value or cost on the material issued based on one of the above
three assumptions.
Charging inventory to production
 FIFO (First in First Out):
 Assumes materials issued in order in which they were
delivered into inventory. Priced at cost of earliest delivery
remaining in stock.
Advantages Disadvantages
Logical , represents what is FIFO can be cumbersome to
physically happening operate

Easy to explain Managers can be confused

by constantly changing prices

Closing inventory valuation In period of inflation, issue

nearer to replacement cost prices are below market
value
Charging inventory to production

 LIFO (Last in First Out):

 Assumes materials issued in reverse order to delivery. Most
recent issued first
Advantages Disadvantages
Inventory issued at a price LIFO can be cumbersome to
close to market value operate. Tendency to jump
from batch to batch.
Managers made aware of LIFO usually opposite to what
recent costs for making is physically happening-
decisions confusing
Decision making affected by
constantly changing prices
Charging inventory to production

 AVCO (Cumulative Weighted Average Cost):

 Calculates weighted average price for all units in inventory.
Issues are priced at this average cost (total cost/total units)

Advantages Disadvantages
Price fluctuations are evened Issue price can bear no
out. Easier data for decision relation to an actual price
making paid.
Easier to administer than Prices tend to lag behind
FIFO and LIFO. No need to current market values in time
identify batches separately of inflation
Exercise 3

Calculate the cost of issues ad the closing inventory in

the following transactions:

Purchases Price/Unit Value Issues

 
Units £ £ Units
15-Jan 400 3 1200  
19-Jan 150 2 300  
23-Jan       200
07-Feb 300 2.5 750  
14-Feb       340
Learning Materials

 Chapter 6 – ACCA F2 Study text