Symbiosis Institute of Telecom Management

PRIME COST MATERIAL COST

A.V.Chirputkar, Faculty - Finance, SITM.

M.Com. F.C.A. M.B.F. (ICAI), C.I.S.A. (USA)

2006 Cisco Systems, Inc. All rights reserved.

Cisco Public

Inventory Meaning
Inventory Cycle Raw Material; Work In Progress; Finished Goods Importance of Inventory Cycle

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Type of Industries and Inventory

Manufacturing: Raw Material, WIP and Finished Goods. In manufacturing raw material is converted into finished goods.

Trading: Finished Goods. It is just buying and selling activity

Service: Preferably no inventory Telecom Service Providers have inventory.

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Importance of Inventory
Inventory value is included in Profit & Loss Account which affects profit of the Company Inventory in shown as Current Assets in Balance Sheet hence inventory value affects Balance Sheet position also. So change in inventory value will change profit and financial position of company.

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Valuation of Inventory
Valuation of Inventory is a systematic process which is done at periodical intervals. Inventory has two values; Cost price Net Realizable value

(Value of inventory is = lower of cost or net realizable price)

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Objectives of Inventory Valuation

Examine alternative inventory valuation methods Value = Quantity X Rate

Change in value of inventory will change profit

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Inventory Formula

Cost of goods sold = Opening Stock of inventory+ Net Purchases Closing Stock of Inventory

Above formula can also be used in relation to WIP and Finished Goods to arrive at Cost of Goods Sold

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Inventory Recording Systems

Two systems for recording merchandise inventory PERPETUAL INVENTORY SYSTEM
Maintains a continuous inventory record of all goods bought and sold COGS accumulated as inventory is sold

PERIODIC INVENTORY SYSTEM

Physical stocktake (an actual count) of inventory is required at end of period to update inventory
Until then, COGS = ?

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Inventory Valuation
How we divide the costs between COGS and ending inventory depends on the inventory system Perpetual system: We record the cost of each item sold ; this then gives us the cost of the remaining items Periodic system: Must determine the cost of items remaining in ending inventory to calculate COGS; individual sales are not tracked, an end of period stocktake determines ending inventory; cost flow assumption can significantly impact the calculation of ending inventory and COGS

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Four Main Cost-flow Assumption/Approaches

1. Specific Identification 2. FIFO - First In First Out 3. LIFO - Last In First Out* 4. Weighted Average (Average Cost) Also - replacement cost - lower of cost or net realisable value (*As per AS-2: Valuation of Inventory, only 1, 2 and 4 are allowed in India)

http://www.icai.org/icairoot/resources/as_2.html#cf

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Rule - Lower of Cost or Net Realisable Value

1. Inventories must be measured at the lower of historic cost or NRV on an item by item basis 2. Follows the conservatism principle

3. Means that no profit can be booked until sale has been realised.
4. NRV = Estimated sale proceeds less marketing, selling and distribution costs

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Inventory Valuation Case Study

A retailer reports the following data: Beginning 6 items at Rs.10 Buy 10 items at Rs.11 10 items at Rs.13 4 items at Rs.15 Total Available 30 Sell 22 Remaining 8 Replacement cost Rs.16 per item What is the COST of the 8 remaining items?

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Specific Identification
Physical linking of the cost of each item of inventory
Goods Available Unit Beginning Inv Purchases: 6 10 10 4 30 Cost @ 10 @ 11 @ 13 @ 15 Total = = = = Rs. 60 Rs.110 Rs.130 Rs. 60 Rs.360 Ending Inventory Unit 2 1 1 4 8 Cost Total = = = = Rs.20 Rs.11 Rs.13 Rs.60

@ 10 @ 11 @ 13 @ 15

Cost of Goods available for sale Less: Ending inventory Cost of Goods Sold:
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Rs.104 Rs.360 Rs.104 Rs.256

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FIFO - First In, First Out

Goods Available Unit Beginning Inv Purchases: Cost Total Ending Inventory Unit Cost Total

6 @ 10 = Rs. 60 10 @ 11 = Rs.110 10 @ 13 = Rs.130 4 @ 15 = Rs. 60 30 Rs.360 Cost of Goods available for sale Less: Ending inventory Cost of Goods Sold:

4 4 8

@ 13 = Rs.52 @ 15 = Rs.60 Rs.112 Rs.360 Rs.112 Rs.248

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WAC - Weighted Average Cost

Assumes all items are valued at the average cost of all purchases
Ending Inventory

Units Cost 8 @ Rs.12 Cost of goods available for sale Less: Ending inventory Cost of goods sold

Total = Rs. 96 Rs.360 Rs. 96 Rs.264

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Comparison of Methods & Systems

1. In periods of rising prices - profit & ending inventory under FIFO > AC > LIFO 2. The order is same under either inventory systems (perpetual or periodic) but actual Rs. values of COGS, Profit & Ending Inventory will differ under LIFO & AC 3. Judgment is required in method selection but method must be applied consistently from period to period 4. Material effects of method changes are required to be disclosed

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Material Losses
Material Cost increases due to various types of material losses. Controlling material losses will help the company to minimize costs.

Classification of Material Losses:

a) Wastages b) Scrap c) Spoilage d) Defectives

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Material Losses - Waste

It is a loss of material due to evaporation, shrinkage etc. Wastage could be visible or invisible. Normal Wastage: It is inherent due to nature of material or production process. It can not be avoided. The loss due to normal wastage is borne by good number of units produced and passed on to customers. Abnormal Wastage: It is over & above normal wastage. It is borne by Company itself. It can be controlled by strict quality control.

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Material Losses - Scrap

It is a material left resulting from manufacturing process. If sold it will fetch value from market unlike waste.

Depending upon the reason, it is treated in cost accounting. The cost accounting treatment is similar to wastage as mentioned earlier.

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Material Losses - Spoilage

It is an output from production which does not meet predetermined quality. It can not be rectified and thus has to sell off without further processing.

Normal Spoilage: The cost of normal spoilage is transferred to good units produced and thus ultimately borne by customer.
Abnormal Spoilage: It is borne by company and transferred to Costing Profit & Loss Account.

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Material Losses - Defectives

It is an output from production which does not meet predetermined quality. It can be rectified and thus has to sell off after certain processing. Still its quality is less than the good units. The cost accounting treatment is same as spoilage. Difference between Wastages, Scrap, Spoilage and defectives is important.

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Inventory Control
Material cost is maximum in case of manufacturing and trading organisations. It is important that there should be proper control over inventory. There are various techniques of Inventory Control

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Objectives of Inventory Control

It helps in smooth supply of material to production department results into efficient and uninterrupted flow of production.

It helps in minimizing investment in inventory.

Reduction in loss of material, handling and storage costs are kept minimum.

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Techniques of Inventory Control

Min Max Plan Order Cycling System

ABC Analysis
Fixation of various levels Maximum level, Minimum Level, Safety Level, Re-order level etc with the help of formulae.

E.O.Q.
Perpetual & Periodic Inventory System Just In Time Inventory
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ABC Analysis Case Study

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Economic Order Quantity Case Study

The concept of EOQ Formula

The Company has a monthly demand of 1000 units. The cost of placing an order is Rs. 100 and the annual carrying cost per unit is Rs. 15. Find out EOQ. Find out total carrying cost and ordering cost at EOQ.

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Just in Time Case Studies

MacDonald Software Implementation

Dell
Sony

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Q&A

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Thanks

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