Costing and accounting system
Session 1-2
Types of inventory
• Direct material
▫ Which represent direct material in inventory
awaiting manufacture.
• Work in progress
▫ Goods partly worked on but not fully completed
• finished goods
▫ Goods fully completed but not yet sold
Inventory
• Inventory is valued at cost or net realizable
value.
• Net realizable value present the expected selling
price minus the cost still to be incurred to sell it.
• Cost is all the expenditure incurred in getting a
product or service to its present location and
condition. Expenditure which relates to
production overhead.
Inventory
• Inventory records should be up to date in both numbers and
value because:
▫ It provide control of inventory
▫ Allow the value of the inventories at any point in time to be
ascertained.
• The way in which inventory costs are charged to
production can have an effect on determination of the
cost of production.
• Ways to value inventory:
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FIFO
LIFO
Average cost
Standard cost
Market price
FIFO
• It is based on charging inventories used at the
earliest purchase price.
• Using this method the remaining inventory is
charged on the most recent price, which can be
argued to be realistic
• It is accepted in UK taxation and international
accounting.
LIFO
• It charge inventories to production at most
recent cost.
• In times of inflation it can argued as being
realistic but it does mean that the remaining
inventory tend to be undervalued in relation to
market price.
• This method is not recommended as basis of
valuation.
Standard costing
• A predetermined cost is established for each
item for a period and is then used for charging
costs o product or service.
• It have advantage of simplicity
• It differ from the actual cost and need to be
checked against to insure that the difference is
revised in standard cost of next period.
Market Price
• Is used when there is price volatility un basic
material cost because of market condition or due
to the demand and supply.
inventory
• The firms needs to measure and manage inventories
efficiently and effectively in order to generate the
maximum possible financial return from inventory.
• There are three reason why to hold inventory:
▫ Transaction motive
 Occurs when there is a need to maintain inventory to meet
production and sales trends, and it is not possible to meet these
needs instantly
▫ Precautionary motive
 Maintain additional inventories to meet unforeseen
circumstances. Uncertain future demand
▫ Speculative motive
 Maintain minimum or maximum level of inventory to benefit
from expected increase or decrease in future prices.
Inventory
• Management should ascertain the optimum
inventory level which depends on a comparison of
future cost saving from purchasing now and the
increase in cost resulting from holding new
inventory.
• Management minimize the amount of inventory
hold because of the cost associated:
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Storage and handling cost
Finance cost
Theft and obsoleteness
Opportunity cost
Economic order quantity model(EOQ)
• EOQ is used due to the fact that ordering frequent
and small inventory to try to lower the inventory
level or to order infrequent large inventory are
associated with large cost.
• The EOQ is the order quantity that yields the lowest
total costs of ordering and holding the inventory.
• In simplest form, EOQ assumes that demand is
constant so that inventories will be depleted evenly
over time, and replenished instantly or within a
constant lead time when they are needed.
Movement of inventory
EOQ assumptions
• The demand for the product can be predicted
with accuracy
• Demand is constant over the period and does
not fluctuate through seasonality or other
reasons
• Constant reorder lead time
• No safety inventory required
• No discount on bulk purchases
Economic Order Quantity
D
represent the annual demand for the
inventory item
Crepresent the cost of placing an order
H represent the cost of holding one unit of
inventory for a year
Example 1.2
Effect of discount
• Obtaining large purchase order will result in
discount in price which will result in cost saving:
▫ Reduction on ordering cost of small frequent
quantity
▫ Saving in purchase price
• The cost saving must be compared with increase
holding cost.
▫ Calculate the EOQ
▫ Calculate the saving
 Order saving
 Discount on price
▫ Additional cost of handling
▫ Compare the values
Example:
• the cost of raw material is $14 per unit,
total annual demand 18,000 unit
holding cost $8
ordering cost $10
if the company obtained a order of 2,000 unit a
discount of 5% is given
Reorder level
• Periodic inventory checks may be required to ensure
that the amount of physical inventories held
consistence with the indicated amount in books.
• There should be procedure for recording
inventories:
▫ to prevent lack duplication and lack or coordination.
▫ To determine the point at which inventory should be
reordered
▫ Information about the required about lead time
• Lead time : the time between the placing of an order
and the receipt of the goods.
• 1.3
Reordered level
• Maximum inventory level:
▫ Is the level above which the inventory of any item
should not normally rise.
• Minimum inventory level:
▫ Is the level below which the inventory of any item
should not be allowed to fall.
▫ It will effect the production and cause loss
▫ 1.4
Reordered level
• Stock out
▫ Is the opportunity cost resulting from running out of
inventory.
• It is difficult to predict the demand of inventories
with certainty and delivery of inventories.
• Safety inventories:
▫ Are the inventories that are held in excess of the
expected demand during the delivery lead time to
avoid running out of inventories.
1.5
Safety inventory
Just in time inventory control (JIT)
• A system in which material arrives exactly as they
are needed in production.
• It requires a business to build a relationship with
the supplier to provide him with small more
frequent orders and building electronic orders to
reduce the ordering cost.
• EOQ is concerned with minimizing the overall cost
of inventory with regard to ordering and holding
cost
• JIT is concerned with minimizing inventory and
ideally eliminating inventory.
Advantage and disadvantage of JIT
Demand pull approach
• Under the demand pull approach each process
produced what requires in the next stage
• If there is a disturbance in the next stage the
production stops of the early stage until it is
resolve.
Demand pull approach
Integrated accounting system
• The double bookkeeping system:
▫ is a logical integrated system of keeping financial
records or accounts in financial accounting system
▫ It ensure that each individual transaction as
recorded in at least in two different account.
• Financial accounting system:
▫ intended to inform management how much is
owed to and by various external parties and to
monitor overall performance of the organization
▫ consider as instrumental as well as legal
Integrated accounting system
• Cost accounting system:
▫ Is set up to enable an organization to work out the cost of
product or service sold, or cost of particular job, contracts,
or manufacturing process.
▫ There is no legal requirement to produce this information
▫ Management use cost accounting for planning controlling
and decision making.
• Integrated accounting:
▫ A set of accounting records that integrate both financial and
cost account using a common input of data or all account
purposes.
▫ This was is much cheaper quicker and more reliable than
using two separate system
Advantages of using integrated system
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Accuracy
Speed
Volume
Automated documentation
Updated information
Availability of information
Management information
Presentation of information
Cost saving
Ease of use
Accountability / audit trail