© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 7
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CHAPTER 7
Inventory
Management
© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 7
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Learning Objectives
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How are inventories presented on a company’s financial
statements?
How does the flow of inventory costs differ between a
manufacturing and a merchandising company?
What are the various methods used to value inventory?
How are these methods applied in practice?
What are the benefits and challenges of just-in-time (JIT)
inventory management?
Why are inventory management practices important in
controlling costs of inventory?
© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 7
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Introduction to Inventory
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Goods bought or manufactured for resale but unsold

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Timing difference between production capacity and
customer demand
Cost includes all costs of purchase or manufacture to
bring inventory to its present location and condition
On a company’s statement of comprehensive income,
the cost of inventories is recorded as “Cost of goods
sold” and on the statement of financial position, it is
reported under current assets as “Inventory.”
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Inventory for a
Merchandising Company
Cost of Goods Sold: Merchandising Company
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Inventory for a Merchandising Company
Statement of Comprehensive Income
Statement of Financial Position
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Inventory for a Merchandising Company
The Flow of Costs in Purchasing
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Inventory for a
Manufacturing Company
Inventory types
1. Raw materials – unprocessed goods
2. Work in process – uncompleted goods
3. Finished goods – manufactured or
purchased and ready for sale
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Inventory for a Manufacturing Company
Cost of Goods Manufactured: Manufacturing Company
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Inventory for a Manufacturing Company
Cost of Goods Sold Statement: Manufacturing Company
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Inventory for a Manufacturing Company
Statement of Comprehensive Income
Statement of Financial Position
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Inventory for a Manufacturing Company
The notes to the financial statements would
show a breakdown of the valuation of
inventory in the current assets section of the
statement of financial position.
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Inventory for a Manufacturing Company
The Flow of Costs in Manufacturing
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Valuation of Inventory
Lower of cost or net realizable value (NRV)
 Individually purchased inventory

 Purchase
cost is used to value the inventory
and the cost of goods sold when the inventory
is sold

Similar/undifferentiated products (bulk)
 Weighted
average cost
 FIFO (first in, first out)
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Example
A product is purchased on three separate occasions:
Units
Unit price
Total cost
5,000
$1.20
$6,000
2,000
$1.25
$2,500
3,000
$1.27
$3,810
Calculate the cost of goods sold for the 6,000 units sold
and the value of the ending inventory
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Weighted Average Method for
Merchandising Companies
Units
5,000
2,000
3,000
10,000
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


Unit price
$1.20
$1.25
$1.27
Total cost
$6,000
$2,500
$3,810
$12,310
The weighted average cost is
$12,310/10,000 = $1.231 per unit.
The cost of goods sold is
6,000 @ $1.231 = $7,386
The value of the ending inventory is
4,000 @ $1.231 = $4,924
Total cost $7,386 + $4,924
$12,310
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First-In, First-Out Method for
Merchandising Companies
Units
5,000
2,000
3,000
Unit price
$1.20
$1.25
$1.27
Total cost
$6,000
$2,500
$3,810
Cost of Goods Sold
5000@$1.20 = $6,000
1000@$1.25 = $1,250
6000
$7,250
Units
5,000
2,000
3,000
Unit price
$1.20
$1.25
$1.27
Total cost
$6,000
$2,500
$3,810
Ending Inventory Value
1000@$1.25 = $1,250
3000@$1.27 = $3,810
4,000
$5,060
Total cost $7,250 + $5,060
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$12,310
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Comparison of Methods
Weighted Average Method
If 6,000 units sold @ $2.00
Sales
$12,000
Cost of goods sold (WAM)
7,386
Gross profit
4,614
FIFO Method
Sales
Cost of goods sold(FIFO)
Gross profit
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$12,000
7,250
4,750
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Net Realizable Value (NRV)
NRV is the potential proceeds of sale of
inventory, less any costs of disposal
 If the NRV is lower than the recorded cost,
the inventory item should be recorded at
NRV

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Methods of Costing Inventory
in Manufacturing

Custom
 Unique,

single products
Batch
A
quantity of the same goods produced at the
same time ( a production run)

Continuous (Process Costing)
 Continuous
production process of the same,
indistinguishable goods
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Job Order Costing
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Cost of raw materials as they are issued to each job
(either a custom product or a batch of products)
Plus the cost of time spent by different categories of
labour
To each of these costs, overhead is allocated to
cover the fixed and variable manufacturing
overheads that are not included in materials or
labour (overhead will be explained in Chapter 11)
Accumulated cost of materials, labour, and
overhead is the cost of that custom product
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Job Costing Example
Helo Ltd manufactures components for helicopters in batches of
100 components.
Each batch requires 500 Kg of rolled and formed steel, which takes
15 hours of labour.
July Transactions
 Purchase of steel 1,000 Kg @ $12/Kg
 Issue of steel to production 500 Kg
 Direct labour to roll and form 500 Kg steel 15 hours @ $125/hour
 Overhead is allocated $2,000 at completion of batch.
 60 of the components manufactured in the batch were sold for $130
each.
 At month end, but prior to the completion of the job, 500 Kg of steel
had been issued to production and 7 hours had been worked.
Calculate the value of work in process at month end
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Work in Process
Materials: Steel 500 Kg @ $12/Kg =
Labour: 7 hours @ $125
Work in progress
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$6,000
875
$6,875
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At the completion of a batch of 100
components, calculate:
 Total
job cost
 The unit cost per component
 The gross profit
 The value of
raw materials inventory
 finished goods inventory
 work in process inventory

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Materials: Steel 500 Kg @ $12/Kg
Labour: 15 hours @ $125
Overhead
Total job cost
$6,000
1,875
2,000
$9,875
Cost per component
$98.75
($9,875/100)
Sales income (60 @ $130) =
Cost of sales (60 @ $98.75) =
Gross profit is $7800 - $5925 =
$7,800
$5,925
$1,875
Finished goods inventory (40 @ $98.75) =
$3,950
Raw materials inventory 500 Kg of steel @ $12/Kg = $6,000
(purchased 1000Kg less used 500Kg)
Total inventory
$9,950
There is no Work in progress as the job is complete
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Process Costing
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Costs are collected over a period of time
together with a measure of the volume of
production
At the end of the accounting period, the total
costs are divided by the volume produced
(equivalent units) to give a cost per unit of
volume
Equivalent units are the number of fully
completed units in production
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Process Costing
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Equivalent units measure the fully completed
units by multiplying the number of units in the
work-in-process inventory by their percentage of
completion
This amount is added to the finished units to
determine the equivalent units
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Process Costing
Either the weighted average method or the firstin, first-out (FIFO) method can be used to
calculate inventory costs for process costing.
 Under both methods, it is necessary to complete
three steps:
1. Determine the number of units completed.
2. Calculate the equivalent units in work in
process and the cost per equivalent unit.
3. Assign the cost to finished goods and ending
WIP inventory
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Note: In process costing examples, unless
you are advised otherwise, materials are
assumed to be added at the beginning of the
process, and conversion costs are added
uniformly throughout the process.
Material
added
Conversion costs applied uniformly
Beginning
of process
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End of
process
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Process Costing with Partially
Completed Units – Weighted Average
Kazoo produces oils on a process basis during a month
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Opening work in progress 7,000 units:
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55% completed
Materials $12,000 and conversion costs $30,000.
12,000 units commenced production during the month.
Closing work in progress 4,000 units, 75% complete.
Cost of materials issued to production during the month
was $140,000.
Conversion costs for production during the month were
$80,000.
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
Calculate:
 The
number of units completed
 The equivalent units in WIP and the cost per
equivalent unit, using the weighted average
method
 The cost of work in process and finished
goods at month end.
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Calculation of Units Completed
Closing WIP
Units
7,000
12,000
19,000
4,000
Completed
15,000
Opening WIP
Units commenced
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Calculation of Equivalent
Units and Cost per Unit
Opening Cost for
WIP $ month $
Material
Conversion
Total
Total $ Completed
WIP
Total Cost per
units Equivalent equivalent equivalent
units
units
unit $
12,000 140,000 152,000
15,000
4,000
19,000
$8.000
30,000 80,000 110,000
15,000
*3,000
18,000
$6.111
$42,000
$262,000
$14.111
* 4,000 units, 75% complete at end of month = 3,000 equivalent units
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Assignment of Costs
Work in progress:
Materials 4,000 @ $8
Conversion 3,000 @ $6.111
Finished goods:
15,000 units @ $14.111
Total costs
$32,000
$18,333
$50,333
$211,666
$262,000*
* Materials $12,000 + $140,000 + Conversion $30,000 + $80,000
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Process Costing with Partially
Completed Units – First-in First-Out
(FIFO)
Kazoo produces oils on a process basis during a month
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Opening work in progress 7,000 units:
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55% completed
Materials $12,000 and conversion costs $30,000.
12,000 units commenced production during the month.
Closing work in progress 4,000 units, 75% complete.
Cost of materials issued to production during the month
was $140,000.
Conversion costs for production during the month were
$80,000.
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
Calculate:
 The
number of units completed
 The equivalent units in WIP and the cost per
equivalent unit, using the FIFO method
 The cost of work in process and finished
goods at month end.
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Calculation of Units Completed
Closing WIP
Units
7,000
12,000
19,000
4,000
Completed
15,000
Opening WIP
Units commenced
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Calculation of Equivalent
Units and Cost per Unit
Opening
WIP $
Material
Conversion
Total
0
0
$42,000
Cost for Beginning
month $
WIP
completed
140,000
80,000
220,000
0
*3,150
Completed
units
8,000
8,000
Ending
WIP
Equivalent
units
4,000
**3,000
Total
Cost per
equivalent equivalent
units
unit $
12,000
14,150
$11.6667
$5.6537
$17.3207
* 7.000 units, 55% complete, 45% added in current month: 7,000 x 45% = 3,150
** 4,000 units, 75% complete at end of month = 3,000 equivalent units
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Assignment of Costs
Work in process:
Materials 4,000 @ $11.6667
Conversion 3,000 @ $5.6537
Finished goods:
Beginning WIP already completed
Beginning WIP finished (3,150 @ $5,6537)
Units started and completed
(8,000 units @ $17.3207)
Total costs
$46,667
$16,961
$63,628
$42,000
$17,809
$138,564
$198,373
$262,000*
* Materials $12,000 + $140,000 + Conversion $30,000 + $80,000
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Valuation of Inventory for
Service Companies
Professional service firms also have
inventories.
 Accountants and lawyers are examples of
firms with large work-in-process
inventories, covering work carried out on
behalf of clients but not yet invoiced.

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Just-In-Time Inventory
Management
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Maintain minimal inventories (as close to zero as
possible) to reduce inventory carrying costs, such as
storage and materials handling costs, and to reduce the
cost of obsolescence
Advantages
 Cost savings
 Improved customer and employee satisfaction
 Improved quality
Disadvantages
 Inability to predict demand
 Strong reliance on suppliers
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Backflush Costing

Transfers the cost of materials from suppliers, along
with conversion costs, to finished goods inventory
when production of finished goods is complete (the
trigger point)
The Flow of Costs in Backflush Costing
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Long-Term Contract Costing
Large units produced over longer periods
 Percentage of completion

 Revenues
and gross profit are recognized in
the applicable periods of production, not when
production has been completed.
 The costs incurred in reaching the relevant
stage of completion are then matched with
income
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Long-Term Contract Costing
Architects certificate as to stage of
completion
 Progress payments by customer
 Retention value

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Long-term Contract Costing
Example
Macro Builders has entered into a 2 year contract to construct a
building.
Contract price is $1.2 million,
Expected cost of construction of $1 million.
After 1 year, the following costs have been incurred:
Material delivered to site
$500,000
Salaries and wages paid
130,000
Overhead costs
170,000
Certification of value of work completed is $600,000.
Macro estimates cost of $250,000 to complete over and above the costs
already incurred.
Calculate:
 The anticipated profit on the contract
 The amount of profit that can be considered to have been earned to
date.
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Anticipated Profit
Costs of construction:
Material delivered to site
Salaries and wages paid
Overhead costs
Less work not certified
Cost of work certified
$500,000
130,000
170,000
$800,000
200,000
$600,000
Anticipated profit:
Cost of work certified
Work not certified
Estimated cost to complete
Currently estimated cost
Contract price
Anticipated profit
$600,000
200,000
250,000
1,050,000 (budget $1 million)
1,200,000
$150,000
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Profit to Date
Expected cost of construction
Certified as complete
$1,050,000
$ 600,000
Percentage complete
57% ($600,000/$1,050,000)
Anticipated profit
$ 150,000
Recognise profit of 57% of $150,000 = $85,500
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Inventory Management

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Objective is to optimize the levels of inventory
 Reduce costs associated with ordering and carrying
inventories
 Ensuring there is enough inventory on hand to meet
consumer demand
Costs associated with ordering and carrying inventory
1. Ordering costs
2. Carrying costs.
3. Stockout costs.
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Economic Order Quantity and
Lead Times

Economic order quantity (EOQ)
 Determine
the levels of inventory that will
reduce costs while meeting demand

Lead time
 Time
between when an order is placed with a
supplier and when it is needed

Safety stock
 an
amount of extra stock that is kept on hand
to cover any unexpected increases in demand
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Economic Order Quantity
Calculated using the following formula
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Conclusion
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Several methods of calculating the value of
inventory and cost of goods sold
How inventories are reported on the financial
statements for a company
Looked at the two main methods of costing
inventories, job costing and process costing
A method of long-term contract costing
Benefits and challenges of using just-in-time (JIT)
inventory management practices
Economic order quantity can be used to optimize
inventory costs.
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