Cost - Chapter 7
Terms
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- Operations Management – Definition and Broad Concept
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All types of activities providing a substantial back-up for the manufacturing and delivery of different types of products provided by a business entity.
Deals with:
Production sevices
Production mix
Plant layout
Layout of retail outlets
Transportation services
Warehousing services
Supplying services - Inventories - Definition and Broad Concept
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Itemized lists of the quantities and amounts of materials and products owned by an enterprise as of a specific date.
-Inventories involve a wide variety of products
-inventories are classified as current assets
-Inventories are valuated as of a specific date
-Inventories affect the contents of both of the income statement and the balance sheet - Importance of inventories
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-Magnitude of investment in the inventories
-Impact on the operating efficiency
-Diversification of inventory operating and accounting systems and methods
-Remarkable impact on the financial statements (Inventory impacts BS and IS)
-Vulnerable to theft and fraud - Major components of inventories
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Raw Materials (raw timber)
Semi-finished materials (wood, cotton, yarn)
Finished materials (textile)
Semi finished products (suits & dresses in manu.)
Finished goods (suits & dresses) - Inventories – What critical decisions need to be made (2)
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Quantity to order
Date - Inventories – Factors to take into consideration
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Sales forecast
Production capacity
Safety stock (min inventory to be kept of a specific material in order to: (a) Meet unexpected increases in demand (b) avoid the detractive impact of unexpected delays in the delivery of ordered materials.)
Purchase order lead time (the time that elapses between the placement of a purchasing order and its delivery)
Reorder point (the quantity level of the inventory that triggers a new order being placed. = Safety Stock + Consumtion per time unit xLT)
Economic-order-quantity (EOQ) -
Reorder Point – What is Reorder point?
Consumption = 100 units per week
Lead time = 2 weeks - 200 units
- Economic Order Quantity – Explain
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The optimum quantity of a specific material or product to be purchased through a purchasing order in a given period of time.
Use the EOQ for the following:
-controlling max and min inventory levels
-carrying out a balanced trade-off between ordering costs and carrying costs
-determination of the reorder point which represents the quantity level of the inventory that triggers the issuance of a new order. - Economic Order Quantity (EOQ) – Equation
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EOQ = 2 D P
C
D-Demand in number of units
P-ordering costs per purchasing order
C-carrying costs per stock unit for a specific accounting period - Economic Order Quantity (EOQ) – Computation assumptions
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The same fixed quantity is ordered at each reorder point
Demand for the product is known with certainty
Lead time is know with certainty
Purchasing cost per unit is unaffected by the quantity ordered
Cost of stockout is so prohibitively high that inventory is always replenished before a stockout occurs
Costs of quality are recognized in purchase order size decision, only to the extent that they can be included as a component of ordering costs. - Major types of Inventory costs (5)
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Purchasing costs – cost of acquiring
Ordering costs - staff
Carrying costs - storage
Stockout costs – losses from unavailable q
Quality costs - Purchasing Costs – Examples (6)
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Source Document
Freight
Sales Tax
Insurance
Exchange Rates
Discounts - Ordering Costs – Examples (4)
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Purchasing Department:
Location
Utilities
Labor
Benefits
Supplies
Consultants (high tech)
Travel & Accommodation
Training
Brokerage Fees - Carrying Costs - – Examples (10+)
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Location
Utilities
Payroll
Fringe Benefits
Internal Transportation
Financing
Scanners
Fixtures
Safety
Security
Receiving & Delivery
Insurance - Stockout Costs
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Fines for failure to deliver
Loss of a client
Premiums paid for irregular supplies
Loss of market share
Cost of production hault - Prevention Costs - Define
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Aim to prevent the production of products that so not conform with quality control standards.
-suppliers evaluation
-training
-equipment designing reviews
-preventive maintenance - Appraisal Costs – Define
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Cost elements that aim to detect products that so not conform with quality control standards during the production (manufacturing) process.
-Quality control, Technical Inspections - Internal Failure Costs
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Incurred when nonconforming products are detected prior to its shipment to customers
-rework, repair, scraping - External Failure Costs
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Incurred when nonconforming products are detected after its shipment to customers.
Transportation expenses, cost of repairs under warranty, consumer surveys. -
Major inventory valuation methods
(LIFO & FIFO not valuation methods) -
Actual costs
Lowest of costs or market value
Replacement cost
Selling cost - Actual Costs – Define & Best use
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Valuates inventory at historical acquisition cost plus any related capital expenses.
For industrial corporations that use the inventory and don’t resell - Lowest of cost or market value
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Lower of acquisition cost or current marketing value.
Used by companies who buy and sell inventory - Replacement costs
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Method that valuates an inventory at the cost of replacing its contents as of the closing date of the financial statements.
Not endorsed by govt bodies and therefore not widely used - Selling price
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Method that valuates an inventory at the estimated price at which it can be sil as of the closing date of the financial statements.
Used for scrap - Inventory costing methods
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FIFO
LIFO
Average price method
Standard price method - FIFO
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Material units delivered are priced at the OLDEST COST PRICE listed on the stock ledger sheets.
The materials on hand are priced at the MOST RECENT purchasing prices.
For bulk volumes and high unit costs
Accurate BS, inaccurate IS, and no tax benefits. - LIFO
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Materials units issued are priced at the MOST RECENT purchasing price
Materials on hand are priced at the OLDEST purchasing prices
Better for the following reasons:
-equalizes profits and lossesduring successive periods of rising and falling prices
-decreases profits during rising prices and increases profits during falling prices
-reduces income taxes during rising prices and increases taxes during falling prices
-more accurate IS but inaccurate BS
-Endorsed by IRS since 1939
-Accurate IS and Bad BS, tax benefits during inflationary periods and enhanced organizational cash flows - Average cost method
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Materials on hand are valuated based upon a weighted average that combines the quantities and process of relevant batches received.
Best for stockrooms handling inventory units whose prices are significantly fluctuating within an accounting period - Standard cost method
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Materials and products issues and at hand are valuated based upon a pre-set standard price provided by the purchasing department.
Fits stockrooms handling inventory items of relatively small material value, such as supplies. - Inventory systems – Define
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Inventory transactions
Inventory supporting documents
Inventory records
Inventory plans
Inventory policies
Inventory procedures
warehouses organization structures
storage systems
recording of inventory movement
handling accounting inventories
taking physical inventories
computation of inventory variances
justification of inventory variances
recording inventory adjusting entries
inventory reporting - Classification of major types of inventory systems
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NATURE
Accounting inventory systems
Physical inventory systems
PERFORMANCE FREQUENCY
Periodic inventory systems
Perpetual inventory systems
PERFORMANCE STYLE
Declared inventory systems
Undeclared inventory systems
APPLICATION
General Inventory Systems
Special Inventory Systems - Accounting Inventory Systems
- Inventory systems that take a computational count of the inventory movement and balance based upon supporting documents and records
- Physical Inventory Systems
- Inventory systems that take a physical count of the inventory balance.
- Periodic Inventory Systems
- Inventory systems that operate on periodic basis, such as monthly, quarterly, and annual inventories.
- Perpetual Inventory Systems
- Continuous basis that records balance and movement of each inventory item after each related transaction. Inv taken all year round as opposed to being taken at set times.
- Advantages of perpetual physical inventories
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Convenience and practicality – does not interrupt operations
Frugality – saves costs related to interruption
Controlling efficiency – provides stronger controls - Inventory Variances - Define
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Differences between the amounts of physical and accounting inventories
Computation:
Amount of accounting inv minus physical inventory
Positive inventory variance
PI>AI or AI<PI
Negative Variance
PI<AI or AI > PI
*** Must put N or P Also, neither is better than the other. -
Inventory Variances – Record in Journal
Positive Inventory Variance -
Material Controls XX (BS)
Inventory Adjustment XX (IS) -
Inventory Variances – Record in Journal
Negative Inventory Variance -
Inventory Adjustment XX (IS)
Material Controls XX (BS) -
Inventory Variances – Record on BS & IS
Positive Inventory Variance -
BS
Inventory XXXX
+ Material Controls XXXX
XXXX
IS
Inventory Adjustment XXXX -
Inventory Variances – Record on BS & IS
Negative Inventory Variance -
BS
Inventory XXXX
- Material Controls XXXX
XXXX
IS
Inventory Adjustment XXXX - Materials Requirements Planning
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An inventory planning system focusing on the amount and timing of finished products demanded, and then deals with the determination of relevant materials required for the production activities.
Major components
Organization structure
Master sales schedule
Master production schedule
Materials files
Inventory reports