Inventory Accounting And Control

Inventory Accounting and Control

Accounting Principles

Tracking of Inventory

Inventory accuracy is always a big concern for any organization. The processes discussed

here are concerned with determining the quantity of inventory in units (unit may include

multiple e.g. cases, drums etc.). The dollar data on financial statements are determined by

multiplying the units’ information by the cost information, which is subsequently

described.

Perpetual Inventory Systems : In a perpetual inventory system, records are kept of each

transaction, receipt or withdrawal from inventory, and the new on-hand balance is

recorded. This indicates, at all times, the up-to-date quantity of an item that is in stock

and may also indicate inventory on order and allocated. The accuracy of the records

depend upon the speed with which the transactions are recorded and accuracy of the

input. Such speed and minimization of human error may be possible only through

computerized systems. The computer can also be programmed to flash an exception

message when the stock balance is at or below the order point. Manufacturing companies

and wholesale distributors use this system mainly tracking inventory of raw materials and

finished goods.

Periodic Inventory Systems : A periodic system does not attempt to keep track of each

issue and disbursement of items. Instead, a review is made in regular cycles, which might

be daily, weekly, or monthly, depending on the nature of the goods, to determine the

inventory level and signal the need for replenishment or other action.

Periodic review systems need larger safety stock than continuous review systems, given

same variations in demand, as safety stock must cover variations in demand during the

replenishment period as well as during the lead-time. The review period is fixed and the

order quantity is allowed to vary.

Periodic systems are often used for MRO supply items or for other small, inexpensive

parts.

Visual Review Systems : A visual review system is similar to a periodic system in that

no perpetual on-hand balances are recorded. However, it is generally a little less formal

than a periodic system, with reliance on visual recognition by users for reorder or other

actions. The two-bin system of inventory storage is a common method of operating this

system.

Visual reviews are often used to manage office supplies, common hardware items and

other small, inexpensive MRO supplies.

Four-Wall Inventory Systems : Four-wall systems (also known as wall-to-wall systems)

record inventory receipts when they first arrive at a plant or warehouse. However, they

are not subtracted from inventory until they leave the location in the form of deliverable

finished goods. This technique is often used when materials are received, converted into

deliverable form, and shipped within a very short period of time. They may not be held in

a storeroom at all.

Determine the Cost of Inventory

It would seem that the cost of an inventory item is a very straightforward data element

that does not present any kind of problem. This is seldom the case, however, because the

total number of units in an inventory may be the result of several purchases, or factory

orders that were procured or built at different costs. Seldom is attention given to actually

picking stock items in a particular order, except where traceability or shelf life may be

factor. Still, the values assumed for items withdrawn from inventory must be valued for

financial reporting and for certain control functions, such as ABC analysis. The inventory

costing procedure will affect the book value of inventory investment, profit, taxes and

cash flow.

First In, First Out (FIFO) : The FIFO method assumes that items are issued from stock

in the same sequence as they are received. Means the oldest items are issued first and so

on. In a period of changing costs, this would tend to keep the total inventory value on the

balance sheet close to the current market value but would charge cost of sales at the least

recent cost values. Thus, during an inflationary period it will result in lower cost of goods

sold and decreased cash flow with opposite results during a deflationary period.

Last In, First Out (LIFO) : The LIFO method assumes that the most recent arrivals in

inventory are the first ones being issued. Essentially, this method assigns cost of sales

based on the most recent costs incurred. During an inflationary period this method results

in higher cost of goods sold and increased cash flow. This would tend to understate the

total inventory value on the balance sheet, often substantially, as time goes by. However,

it would charge cost of sales with values close to the current market value Opposite

results are obtained during a deflationary period.

Weighted Average Cost Systems : The weighted average cost method calculates the

value of items in inventory on the basis of their weighted average cost. The cost of items

consumed by production equals the weighted average unit cost of inventory. This method

smooths the effect of inflation and deflation on the valuation of inventory and the costs of

goods sold. Often, a weighted average is used to take into consideration the quantities

that were received into inventory from various procurement orders or production runs.

Standard Cost Systems : With standard cost systems, a single value is selected for an

inventory item that is reasonable, often based on an average of historical or anticipated

costs. The difference between the actual costs incurred and the standard costs is then

reported in the form of a variance from the standard. This technique reports the inventory

assets and cost of sales in consistent terms.

Replacement Cost Systems : This technique attempts to assign a cost to inventory items,

based on the next price incurred. This method might be used to get a more realistic

inventory value when parts are held for a long time without any usage, such as certain

maintenance parts.

Actual Cost Systems : To be realistic about cost requires that some form of a lot control

technique be in place so that materials withdrawn from inventory can be traced directly to

a specific purchase or production run. This method is not used very often except for

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