Ch 7 - Inventory Management Flashcards
Learning Objectives 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?
Long-Term Contract Costing
Used to calculate annual revenues/expenses for large contracts that last over multiple periods (ex. Construction projects)
Percentage of completion is the most common costing method
- 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 calculated and are then matched with income
- This is in line with the accrual principle and the matching principle
VOWD
value of work done
4 steps to Calculate Long-Term Contract Costing
METHODS OF CALCULATION:
- Calculate estimated costs = costs to date + additional estimated costs to complete
- Calculate estimated profit = contract price - estimated total costs (and subtract any additional land costs)
- Calculate % of completion using
- % costs incurred
- % certified costs OR
- value of work completed
4.Calculate profit = % complete x estimated profit
Calculate estimated costs
Step 1: Calculate estimated costs = costs to date + additional estimated costs to complete
Calculate estimated profit
Step 2: Calculate estimated profit = contract price - estimated costs
Calculate % of completion using which three methods?
Step 3: Calculate % of completion using
- % costs incurred
- % certified costs OR
- value of work completed
Calculate profit
Step 4: Calculate profit = % complete x estimated profit
What should you use to calculate % completed if it is available?
*If an architect’s or engineer’s certificate exists as to stage of completion to calculate % complete – USE THIS as the actual cost completed to date.
- This is a verifiable document from a professional that helps remove any bias
- better choice than % costs incurred which can be subjective if costs are due to contractor error, inexperience, bias (earnings management!)
Progress payments
• Payments by the customer that are not necessarily the true profit amount – it is just a contract agreement on timing of payments – don’t use this to determine % complete!
Retention value
- a % of the contract retained by customer (often 10%) that is not released until a specified period after contract end date (also called a “holdback”)
- This amount is usually held until the contract has been verified as being complete in all aspects by the customer or an independent party, and to ensure that no liability exists on the customer’s part.
Holdback
• a % of the contract retained by customer (often 10%) that is not released until a specified period after contract end date (also called a “Retention value”)
Inventory
Goods bought or manufactured for resale but unsold
Cost of inventory
Cost includes all costs of purchase or manufacture to bring inventory to its present location and condition
How to record inventory on a company’s statement of comprehensive income
On a company’s statement of comprehensive income:
•the cost of inventories is recorded as “Cost of goods sold”
How to record inventory on a company’s statement of financial position
On the statement of financial position:
•it is reported under current assets as “Inventory.”
How to record inventory on a company’s statement of financial position
On the statement of financial position:
•it is reported under current assets as “Inventory.”
Objective of inventory management
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
Economies of Scale
The cost of ordering an inventory decreases with the increase in ordering volume
Lead Times
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
EOQ formula
Square root(2DO/C)
D = demand for a given time period (# of units) O = ordering costs ($ per order) C = carrying costs ($ per unit)
Costs of Inventory
Includes all costs of purchase, conversion (manufacturing costs) and costs bringing the inventory to its present location and condition
Includes costs of inventory PLUS import duties, transportation/freight costs, less rebates/discounts
Conversion costs include direct labour PLUS allocation of fixed/variable production costs/overhead
Manufacturing company Inventory types
- Raw materials – unprocessed goods
- Work in process – uncompleted goods
- Finished goods – manufactured or purchased and ready for sale
Raw materials
Unprocessed goods
Work in process
Uncompleted goods
Finished goods
manufactured or purchased and ready for sale
Cost of Goods Sold formulas
Beg Inv + Purchases – Ending Inv = CoGS
Beg Inv + CoG MF – End Inv = CoGS
Valuation of Inventory
Valuation of Inventory
Must be lower of cost or net realizable value (NRV) as per
IFRS Cost: cost of acquiring or MF inventory
NRV: value at which inventory could be sold on open market, less cost of disposal (shipping, reclamation)
Normally cost is less than NR
IFRS Cost
IFRS Cost: cost of acquiring or MF inventory
Normally IFRS cost is less than NRV
Net Realizable Value (NRV)
NRV: value at which inventory could be sold on open market, less cost of disposal (shipping, reclamation)
Normally IFRS cost is less than NRV
Valuation of Individually purchased inventory
Purchase cost is used to value the inventory and the cost of goods sold when the inventory is sold
Valuation of Similar/undifferentiated products (bulk)
Weighted average cost
OR
FIFO (first in, first out)
Job order Costing
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
Accumulated cost of materials, labour, and overhead is the cost of that custom product
Custom: Unique, single products
Batch: A quantity of the same goods produced at the same time (a production run)
Process Costing
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
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 unit
Continuous: continuous production process of the same, indistinguishable go
Three steps needed when using weighted average cost of FIFO
Under both methods, it is necessary to complete three steps:
- Determine the number of units completed.
- Calculate the equivalent units in work in process and the cost per equivalent unit.
- Assign the cost to finished goods and ending WIP inventory
Just-in-time
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 of Just-in-time
Advantages
- Cost savings
- Improved customer and employee satisfaction
- Improved quality
Disadvantages to Just-in-time
Disadvantages
- Inability to predict demand
- Strong reliance on suppliers
