Introduction to Costing Flashcards
Inventory control should cover the following functions:
- The ordering of inventory
- The purchase of inventory
- The receipt of goods into stores
- The storage of goods
- The issue of inventory
- Maintenance of inventory at most appropriate level
Reasons for inventory control
- Holding costs may be expensive
- Production will be disrupted if we run out of raw materials
- Unused inventory with short shelf life may incur unnecessary expenses
- Ensure quality inputs used to maintain good reputation with customers
Every movement of material should be documented using the following:
- Purchase requisition
- Purchase order
- Goods received note (GRN)
- Materials requisition, transfer or returned note.
An Efficient system
An efficient system of material control is one which ensures, availability of the right quantity of material of right quality at the right time in order to maintain an even flow of production and at the same time avoiding excessive investment in inventories.
Proper records of physical procedures for ordering and receiving are kept ensures:
- Enough inventory is held
- No duplication of ordering
- Quality is maintained
- Adequate record for accounting purposes
Periodic stock taking
items are physically counted and valued at a set point in time, usually at the end of an accounting period.
Continues stock taking
counting and valuing selected items at different times on a rotating basis.
Reasons for discrepancies are:
- Quantity errors e.g. miscounts during the stock take.
- Classification errors e.g. stainless steel classified as mild steel
- Pricing errors e.g. a correctly counted and classified item might be priced at $56 for 1000 instead of $56 per 100.
- Recording errors e.g., an omission of the entry of a goods received note.
- Systems error e.g., no adequate recording of returns to stores.
Perpetual inventory
an inventory recording system whereby the records (bin cards and stores ledger accounts) are updated for each receipt and issue of inventory as it occurs.
This means that there is a continuous record of the balance of each item of inventory. The balance on the stores ledger account therefore represents the inventory on hand and this balance is used in the calculation of closing inventory in monthly and annual accounts.
Inventory costs include
- purchase costs,
- holding costs,
- ordering costs and
- costs of running out of inventory.
The reorder level is determined by consideration of the following:
✓ The maximum rate of consumption
✓ The maximum lead time
Reorder level
Maximum Usage x Maximum Lead Time
Minimum Level
Reorder level – (Average usage x Average lead time)
Maximum Level
Reorder level + Reorder quantity – (Minimum Usage x Minimum Lead Time)
Average Inventory
Safety Inventory (Buffer Stock) + 1⁄2 Reorder Qty.
Economic order quantity (EOQ)
is the order quantity which minimizes inventory costs WHEN THERE IS NO DISCOUNT. aka. The optimum order size. It is that Reorder Quantity (ROQ) that minimizes the balance of cost between ordering (Co) and holding (Ch) costs
EOQ Assumptions
❖ Known, constant per unit stockholding cost
❖ Known, constant ordering cost
❖ Rates of demand known
❖ Known, constant price per unit (quantity discounts may be offered)
❖ Replenishment made instantaneously (whole batch is delivered at once) – partial deliveries and delays common
❖ Average stock = Q/2 (violated if constant amount not used per day; there is distinct possibility that seasonal and cyclical factors will produce uneven usage)
EOQ=
√(2CoD)/Ch
CH = cost of holding ONE UNIT of inventory
C0 = cost of placing ONE ORDER
D = demand FOR ONE YEAR
Total cost =
Order cost (Co) + Carrying cost (Ch) + Purchase cost (PC)
Annual Co =
D/Q x (Co)
Annual Ch =
Q/2 x (Ch)
PC =
D x unit cost
No. of orders =
D/Q
Average inventory =
(Q/2) + safety stock
Total cost example with discounts
Total cost at (5,000 units), less 2% discount Co=D/QxCo=30,000/5,000x180=$1,080
Ch = Q/2 x Ch = 5,000/2 x 1.20 = $3,000
PC = D x unit cost = 30,000 x (98% x $12) = $352,800 Total cost = $356,880
Best decision for discounts answer response example
Order in batches of 8,000 given that it yields the lowest total cost
8000 being the quantity when calculating Ch
MARK-UP IS A % OF COST PRICE
SP = CP + %CP
MARGIN IS A % OF SELLING PRICE
SP = CP + %SP
FIFO
assumes that materials are issued out of inventory based on the first set of items to be received. Goods issued are priced at the cost of the earliest delivery.
LIFO
assumes that materials are issued out of inventory based on the last set of items received. Goods issued are priced at the cost of the last delivery.
AVCO
calculates a weighted average price for all units in inventory and goods issued are priced at this average cost. The balance of inventory would have the same unit valuation. A new weighted average price is calculated whenever a new delivery of materials is received into stores.
Formula – Total cost/ Total number of units.
inventory valuation notes
You cannot issue/sell what you do not have Transactions must be processed in strict date order
After each transaction, you must determine the make-up of your inventory balance
FIFO calculation
If I bought 500 at 24$ and and then 200 at $35 when I’m selling them I will first sell the items valued at 24. So once those are used up (may be sold in pieces) I will then take from the 200 at 35.
LIFO calculation
If I bought 500 at 24$ and and then 200 at $35 when I’m selling them I will first sell the items valued at 35. So once those are used up (may be sold in pieces) I will then take from the 500 at 24.
AVCO calculation
each time a new price is added u average it. So when ur issuing you will do it at the price its at at that given time.
Inflationary conditions - rising prices
✓ Earlier and lower priced items sold first, therefore CGS is lower and profits higher.
✓ Conversely, higher priced items make up closing inventory, which lowers CGS and makes profits higher.
✓ Under LIFO, the opposite occurs.
Deflationary conditions - falling prices
✓ Conditions opposite to those under FIFO
✓ Average cost falls in between FIFO and LIFO
Labour Efficiency
Expected Hours to make (Actual) Output x 100
Actual Hours worked
If this ratio is higher than 100% it means the staff is working efficiently
Labour Capacity or Utilization
Actual Hours worked x 100
Hours Budgeted
▪ If this ratio is higher than 100% it means the staff is working longer and harder than initially anticipated.
Labour Production Volume
Expected hours to make (actual) output x 100
Hours Budgeted
OR
Efficiency Ratio x Capacity Ratio
labour turnover
Replacement ____ x 100
Average Number of Employees
Where, Average Number of Employees = (# at Beginning of Year + # at year end)/2
main costs of labour turnover?
Replacements Costs – incurred to hire employees
Preventative Costs – incurred to prevent employees from leaving
What are the three main remuneration methods?
- Time Work or Time-Based Payments
- Piecework Schemes (Output Related Payments)
- Bonus/Incentive Schemes
Shift premium -
the extra amount paid over the basic hourly rate for work done during unsocial hours
Output related or Piece work schemes
Payment to employees is linked to how much they produce. It is usual that a GUARANTEED minimum wage will be paid (prevents loss of earnings when production is low through no fault of the employee)
Wages = Units produced x rate of pay per unit
Piece Work schemes types
▪ Straight Piecework – the more output an employee produces, the more he/she gets paid.
▪ Piecework with Minimum Guarantee – employee will get paid once they have produced minimum amount.
▪ Differential Piece Work – the more employees produce is the higher the rate per unit of output that they will get paid.
RECORDING LABOUR COSTS
▪ Labour Attendance – attendance record or clock card ▪ Job Time – daily/weekly time sheets, job card
▪ Piecework – piecework ticket/operation card.
▪ Idle Time
*
Has a cost (basic wage paid for unproductive hours)
* Ratio = (Idle hours/Total hours) x 100%
DIRECT LABOUR
- Basic pay of direct workers
- Basic pay component of direct workers when they work overtime or on shift
- Overtime premium paid to direct workers where the overtime is worked at the specific request of the customer
INDIRECT LABOUR
- Basic pay of indirect workers
- Overtime premium paid to indirect workers
- Overtime premium paid to direct workers in the normal course of business
- Bonus payments
- Employer’s NIS, etc.
- Idle time
OVERTIME DONE TO MEET PRODUCTION REQUIREMENTS
NB. Separate Direct from Indirect Labour
➢ DIRECT LABOUR (CHARGED TO JOB) = TOTAL HOURS X REGULAR RATE
➢ INDIRECT LABOUR (CHARGED TO PRODUCTION OVERHEAD) = OVERTIME HOURS X OVERTIME PREMIUM (the extra)
OVERTIME DONE AT CUSTOMER’S REQUEST
NB. No Indirect Labour – ALL DIRECT
➢ DIRECT LABOUR (CHARGED TO JOB) = (REGULAR HOURS X REGULAR RATE) + (OVERTIME HOURS X OVERTIME RATE)
Cost of sales –
Opening inventory + Purchases – Closing inventory
Inflationary conditions - rising prices
✓ Earlier and lower priced items sold first, therefore CGS is lower and profits higher.
✓ Conversely, higher priced items make up closing inventory, which lowers CGS and makes profits higher.
✓ Under LIFO, the opposite occurs.
