FRM: Inventory Accounting

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Inventory Accounting

Perpetual or Periodic

Invnetory Valuation

Methods: FIFO, LIFO, WTG

Inventory Audit

Expected vs Actual

Inventory Optimization

Planning, Aging, Ratios

What are standard methods of Inventory Accounting

Methods of taking Inventories: The value of stock is accounted in two ways viz.:
1. Periodic Inventory: Under this method value of stock is ascertained by physically counting the stock at the end of the year and as on accounting date.  In order to finalize the stock figure, purchases and sales have to be suspended.  This method involves following steps: Certain items are physically counted, while others are weighed in kilos or tonnes or litres. This depends on nature of items and usual market quotations for the items. All the items are thus listed, priced, extended and added so as to get the figure of inventory. This is done through stock book or stock sheets. This system is simple but suffers from serious drawbacks, the most important of which is that discrepancies and losses in inventory will never come to light. Plus this annual stock taking also affect business operations for a few days.
2. Perpetual Inventory: Under this method stock registers are maintained which will give the inventory balances at any time desired. This system provides running records of inventories on hand based on FIFO, LIFO etc. methods.

What is Stock Card? Bin Card? Consumption Report?

Stock Cards. In FIFO accounting, one option of keeping track of inventory is the stock card. It is a sheet that tracks purchases, sales, returns, and other drawings. It tracks the unit price and inventory counts. ... This is where the stock card comes in handy.
Bin Cards are STORES record card of quantities of a particular material or component received, quantities issued and the balance of the material in store. These balances can be checked against the actual quantities in stock by STOCKTAKING.
Consumption Report is The materials consumption report is a document used in the production process to summarize the goods used during a specific accounting period.

What is Inventory Valuation and why it is needed?.

Inventory comprises a significant portion of the assets of many enterprises and the bulk of working capital is locked up in this item. It generally constitutes the second largest item after fixed assets in the financial statements, particularly of manufacturing organizations. Inventory valuation affects both the results of the operation of enterprise as well as the Balance Sheet which represents the financial position of the enterprise. 
Objectives of Inventory Valuation:
Determination of Income: Gross Profit is not sales minus purchase. It is equal to sales minus cost of goods sold. Cot of goods sold is Purchase + Opening stock - Closing stock. Therefore, closing stock must be valued and brought into accounts. This done by crediting Trading account and debiting Closing stock. The Closing stock becomes the Opening stock of the next period and is debited to Trading account along with purchases. 
Determination of Financial Positions: In the balance sheet 'Inventory' is a very important item shown under 'Current Assets'. If this figure is not correctly valued, to that extent the balance sheet will be misleading. Proper Inventory Reconciliation along with actual stock count should be done in order to avoid errors before posting to Ledger Accounts. 

Methods of Cost of Valuation of Inventories:

Further there are 3 methods of valuation costs
1. Methods based on Cost Price or Historical costs: This refers to the cost on the date of acquisition i.e. sales or purchase.
2. Current Replacement Costs: This refers to cost of the asset on the date of its use or disposition. i.e. sales or purchase.
3. Standard Costs: This refer to one standard cost for item derived approx out of historical costs during sales or purchase of that item.

Various Valuation of closing stock based on Historical cost methods:

Methods based on Actual Cost
A. First-in First-out (FIFO)
B. Last-in First-out (LIFO)
C. Highest-in First-Out (HIFO)
D. Specific identification price
E. Base stock price
F. Adjusted selling price
G. Latest purchase price
Methods based on Average Cost
A. Simple average price
B. Weighted average price

What is Stock Audit and why it is needed?

Stock audit or inventory audit is a term that refers to physical verification of a company or institution's inventory assets. ... Every business institution at least needs to perform a stock audit once a year to update and ensure that the physical stock and the computed stock match.
There are three main types of audits: external audits, internal audits, and Internal Revenue Service (IRS) GST audits.
External audits are commonly performed by Certified Public Accounting (CPA) firms and result in an auditor's opinion which is included in the audit report.
An unqualified, or clean, audit opinion means that the auditor has not identified any material misstatement as a result of his or her review of the financial statements.
External audits can include a review of both financial statements and a company's internal controls.
Internal audits serve as a managerial tool to make improvements to processes and internal controls.

What is Inventory Audit and why it is needed?

An inventory audit is an analytical procedure that cross-checks if financial records match inventory records, or the count of physical goods. Inventory audits don't have to be done by auditors, but it helps to have an experienced auditor run through your finances to confirm your stock counts are accurate.

What is Inventory Optimization?.

According to Wikipedia, inventory optimization is: “a method of balancing capital investment constraints or objectives and service-level goals over a large assortment of stock-keeping units (SKUs) while taking demand and supply volatility into account.”

In plain English, inventory optimization is the practice of having the right inventory to meet your target service levels while tying up a minimum amount of capital in inventory. To achieve this, you need to account for both supply and demand volatility. Inventory optimization is the next level of inventory management for warehouse and supply chain managers and buyers.

Inventory Optimization will make you more competitive The world is going through several revolutions simultaneously; digitalization, globalization and security threats are just a few of the macro trends that affect companies and supply chains worldwide. Consumer behaviors and habits are changing more rapidly than anyone thought possible just a few years ago while new technology makes it possible to source cheaper and better products from all over the world. This results in complex global supply chains where every link contains an opportunity for something to go wrong. But those who account for uncertainties within their supply chain will be one step ahead of their competition and better prepared to meet customer demand.

Enterprise-sized companies like Amazon and Target already have advanced systems in place for optimizing the supply chain, allowing them to source products from all over the world and deliver to their customers – sometimes within a few hours. But this is far from reality for many small- and mid-sized businesses (SMBs) who are still trying to calculate order quantities, safety stock and reorder points in Excel. Manually managing the supply chain results in rough estimates for inventory quantities which in turn leads to excess inventory (that will eventually go obsolete) or, alternatively, poor service levels to their customers. Ten years ago it might have been ok to ask your customer to wait a few weeks until you got the right product in stock, but today you’re likely to lose that customer to another vendor if you aren’t able to deliver. After all, your competitor is just a click away.

Key Elements of Inventory Optimization
Optimizing your inventory means that you will determine exactly how much you need to order of every single SKU and when you need to order it to always be able to serve your customers. Inventory optimization takes seasonality and campaigns into account as well as supplier lead times and schedules. This way you will always have the right products in the right warehouse without tying up too much capital in inventory.

This blog post will briefly go through the key elements of optimizing your inventory and link to resources that will give you more details of each key concept:

1. Demand forecasting
2. Inventory policy
3. Replenishment

1. Demand Forecasting

There are several ways to forecast demand including looking at last year’s or last period’s demand or request forecasts from your sales force. This can work for some SKUs, but on other items these methods can put you on the completely wrong track.

Every product has a life cycle. For example, when the product is first introduced to the market it will not have any historical demand at all. From there it will likely move into to a positive trend where the demand is constantly growing until it becomes a stable and fast moving SKU. From there, it might get more irregular and then move into a negative trend where the demand is falling to becoming a dying and finally obsolete product. To accurately forecast your SKUs you need to know where in the life cycle all your SKUs are right now and how they move through the product life cycle.

Another thing to keep track of is seasonality. A product that only sells in the summer, like sunscreen, cannot be forecasted based on the previous quarter’s demand. New product introductions also throw a wrench into demand forecasting; a product that was new a year ago cannot be forecasted based on last year’s demand.

Finally, campaigns and promotions are great tools for marketers but can be a headache for planners and purchasers. It might seem obvious that you have to plan for campaigns, but in reality this is not always done properly and the entire campaign risks failure.

2. Inventory Policy

The next step is to determine your inventory policy, which means determine which products to stock and how much to keep of each unit.

One common method is to sort SKUs based on ABC analysis, where you classify your inventory into A, B and C classes depending on their annual consumption value. This blog will not go into the detail of ABC classification, but you can read all about it in our blog post on ABC analysis. This analysis helps you to determine which items to stock in your warehouse and which items can be ordered on demand.

Then you need to determine how much safety stock you need to keep in order cover sudden demand peaks, supplier disruptions or other unforeseen disruptions. You can read more about safety stock calculations in our blog.

Finally, it doesn’t matter if you have the exact right quantity of each item if you store them in the wrong places. Therefore, if you have more than one warehouse, you need to optimize your inventory to be distributed over your locations in the right quantities at the right time and place. And if you don’t have enough demand of an item in one specific region, but still enough global demand, you’ll want to find the right warehouse to store it in to be able to ship it out to where it’s needed as quickly and cost effectively as possible.

3. Replenishment

Last but certainly not least is stock replenishment. This is to calculate reorder points and order quantities and turn them into actual orders.

A few things you need to track to optimize your purchases are:

1. Supplier Reliability

Supplier lead times have a big effect on stock availability and service levels. In addition to lead times for your different items, you also need to know opening hours and production cycles. For example, many Chinese manufacturers shut down production completely for the Chinese New Year which comes as a surprise to many western distributors. Another common challenge is some products have lead times of several months. If one of your fast-moving items has an exceptionally long lead time and your customers expect fast deliveries, you can get into real trouble if you didn’t order enough quantities in time.

2. Goods in Transit

If you are placing an order for an item, it’s not enough to know what you currently have in stock to determine the order quantity. You also need to know what you currently have in transit and on the way into your warehouses from your suppliers. This may seem obvious, but most ERPs and other systems don’t have this information easily available.