Inventory Control and Depreciation
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The document outlines inventory control processes, depreciation accounting, and methods used to manage and account for inventory and asset value over time. It covers types of inventory, calculation methods, objectives, and techniques for effective inventory management, as well as depreciation definitions, causes, and calculation methods like straight-line and written down value. Key concepts such as economic order quantity, safety stock, and amortization are also discussed to highlight their importance in financial and operational efficiency.
Inventory Control and Depreciation
- 1. INVENTORY CONTROL & DEPRECIATION o Subhashni Jaiswal o Dhani Venkata Phanindra Reddy o Hriday Pratim Bora o Syed Junaid Ali o Ayushi Gupta o Chiranjeevi R. GROUP- 10
- 3. INTRODUCTION INVENTORY The term inventory means the value or amount of materials or resources on hand. It includes raw material, work in progress, finished goods & stores & spares. INVENTORY CONTROL It is the process by which inventory is measured & regulated according to predetermined norms such as economic lot size for order or production, safety stock, minimum level, maximum level, order level etc.
- 4. TYPES OF INVENTORY REASONS FOR HOLDING THE INVENTORY Raw Materials To reap the price available on seasonal raw materials. Work in progress To balance the production flow. Ready made components When the components are brought rather than made. Scraps They are disposal of ink bulk. Finished Goods Lying in stock rooms & waiting dispatches.
- 5. INVENTORY CALCULATION It is used to calculate how much inventory a company has on hand INVENTORY=BEGINNING INVENTORY +NEW INVENTORY PURCHASES – COST OF INVENTORY SOLD
- 6. SYSTEM OF ACCOUNTING FOR INVENTORY SYSTEMS PERIODIC INVENTORY SYSYTEM 1. Involves physical count of materials on hand at periodical intervals to arrive at the ending inventory 2. This system is typically used by small businesses that can't afford or don't need an electronic tracking system (i.e. the bar code system) PERPETUAL INVENTORY SYSTEM 1. Updates inventory and cost of goods sold after every purchase and sales transaction. 2. It shows both the cost of materials issued and ending materials inventory directly.
- 7. OBJECTIVES OF INVENTORY CONTROL To meet the unforeseen future demand due to variation in forecast figures and actual figures. To meet the customer requirement timely, effectively , efficiently, smoothly and satisfactorily. To balance various costs of inventory such as order cost or setup cost and inventory carrying cost. To smoothen the production process. To gain economy production or purchase in lots.
- 8. BENEFITS OF INVENTORY CONTROL Ensures an adequate supply of materials Minimizes inventory costs Facilitates purchasing economies Better utilization of available stocks Provides a check against the loss of materials Enables management in cost comparison Consistant & reliable basis for financial statements
- 9. INVENTORY CONTROL TECHNIQUES ABC analysis Economic order quantity (EOQ) Reorder-point Safety stock
- 10. ABC ANALYSIS (ALWAYS BETTER CONTROL) This technique divides inventory into three categories A,B & C based on their annual consumption value. It is also known as Selective Inventory Control Method. This method is a means of categorizing inventory items according to the potential amount to be controlled. ABC analysis has universal application for fields requiring selective control.
- 11. PROCEDURE FOR ABC ANALYSIS Make the list of all items of inventory. Determine the annual volume of usage & money value of each item. Multiply each item’s annual volume by its rupee value. Compute each item’s percentage of the total inventory in terms of annual usage in rupees. Select the top 10% of all items which have the highest rupee percentages & classify them as “A” items. Select the next 20% of all items with the next highest rupee percentages & designate them “B” items. The next 70% of all items with the lowest rupee percentages are “C” items.
- 12. RE-ORDER LEVEL It is the inventory level at which a company would place a new order or start a new manufacturing run. Example : ABC Ltd. is a retailer of footwear. It sells 500 units of one of a famous brand daily. Its supplier takes a week to deliver the order. The inventory manager should place an order before the inventories drop below 3,500 units (500 units of daily usage multiplied with 7 days of lead time) in order to avoid a stock- out. REORDER LEVEL = LEAD TIME IN DAYS × DAILY AVERAGE USAGE
- 13. ECONOMIC ORDER QUANTITY (EOQ) Economic order quality deals when the cost of procurement and handling of inventory are at optimum level and total cost is minimum. In this technique, the order quantity is larger than a single period’s ne requirement so that ordering costs & holding costs balance out. EOQ or Fixed Order Quantity system is the technique of ordering materials whenever stock reaches the reorder point.
- 15. ASSUMPTIONS OF EOQ Demand for the product is constant Lead time is constant Price per unit is constant Inventory carrying cost is based on average inventory Ordering costs are constant per order All demands for the product will be satisfied (no back orders)
- 16. EOQ=√2AB/C A=Usage unit for inventory Planning Period (total inventory requirements) B=Ordering cost per buying order C=Carrying Cost per unit EXAMPLE Annual requirement quantity (A)=10,000 units Cost per order (B)= $2 Cost per unit = $8 Carrying cost percentage = 0.02 EOQ=√2*10,000*2/8*0.02 = 500 units
- 17. SAFETY STOCK Safety stock is the stock held by a company in excess of its requirement for the lead time. Companies hold safety stock to guard against stock-out. Safety stock is calculated using the following formula: Lead time is the time which supplier takes in ordering the items Safety Stock = (Maximum Daily Usage − Average Daily Usage) × Lead Time
- 18. FIRST-IN-FIRST-OUT (FIFO) FIFO Method assumes that the inventory is consumed in chronological order that is those received first are issued / consumed first and value fixed accordingly. WHERE FIFO CAN BE USED FIFO is just like a queue . Where first come will be first served. Distributors use this method in moving first product they acquired.
- 19. LAST IN FIRST OUT(LIFO) LIFO stands for last-in, first-out, meaning that the most recently produced items are recorded as sold first. Since the 1970s, some U.S. companies shifted towards the use of LIFO, which reduces their income taxes in times of inflation , but with International Financial Reporting Standards banning the use of LIFO
- 20. WHERE LIFO CAN BE USED LIFO is like stack. Where the last product received will be first send out.
- 21. SIMPLE AVERAGE METHOD Under this method, simple average rate at cost is obtained by adding the rate of purchases represented by stock at the time of issue & then dividing the same by the number of such rates. The rate needs to be revised at the time of any new purchase or exhaustion of any existing stock. For the purpose of ascertaining the average rate, the quantity by which each purchase is made has to be ignored. To dampen the severity of the effect of rises & falls in the purchase price, use of any kind of average rate is made. Thus, in case of fluctuating rates of purchase, average cost is used.
- 22. QUESTION: From the details prepare stores ledger under simple average method. 2010 Dec 1 Opening Balance 400 kg @ $ 1.25 5 Received 200 kg @ $ 1.30 8 Issued 480 kg 10 Issued 40 kg 15 Received 320 kg @ $ 1.35 18 Issued 200 kg 20 Received 400 kg @ $ 1.40 25 Issued 160 kg 28 Issued 240 kg Shortage of 40 kg on 16.12.2010 & another shortage of 40 kg on 26.12.2010 is found by the stock verifier.
- 23. Workings: Calculation of simple average price: For Issue on 8th Dec = (1.25+1.30)/2 = $ 1.275 For Issue on 10th Dec = $ 1.30 For Shortage on 16th Dec = (1.30+1.35)/2 = $ 1.325 For Issue on 18th Dec = $ 1.325 For Issue on 25th Dec = (1.35+1.40)/2 = $ 1.375 For Shortage on 26th Dec = $ 1.40 For Issue on 28th Dec =$ 1.40
- 24. WEIGHTED AVERAGE METHOD The weighted average cost under this method is obtained by dividing the total value (at cost) of materials in stock at the time of issue by the total quantity of materials in stock. Only the rates are taken into consideration in case of simple average, on the other hand, the rates & corresponding quantities are considered in case of weighted average because by multiplying the quantity by the rate, the value at cost is obtained. If q, q1, q2, & q3 are the quantities in stocks on a day with p, p1, p2 & p3 as the corresponding purchases, the weighted average rate will be worked out as below: Weighted average rate = pq + p1q1+p2q2+p3q3 q + q1 + q2 + q3
- 25. DEPRECIATIO N
- 26. DEPRECIATION ACCOUNTING STANDARD (AS-6) DEFINITION Depreciation is a measure of the wearing out, consumption or other loss of value of a depreciable asset arising from use, effluxion of time or obsolescence through technology and market changes.
- 27. DEPRECIABLE ASSET Are assets expected to be used during more than one accounting period. Have a limited useful life. Are held by an enterprise for use in the production or supply of good and services, for rentals to others, or for administrative purposes & NOT for sale in the ordinary course of business. e.g. buildings , machines ,plants, trucks, vans land improvements such as tunnels, underpasses, parking lots etc.
- 28. DEPRECIATION NOT APPLICABLE TO Forests, Plantations and similar regenerative natural resources Wasting Assets including- Mineral rights, Expenditure on the Exploration for and Extraction of Minerals, Oil, Natural Gas and similar non-regenerative resources. Expenditure on Research & Development; Goodwill Livestock Land- unless it has limited life
- 29. FEATURES Depreciation is decline in the book value of fixed assets. Depreciation includes loss of value of assets due to passage of time, usage etc. Depreciation is continuing process till the end of the useful life of assets. Depreciation is an expired cost and hence must be deducted before calculating taxable profits. Depreciation is a non cash expense. It doesnot involve any cash flow. Depreciation is the process of writing off the capital expenditure already incurred.
- 30. CAUSES OF DEPRECIATION Physical wear & tear Physical Deterioration Expiry of legal rights By obsolescence By depletion Permanent fall in price
- 31. CALCULATION OF DEPRECIATION Historical cost of the asset Estimated useful life of depreciable asset Estimated residual/scrap value of depreciable assets
- 32. HISTORICAL COST OF THE ASSET Historical cost of a depreciable asset represents its money outlay or its equivalent in connection with its acquisition, installation and commissioning as well as for additions to or improvement thereof. The historical cost of a depreciable asset may undergo subsequent changes arising as a result of increase or decrease in long term liability on account of exchange fluctuations, price adjustments, changes in duties or similar factors.
- 33. ESTIMATED USEFUL LIFE OF DEPRECIABLE ASSET Determination of the useful life of a depreciable asset is a matter of estimation and is normally based on various factors including experience with similar types of assets. Such estimation is more difficult for an asset using new technology or used in the production of a new product or in the provision of a new service but is nevertheless required on some reasonable basis.
- 34. ESTIMATED RESIDUAL/SCRAP VALUE OF DEPRECIABLE ASSETS Determination of residual value of an asset is normally a difficult matter. If such value is considered as insignificant, it is normally regarded as nil. On the contrary, if the residual value is likely to be significant, it is estimated at the time of acquisition/installation, or at the time of subsequent revaluation of the asset. One of the bases for determining the residual value would be the realisable value of similar assets which have reached the end of their useful lives and have operated under conditions similar to those in which the asset will be used.
- 35. AMORTIZATION Spreading an INTANGIBLE ASSET cost over that asset’s useful life. For example, a patent. The cost involved with creating the patent is spread out over the life of the patent, with each portion being recorded as an expense on the company’s income statement.
- 36. DEPLETION It refers to the allocation of the cost of natural resources over time. For example, an oil well A finite life before all of the oil is pumped out. Therefore the oil well’s setup costs are spread-out over the predicted life of the oil well. Depletion is the actual physical reduction of natural resources by companies. For example, coal mines, oil fields and other natural resources are depleted on company accounting statements. This reduction in the quantity of resources is meant to assist in accurately identifying the value of the asset on the balance sheet.
- 37. METHODS OF DEPRECIATION There are two methods of depreciation. STRAIGHT LINE METHOD (SLM) - Amount of depreciation is fixed. Useful to assets whose service remain uniform throughout the year. For eg: Furniture & fixtures. WRITTEN DOWN VALUE METHOD (WDV) -Depreciation is charged at fixed rate on the reducing balance every year.
- 38. STRAIGHT LINE METHOD Advantages : Simple, easy to understand and to apply It provides uniform charge every year It’s calculated on original cost over the life time Disadvantages: Depreciation is not related to the usage factor It ignores the fact that in the later years of the life of the asset, efficiency of the asset declines. Loss of interest on investment in the asset is not accounted
- 39. WRITTEN DOWN VALUE METHOD Advantages: it’s a simple method of providing depreciation as a fixed rate is applied on book-value or written down value of assets. This method is quite popular It provides uniform charge for charge for services of the asset through out the life INCOMETAX accepts this method for tax purpose Disadvantages: The method is slightly complicated If the asset has no residual value, it is very difficult to calculate the rate.
- 40. EXAMPLE ON SLM AND WDV 1.Cost of fixed asset $100,000 2.Residual Value Nil 3.Useful Life 4 Years 4.Rate of depreciation 40% (for calculating depreciation using reducing balance method)