With the global recession in full swing, most companies in the commercial space are

scrambling to avoid further degradation of their companies’ value by delivering

profitable business performance despite significantly lower sales volumes. For many
companies this battle has already been lost and the subject is more one of survival, as is
the case for the American auto industry.
When examining the crucial factors that are influencing operations performance during
these tough economic times, inventory exposure is a topic raised frequently. Many
companies did not anticipate the full impact of the recession and paid dearly in the form
of excess inventory in all stages of the supply chain.
The impact of inventory on cash flow can be devastating, resulting in everything from
payable extensions to missed payrolls and loan defaults.
Still, despite the lean six sigma purists who preach that inventory represents waste,
inventory does play an important strategic role in buffering against demand variations
and potentially harmful supply disruptions.
Therefore, the key challenge is selecting the appropriate inventory management &
valuation strategies and thereby, clearly understanding the cost and benefit implications
to business performance.
For many companies, inventory represents a large (if not the largest) portion of
assets and, as such, makes up an important part of the balance sheet. It is, therefore,
crucial for investors who are analyzing stocks to understand how inventory is valued. The
project work undertaken therefore focuses on different methods of valuation of
inventory- FIFO,LIFO,AVERAGE COST,LOWER OF COST OR MARKET
VALUE & SELLING PRICE METHOD.
Also the impact of these Costing methods on the Income Statement and Balance
sheet is studied.
For example: FIFO, is well suited to the balance sheet because the ending inventory is
closest to current values.

1
Among the factors managers should consider in choosing an inventory costing method
are:the trend of prices and the effects of each method on Financial
statements,Income taxes,and Cash flows as the choice of accounting method can
dramatically affect valuation ratios. Therefore, the effect of rising and falling prices on
the net income & ending value of inventory is studied with the help of illustration.
For example: In periods of rising prices, LIFO results in lower net income and thus lower
taxes.

A detail analysis is made for evaluating the level of inventory of the company through
inventory turnover ratio. Evaluating the differences in stock levels of the company
(actual &budgeted) of stock & non-stock items, study of ABC analysis technique.

Based on the interpretations derived from the analysis some of the techniques of
inventory control like-Use of input-output ratios, establishing optimum size of
inventory, etc are suggested.

Getting behind the scenes at a company means more than simply knowing its
earnings per share . Finding out where a firm’s cash is tied up in inventories and
receivables can help shed light on its how efficiently it is being managed. Of course, it
takes time and effort to extract the information from company financial statements. But
doing the analysis will certainly help to find which companies are worthy of investment.

2
2.1 INDUSTRY OVERVIEW

The Seamless Steel Tube Industry is almost one century old. The prime
reason for the development of this industry was provided by the
transport sector. Towards the end of the last century, seamless steel
tube plants were set-up in U.S.A. to cater to the tube requirements of
the bicycle frame. Subsequently with the advent and popularisation of
4-wheelers, there was rapid development in the petroleum sector. The
petroleum sector consumed large quantities of seamless steel tubes for
drilling, casing, transport, etc. Since then, as of today, the petroleum
sector accounts for the bulk of the usage of seamless tubes and pipes.

The Indian Seamless Steel Tube Industry is about 35 years old.

 The first plant was set-up as a Joint Venture between TISCO & Stewart-Lloyd
of U.K. at Jamshedpur. Presently, after dis-investment by Stewart-Lloyds, this
facility forms part of the TISCO operations.

 After the another seamless tube facility was established by BHEL at

Tiruchirapalli to manufacture mechanical tubing required for boilers
and heat exchangers.

 The third commercial venture in the field of seamless tubes was of

M/s Indian Seamless Metal Tubes Ltd., who set up a plant at Ahmednagar,
Maharashtra.
Because of the substantial demand-supply gap, a number of new Entrepreneurs
sought to set up seamless tube plants.

3
 TYPES OF PIPES & MAJOR PLAYERS
TUBES

Seamless Pipes Maharashtra Seamless, Jindal Saw,

ISMT, Remi Tube

HSAW Jindal Saw, Welspun Gujarat, Man Ind,

(Helically Submerged Arc
Welded)

LSAW Welspun Gujarat, Man Ind, Jindal Saw

(Longitudinally Submerged Arc
Welded)

ERW (Electric Resistance Welspun Gujarat, Maharashtra Seamless

Welded)

2.2 ISMT PROFILE

THE COMPANY HAS TWO MAIN SEGMENTS- STEEL & TUBES.

4
The company’s product profile comprises of bearing steel, high alloy steel, micro alloyed
steel, spring steel, free cutting steel and carbon steel in the steel business segment.
It also manufactures seamless tubes in hot finished, cold drawn and cold pilfered
conditions with outside diameter (OD) of upto 8”.

THE MAJOR CONSUMING INDUSTRIES FOR COMPANY’S SEAMLESS

TUBES ARE: BEARING, AUTOMOTIVE, OIL & GAS EXPLORATION, GENERAL
ENGINEERING, BOILERS & HEAT EXCHANGERS, PROCESSING, ETC.

KEY CUSTOMERS. OF THE COMPANY INCLUDE:

BAJAJ AUTO, TATA MOTORS, ASHOK LEYLAND, M&M IN THE AUTO
INDUSTRY, SKF, FAG, NRB, INA IN BEARING INDUSTRY AND ONGC AND OIL
IN OIL & GAS EXPLORATION.

KEY MANAGEMENT PERSONNEL:

Mr. V. Balasubramanian
Joint Managing Director

Mr. Nirmal Chandra

President (Projects & Product development)

Mr. Rajiv Goel

Chief Financial Officer

Mr.O.P.Kakkar
Managing Director

Mr.B.R.Taneja
Chief Executive Officer

Mr.Salil Taneja
Joint Managing Director
VISION
To be the most sought after, efficient, profitable and respected producer globally of
precision seamless tubes and alloy steels.
B. R. Taneja, CEO

5
 CORE VALUES

» Integrity
» Honesty
» Fairness
» Secularity
» Diversity
 
MISSION

 To produce the highest quality steel, seamless tubes and tubular products for
the Bearing, Automotive, Mining, General Engineering, Energy and ‘High
Value OCTG’ sectors and to build global market share globally in these
sectors

 To provide the best value proposition in terms of cost and quality of

product/service to our customers in the industry. To do so through a
wholehearted commitment to the Quality Systems.

 To maximize the utilization of our assets as measured by

‘Contribution’generated.

PEOPLE

To create a working environment that encourages creativity, empowers individuals,

creates accountability and rewards performance. To create a self learning organization
that gathers knowledge and reacts quickly to changes in customer expectations and the
environment.

SOCIAL RESPONSIBILITY

 Recognizing that industry must play an important role in the social

development of its immediate environment we have developed a focused and
6
 pro-active social agenda. ISMT has joined with Prithvi (an NGO based out of
Pune) in the development of an innovative partnership in industry-NGO
cooperation to combat the HIV epidemic in India.

 ISMT also promotes regular events aimed at improving the living standards
and awareness levels in the local communities.

PRODUCT RANGE

ISMT
ISMTtube
tubedivision
divisionmanufactures
manufacturesseamless
seamless
tubes
tubesas
aswell
wellas
asaanumber
numberofofValue
ValueAdded
Added
Products
Productsmade
madefrom
fromtubes
tubes

Value Added Products

CUSTOMER APPROVALS

7
 FAG

2.3 SWOT ANALYSIS

8
  STRENGTHS

BACKWARD INTEGRATION- PROVIDES COMPETITIVE EDGE

ISMT is backward integrated as it also has a steel plant which is the source of the raw
material for the tubes plant. This helps the company with a steady supply of steel of
required quality. It also helps the company to absorb rise in steel prices. The excess
quantity is sold. The company produces high grade steel alloys.

INCREASING EMPHASIS ON INFRASTRUCTURE

Thrust on infrastructure development and a gradual shift towards higher automation

within construction and earthmoving sectors is expected to provide immense scope for
growth in hydraulic cylinders.

USAGE OF MODERN TECHNOLOGY

The company is using the latest German technology PQF (Premium Quality Finishing)
mill in its latest round of expansion. This will help the company to boost its margins and
get vendor acceptability. It will also help the company to reduce threats from dumping.

 WEAKNESSES (KEY CONCERNS)

HUGE CAPEX- COST DELAY COULD IMPACT NEGATIVELY

The ongoing Expansion project at Baramati aims at three fold increase in seamless tube
production. ISMT is hence exposed to risks associated with such large project. Any delay
in project implementation could cause cost overrun and impact margins negatively.
STRUCTO ACQUISITION- INTEGRATION WITH A CROSS-CULTURAL
COMPANY

Structo is a foreign company. Integration with it poses challenges relating to workforce,

9
technology, logistics and processes.

 OPPORTUNITIES

LARGE CAPEX PLANS- WILL LEAD TO HIGHER EARNINGS FROM FY09

The company is in the process of expanding its seamless business at its Ahmednagar
facility from 65,000 tons to 75,000 tons and at Baramati from 90,000 tons to 4,00,000
tons between FY07-08. These will come on stream by Q4FY08. The overall capacity by
FY08E will go up to 4,75,000 tons from 1,55,000 tons in FY07.
After the expansion, ISMT will become the second largest seamless tube manufacturer
in India after Maharashtra Seamless (5,00,000 tons).
The company is expected to grow at the rate of 30% between FY08-11 following the
expansion.

ACQUISITION OF STRUCTO – WILL ADD NEW CUSTOMERS

ISMT recently acquired 100% stake in Structo Hydraulics AB (Structo), in Sweden. It is

one of the largest and best-known manufacturers of tubular components for the hydraulic
cylinder industry. In the near term, ISMT expects this acquisition to create a captive
market of roughly 1,00,000 tons per annum of high value seamless tubes.

INCREASING DEMAND FROM OIL EXPLORATION & PRODUCTION (E&P)

COMPANIES

Due to sharp increase in global crude prices and rising demand-supply mismatch, global
E&P budgets have been hiked; global E&P expenditure touched US$260 bn in
2006,compared to less than US$150 bn spent in 2004. The global rig count which is an
10
indicator of worldwide exploration activity has increased by 32% in the past three years
and 73% in the past five years to 3,144. This has led to a rise in demand for OCTG pipes
used in rigs (mostly seamless pipes).

 THREATS

GLOBAL SLOWDOWN

The most significant threat that the management perceives is the overall slowdown in the
global economy.

RISING INPUT PRICES

Another possible threat is the increase in input prices throughout the year. While the
company retains the ability to pass on such cost increases to the customer there is a
definite time lag. Which impacts the margins of the company temporarily.

2.4 Business Structure:

The group has two distinct businesses - the steel business, which comprises
of the steel division and tube division and the aircraft business which is
handled by TAAL.

11
TANEJA AEROSPACE & AVIATION LTD (TAAL)

Steel Business

Taneja Aerospace and Aviation Limited (TAAL), a group company of

ISMT, is the first and the only private sector aircraft manufacturing
company in the country. In addition to manufacturing a six seat aircraft
TAAL manufactures advanced aero-structures and parts for the Indian
and international aerospace industry. It is also the sole marketing
representative for Cessna in India for its business class jets.

Steel Business – Structure

The steel business produces two products: Seamless Tubes and Steel
Bars

12
Steel Business – Locations

 The steel business is headquartered in Pune, a old university town and now also
an industrial city, approx 150 km east of Mumbai.

 All three factories (two tube mills and the steel mill) are located within a radius of
100 km of this city making for easy coordination.

 Exports are effected through the port at Mumbai (the largest commercial city in
India) which is connected to Pune via a modern Expressway.

13
 • Group Headquarters (Pune)
• Steel Mill (Jejuri)
• Tube Mills (Ahmednagar, Baramati)

2.5 Company History

THE INDIAN SEAMLESS METAL TUBES LTD.

1977
Incorporated

THE INDIAN SEAMLESS METAL TUBES LTD. Starts

1980
commercial production

1988 TANEJA AEROSPACE & AVIATION LTD. Incorporated

INDIAN SEAMLESS STEELS & ALLOYS LTD.

1989
Incorporated.

TANEJA AEROSPACE & AVIATION LTD. First

1994
certification of airworthy flight/ commercial production

INDIAN SEAMLESS STEELS & ALLOYS LTD. Starts

1994
commercial production

14
 KALYANI SEAMLESS TUBES LTD merges with THE
1999
INDIAN SEAMLESS METAL TUBES LTD.

2005 ISMT Limited formed through the merger of The Indian

Seamless Metal Tubes Ltd and Indian Seamless Steels and
Alloys Ltd.

ISMT Ltd. acquired a 100% stake in Structo Hydraulic AB,

2007
Sweden.

2.6 PHYSICAL HIGHLIGHTS:

Sales Turnover
391
400
350 321
300 261
241
250 202
200
150
100
50
0
2004-05 2005-06 2006-07 2007-08- 2008-09
Projected Projected

REVENUE BREAKDOWN
2007-08
15
Energy 14.35%
Direct Expenses 12.59%
Fixed Expenses 7.33%
Finance Charges 5.50%
Others 4.88%
Net Profit 8.27%
Raw Material 47.09%

2007-08

14% Energy
Direct Expenses
Fixed Expenses
Finance Charges
13%
47% Others
Net Profit
Raw Material
7%

5%
5%
8%

FINANCIAL HIGHLIGHTS
(Rs. In Crore)

16
Particulars Financial Year
  2007-08 2006-07
Gross Sales 2063.07 2056.06
Profit before Financial Charges, Depreciation,
Amortization & Tax(EBIDTA) 225.63 268.55
Gross Profit 181.39 197.41
Profit Before Tax 126.10 137.66
Taxation 26.06 7.54
Net Profit 100.04 130.12

Profitability
2007-08 2006-07

268.55
225.63

100.04 130.12

EBIDTA
Net Profit

MARKET:

Auto & GE 30%

OCTG 17%
Bearings 13%
Construction Equipment 16%

17
 Power 13%
Others 11%

Industry Mix

Others
11%

Power Auto & GE

13% 30%

Construction EquipmentOCTG
16% 17%

Bearings
13%

2.7 Expansion Projects:

 Increase seamless tube capacity to 470,000 MTPA.

18
  Installation of a new Finishing Mill at Baramati plant. 400,000tns.Capacity to be
in place by February 2008, time schedule of 21 months.
 Existing Mill upgradation at Ahmednagar to increase capacity to 70,000 MTPA
by.
 Mill 1: Modernisation of Piercing Mill outlet system and Assel Mill Inlet
and outlet system.
 Mill 2: New Billet reheating and Shell Reheating furnaces, Induction
furnace modification.
 Steel Plant capacity to be enhanced to 500,000 MTPA by installation of additional
 50 ton Electric Arc Furnace
 50 ton Ladle Refining Furnace & Vacuum Degassing
 2/3 strands Continuous Caster.
 ISMT to be the second largest global player among the Precision Tube producers

Inventory analysis can have a big effect on the bottom line. Unfortunately, a company
probably won't publish its entire inventory situation in its financial statements.
Companies are required, however, to state in the notes to financial statements what
inventory system they use. By learning how these differences work, comparison of the
companies within the same industry becomes easier.

 Understanding the importance of inventory control-

19
 For any company that makes or sells merchandise, inventory is an extremely
important asset. Managing this asset is a challenging task. It requires not only
protecting goods from theft or loss, but also ensuring that operations are highly
efficient.

 Understanding the importance of inventory valuation-

For many companies, inventory represents a large (if not the largest) portion of
assets and, as such, makes up an important part of the balance sheet. It is,
therefore, crucial for investors who are analyzing stocks to understand how
inventory is valued.

 Study of the different inventory valuation methods-

In accounting for inventory, management has to choose among different costing

methods and valuation methods. These different systems and methods usually
result in different amounts of reported net income.

 Analyzing the impact of different inventory valuation systems.

 Suggesting techniques for proper accounting of inventory.

Research methodology is the method or entire procedure involved in carrying out

research for specific purpose.Research is thus a contribution to the existing stock of
knowledge made for its advancement.The purpose of research is to discover answer to
questions through the application

4.1 SOURCES OF DATA

20
1. Primary data- During the research,primary data was collected through personal
interview of concerned company officials.

2. Secondary data-For the purpose of this research secondary data is the major source of
information. It includes published sources like downloading required data from internet
and gathering from books and unpublished sources like database of the company.

4.2 SCOPE OF STUDY:

 What is the impact of inventory decisions on operating results?

 How should inventory be valued?

 How should the level of inventory be evaluated?

 The effects of inventory misstatements on income measurement.

 Effects of inventory costing methods on income determination & income taxes.

4.3 LIMITATIONS:

 The study concentrates basically on the valuation of raw materials.

 Work in progress and finished goods are not taken into consideration for the
study of concept of valuation of materials as the scope of the topic is too wide to
be covered in the period of two months of training.
 The study of inventory statements is based on the data available for the year 2008-
09.As the company does not maintain requisition records for more than one year .

21
  The financial data is considered for the financial year 2007-08.As the records for
the financial year 2008-09 are yet to be audited.

5.1 CONCEPT OF INVENTORY:

WHAT IS INVENTORY?

Inventory is defined as assets that are intended for sale, are in process of being produced
for sale or are to be used in producing goods.

22
The following equation expresses how a company's inventory is determined:

Beginning Inventory + Net Purchases - Cost of

Goods Sold (COGS) = Ending Inventory

In other words, you take what the company has in the beginning, add what they
have purchased, subtract what they've sold and the result is what they have remaining.

Inventory is considered as a current asset because a company sells it within a year or

within its operating cycle.

For a merchandising company, inventory consists of all goods owned and held for sale in
the regular course of business.

Manufacturing companies are engaged in making products they have three kinds of
inventory:

1. Raw material(goods used in making products,stores,spares,consumables)

2. Work in progress(partially completed products)

3. Finished goods ready for sale

The work in process and the finished goods inventories have 3 cost components:

 Cost of the raw materials that go into the product

 Cost of the labor used to convert the raw materials to finished goods

 Overhead costs* that support the production process

23
 *Overhead costs include the costs of indirect materials (such as packing material),
indirect labor (such as salary of supervisor), factory rent, depreciation of plant assets,
utilities, and insurance.

PURPOSES OF INVENTORY

1. To maintain independence of operations

2. To meet variation in product demand

3. To allow flexibility in production scheduling

4. To provide a safeguard for variation in raw material delivery time

5. To take advantage of economic purchase-order size

INVENTORY COSTS:

Inventory cost includes:

 Invoice price less purchase discounts

 Freight-in, including insurance in transit

 Applicable taxes and tariffs

 OTHER COSTS:

 Holding (or carrying) costs

 Costs for storage, handling, insurance, etc

 Setup (or production change) costs

 Costs for arranging specific equipment setups, etc

 Ordering costs

24
  Costs of someone placing an order, etc

 Shortage costs

 Costs of canceling an order, etc

Other costs-for ordering, receiving, and storing-should in principle be included in

inventory costs. In practice it is difficult to allocate such cost to specific inventory item
that they are usually considered expenses of the accounting period rather than inventory
costs.

Goods flows and Cost Flows:

GOODS FLOW:

Goods flows refer to the actual physical movement of goods in the operations of the
company. Cost flow refers to the association of costs with their assumed flow in the
operations of the company. The assumed cost flow may or may not be the same as the
actual goods flow. The possibility of a difference between cost flow and goods flow may
seem strange first, but it arises because several choices of assumed cost flow are available
under generally accepted accounting principles. In fact, it is sometimes preferable to use
an assumed cost flow that bears relationship to goods flow because it gives a better
estimate of income, which is the main goal
of inventory valuation. The assumed flow of inventory costs
does not have to correspond to the
Merchandise in Transit: physical flow of goods.

Because merchandise inventory includes all

items that a company owns and holds for sale, the status of any merchandise in transit,
whether the company is selling it or buying it, must be evaluated to see if the
merchandise should be included in the inventory count. Neither the seller nor the buyer
has physical possession of merchandise in transit. As figure 4 shows, ownership is

25
determined by the terms of the shipping agreement, which indicate when titile passes.
Outgoing goods shipped FOB (free on board) destination are included in the seller’s
merchandise inventory, whereas those shipped FOB shipping point are not. Conversely,
incoming goods shipped FOB shipping point are included in the buyer’s merchandise
inventory, but those shipped FOB destination are not.

Merchandise on Hand Not Included in Inventory :

At the time a company takes a physical inventory, it may have merchandise on hand to
which it does not hold title. For example, it may have sold goods but not yet delivered
them to the buyer, but because the sale has been completed, title has passed to the buyer.
Thus,the merchandise should be included in the buyer’s inventory, not the seller’s. Goods
held on consignment also fall into this category.

A consignment is merchandise that its owner (the consignor) places on the premises of
another company (the consignee) with the understanding that payment is expected only
when the merchandise is sold and that unsold items may be returned to the consignor.
Title to consigned goods remains with the consignor until the consignee sells the goods.
Consigned goods should not be included in the consignee’s physical inventory because
they still belong to the consignor.

5.2 INVENTORY ACCOUNTING: (DECISIONS)

The primary objectives of inventory accounting: determine income properly by

matching the costs of period against revenues for the period.

26
 In accounting for inventory, management must choose among different processing
systems, costing methods, and valuation methods.

 These different systems and methods usually result in different amounts of

reported net income. Thus, management’s choices affect investor’s and creditor’s
evaluations of a company, as well as
internal evaluations, such as the Management considers the
performance reviews on which behavior of inventory prices over
bonuses and executive compensation time when selecting inventory
are based. costing methods.

 The consistency convention

requires that once a company has decided on the systems and methods it will use
in accounting for inventory, it must use them from one accounting period to the
next useless management can justify a change.

 When a change is justifiable, the full disclosure convention requires that the
company clearly describe the change and its effects in the notes to its financial
statements

Management choices in Accounting for inventories:

27
 INVENTORY INVENTORY INVENTORY

PROCESSING COSTING METHODS:

APPLICATION OF MATCHING RULE METHODS:
VALUATION
SYSTEMS:
 Specific Identification  Cost
 Periodic
 Average Cost To  Market (if lower than
 Perpetual COST OF GOODS AVAILABLE FOR cost)
SALE
 First in First Out (FIFO)

 Last in First Out (LIFO)

Determines

COST OF GOODS SOLD ENDINGINVENTORY

5.3 INVENTORY VALUATION:

For many companies, inventory represents a large (if not the largest) portion of assets
and, as such, makes up an important part of the balance sheet. It is, therefore, crucial for
investors who are analyzing stocks to understand how inventory is valued.

HOW DO WE VALUE INVENTORY?

The accounting method that a company decides to use to determine the costs of inventory
can directly impact the balance sheet, income statement and statement of cash flow.

In FINANCIAL ACCOUNTING,the inventory is traditionally valued at lower of the cost

or market value.

28
(There is one exception to this general rule.In case of wine and timber trade,value of
stocks appreciates from year to year due to maturity in quality.)

On the other hand,COST ACCOUNTING (RECORDS) RULES provide that inventory

should be valued at cost of production.

For this reason the difference in valuation of stocks in financial accounts and cost
accounts is to be shown as an item in the reconciliation statement between financial and
costing profit/loss.

Principal Bases for Inventory valuation:

I. ACTUAL COST:

There are three inventory-costing methods that are widely used by both public and
private companies:
 FIRST-IN, FIRST-OUT (FIFO) –

This method assumes that the first unit making its way into inventory is the first sold. It
assumes that the costs of the first items acquired should be assigned to the first items
sold. The cost of the goods on hand at the of the period are assumed to be from the recent
purchases.

The FIFO method values ending inventory at the most

recent costs and includes earlier costs in cost of goods sold.

Any business regardless of its goods flow,can use the FIFO method
because the assumption underlying it,is based on the flow of costs,not he flow of
goods.

29
 For example:-

Let's say that a bakery produces 200 loaves of bread on Monday at a cost of Rs.2
each, and 200 more on Tuesday at Rs.2.50 each. FIFO states that if the bakery
sold 200 loaves on Wednesday, the COGS is Rs.2 per loaf (recorded on the
income statement) because that was the cost of each of the first loaves in
inventory. The Rs.2.50 loaves would be allocated to ending inventory (appears on
the balance sheet).

 LAST-IN, FIRST-OUT  (LIFO) –

This method assumes that the last unit making its way into inventory is sold first.
The older inventory, therefore, is left over at the end of the accounting period. It
assumes that costs of the last items purchased should be assigned to the first items
sold and that the cost of ending inventory should reflect the cost of the goods
purchased earliest.

The effect of LIFO is to value inventory at the earliest prices and to

include the cost of the most recently purchased goods in the cost of
goods sold.

This assumption,of course,does not agree with the actual physical movement of
goods in most businesses

For example:-

For the 200 loaves sold on Wednesday, the same bakery would assign Rs.2.50 per
loaf to COGS while the remaining Rs.2 loaves would be used to calculate the
value of inventory at the end of the period.

 AVERAGE COST –

30
 This method is quite straightforward; it takes the weighted average of all units
available for sale during the accounting period and.then uses that average cost to
determine the value of COGS and ending inventory.

Average cost is computed by dividing the total cost of goods available for sale
by the total units available for sale.This gives an average unit cost that is
applied to the units in ending inventory.

For example:-

In the bakery example, the average cost for inventory would be Rs.2.25 per unit,
calculated as [(200 x Rs.2) + (200 xRs.2.50)]/400.

LOWER OF COST OR MARKET (LCM) RULE:

1. In principle, inventories are to be valued at cost.

2. Where cost+ normal profit margin cannot be covered upon sale in the ordinary
course of business ,a lower figure is to be used.

3. Inventory at times may be shown in the financial statements at less than its
historical or original cost. If the market value of inventory falls below its historical
cost because of physical deterioration, obsolescence, or declined in price level, loss
has occurred. This loss is recognized by writing the inventory down to market that
is to its current replacement cost.

When the replacement cost of inventory falls below its historical cost, the lower of cost
or market{LCM} rule requires that the inventory be down to the lower value. This rule is
an example of the conservatism convention because the loss is recognized before an
actual transaction takes place.

In financial accounting, traditionally inventory is required to be stated and

valued using either the cost or the market value method - whichever is lower.

31
If the cost of inventory exceeds the market value, an adjustment must be made to the
inventory value entry on the balance sheet. Since it is unlikely that a company would
produce and inventory a product at a cost to the company that exceeds market value, such
a situation would usually occur because of a negative change in the market value of the
inventoried asset.
For example, let's say a company produces crude oil at a cost of $25.00 per
barrel. If the market price of crude oil drops to just $20.00 per barrel, then an accounting
entry must be made to adjust for the change in the market value of the inventory. The
entry would look something like this, assuming the company only produced one barrel of
oil at $25.00 per barrel:

    Debit        Loss from decline in market value of crude oil    $5.00        
    Credit       Inventory                                                  $5.00    

In the case of crude oil, market price is very easy to determine, as it's a commodity that is
traded internationally and the price has a very low bid-ask spread. In most cases, the
market price of inventory is much less easily determined.
It is required that inventory be stated at replacement cost, if there is a difference
between the market value and the replacement value, but upper and lower boundaries are
applied to the replacement cost of the inventory. This is known as the lower of cost and
market value method of inventory valuation.

The upper boundary is called the ceiling. The ceiling applied to the market value of
inventory is such that the market value must be below the net realizable value (NRV),
which is a reasonable estimation of the eventual selling price of the asset in
inventory minus the costs of the sale or disposal of the asset. The ceiling is in place to
remove the opportunity for a company to overstate the value of its inventoried assets.

CEILING =

NET REALIZABLE VALUE (NRV) =EXPECTED SELLING PRICE - COSTS OF SALE

32
The lower boundary is called the floor.
The floor applied to the market value of inventory is such that the stated market value
must not be lower than the NRV minus an approximation of profit realized from the
asset's sale. The floor is in place to remove the opportunity for a company
to unrealistically overstate profit by understating the value of its inventoried assets.
FLOOR =

NET REALIZABLE VALUE (NRV) – NORMAL PROFIT

ILLUSTRATION:

Case Case Case Case Case

I II III IV V

Cost 100 100 100 4 100

0

*Net realizable value (NRV) 80 8 80 80 8

0 0

**Net realizable value (NRV)-normal 50 50 5 50 50

profit 0
Cost must be determined by one of
the inventory costing methods
Market (replacement cost) 6 90 40 30 110
before it can be compared with the
0 market value.
Inventory 60 80 50 40 80

*upper limit of market

**lower limit of market

33
 II. SELLING PRICE METHOD:

The use of SELLING PRICE as inventory valuation method is accepted only in certain
cases.This method can be successfully used when accurate determination of cost is not an
easy exercise,e.g.,spoiled work,scrap material and obsolete items.Even when this method
is used under peculiar circumstances,it is suggested that transportation and marketing cost
should be deducted in order to obtain proper inventory valuation.This method,has got
only exceptional usage.

6.1 Impact of Costing methods on the Income Statement and Balance sheet Under
the periodic Inventory System:

If inflation were nonexistent, then all three of the inventory valuation methods would
produce the exact same results. When prices are stable our bakery would be able to
produce all of its loafs of bread at Rs.2, and FIFO, LIFO and average cost would give us
a cost of Rs.2 per loaf.

Unfortunately, over the long term, prices tend to rise, which means the choice of
accounting method can dramatically affect valuation ratios.

If prices are rising/falling each of the accounting methods produce the following
results:

Illustration:

Rising market Falling Market

Date Receipts Issues Date Receipts Issues
Jan- Jan- 200 u @
01 200 u @ Rs.1.00 01 Rs.1.80
Jan- Jan- 300 u @
03 300 u @ Rs.1.20 03 Rs.1.60
Jan- 200 u Jan- 200 u
34
 06 rising market Linear (rising market) 06
Jan- Falling market Jan- 300 u @
12 300 u @ Rs.1.20 12 Rs.1.40
Jan- Jan-
15
1020 979 400 u 15 400 u
900
Jan- 660 701 780 Jan- 300 u @
20 300u @ Rs.1.60 20 Rs.1.20
Jan- Jan-
22 200 u 22 200 u
Jan- Jan- 300 u @
28 300 u @ Rs.1.80 28 Rs.1.00

RESULTS:

Rising Market Falling Market

Averag Averag
FIFO e LIFO FIFO e LIFO
Beginning
inventory Rs.200 Rs.200 Rs.200 Rs.360 Rs.360 Rs.360
Purchases 1800 1800 1800 1560 1560 1560
           
Rs.200 Rs.200 Rs.200 Rs.192 Rs.192 Rs.192
Total materials cost 0 0 0 0 0 0
Amount issued 980 1021 1100 1260 1219 1140
           
Rs.102
Ending inventory 0 Rs.979 Rs.900 Rs.660 Rs.701 Rs.780

35
 rising market Linear (rising market)
falling market

1260
1219
1140
1100
1021
980

First in First Out:

36
  FIFO gives us a better indication of the value of ending inventory (on the balance
sheet), but it also increases net income because inventory that might be several
years old is used to value the cost of goods sold. Increasing net income sounds
good, but remember that it also has the potential to increase the amount of taxes
that a company must pay.

Last in First Out:

 LIFO isn't a good indicator of ending inventory value because the left over
inventory might be extremely old and, perhaps, obsolete. This results in a
valuation that is much lower than today's prices. LIFO results in lower net income
because cost of goods sold is higher.

There is a however a strong argument to support LIFO.A certain size of inventory

is necessary in a going concern-when inventory is sold,it must be replaced with
more goods.The supporters of LIFO reason that the fairest determination of
income occurs if the current costs of merchandise are matched with current sales
price,regardless of which physical units of merchandise are sold. When prices are
moving either up or down,the costs of goods sold will,under LIFO show costs
closer to the price level at the time the goods are sold.Thus,the LIFO method
tends to show a smaller net income during deflationary times than other methods
of inventory valuation.

Average cost:

 The Average cost method tends to level out the effects of cost increases and
decreases because the cost of the ending inventory is influenced by all the prices
paid during the year and by the cost of beginning inventory.

(Note: if prices are decreasing then the complete opposite of the above is true.)

37
6.2 EFFECTS OF INVENTORY VALUATION METHODS ON INCOME
DETERMINATION:

EXAMPLE:

Monthly Inventory Purchases*

Month Units Purchased Cost/ea Total Value

January 1,000 Rs.10 Rs.10,000

February 1,000 Rs.12 Rs.12,000

March 1,000 Rs.15 Rs.15,000

Total 3,000

38
 Beginning Inventory = 1,000 units purchased at Rs.8 each (a total of 4,000 units)

WORKING:

 Income Statement (simplified): January-March*

 Item  LIFO FIFO Average

Sales = 3,000 units @ Rs.20 each Rs.60,000 Rs.60,000 Rs.60,000

Beginning Inventory 8,000 8,000 8,000

Purchases 37,000 37,000 37,000

Ending Inventory (appears on B/S)

8,000 15,000 11,250
*See calculation below

COGS Rs.37,000 Rs.30,000 Rs.33,750

Expenses 10,000 10,000 10,000

Net Income Rs.13,000 Rs.20,000 Rs.16,250

*Note: All calculations assume that there are 1,000 units left for ending inventory:

 (4,000 units - 3,000 units sold = 1,000 units left)

39
 

For figuring out the ending inventory, the results of which depend on the accounting
method, in order to find out what COGS is, the above equation is rearranged into the
following:

Beginning Inventory + Net Purchases - Ending

Inventory = Cost of Goods Sold

LIFO Ending
1,000 units X Rs.8 each = Rs.8,000
Inventory Cost =

The last units in are sold first; therefore, we leave the oldest units for ending
inventory.

 Here an argument can be made against LIFO that because the inventory
valuation on the balance sheet reflects earlier prices,it often gives an
unrealisitic picture on the inventory’s current value.Balance sheet
measures like working capital and current ratio may be distorted and must
be interpreted carefully.

FIFO Ending
1,000 units X Rs.15 each = Rs.15,000
Inventory Cost =

40
The first units in (the oldest ones) are sold first; therefore, we leave the
newest units for ending inventory.

 During periods of rising prices,FIFO yields the highest possible amount of

net income because cost of goods sold shows the earliest costs
incurred,which are lower during periods of inflation.
Another reason for this is that businesses tend to raise selling prices as
costs increase,even when they purchased the goods before the cost
increase.
 In periods of declining prices, FIFO tends to charge the older and higher
prices against revenues, thus reducing income. Consequently ,a major
criticism of FIFO is that it magnifies the effects of business cycle on
income.

[(1,000 x 8) + (1,000 x 10) + (1,000 x 12) +

Average Cost Ending (1,000 x 15)]/4000 units = Rs.11.25 pu

Inventory = 1,000 units X Rs.11.25 each = Rs.11,250

We take a weighted average of all the units in inventory.

 Average cost produces results that fall somewhere between FIFO and

LIFO. Some analysts,however,criticize this method because they believe
recent costs are more relevant for income measurement and decision
making.

41
6.3 EFFECTS OF INVENTORY VALUATON ON OPEARATING RESULTS:

Each inventory valuation method causes the various ratios to produce significantly
different results (excluding the effects of income taxes):

Using the information above, we can calculate various performance and leverage ratios.

Let's assume the following:

Assets (not including inventory) Rs.150,000

Current assets (not including

Rs.100,000
inventory)

Current liabilities Rs.40,000

Total liabilities Rs.50,000

WORKING:

42
 Ratio LIFO FIFO Average Cost

Debt-to Asset
0.32 0.30 0.31
(Total liabilities/Assets +inventory)

Working Capital 2.7 2.88 2.78

Inventory Turnover (Sales/Average

7.5 4.0 5.3
inventory)

Gross Profit Margin (Sales-Cogs/Sales) 38% 50% 44%

As it is can be seen from the ratio results, inventory analysis can have a big effect on the
bottom line. Unfortunately, a company probably won't publish its entire inventory
situation in its financial statements. Companies are required, however, to state in the
notes to financial statements what inventory system they use. By learning how these
differences work, one will be better able to compare companies within the same industry.

6.4 Effects of each method on financial statements,income taxes,and cash flows.

43
Each method has its advantages and disadvantages-none is perfect. Among the factors
managers should consider in choosing an inventory costing method are: the trend of
prices and the effects of each method on financial statements,income taxes,and cash
flows.

A. EFFECTS ON THE FINANCIAL STATEMENTS:

As it is already pointed out, inventory costing methods have different effects on the
income statement and balance sheet.

The LIFO method is best suited for the income statement because it matches revenues
and cost of goods sold.

But its not the best method for valuation of inventory on the balance sheet,particularly
during a prolonged period of price increase or decreases.

FIFO,is well suited to the balance sheet because the ending inventory is closest to current
values and thus gives a more realistic view of a company’s current assets.Readers of
financial statements must be alert to the inventory methods a company uses and be able
to assess their effects.

B. EFFECTS ON INCOME TAXES:

Changes in inventory costing method

can cause sizable fluctuations in income and
In periods of rising prices,LIFO
make income statements hard to interpret results in lower net income and thus
from year to year, a company should change lower taxes.
its inventory method only if there is a good
reason to do. The company must show the
nature and effect of the change in its financial statements.

44
 Many accountants believe that using FIFO and average-cost methods in periods of
rising prices causes businesses to report more than their actual profit, resulting in excess
payment of income tax. Profit is overstated because cost of goods is understated relative
to current prices. Thus, the company must buy replacement inventory at higher prices,
while additional funds are needed to pay income taxes. Over a period of rising prices, a
business that uses the LIFO method may find that for balance sheet purposes, its
inventory is valued at a figure far below what it currently pays for the same items.
Management must monitor such a situation carefully, because if it lets the inventory
quantity at year and fall below the level at the beginning of the year, the company will
find itself paying higher income taxes. Higher income before income taxes results
because the company expenses the historical costs of inventory, which are below current
costs. When sales have reduced inventories below the levels set in prior years, it is called
a LIFO liquidation---that is, units sold exceed units purchases for the period.

Managers can prevent a LIFO liquidation by making enough purchases before the end
of the year to restore the desired inventory level. Sometimes, however, a LIFO
liquidation cannot be avoided because products are discontinued or supplies are
interrupted.

C. EFFECTS ON CASH FLOWS:

Generally speaking, the choice of accounting methods does not affect cash flows. For
example, a company’s choice of average cost, FIFO, or LIFO does not affect what it pays
for goods or the price at which it sells them. However, the fact that income tax law
requires a company to use the same method for income tax purposes and financial
reporting means that the choice of inventory method will affect the amount of income tax
paid. Therefore, choosing a method that result in lower income will result in lower
income taxes due. In most other cases where there is a choice of accounting method, a
company may choose different methods for income tax computations and financial
reporting.

45
6.5 EVALUATING THE LEVEL OF INVENTORY:

Inventory turnover measures how quickly the company is moving merchandise through
the warehouse to customers.

Inventory Turnover= Annual cost of goods sold/Average Inventory

Although, the amount of inventory to be kept at any point in time is ambiguous, the
inventory turn ratio is a metric for determining inventory usage. Inventory usage is
calculated as a ratio of the annual cost of goods sold to the average inventory.

Inventory Days = 365 Days  / (Average Cost of Goods

Sold/Average Inventory)

This number of inventory days is also known as the “days-to-sell” figure.

But, it’s not enough to know the number at any specific time. Investors need to know if
the days-to-sell inventory figure is getting better or worse over several periods.
 Investors would be pleased if the number of inventory days were falling as a
result of greater efficiencies gained through tighter inventory controls.
 On the other hand, products might be moving off the shelf more quickly simply
because the company is cutting its prices.

46
 Looking at the figures extracted from the Annual Report of ISMT LTD.:

Year 2007-2008 2006-2007 2005-2006

Cost of goods sold

984.28 932.22 821.15
(in crores)

Inventory:

Opening (in crores) 223.34 184.65 127.30

Closing (in crores) 210.60 223.34 184.65

Average (in crores) 216.97 203.99 155.97

No. of turns 4.53 4.56 5.26

OBSERVATIONS:

47
  Here the figures reveal that there is a slight reduction in the Inventory turnover
rates as well as the No.of inventory days (days to sell inventory) in comparison
with the last 3 years data.
 One of the reasons may be pointed out as a decrease in market demand because
slowdown in the global economy affecting seamless tube industry.
 Another reason may be continuous increase in input costs throughout the year,
resulting in decline in operating margins slightly.

However, the difference in figures is not significant. Even during the

situation of global slowdown company has been able to maintain the level of
inventory turnover quite consistently.with the past figures.

Broadly speaking, the smaller number of days, the more efficient a company - inventory
is held for less time and less money is tied up in inventory. Instead, money is freed up for
things like research and development, marketing or even share buybacks and dividend
payments.

If inventory days are increasing, that’s not necessarily a bad thing. Companies normally
let inventories build up when they are introducing a new product in the market or ahead
of a busy sales period.

6.6 ANALYZING THE STOCK LEVELS OF THE COMPANY

48
 ISMT LIMITED

INDEGENIOUS STEEL STOCK AGAINST BUDGET 2008-2009

(IN TONNES)

STEEL STORE
MONTH ACT.STOCK BUD.STOCK
Apr-08 5738.30 5500.00
May-08 5527.67 5500.00
Jun-08 5089.20 5500.00
Jul-08 5794.30 5500.00
Aug-08 5547.60 5500.00
Sep-08 4748.66 5500.00
Oct-08 5682.24 5500.00
Nov-08 6723.00 5500.00
Dec-08 6024.00 5500.00
Jan-09 5035.90 5500.00
Feb-09 3611.10 5500.00
Mar-09 3644.70 5500.00

8000
7000
6000
5000
4000
#REF!
3000 ACT.STOCK
2000 BUD.STOCK
1000
0

OBSERVATIONS:

49
  Observing the above figures reveals that actual stock and budgeted stock remain
consistent during the intial months of the year.
 During the months of November and December the actual level of stock seems to
show an increase.
 In the latter part of the year (i.e. from JAN to MAR)there is a significant decrease
in actual stock levels due to the company’s policy to keep the stock low to adopt
to the slowdown in global slowdown in seamless tube industry.

ISMT LIMITED
STOCK ITEMS INVENTORY VALUE REPORT FOR GENERAL STORES
(APR’08 TO MAR’09)
(RS.IN LAKHS)

Opening
Month value Receipt value Issue value Closing value
April 150 40 37 153
May 153 55 53 155
June 155 45 46 155
July 155 53 50 158
August 158 53 54 157
September 157 65 56 165
October 165 82 62 184

50
 November 184 53 56 181
December 181 39 50 170
January 170 43 37 175
February 175 50 55 170
March 170 71 58 181

Observations:

The data above shows that there is an increase in stock items inventory from
Sept’08 as compared to the initial months of the year.

ISMT LIMITED
NON-STOCK ITEMS INVENTORY VALUE REPORT FOR GENERAL STORES
(APR’08 TO MAR’09)
(RS.IN LAKHS)

Opening Receipt Closing

Month value value Issue value value
April 608 27 39 596
May 596 52 49 599
June 599 27 52 574
July 574 50 63 560
August 560 33 46 547
September 547 74 79 542
October 542 100 67 576

51
 November 576 276 280 572
December 572 63 77 557
January 557 39 46 549
February 549 18 16 552
March 552 26 44 534

OBSERVATIONS:

The data above shows that there is a decrease in non-stock items inventory from
JUNE’08 as compared to the initial months of the year.

ABC ANALYSIS TECHNIQUE:

 The annual consumption analysis if any organization would indicate that a

handful of top high value items, less than a 10 percent of the total number,will
account for a substantial portion of about 75% of the total consumption value and
such vital few items are called “A” items.
The items falling under this category require careful attention of material
manager.
 Similarly,large number of bottom items-over 70% of the total number-account for
only 10% of the consumption value and are referred to as “C” category items.
 The items that lie between the top and the bottom are referred to as “B” category
items.

52
The table summarises how an organization treats the various category items
according to their consumption value:

A items-High consumption B items-Moderate C items- Low

value consumption value consumption value

1 Very strict control Moderate control Loose control

2 No safety stocks(or very low Low safety stock High safety stocks
safety stock)
3 Maximum follow up and Periodic follow up follow up and
expediting expediting
exceptional cases

4 Rigorous value analysis Moderate value analysis Minimum value

analysis

53
5 Must be handled by senior Can be handled by Can be fully
officers ABC Analysismiddle management delegated
CONSUMPTION VALUE (Rs.)
7082906 % CONSUMPTION

2047524
70% 1023792
20%
10%
A
B
C

Following is the ABC analysis REPORT of ISMT LIMITED

ISMT LIMITED

ABC ANALYSIS

From Date: 1 Jun-09 To Date: 30 Jun-09

CLAS No. of CONSUMPTION % OF TOTAL

S Items VALUE CONSUMPTION
A 38 7082906 70%
B 98 2047524 20%
C 753 1023792 10%
Total 889 10154222 100%

54
PARETO ANALYSIS:

 It is observed that in practice 20% of the total quantity of stocks may account for
about 80% of its value.
This principle is known as PARETO ANALYSIS and is based on the observation by
PARETO.
 Main point is that a very small portion of stock items, which jointly account for
80% of the total value,a firm may be able to control most of its monetary
investment in stocks.If the frequency is applied to sales,it is observed that with a
small portion (say 20% customers) of the items may account for a large
proportion say (80% of turnover).

The ABC analysis is an outgrowth of Pareto analysis only.

55
 ESTABLISHING OPTIMUM SIZE OF INVENTORY:

In general,following two methods are used for establishing the

desired inventory balances of raw materials:

1. Inventory turnover rate.(already studied before)

2. Lowest combined total ordering and carrying cost.

Inventory cost can be divided as:

a) Ordering and related cost

b) carrying cost.

The optimum inventory size is achieved when the combined total ordering and
carrying costs are at their lowest point.

56
 This may be illustrated by assuming the following facts for a single raw
material item:

Invoice price per unit Rs.5

Annual quantity required 1000 units
Ordering cost per order Rs.8
Inventory carrying costs as a percentage of invoive price -15%

Table showing optimum inventory size:

No. of Units per Average Average Inventory Order Total

Order order inventory inventory carrying processing combined
per cost(Rs.5) cost (15% cost(Rs. 8 order
item(1/2 of inventory per order) processing
order) cost) &
inventory
carrying
cost
1 1000 500 2500 375 8 383
2 500 250 1250 188 16 204
3 333 166 830 125 24 1499
4 250 125 625 94 32 126
5 200 100 500 75 40 115
6 167 83 415 62 48 110
7 143 71 355 53 56 109
8 125 63 315 47 64 111
9 111 56 280 42 72 114
10 100 50 250 37 80 117
57
Arrow indicates optimum inventory size
The table shows that lowest combined total ordering and carrying costs occur,if
annual requirements of 1000 units is filled in seven orders of 143 each.This results in
an average inventory of Rs.355.

 INPUT- OUTPUT RATIO ANALYSIS:

This is one of the methods of exercising control on inventories.

Input-output ratio is a relation between quantity of material charged to the production

process and the quantity of material in the final output.

For example:

If 2 kg of material A is put in the production process and the content of this material in
the final product is 1.6 kg, the input –output ratio will be 2/1.6*100=125%

 Input-output ratio helps in the comparison of actual consumption of material with

standard consumption.
 If actual I-O ratio is higher than the standard ratio, the performance of production
department is adverse.
 If actual I-O ratio is higher than the standard ratio, the performance of production
department is satisfactory.
 It determines the efficiency of manufacturing department.
 Cost of raw material in the finished product can be arrived at by multiplying cost
of raw material per unit by the input-output ratio.

58
 However standard ratio should be evaluated periodically.

ILLUSTRATION:

A is a raw material used in production process.It costs Rs.10/kg and I-O ratio is
125%.Due to non-availability if this material,the following two substitutes are available:

Material Rate/kg I-O ratio

A1 Rs.15 110%
A2 Rs.12 140%

Recommend which of the grades is to be used.

Solution:

Since the rate and I-O ratio vary in case of both the substitutes,the final decision on the
cost of each of the substitutes in the finished product per unit.

The cost of raw material = Input/output *Rate per unit in the finished product

Substitute A1= 110*15/100=Rs.16.50 per kg

59
 Substitute A2= 140*12/100=Rs.16.80 per kg

Substitute A1 is recommended as it is more economical.

For proper results, performance in the field of inventory control should

be properly reported to management. Following points merit attention:

i. A calendar of returns should be prepared showing the various reports, time

schedule and the level of management where report is to be sent,periodicity of
reports,etc
ii. Number of purchase orders placed during the month, cumulative for the year up to
the day of sending the reports.
iii. Separate reports for foreign & local orders.
iv. Number of purchase requisitions, orders placed, number of requisitions pending.
v. Savings materialized by purchasing at price below market price.
vi. Savings through material substitution.
vii. Loss due to wastage,spoilage,obsolescence.
viii. Cost of placing orders.
ix. Svings achieved vs.target savings in inventory control.
x. Cost of running the department.

60
Appropriately rationalizing company’s inventory strategies is of vital importance
to business performance. Too much inventory or inventory which is poorly positioned
can result in impacts on cost and cash flow that can be potentially fatal in the current
business climate. The goal of an appropriate inventory strategy is to ensure that
a company can maximize opportunities in the market place with as little inventory
as possible. This takes a clear understanding of the various factors that should be
considered including product positioning, probable degrees of demand volatility, and
appropriate considerations for supply disruption risks.

As it can be observed from the study undertaken, inventory analysis can have a big effect
on the bottom line. Unfortunately, a company probably won't publish its entire inventory
situation in its financial statements. Companies are required, however, to state in the
notes to financial statements what inventory system they use. By learning how these
differences work, one will be better able to compare companies within the same industry.

61
STUDY MATERIAL:

FINANCIAL MANAGEMENT-NEEDLES & POWERS

ICSI STUDY MATERIAL-COMPANY ACCOUNTS, COST & MANAGEMENT

ACCOUNTING (EXECUTIVE PROGRAMME)

ISMT LTD ANNUAL REPORT 2007-08

WEBSITES:

www.scribd.com

www.ismt.co.in

www.about.com

62
 QUESTIONNAIRE:

1. How do you value inventory?

I. STEEL SEGMENT:
 Raw materials are valued at lower of cost or net realizable value.
Cost is determined on FIFO basis.
 Finished Goods are valued at lower of cost or net realizable value.
Cost includes raw material, labour cost, manufacturing expenses,
production overheads and depreciation.
 Stores & Spares are valued at cost determined on FIFO basis,
except for those which have a longer usable life, which are valued
on the basis of their remaining useful life.
II. TUBE SEGMENT:
 Raw materials are valued at lower of cost or net realizable value.
Cost is determined on WEIGHTED AVERAGE basis.
 Finished Goods are valued at lower of cost or net realizable value.
Cost includes raw material,labour cost,manufacturing
expenses,production overheads and depreciation.
 Stores & Spares are valued at cost determined on WEIGHTED
AVERAGE basis except for those which have a longer usable life,
which are valued on the basis of their remaining useful life.

2. Reasons for flat sales in FY 2007-08?

63
 The company is currently facing capacity constraints, with all its plants running at
about 100% capacity utilisation level. With the capacity augmentation project at
its final stages of commissioning, the Company is confident of achieving higher
volumes and greater efficiency in a short span of time

3. Is price volatility a concern?

This industry like many others is subject to cyclical price behavior. The period
starting October 2007 upto July 2008 witnessed more than 60% increase in prices
of key raw materials being used by the Company. There is a time lag in passing
on the price variation to end customers who are largely OEM's which temporarily
does affect the Profitability of the Company. Given that the expansion project
reduces our operating costs quite substantially we will be even better prepared for
any such adverse price movements. In the shorter term, to hedge against price
movements in input costs, a price variation clause has been incorporated in our
export orders and contracts, wherein the advantage or the disadvantage of the
price variation is passed on to the customer. In the domestic markets our orders
tend to have short lead-times which automatically reduce our risk exposure.

4. Will the Company be able to sustain the EBIDTA margins of FY 2007-08 in

context with the highly volatile raw material prices?

Raw materials used by the company like Pig Iron, Sponge Iron & Scrap are
commodity products and hence their price movements are cyclical in nature. Any
major change in the raw material prices would lead to a corresponding (and not
necessarily proportionate) change in the selling price of the products.

Hence the benchmark margin for a product like seamless tubes and pipes should
be calculated on the basis of Earnings per Ton and not Earnings to Sales in such a
volatile scenario.

64
 Company is confident of achieving higher Earnings per ton through use of
modern technology, higher efficiencies and also through producing more value
added products.

5. Any threats?

There are always threats in any business. However, we believe we have a very
strong position in the market and that with the commissioning of the new mill we
will further strengthen our competitive position. Our operating costs will be lower
and as explained earlier, we will have a much larger addressable market open to
us.

6. What are some of the main initiatives implemented to rationalize costs and
achieve profitability?

» Better asset utilization

» Yield improvement
» Process cost improvement

7. Is China an existing or a potential threat?

No, we do not see China as a major threat at this time. We are in the specialized
Tube market whereas the Chinese focus is on the high volume OCTG sectors. In
addition we believe that our prices, particularly with the new mill coming on
stream, are competitive with existing Chinese prices.

8. What is the size of the world seamless tube market?

About 30-32 Million tonnes.

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9. How large is the Indian market?

About 500,000 tonnes.

10. Who are the other players?

MSL, Saw Pipes, BHEL & imports.

11. What is your differentiating factors vis-à-vis competition?

o » Specialized precision seamless tube manufactures

o » Strong technology orientation
o » Believe in creating and retaining knowledge.
o » Niche products
o » Capability to service small lot orders

12. What are you doing to insulate yourself from the impact of exchange rate
fluctuations?

We are hedging with forward currency contracts as well as matching outflows and
inflows through borrowings in foreign currencies. Simply put, our strategy is not
to speculate on currencies and to make money only on selling tubes.

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