Professional Documents
Culture Documents
Inventory
Inventory
Inventory
Inventory Control or Stock control can be broadly defined as "the activity of checking a shop’s
stock".[1] More specifically inventory control may refer to:
In operations management, logistics and supply chain management, the technological system
and the programmed software necessary for managing inventory
In economics and operations management, the inventory control problem, which aims to reduce
overhead cost without hurting sales? It answers the 3 basic questions of any supply chain:
When? Where? How much?
In the field of loss prevention, systems designed to introduce technical barriers to shoplifting
Ensuring that the products are on the shelf in shops in just the right quantity.
Recognizing when a customer has bought a product.
Automatically signalling when more products need to be put on the shelf from the stockroom.
Automatically reordering stock at the appropriate time from the main warehouse.
Automatically producing management information reports that could be used both by local
managers and at head office.
These might detail what has sold, how quickly and at what price, for example. Reports could be used
to predict when to stock up on extra products, for example, at Christmas or to make decisions
about special offers, discontinuing products and so on. Sending reordering information not only to
the warehouse but also directly to the factory producing the products to enable them to optimize
production.
Stock Control A stock control system should keep you aware of the quantity of each kind of merchandise
on hand. An effective system will provide you with a guide for what, when, and how much to buy of
each style, color, size, price and brand. It will reduce the number of lost sales resulting from being out of
stock of merchandise in popular demand. The system will also locate slow selling articles and help
indicate changes in customer preferences. The size of your establishment and the number of people
employed are determining factors in devising an effective stock control plan. Can you keep control by
observation? Should you use on-hand/onorder/sold records? Detachable ticket stubs? Checklists?
And/or physical inventory? If so, how often? With the observation method (the eyeball system), unless
the people using it have an unusually sharp sense of quantity and sales patterns, it is difficult to keep a
satisfactory check on merchandise depletion. It means that you record shortages of goods or reorders as
the need for them occurs to you. Without a better checking system, orders may only be placed at the
time of the salesman's regular visit, regardless of when they are actually needed. Although it may be the
simplest system, it also can often result in lost sales or production delays. Detachable stubs or tickets
placed on merchandise provide a good means of control. The stubs, containing information identifying
the articles, are removed at the time the items are sold. The accumulated stubs are then posted
regularly to the perpetual inventory system by hand or through the use of an optical scanner. A
checklist, often provided by wholesalers, is another counting tool. The checklist provides space to record
the items carried, the selling price, cost price, and minimum quantities to be ordered of each. It also
contains a column in which to note whether the stock on hand is sufficient and when to reorder. This is
another very simple device that provides the level of information required to make knowledgeable
decisions about effective inventory management. Most smaller operations today, except for the very
smallest, are using some form of a perpetual online system to record the movement of inventories into
and out of their facilities. In a retail operation, the clerk at the register merely scans the ticket with a
reader, and the system shows the current price and removes the item from the inventory control
system. A similar process occurs in a manufacturing operation, except that the "sale" is actually a
transfer of the inventory from control to production. This is a particularly critical system in a large
operation such as a grocery store where they regularly maintain 12,000 plus items. Often a vendor will
provide on-site or computerized assistance needed to help their smaller customers maintain a good
understanding of their own inventory levels and so keep them in balance
Inventory Control Records Inventory control records are essential to making buy-and-sell decisions.
Some companies control their stock by taking physical inventories at regular intervals, monthly or
quarterly. Others use a dollar inventory record that gives a rough idea of what the inventory may be
from day to day in terms of dollars. If your stock is made up of thousands of items, as it is for a
convenience type store, dollar control may be more practical than physical control. However, even with
this method, an inventory count must be taken periodically to verify the levels of inventory by item.
Perpetual inventory control records are most practical for big-ticket items. With such items it is quite
suitable to hand count the starting inventory, maintain a card for each item or group of items, and
reduce the item count each time a unit is sold or transferred out of inventory. Periodic physical counts
are taken to verify the accuracy of the inventory card. Out-of-stock sheets, sometimes called want
sheets, notify the buyer that it is time to reorder an item. Experience with the rate of turnover of an
item will help indicate the level of inventory at which the unit should be reordered to make sure that the
new merchandise arrives before the stock is totally exhausted. Open-to-buy records help to prevent
ordering more than is needed to meet demand or to stay within a budget. These records adjust your
order rate to the sales rate. They provide a running account of the dollar amount that may be bought
without departing significantly from the pre- established inventory levels. An open-to-buy record is
related to the inventory budget. It is the difference between what has been budgeted and what has
been spent. Each time a sale is made, open-to-buy is increased (inventory is reduced). Each time
merchandise is purchased; open-to-buy is reduced (inventory is increased). The net effect is to help
maintain a balance among product lies within the business, and to keep the business from getting
overloaded in one particular area. Purchase order files keep track of what has been ordered and the
status or expected receipt date of materials. It is convenient to maintain these files by using a copy of
each purchase order that is written. Notations can be added or merchandise needs updated directly on
the copy of the purchase order with respect to changes in price or delivery dates. Supplier files are
valuable references on suppliers and can be very helpful in negotiating price, delivery and terms. Extra
copies of purchase orders can be used to create these files, organized alphabetically by supplier, and can
provide a fast way to determine how much business is done with each vendor. Purchase order copies
also serve to document ordering habits and procedures and so may be used to help reveal and/or
resolve future potential problems. Returned goods files provide a continuous record of merchandise
that has been returned to suppliers. They should indicate amounts, dates and reasons for the returns.
This information is useful in controlling debits, credits and quality Issues. Price books, maintained in
alphabetical order according to supplier, provide a record of purchase prices, selling prices, markdowns,
and markups. It is important to keep this record completely up to date in order to be able to access the
latest price and profit information on materials purchased for resale.
Rate of consumption
Lead time
Storage /warehousing /carrying costs
Insurance cost
Seasonal considerations
Price fluctuations
Economic Order Quantity (EOQ)
Quality of raw material
Availability of space
Availability of funds
Government and other legal and statutory requirements.
A systematic material control results in economy and efficiency in the
maintenance of each item of inventory and at the same time ensures that it is
available as and when required. It helps in avoiding blocking up of funds in
unnecessary stock items. Now, coming back to the topic under discussion, to
ensure smooth running of production process, the materials department of an
enterprise sets different levels for each item of inventory. These levels are:
1. Maximum level
2. Minimum level
3. Reorder level
4. Danger or safety stock level
Now let’s have a detailed discussion on each one of these.
1. Maximum level: This is the maximum quantity above which stock should
never be held at any time. It is fixed after considering the following factors:
Investment required in stores, raw materials and other items of inventory
Availability of storage space
Lead time for delivery of materials
Obsolescence rate
Consumption rate of materials
Economic Order Quantity
Storage and Insurance costs
Price advantage due to bulk purchases.
Maximum Level can be calculated as:
Or
Average Stock level shows the average stock held by a firm. The average stock level can be
calculated with the help of following formula.
Inventory Systems
Each of the three cost flow assumptions listed above can be used in either of two systems (or methods) of
inventory:
A. Periodic
B. Perpetual
A. Periodic inventory system. Under this system the amount appearing in the Inventory account is not
updated when purchases of merchandise are made from suppliers. Rather, the Inventory account is commonly
updated or adjusted only once—at the end of the year. During the year the Inventory account will likely show
only the cost of inventory at the end of the previous year.
Under the periodic inventory system, purchases of merchandise are recorded in one or
more Purchasesaccounts. At the end of the year the Purchases account(s) are closed and the Inventory account
is adjusted to equal the cost of the merchandise actually on hand at the end of the year. Under the periodic
system there is noCost of Goods Sold account to be updated when a sale of merchandise occurs.
In short, under the periodic inventory system there is no way to tell from the general ledger accounts the
amount of inventory or the cost of goods sold.
B. Perpetual inventory system. Under this system the Inventory account is continuously updated. The
Inventory account is increased with the cost of merchandise purchased from suppliers and it is reduced by the
cost of merchandise that has been sold to customers. (The Purchases account(s) do not exist.)
Under the perpetual system there is a Cost of Goods Sold account that is debited at the time of each sale for the
cost of the merchandise that was sold. Under the perpetual system a sale of merchandise will result in two
journal entries: one to record the sale and the cash or accounts receivable, and one to reduce inventory and to
increase cost of goods sold.
"FIFO" is an acronym for First In, First Out. Under the FIFO cost flow assumption, the first (oldest) costs are
the first ones to leave inventory and become the cost of goods sold on the income statement. The last (or
recent) costs will be reported as inventory on the balance sheet.
Remember that the costs can flow differently than the goods. If the Corner Shelf Bookstore uses FIFO, the
owner may sell the newest book to a customer, but is allowed to report the cost of goods sold as $85 (the first,
oldest cost).
Let's illustrate periodic FIFO with the amounts from the Corner Shelf Bookstore:
A2. Periodic LIFO
"Periodic" means that the Inventory account is not updated during the accounting period. Instead, the
cost of merchandise purchased from suppliers is debited to an account called Purchases. At the end
of the accounting year the Inventory account is adjusted to equal the cost of the merchandise that is
unsold. The other costs of goods will be reported on the income statement as the cost of goods sold.
"LIFO" is an acronym for Last In, First Out. Under the LIFO cost flow assumption, the last (or
recent) costs are the first ones to leave inventory and become the cost of goods sold on the income
statement. The first (or oldest) costs will be reported as inventory on the balance sheet.
Remember that the costs can flow differently than the goods. In other words, if Corner Shelf
Bookstore uses LIFO, the owner may sell the oldest (first) book to a customer, but can report the
cost of goods sold of $90 (the last cost).
It's important to note that under LIFO periodic (not LIFO perpetual) we wait until the entire year is
over before assigning the costs. Then we flow the year's last costs first, even if those goods
arrived after the last sale of the year. For example, assume the last sale of the year at the Corner
Shelf Bookstore occurred on December 27. Also assume that the store's last purchase of the year
arrived on December 31. Under LIFO periodic, the cost of the book purchased on December 31 is
sent to the cost of goods sold first, even though it's physically impossible for that book to be the one
sold on December 27. (This reinforces our previous statement that the flow of costs does not have to
correspond with the physical flow of units.)
Let's illustrate periodic LIFO by using the data for the Corner Shelf Bookstore:
As before we need to account for the total goods available for sale: 5 books at a cost of $440. Under
periodic LIFO we assign the last cost of $90 to the one book that was sold. (If two books were sold,
$90 would be assigned to the first book and $89 to the second book.) The remaining $350 ($440 -
$90) is assigned to inventory. The $350 of inventory cost consists of $85 + $87 + $89 + $89. The
$90 assigned to the book that was sold is permanently gone from inventory.
If the bookstore sold the textbook for $110, its gross profit under periodic LIFO will be $20 ($110 -
$90). If the costs of textbooks continue to increase, LIFO will always result in the least amount of
profit. (The reason is that the last costs will always be higher than the first costs. Higher costs result
in less profits and usually lower income taxes.)
With perpetual LIFO, the last costs available at the time of the sale are the first to be removed from the
Inventory account and debited to the Cost of Goods Sold account. Since this is the perpetual system
we cannot wait until the end of the year to determine the last cost—an entry must be recorded at the
time of the sale in order to reduce the Inventory account and to increase the Cost of Goods Sold
account.
If costs continue to rise throughout the entire year, perpetual LIFO will yield a lower cost of goods
sold and a higher net income than periodic LIFO. Generally this means that periodic LIFO will result
in less income taxes than perpetual LIFO. (If you wish to minimize the amount paid in income taxes
during periods of inflation, you should discuss LIFO with your tax adviser.)
Once again we'll use our example for the Corner Shelf Bookstore:
Let's assume that after Corner Shelf makes its second purchase in June 2014, Corner Shelf sells
one book. This means the last cost at the time of the sale was $89. Under perpetual LIFO the following
entry must be made at the time of the sale: $89 will be credited to Inventory and $89 will be debited
to Cost of Goods Sold. If that was the only book sold during the year, at the end of the year the Cost
of Goods Sold account will have a balance of $89 and the cost in the Inventory account will
be $351 ($85 + $87 + $89 + $90).
If the bookstore sells the textbook for $110, its gross profit under perpetual LIFO will be $21 ($110 -
$89). Note that this is different than the gross profit of $20 under periodic LIFO.
Under the perpetual system, "average" means the average cost of the items in inventory as of the date
of the sale. This average cost is multiplied by the number of units sold and is removed from the
Inventory account and debited to the Cost of Goods Sold account. We use the average as of the time
of the sale because this is aperpetual method. (Note: Under the periodic system we wait until the year
is over before computing the average cost.)
Let's use the same example again for the Corner Shelf Bookstore: