A.

Managing Unproductivity

a. Unproductivity

b. Types of Unproductivity

c. Unproductivity Management

B. Obsolescent and obsolete inventory

C. Causes of unproductivity inventory

D. Inventory Control through Accounting Techniques:

a. Valuation of Inventory - Purpose, Methods

A. Managing Unproductivity:

Unproductivity management is basically concerned with effective control of waste i.e. obsolete,
scrap and surplus inventory, usually performed by stores personnel. A huge sum of money is
locked up in the form of idle inventory due to the presence of such surplus/obsolete stock.

Unproductive means sales. Therefore, when material has been declared as surplus, the
materials, purchasing or salvage and reclamation department, as appropriate, should be informed.
The managers are concerned with efficient effective and profitable disposal of surplus, obsolete,
scrap and waste materials, generated within the firm. In modem times, disposal problem has
become highly complex and important due to following reasons:

• Wide varieties of wastes, and surplus materials

• Increased size and diversified product lines and decentralized management of companies

• The need to develop and use new methods to avoid generation of solid waste products

• Disposing wastes into air and waterway causing pollution of different types

• Resistance from community and government.

• Strict rules and regulations of government for disposal of waste and effluents

• Increased level of competition and hence necessity of reworking or reprocessing for cost
economics

• Need to conserve scarce material and natural resources etc.

Responsibility: Depending upon the size, type of manufacturing processes and the nature and
complexity of wastes, the disposal management may either be centralized i.e. separately
organized or may be subordinated to either purchase department, sales department, marketing
department or stores department

a. Unproductivity:

Unproductive is defined as “Costs incurred without procuring a proper profitable return to the
enterprise” by H. N. Broom a prominent author on Production Management.

Failure to use money, materials, machines, manpower, markets with maximum effectiveness will
lead to wastage with the result that the enterprise suffers a loss. England and Leenders prominent
authors on Materials Management defines waste as “Materials and supplies which have been
changed during the production process and which, through carelessness, faulty production
methods, poor handling or other causes have been spoiled, broken or otherwise rendered unfit for
further use or reclamation.”

It may also be defined as “The residue of materials which results from normal manufacturing
process and has no economic (resale) value but may change later on e.g. smoke, cutting oil,
which cannot be reclaimed.

Loss, shrinkage, evaporation of materials during manufacturing process or a residue without

measurable recovery value may also be termed as waste.

Considering control and accounting aspects unproductive may broadly be classified as:

1. Normal Unproductive: The cost of such wastes may be absorbed from normal or good
output, i.e. due to such waste, per unit cost will go up and the profit will be adversely affected.
Such waste is normal, natural and logical looking to the nature of products and process.
However, such legitimate wastes are reducible.
2. Abnormal Unproductive : Such wastes are controllable by appropriate policies of the
management < Abnormal loss arising out of abnormal wastes are charged to costing profit and
loss account and therefore the cost of production, will not be inflated, unnecessarily.

3. Recoverable: The waste that can be converted into some useful resource or as a joint/by
products, e.g. energy.

4. Irrecoverable: The resources that get lost with the passage of time and cannot be regained
later on e.g. Handlooms in textile mill, manpower, energy capacity services etc.

Thus as an element of the system “Waste is any unnecessary input or undesirable output from
any system encompassing all types of resources”.

b. Types of Unproductivity Inventory:

1. Surplus Inventory:

An item is said to be surplus when its existing stocks is likely to last longer than the normal
period of consumption. Surplus is usually not an inspiring word. It includes those materials and
equipment which have no immediate use but have accumulated due to faulty planning,
forecasting and purchasing. However, such stocks have usage value in future.

It is the excess of materials in the stock either not required by the unit concerned or likely to last
longer.

2. Obsolete Inventory:

An item which may become obsolete due to change in design modification or substitution, new
inventions, discoveries and are unlikely to be used in near future. It also includes those materials
and equipment which are not damaged and which have economic worth but which are no longer
useful for the company’s operation owing to many reasons. Obsolescence is “The loss of
intrinsic value of an asset due to its supersession”.

Channels for unproductive of Surplus and Obsolete Materials

Disposal may take any of the following routes, as shown in the figure given below:

a. Use within The Firm: This practice if resorted to, obtains maximum value from disposal
items which may take any one or more of the following ways:
• Use items other than for which they were originally purchased

• Avoid the need to buy lower sizes by converting the surplus to lower sizes

• Convert it into different blocks, jigs, fixtures, maintenance parts etc.

b. Return to Original Suppliers: This may fetch 90 % to 100 % of purchase price, by

requesting the supplier to modify the purchase order and receive the goods back at an agreed
price/discount within specified time agreed upon.

c. Sale to Actual Users: This channel facilitates sale of disposal items on as is where is basis,
communicated either through letters or advertisements to the actual users.

3. Scrap:

Scrap may be defined as process wastage such as turnings, borings and flashes.

They may have an end use within the plant.

Materials which have outlived their useful life or for which there is no demand in their original
form are classified as scrap.

Disposal of Scraps

Scraps may be disposed off by:

a) By public auction

b) Selling it to sister concerns for using it as an input in joint products or by products.

c) By entering into annual contracts

d) By reworking for reuse

e) By inviting tenders from scrap purchasers.

f) To sell directly to the end users

4. Salvaged Inventory:
Those materials which cannot be put to use for their original purpose. However, parts may be
collected and utilized in repairs and replacements etc. Salvaged inventory may better be
reclaimed for the purpose of effecting economy especially in the use of funds.

5. Spoilage and Defectives:

Spoilage includes surplus generated from inefficient use of production machinery, carelessness
and poor purchasing. Defectives arises due to use of wrong machine or carelessness/unfitness/
inattentiveness of workers, unauthorized set-up change during processing.

c. Unproductive Management:

Unproductive Management is a inter and multi-disciplinary activity involving engineering

principles, economic urban and regional planning, management techniques and social sciences,
to minimize overall wastivity of the system under consideration.

Therefore, a systematic approach to waste management encompassing the wastes of all kinds of
resources at all stages should be adopted.

As inventory is a major element of cost in cotton textile mill, wastage of materials is of critical
importance from management’s viewpoints. The goal of unproductive management is to
minimize the waste whereas, that of resource management is to maximize the utilization of
resources.

To measure the performance of any system the new concept of "Unproductivity’, formulated as
under, has been propounded:

Unproductivity = ----------Input (I)

Unproductive management can be functionally classified as under

1) Generation or inception

2) Reduction or minimization

3) Collection and segregation

4) Recycling or reuse

5) Disposal
The list is more suggestive rather than exhaustive For the purpose of effective Unproductive may
be classified as:

1. Salvable Waste: The waste with some salvage value e.g. scrap, rejected goods,
surplus/obsolete items, equipment etc. which, if disposed off efficiently, may provide good
return to the organization through cost reduction and consequently higher profit and material
conservation.

2. Non Salvable Waste: The waste with no salvage value, but requires further processing and
treatment for disposal. Such wastes pose environmental hazards and entails other social costs.
Hence, proper management ensures resource recovery as well as lesser overall costs.

Identification of Excess Inventory: Excess inventory depends upon company policy with
regard to inventory holding. Usually such inventories are identified at the time of periodical
physical verification.

B. Obsolescent and obsolete inventory

Obsolescence: Obsolescence is a financial loss if a product is not saleable at its full value either
because of deterioration or new product introduction or ageing beyond sell-by date or even if it
loses its fashion appeal. Generally it is the average inventory value declared obsolete every year.
This may not be constant every year but some approximation needs to be done and it varies from
industry to industry and product to product. Obsolesces are common in technology products,
food and beverage, pharmaceuticals and FMCGs. We also see companies offering large
discounts to liquidate products to reduce losses due to obsolescence.

Obsolescence and Deterioration: This is inventory which is classified as being unfit to sell, or
lying in the storage waiting for the appropriate use. It is typically estimated to be about 1% of the
inventory carrying cost and slightly higher for specific industries.

C. Causes of unproductivity inventory

Inventory waste can cost your business valuable time and resources. Inventory ties up capital and
if you’re not managing it effectively it will quickly absorb important cash flow and worse, it can
hide inefficiencies within your operations.
It is crucial to optimize inventory control to help reduce your inventory waste. However, before
you can reduce waste, you need to first understand where this waste occurs. Based on the
principles of lean manufacturing, we have identified five areas of inventory waste where
companies can reduce waste to improve profitability.

1. Overproduction

Producing too much stock in advance means you not only incur the high costs of holding
inventory, but you could also be left holding stock you’re unable to sell.

Avoid overproduction by making things only as quickly as the customer wants. Just-in-time
inventory lets you hold the minimum stock required to keep your business running. You can
order what you want for your immediate needs and limit overproduction by only producing what
is needed, when it is needed.

Accurate forecasting would also inform your manufacturing decisions. Here’s how to incorporate
demand forecasting to your business.

2. Delays

Delays, referred to as the ‘waste of waiting’, increase production costs and generally occur
through the inefficiencies of processing bottlenecks or late delivery of supplies or information.

Manufacturing bottlenecks can also adversely affect the entire processing chain. Whether waiting
for a delivery of raw materials, a previous task to be completed or a machine to be fixed, having
employees sit idle while they wait is a cost to the business.

Mitigate delays by automating the entire inventory replenishment process using smart software
solutions for timely deliveries. Look at optimizing other areas of your business such as
your warehouse to help manage production flow and efficiency.

3. Inventory defects

Defects can result from poor design and equipment to lack of operator training and non-standard
procedures. The costs associated with inventory defects include the price of problem solving,
rework, rescheduling, extended lead times, delivery fails and a very real likelihood of unhappy
customers when you have failed to meet their needs.

Eliminate inventory waste by reducing raw materials, work in progress and finished goods. The
leaner your inventory stock on-hand is, the easier it is to recognize and rectify defects as they
occur. Invest in modern equipment and the right software that helps the business to remain
competitive while maintaining a consistent quality while helping to reduce waste.

4. Over-processing

Doing more than the customer asks for sounds like a great way to encourage loyalty but it can
very quickly result in inventory waste. If what you are doing doesn’t increase function,
appearance or speed to market of a product, then it represents an inventory waste. Over-
processing can also include double-handling or excessive product packaging.

Review each step in your operations to determine where waste can be effectively reduced. Any
process inventory stock goes through that does not change its value should be eliminated.

5. Transportation

Overproduction of inventory is a leading factor in transport waste. This increases the need for
manual handling, moving stock from one functional area to another with your warehouse or
transporting inventory between factories and stores. Excessive transportation and handling
increases the chance of damage or loss and every moment your loaded trucks are inactive at a
loading dock can be considered inventory waste. From drop trailer programming to expedited
freight, there are numerous reliable solutions that keep your freight moving seamlessly and your
customers happy.

D. Inventory Control through Accounting Techniques:

Inventory constitutes a substantial portion of total assets of many companies, especially

manufacturing and trading concerns. If one analyses the financial statement of such concerns, it
is found that lot of working capital is invested in it. The opening and closing balance of stock on
hand are shown on Debit and Credit side respectively of trading account and as a working asset it
is shown on asset side of the Balance Sheet. The literal meaning 62 of the term Inventory Control
itself depicts that it is both, Physical as well as Accounting control of inventories. For
convenience, accounting control has been separately studied due to its unique contribution
towards inventory control. Control has been defined as Physical control as opposed to accounting
control which is mainly concerned with financial responsibility and asset accounting. Accounts
department maintains control by correctly accounting for receipts and withdrawals reported by
warehouse.

Accounting normally takes place prior to issue and shipment. Entries are verified after reports
relating to shipping and receiving have been consummated. Physical inventories are taken to
ensure that actual inventory agrees with perpetual book inventory. Inventory accounting plays as
important role in ascertaining productivity measures as well as for control modelling relating to
inventory. In addition to this it helps in determining the cost associated with inventories as well
as transaction reporting and requiring accurate and continuous update of stock records. Inventory
control being a management process requires up-to-date records and reports for effective
implementation of different policies and techniques.

a. Valuation of Inventory - Purpose, Methods:

Purposes:

a. Determination of current Income: Correct valuation of inventories in annual accounts reveals

the current income through the process of matching cost against revenues i.e. overvaluation will
unnecessarily inflate the profit and under valuation will lead to decrease in profit

b. True Correct and Fair View of Financial / Economic Affairs: Undervalued or overvalued
inventory, which is a major item of current assets affect profit figures which is included in the
capital also. Therefore, proper valuation of inventory exhibits true and fair view of economic
affairs.

c. Computation of Ratios: Computation of all the ratios based on inventory and capital viz.,
ROTA, ROI, NP Ratio, GP Ratio, Sales Turnover Ratio, Inventory Turnover Ratio, Current /
Liquid Ratio and Decisions based on these ratio will be misleading if inventories are not valued
properly. Any change in the methods of valuation must be disclosed.

Methods:
Methods based on cost price and other factors relating to the use of inventory may be enumerated
as follows:

(1) FIFO (First-In First-Out)

The materials (issued) are priced at the oldest cost price and consequently the inventory is valued
at the price of latest purchases.

(2) LIFO (Last-In First-Out)

The cost of latest acquisitions or purchases are matched against the sales revenue of the period
and the cost of earliest purchases / acquisitions.

(3) HIFO (Highest-In First-Out)

The materials with highest prices are issued first for production / sales. Thus highest price of
materials are recovered first.

(4) NIFO (Next-In First-Out)

Issues are priced at the cost of material ordered but not yet received at the price estimated or
expected for the next purchase.

(5) Specific cost method (Identification cost method)

Identify the consignment to which the unsold goods belong and then value the unsold goods on
the basis of cost price at which they were purchased.

(6) Base Stock Method

It is (necessary) inevitable to carry certain minimum quantity of inventory of materials to carry

out the production uninterruptedly. The investment in fixed current / working capital at their
original cost.

(7) Average Cost Method

In case of frequent purchases where goods have been mixed up in such a manner that it is
difficult to identify each lot separately, the average of the prices at which such lots were
purchased, is taken for valuation of unsold stock.
(8) Standard Price Method

Predetermined fixed price on the basis of a specification of ail factors affecting the price. Thus, it
is a planned and scheduled price used by firms operating standard costing.

(9) Market / Realizable / Replacement Price Method

Under this method the issue is priced at the market price prevailing on the date of issue, so as to
reflect the current market conditions in the costs.

(10) Inflated Price Method

It is used as an accounting procedure to adjust or cover the losses and expenses as direct charges
in the materials consumed.

(11) Reuse Price Method

When materials unfit / substandard for the purpose for which they were originally purchased, are
issued for an alternative use valued at a price different from its purchase price, it is known as
reuse Price.