Inventory Costing.

Inventory
Definitions of Inventory (As Assets):

Inventories are assets that meet the following

requirements:
 a) Held* for sale in the normal course of
operations
 b) In production process with a view to that
sale
 c) In the form of materials or supplies to be
consumed in the production process or
in the provision of services

*Held: Mantenidos
Definitions of Inventory (As Assets):

Inventory is the term for the goods

available for sale and raw materials
used to produce goods available for
sale. Inventory represents one of the
most important assets of a business
because the turnover of inventory
represents one of the primary
sources of revenue generation and
subsequent earnings for the
company's shareholders.
Definitions of Inventory (As Assets):

Inventory is the array of finished

goods or goods used in
production held by a company.
Inventory is classified as a current
asset on a company's balance
sheet, and it serves as a buffer
between manufacturing and order
fulfilment. When an inventory item
is sold, its carrying cost transfers to
the cost of goods sold (COGS)
category on the income statement.
Raw Materials Inventory
 These are the materials or goods purchased
by the manufacturer. The manufacturing
process is applied to the raw material to
produce desired finished goods. For example:
Flour is used to produce bread.
 Finished goods for someone can be raw
material for someone else For example, the
aluminium ingot can be used as raw material
by utensils manufacturer to create spoons,
forks, knifes…
 The business importance of raw material as
an inventory is mainly to protect any
interruption in production planning. Other
reasons can be availing price discount on
bulk purchases, guard against market
shortage situation, etc.
Work in Progress Inventory
 These are the partly processed raw materials lying on the production floor. They
may or may not be saleable. These are also called semi-finished goods.
 It is unavoidable inventory which will be created in almost any manufacturing business.
 This level of this inventory should be kept as low as possible. Since a lot of money
is blocked over here which otherwise can be used to achieve better returns.
 Speeding up the manufacturing process, proper production planning, customer and
supplier system integration etc can diminish the levels of work in progress. Lean
management considers it as waste.
Finished Goods Inventory

 These are the final products after

manufacturing process on raw materials.
They are sold in the market.
There are two kinds of manufacturing
industries:
 First, where the product is first
manufactured and then sold.
 Second, where the order is received first
and then it is manufactured as per
specifications.
In the first one, it is inevitable to keep finished
goods inventory whereas it can be avoided in
the second one.
Packing Materials

 Packing material is the inventory used for

packing of goods. It can be primary
packing and secondary packing. Primary
packing is the packing without which the
goods are not usable. Secondary packing
is the packing done for convenient
transportation of goods
MRO Goods Inventory

 MRO stands for Maintenance, Repair,

and Operating supplies. They are also
called as consumables in various parts of
the world.
 They are like a support function.
Maintenance and repairs goods like
bearings, lubricating oil, bolt, nuts etc are
used in the machinery used for
production. Operating supplies mean the
stationery etc used for operating the
business.
Goods In transit

 Under normal conditions, a business transports raw materials, WIP, finished goods etc
from one site to other for various purpose like sales, purchase, further processing
etc.
 Due to long distances, the inventory stays on the way for days, weeks and even
months depending on distances. These are called Inventory / Goods in Transit.
Goods in transit may consist of any type of basic inventories.
Buffer Inventory

 Buffer inventory is the inventory kept or

purchased for the purpose of meeting
future uncertainties.
 Also known as safety stock, it is the
amount of inventory besides the current
inventory requirement.
 The benefit is smooth business flow and
customer satisfaction and disadvantage is
the carrying cost of inventory. Raw material
as buffer stock is kept for achieving
nonstop production and finished goods
for delivering any size, any type of order
by the customer
Anticipatory Stock

 Based on the past experiences, a

businessman is able to foresee the
future trends of the market and takes
certain decisions based on that.
 Expecting a price rise, a spurt in
demand* etc some businessman
invests money in stocking those goods.
Such kind of inventory is known as
anticipatory stock. It is normally the raw
materials or finished goods and this
strategy is executed by traders.

*Spurt in demand: Sobre-demanda

 Decoupling Inventory.
 In manufacturing concern, plant and machinery
should always keep running. The act of
stopping machinery, costs to the
entrepreneur in terms of additional set up
costs, repairs, idle time depreciation,
damages, trial runs etc. The reason for halt
(Stop) is not always the demand of the product.
It may be because of the availability of input. In
a production line, one machine/process uses
the output of other machines/process. The
speed of different machines may not always
integrate with each other. For that reason, the
stock of input for all the machines should
be sufficient to keep the factory running.
Such WIP inventory is called decoupling
inventory.
Cycle Inventory

 It is a type of inventory accumulated due

to ordering in lots/sizes to avoid carrying
the cost of inventory. In other words, it is
the inventory to balance the carrying cost
and holding cost for optimizing the
inventory ordering cost as suggested by
Economic Order Quantity (EOQ).
Inventory-Related Costs
 Inventory
Cost

Holding Cost Ordering

Inventory- Cost

Related Costs

Warehousing Logistics
Cost Costs
Purchase Cost.
 It is the price of sale given from the
supplier information; the net price before
taxes, freight, insurance and other
management costs; usually expressed in
que quote, unitarily and by a total
amount to invoice.
Ordering Cost.

 These costs include the wages

(Salaries) of the procurement
department and related payroll taxes
and benefits, and possibly similar labor
costs by the industrial engineering staff,
in case they must pre-qualify new
suppliers to deliver parts to the
company. These costs are typically
included in an overhead cost pool and
allocated to the number of units
produced in each period.
Logistics Costs

 Logistics costs are the summation of all

expenditures undertaken to make
available a good or a service to the
market, mainly the end consumer.
 Transportation costs remain the
dominant consideration as they
account for about half of the logistic
costs. Inventory carrying costs are also
significant with a share of about one
fifth of total costs.
Warehousing Costs
 Warehousing costs vary from warehouse to
warehouse however there are usually four
broad categories of warehousing costs which
are explained as follows:
 Receipt Handling and Dispatch
It refers to any expenditure on moving the goods
into or out of the warehouse. Most of the cost is
human labour, including receiving, storing and
loading the goods for delivery etc. Secondary to
labour is the equipment cost, depreciation and
energy/fuel. The price for RH&D is usually
charged as a pallet price in and out
 Warehousing Costs
 Pick and Pack prices.
If a logistics company charges for order picking or pick-
and-pack, this is usually a separate cost which is
charged per pick or per carton picked depending
on the warehouse. This also falls under handling as
well however is normally a separate cost.
 Storage Costs and Pallet Storage Prices
 Storage is the cost incurred as the goods rest in
the facility. This is usually a weekly cost similar to
‘rent’ for your goods. It is often charged either per
pallet per week (pallet storage cost) or per square
foot of footprint
 Operations administration is the cost of keeping
the facility open. Overheads, really. Line
supervision, clerical support, IT, insurance, office
supplies, even taxes all fall under operational
expenses.
Holding Cost.

 These Costs are related to the different

risks in which the company have to
deal by the time they hold the
inventory, at the conditions and
management circumstances that
products have inside and outside the
warehouse; such as: Obsolescence,
Damages, Losses and Pilferage
Costs, among others.
 In this Category we can add, the
opportunity cost for buying and specific
mix of inventory and managing the
turnover rate to this inventory
 Just in Time (JIT) Inventory

 Is a management strategy that aligns raw-material orders from suppliers directly with
production schedules. Companies employ this inventory strategy to increase efficiency
and decrease waste by receiving goods only as they need them for the production
process, which reduces inventory costs. This method requires producers to forecast
demand accurately.
 The JIT inventory system contrasts with just-in-case strategies, wherein producers hold
sufficient inventories to have enough product to absorb maximum market demand.
Inventory acquisition process
Based on Supply Chain Management Process
Procurement Process.

 The procurement process, is one of

the most important process in the
supply chain management (SCM).
The companies around the world
exchange goods and services
thought this process that usually is
based on local or foreign suppliers.
Procurement process is a basic and
fundamental process for all the
companies in the world, weather
they be commercial, manufacturing
or a services company.
Procurement Process.

 The purchase of goods, raw

materials, tools, and other
important supplies, bought with
local or foreign vendors drifts
into different costs structures;
and is the responsibility of the
company administration to be the
more efficient, and economic
these transactions and therefore
accomplish with cost reduction
objectives, or deadlines in
projects or activities.
Procurement Process.

 The added value on this process

is to find the balance, between
time, cost and accomplishment
for technical requirements, that
fulfils the final costumer/ user
expectations, with the
effectiveness and efficiency
required
Procurement Process Relevant milestones

Accomplishment of Requirements
INCOTERMS
Sales Price
Final Offer Import
Info. From Market
Purchase Process
Order
Offers Submission
Analysis.
Vendors Freight Forwarder
management
Tender Based on best 3PL/4PL Foreign
technical/commercial logistics
offer. Freight
RFQ Foreign and local
customs process.
Local/ Foreign Storage
 *Shorthand: Taquigrafia

INCOTERMS
 INCOTERMS: International Commercial Terms.
To facilitate commerce around the world, the International Chamber of Commerce (ICC) publishes a set of
Incoterms, officially known as international commercial terms. Globally recognized, Incoterms prevent
confusion in foreign trade contracts by clarifying the obligations of buyers and sellers.
Parties involved in domestic and international trade commonly use them as a kind of shorthand* to help
understand one another and the exact terms of their business arrangements. Some Incoterms apply
to any means of transportation; others apply strictly to transportation across water.
Storage Cost.
 In logistics, the goods purchased, weather
with local or international suppliers, could
drift into storage costs; weather in a
company's or in a supplier`s, or
custom`s warehouse implying the
collection of a fee to the usage of the
facilities, or the necessity of estimate this
cost for the company.
 Even when most of the time, this fee is
produced during the import process;
companies must estimate their own
storage cost, based on their own costs
Systems and add this proportion to the final
price offered to a costumer, when necessary
 Storage Cost Calculation.
 To estimate the Company´s storage cost (In their own) facilities, the following
elements are considered:

1
Inventory Costs and Expenses
 Salaries/ Overtime Payment
 Employer Burden
 Electrical Energy Service
 Stationery
 Depreciation/ Amortization of assets
assigned to the warehouse.
 Telecommunication Services
 Insurances
 Installation Expenses (Security
Service, Alarms, Sensors)
 Delay Expenses (Time Administration)
 Damages/ Losses due to handing*.
 Depreciation of warehouse facilities.
 Wastage*, obsolescence and
deterioration
 Surface/ Facilities rent.

Initial Inventory Final Inventory

+
2
(Jan 1th) (Dec 31th)
Average Inventory =
(First Method)
2
Handing: Manejo. Wastage: Mermas.
 Storage Cost Calculation.
 To estimate the Company´s storage cost (In their own) facilities, the following
elements are considered:
Inventory Costs and Expenses

1 

Salaries/ Overtime Payment
Employer Burden
 Installation Expenses (Security
Service, Alarms, Sensors)
 Electrical Energy Service  Delay Expenses (Time Administration)
 Stationery  Damages/ Losses due to handing*.
 Depreciation/ Amortization of assets  Depreciation of warehouse facilities.
assigned to the warehouse.  Wastage*, obsolescence and
 Telecommunication Services deterioration
 Insurances  Surface/ facilities rent.


(Monthly initial
inventories from Final Inventory
+
2 Average Inventory =
(Second Method)
Jan- Dec)

13
(Dec 31th)

Handing: Manejo. Wastage: Mermas.

Storage Cost Calculation.

 Inventory Costs and

Expenses
Storage Cost = Average Inventory

Storage cost Index:

Storage Cost = Storage Cost for every Dollar invested
on inventories

In other Words: For every Dollar invested on inventories, the

storage cost, will be equivalent to Storage Cost Index in Dollars
Example #1
 The company MULTICOMMERCE S.A. DE C.V. Is interested in calculating the
storage cost value for their more important products families, in order to identify if the
sale price responds adequately to the transfer of this cost to the client; the accounting
department provides the following information:
o Warehouse employees Salaries + Employer Burden= $19,620.65 (Per Month)
o Energy Service= $654.33 (Per Month) The administration Estimates based on historical
Costs, that the storage cost should no represent
o Stationary= $300 (Per Year)
more than $0.35 for every dollar
o Internet Service= $98.50 (Per Month)
o Security and Alarm Services= $650 (Per Mont) Administration also knows that decrease 10% the
o Depreciation of Warehouse Assets= $65.60 (per Month) price for Products A and B increases the sales in
25%
o Facilities Rent= $2,250 (per Month)

Average Annual Sales

Initial Inventory Final Inventory Sales Price before
Description/ Concept Unitary Cost Unitary Forecast (2020)
(Jan 1st 2020) (Dec 31st 2020) taxes
Margin (In units)

Product A $ 223,200.33 $ 148,785.34 $ 42.15 31.50% $ 55.43 920

Product B $ 149,509.87 $ 99,663.28 $ 31.22 37.10% $ 42.80 985
Product C $ 129,625.30 $ 86,408.22 $ 27.34 42.00% $ 38.82 600
Product D $ 98,644.45 $ 65,756.39 $ 19.78 32.40% $ 26.19 870
Solution.
 First Step: Calculate the Annual Value, for every Cost and Expense, from the
given data.

Monthly
Cost and Expenses Annual Payent
Payment
Warehouse employees Salaries + Employer Burden $ 19,620.65 $ 235,447.80
Energy Service $ 654.33 $ 7,851.96
Stationary $ 25.00 $ 300.00
Internet Service $ 98.50 $ 1,182.00
Security and Alarm Services $ 650.00 $ 7,800.00
Depreciation of Warehouse Assets $ 65.60 $ 787.20
Facilities Rent $ 2,250.00 $ 27,000.00
Total Cost And Expenses $ 23,364.08 $ 280,368.96
Solution.
 Second Step: Calculate the Average Inventory, by summarizing the total
inventory for every type of product on Jan 1st and Dec 31st 2020
Initial Inventory Final Inventory
Description/ Concept
(Jan 1st 2020) (Dec 31st 2020)
Product A $ 223,200.33 $ 148,785.34
Product B $ 149,509.87 $ 99,663.28
Product C $ 129,625.30 $ 86,408.22
Product D $ 98,644.45 $ 65,756.39
Total Inventory $ 600,979.95 $ 400,613.23

Initial Inventory Final Inventory

(Jan 1th) + (Dec 31th)
Average Inventory =
(First Method)
2
$500,796.59
Average Inventory =
$600,979.95 + $400,613.23
(First Method)
2
Solution.
 Third Step: Use the Storage Cost Formula, to calculate the index

 Inventory Costs and

Expenses
Storage Cost = Average Inventory

$ 280,368.96
Storage Cost = $ 500, 796.59 0.5596

Conclusion: for every dollar ($1.00) invested on inventory, the

company pays ($0.5596) on storage cost, this number must
decrease as much as possible
Solution.
 Fourth Step: Based on the Storage Cost Index, the administration realizes that
this must decrease
 How Much Should it Decrease?
Actual Index – Historical Index = 0.5596 - 0.31= 0.249
Is there an Option to Increase the Margin of the products?

Decrease the inventory Cost, by selling more

units than the forecasted, and start with an offer

Solution Choices Decrease the Costs and expenses

Mix: Increase of Sales price +Selling more units

than forecasted
 Solution.
 Sixth Step: Use the Storage Cost Formula, to re-calculate the index

 Inventory Costs and

Expenses
0.35
Storage Cost =
$ 500, 796.59

 Inventory Costs and

Expenses
($ 500, 796.59) (0.35)

$ 175,278.81
 Solution.
 Sixth Step: Using the new Index, Calculate what would be the new value for
cost and expenses

 Inventory Costs and

Expenses
0.35
Storage Cost =
$ 500, 796.59

 Inventory Costs and

Expenses
($ 500, 796.59) (0.35)

$ 175,278.81
% Inventory Costs and Final inv. – Initial Inv. 64.99%
Expenses Decrease
Initial Inv.
Inventory Apportionment

 Apportionment: Proportional distribution of inventory acquisition and Storage

costs; be merchandise, raw materials or any good that is used for production
and sale to the customer.

Acquisition costs commonly includes:

Purchase Cost Foreign Freight Import/Export Local Freight

(Based on Fees (When occur)
Incoterms)

Merchandise
Handing.

Storage Cost