Chapter 5 - Controlling Inventory And Overhead Costs Flashcards
Inventory
Defined as items which had been purchased with the intention of selling it at a profit
Consists of three categories;
Direct material: basic material that is converted during production process
Work in process: materials not ready to be sold because they are still in the production process where labour and and overhead costs have been added
Finished goods: Products for sale after the production process
Define Stock piling
Keeping inventory of raw materials due to the time difference between the acquisition of the material and the use thereof in the production process.
Inventory must be available when required otherwise production will come to a standstill
Stock piling terminology
NORMAL STOCK - material which is in the process of production
BUFFER STOCK - material which for,s a buffer between production and usage
SAFETY STOCK - emergency reserve stock
SPECULATIVE STOCK - stock held for financial gain
STOCK TRANSIT - stock ordered and paid for but still being delivered
OVERSTOCKING - the amount of stock held is not justified by volume of inventory needed for production
UNDERSTOCKING - the amount of stock held is too low for volume of production
AVERAGE STOCK - opening stock-closing stock /2
MAXIMUM STOCK - highest amount of stock a business can keep sue to restraints in storage space
Methods of valuing inventory : FIFO METHOD
According to this method the inventory units first bought must be first sold.
Closing inventory reflects prices of items bought closer to the end of trading period.
PERPETUAL INVENTORY SYSTEM
VALUE OF INVENTORY IS CALCULATED AFTER EACH TRANSACTION
PERIODIC INVENTORY SYSTEM
VALUE OF INVENTORY ONLY CALCULATED AT THE END OF A SPECIFIED PERIOD
Cost categories of trading inventory
PURCHASING COSTS
- costs involving in acquiring the goods from suppliers e.g. Carriage, Railage, Freight
ORDERING COSTS
- costs of preparing, issuing and paying purchase orders for receiving and inspecting items.
STOCK OUT COSTS-
These costs occur when a company runs out of a item that is in high demand.
Like additional ordering costs
Or losing out of a sale
Opportunity costs is the loss of future sales as a result of the lack of stock and poor customer service.
Contribution margin
The difference between sale revenue minus variable costs.
This is used to cover fixed costs and contributes to profit.
4 categories of Quality costs
Prevention costs : costs used to prevent the production of inferior products
Appraisal costs: costs incurred to ensure that the products meet quality standards. Audits, inspections etc
Internal failure costs: costs incurred due to the failure of products to meet quality standards. Eg. Loss of production, scrapping raw materials
External failure costs: costs incurred when inferior products are delivered to customers.
ECONOMIC ORDERING QUANTITY (EOQ)
The most cost effective order size for an item of inventory.
As ordering quantity increases, carrying costs increase but ordering costs decrease
FORMULA
2DO/H + (Pxi)
Reorder point
Indicates a level of inventory at which an order should be initiated as to prevent exhausted inventory.
Reorder point = lead time X average daily/weekly usage
With safety stock = lead time X average daily/weekly usage + safety stock
ACTIVITY BASED COSTING
A cost model used to assign manufacturing overheads to different products produced based on the premise that products consume activities and activities consume resources which incur costs
ABC costing helps in reducing product cost distortion by creating a cost pool for activities that can be identified as cost drivers and then assigning overheads to products based in the actual number of separate activities they require to become finished goods.
ABC COSTING HELPS AN ENTERPRISE
IDENTIFY INEFFICIENT AND UNNECESSARY ACTIVITIES
IDENTIFY PROFITABLE PRODUCTS AND ACTIVITIES
FACILITATING PRODUCT CONTROL AND PRICING
IDENTIFYING AMD ELIMINATING UNPROFITABLE PRODUCTS
ADVANTAGES OF ABC COSTING
IMPROVED COST ESTIMATION AND PRODUCT PRICING
IMPROVED UNDERSTANDING OF OVERHEADS
IDENTIFYING INEFFICIENT ACTIVITIES
IMPROVING PRODUCT RANGE
ABC COSTING LIMITATIONS
TIME CONSUMING TO COLLECT ALL THE DATA AND COST ALL THE ACTIVITIES
THEREFORE ITS AN EXPENSIVE SYSTEM TO ADOPT
ASSIGNING SOME OVERHEAD COSTS MAY PROVE DIFFICULT AND GIVE RISE TO IRRELEVANT COST DRIVERS
MAY BE LIMITED BECAUSE IT USES HISTORICAL DATA
