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7/30/2019 Accounting for Materials (Adobe)
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ACCOUNTING FORMATERIALS
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Cost Accounting
Gathering of cost information
Attachment of costs to cost objects
Establishment of budgets, standard costs,actual costs (of operations, processes, activities orproducts)
Analysis of variances, profitability or the socialuse of funds
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Cost Object
Anything for which a separate measurement ofcost is desired
(Examples: product, service or department)
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Scope of Cost Accounting
The foundation of the internal financial informationsystem to facilitate:
CONTROL (organization and constituent parts work
efficiently towards agreed objectives)
DECISION-MAKING(choice between alternatives)
PLANNING(what cost will be like in the future, providestandards targets against which to compare actual results)
ESTIMATING & PRICING
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Unit Objectives
1. Describe the different procedures anddocuments necessary for ordering, receivingand issuing materials from inventory
2. Describe the control procedures used tomonitor physical and book inventory to
minimize discrepancies and losses.
3. Interpret the entries and balances in thematerial inventory account
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Unit Objectives
4. Prepare calculations, with explanations, of thecosts of ordering and holding inventory(including buffer inventory)
5. Calculate optimal reorder quantities includingsituations where discounts apply.
6. Interpret optimal reorder quantities includingsituations where discounts apply.
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Unit Objectives
7. Produce calculations to minimize inventory costswhen inventory costs when inventory is graduallyreplenished.
8. Apply appropriate methods for establishing reorderlevels where demand in the lead time is constant
9. Calculate the value of closing inventory andmaterial issues using LIFO, FIFO and averagemethods
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Inventory Control System
Controls should cover the following
functions:
1. The ordering of inventory
2. The purchase of inventory
3. The receipt of goods into stores
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Inventory Functions RequiringControl
4. The storage of goods
5. The issue of inventory.
6. Maintenance of inventory at most
appropriate level
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Reasons for Controlling Inventory
1. Holding costs may be expensive
2. Production will be disrupted if we run out of
raw materials
3. Unused inventory with short shelf life mayincur unnecessary expenses
4. Ensure quality inputs used to maintain goodreputation with customers
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Ordering & Receiving Materials
Every movement of material should bedocumented using the following:
1. Purchase requisition
2. Purchase order
3. Goods received note (GRN)
4. Materials requisition, transfer or returned note.
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Ordering, receipt and issue
Proper records of physical procedures forordering and receiving ensure:
Enough inventory is held
No duplication of ordering
Quality is maintained
Adequate record for accounting purposes
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Ordering & Receiving MaterialsDocuments used (1)
Purchase Requisition
From stores to purchasing department
Request for QuotationsFrom purchasing to potential suppliers to secure thebest mix of quality and prices
Purchase Order From purchasing to supplier, accounts payable,
originating dept, stores/goods receiving dept.
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Ordering & Receiving MaterialsDocuments used (2)
Delivery notesent by supplier with goods which are thenchecked against the purchase order for quality
and quantity
Goods Received Note
From stores to accounts payable
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Goods Receival
Incoming goods taken to central goodsreceiving department facilitates control
Ensure goods arriving actually agree in detailto those ordered (purchase order, deliverynote, counted, inspected)
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Goods Receival
GRN prepared as evidence that goodsordered received and can be paid for)
Copies sent to accounts for comparison withsuppliers invoice and payment to be made.
Basis for entering receipts of materials instores (warehouse) records
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Issuing Materials - Documents used
1. Materials requisition noterecords the quantity of goods issued to differentdepartments (or production jobs)
2. Materials transfers and returnstransfer note prepared where goods are transferred toanother dept or job
3. Materials returnsreturned note prepared where goods not used arereturned to the stores dept.
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Form Purchase Requisition
PURCHASE REQUISITIONDate __________________Serial No._____________Purpose: _____________________ (inventory/special capital
equipment/budget ref)
Qty Description
Mater-ialCode
Job/DeptCode
DeliveryReqd
Purchase Order
Date Place No. Date Suppl-ier
Origination Dept. _________________ Authorization ____________
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Form Purchase Order
PURCHASE ORDERTo________________ Serial No:______________Date____________ Purchase Req. No._______
Qty Descriptio
n
Code Delivery
Date
Price Per (unit)
Your quotation_______________To be delivered carriage paid to _____________________
Please quote our Purchase Order number on all correspondence.
For ABC Ltd. ____________________________________
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Form - Goods Received Note
GOODS RECEIVED NOTETo_____________________ Serial No. ________________Date Issued: _______________Carrier_________________Date of delivery___________ Purchase Order No. _________
DescriptionCode Quantity Packages GrossWeight
INSPECTION REPORT Recd by ____________Reqd by ____________Qty passed Qty
rejected
Remarks
Accepted:___________Date: _______________Inspector______________ Date __________
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Computerized Inventory ControlSystems (1)
Many systems are computerized and most havethe following features:
Data must be input into the system may befrom the various forms or the information iskeyed directly into the system and
hardcopies can be printed
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Computerized Inventory ControlSystems (2)
An inventory master file is maintained i.e.database with details for every category ofinventory
The system will generate outputs hardcopyrecords, VDU screen display or printedreports.
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Objectives of Storing Materials 1
1. Speedy issue and receipt of materials
2. Full identification of all materials at all times
3. Correct location of all materials at all times
4. Protection of materials from damage and
deterioration
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Objectives of Storing Materials 2
5. Provision of secure stores to avoid pilferage,theft and fire
6. Efficient use of storage space
7. Maintenance of correct inventory levels
8. Keeping correct and up-to-date records ofreceipts, issues and inventory levels
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Recording Inventory Levels
Most frequently encountered system forrecording inventory movements are
Bin Card Kept with the actual inventory and updated with
receipts and issues
Stores Ledger Account Shows receipts, issues, $ values, inventory
control levels and running balances.
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Bin Card
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Part No._________________ Location: ___________________________
Bin No. ________________ Stores Ledger No. ____________________
Receipts Issues BalanceDate Qty GRN Date Qty Req No.
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Stores Ledger Account
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Material ____________________ Maximum Qty ________________________
Code ______________________ Minimum Qty ________________________
Date Receipts Issues InventoryGRN Qty Unit
Price$
Amt$
Stores
Req.No.
Qty
UnitPrice
$
Amt$
Qty UnitPrice
$
Amt$
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Free InventoryFree Stock Balance (FSB)
Scenario:
You are the storekeeper. On Monday of thisweek, the production manager requests 100
pieces of foam. She needs them on Friday butyou only have 50 pieces.
Give me reasons why you may not betroubled by the insufficient quantity offoam pieces on hand.
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Free InventoryFree Stock Balance (FSB)
Physical stock
Useful for issuing, stocktaking, controlling stock
levels
Free Stock
Useful for replenishment ordering
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Free InventoryFree Stock Balance (FSB)
FSB provides a full picture of the currentinventory position what is really available forfuture use.
FSB = Materials on hand+ Materials on order from suppliers
Materials requisitioned, not yet issued.
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Question on FSB
A wholesaler has 8,450 units outstanding forpart X100 on existing customers orders; there
are 3,925 units in inventory and the calculated
free inventory is 5,525 units.
How many units does the wholesalerhave on order with his supplier?
A: 9,450 B 10,050 C 13,975 D 17,900
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Identification of Materials (1)(inventory/materialscodes)
Materials held in stores are coded andclassified and provide the following advantages
1. Ambiguity is avoided
2. Time is saved descriptions can be lengthyand time consuming
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Identification of Materials (2)(inventory/materialscodes)
3. Production efficiency is improvedcorrect material can be accuratelyidentified from a code number
4. Computerized processing is made easier
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Identification of Materials (3)(inventory/materialscodes)
4. Numbered code systems can bedesigned to be flexible and can beexpanded to include more inventory
items as necessary
Digits in a code can stand for type ofinventory, supplier, department and so forth.
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The Inventory Count(Stocktake)
Involves counting the physical inventory on
hand at a certain date, and then checking
this against the balance shown in the
inventory records.
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Th I t C t
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The Inventory Count(Stocktake)
There are 2 approaches:
Periodic:
all items (raw materials, WIP and finished goods)
counted and valued at a set time, usuallyaccounting year-end
Continuous:
counting and valuing selected items at differenttimes on a rotating basis. Involves a specialistteam counting and checking a number of itemseach day.
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Advantages of Continuous Stocktaking(1)
1. Annual stocktake unnecessary and thedisruption it causes
2. Skilled stocktakers employed reduces likelyerrors
3. More time available reduces errors and
allows investigation
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Advantages of Continuous Stocktaking(2)
4. Deficiencies and losses revealed soonerfor corrective action to be taken
5. Production hold-ups are eliminated as storesstaff always available to deal with issues
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Advantages of Continuous Stocktaking(3)
6. Staff morale improved and standards raised
7. Control over inventory levels is improvedless likelihood of overstocking or stockouts
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Reasons for Inventory Discrepancies 1
Discrepancies will occur investigate thecauses and take corrective action
1. Quantity errors eg, miscounts during thestock take.
2. Classification errors eg, a stainless steel part
classified as mild steel
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Reasons for Inventory Discrepancies 2
3. Pricing errors e.g., a correctly counted andclassified item might be priced at $56 for1000 instead of $56 per 100
4. Recording errors e.g., an omission of theentry of a goods received note.
5. Systems error e.g., no adequate recording ofreturns to stores.
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Perpetual Inventory
This is an inventory recording system whereby therecords (bin cards and stores ledger accounts) areupdated for each receipt and issue of inventory as itoccurs.
There is a continuous record of the balance onhand which is used to calculate the inventory figure
for the financial statements
Continuous stocktaking is necessary to ensure theperpetual system is functioning correctly
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Ob l t d t i ti d l
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Obsolete, deteriorating and slowmoving inventories and wastage
Obsolete (out-of-date) items should be writtenoff and disposed of if no longer required.
Inventory items may be wasted (eg broken,damaged) write-off, update inventory recordsand accounts.
Slow moving (quantity on hand will take a longtime to be used up). Excess inventory to bewritten off as obsolete inventory.
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Preparation for Next Class
We will be looking at inventory control levels
which will cover the following topics:
Inventory costs
Minimum, maximum and reorder levels Reorder quantity
Economic order quantity (EOQ)
Economic order quantity (EBQ)
Read textbook pages 104-113
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INVENTORY CONTROLLEVELS
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Elements of Inventory Costs
Purchase
Holding (or carrying)
Ordering and
Stockout (costs of running out of inventory
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Reasons for Holding Inventories (1)
Ensure sufficient goods are available to meetexpected demand
Provide a buffer between processes
Meet any future shortages
Take advantage of any bulk purchasingdiscounts
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Reasons for Holding Inventories (2)
Absorb seasonal fluctuations in usage/demand
Allow production processes to flow smoothly
Necessary part of production process(maturing cheese)
Deliberate investment policy (expectedinflation or shortages)
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Holding Costs
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Holding Costs(driven by inventory levels)
Storage and stores operations
Interest charges
Insurance
Risk of obsolescence
Deterioration
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Ordering Costs
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Ordering Costs(driven by frequency of orders)
Clerical and administration
Transport
Production run
(for inventory manufactured internally)
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Stockout Costs (1)
Lost contribution from lost sales
Loss of future sales
Loss of customer goodwill
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Stockout Costs (2)
Cost of production stoppages
Labour frustration over stoppages
Extra costs of urgent, small quantity
replenishment orders
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Objective of Inventory Control
Maintain inventory levels so that sum total of
holding, ordering and stockout costs are
minimized.
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Inventory Control Levels
There are 3 critical control levels
Reorder
Minimum and
Maximum
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Reorder Level
Level at which a replenishment order shouldbe placed
Reorder Level= maximum usage (rate of consumption) x
maximum lead time
Lead time is the time between ordering andreplenishment
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Minimum Level
Warning level that inventories approachingdangerously low level and stockouts are
possible
Mininimum level
= reorder level (ave usage x ave lead time
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Maximum Level
Warning level that inventories are reaching apotentially wasteful level
Maximum level= ROL+ reorder quantity (ROQ)
(min usage x min lead time)
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Question - Maximum Level
A large retailer with multiple outlets maintainsa central warehouse from which outlets aresupplied. The following is available for part #
SF525. Ave. usage = 350 per day
Min. usage = 180 per day
Max. usage = 420 per day
Lead time for replenishment = 11-15 days
Reorder qty. = 6,500 units
Reorder level = 6,300 units
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Question - Maximum Level (contd)
Based on the above,
A. What is the maximum level?
A: 5,250 B: 6,500 C: 10,820 D: 12,800
B. What is the approx. no. of SF525 carried asbuffer inventory?
A: 200 B: 720 C: 1,680 D: 1,750
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Example60
The following data relates to a particular stock item: Maximum Usage 130 units per day
Minimum Usage 70 units per day
Lead Time 20-26 days EOQ 5000 units
Calculate:
ROL (Ans = 3,380) Minimum Level (Ans = 1,080)
Maximum Level (Ans = 6,980)
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Reorder Quantity & Ave. Inventory
ROQ is the quantity of inventory ordered whenthe ROL is reached
Average inventory (assuming inventory is usedevenly)
= safety inventory + ROQ
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Economic Order Quantity
EOQ = The optimum order size
EOQ is that ROQ that minimizes the balance
of cost between ordering (Co) and holding(Ch) costs
Can be calculated using a table, graph orformula
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EOQ Assumptions
Known, constant per unit stockholding cost
(some costs may increase on a step basis, eg hiring of
storekeepers)
Known, constant ordering cost
Rates of demand known
Known constant price per unit (quantity discounts
may be offered)
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OQ
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EOQ Assumptions 2
Replenishment made instantaneously (wholebatch is delivered at once)partial deliveries anddelays common
Average stock = Q/2 (violated if constant amount notused per day; distinct possibility seasonal and cyclical factorsproduce uneven usage)
Assumptions unlikely in practice but a useful startingpoint in establishing appropriate ROQ
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EOQ
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EOQ
Let us say 500k units are needed over a giventime period:
5 orders of 100k units incur less ordering costs
than 10 orders of 50k 5 orders of 100k units incur more holding costs
than 10 orders of 50k
As ROQ increases, Ch increases and Co falls
As ROQ decreases, Ch falls and Co increasesLorence Brown, UTECH
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EOQ
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EOQ
Average inventory = Q/2 (assume no safetystock)
No. of orders = D/Q
Annual holding cost = Q/2 x Ch(i.e., ave. inventory x cost to hold 1 unit for a year)
Annual order cost = D/Q x Co(i.e. No. of orders x cost to place 1 order)
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EOQ F l
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EOQ Formula
EOQ = 2 x Co x D / Ch
Co = ordering cost per order
D = demand p.a. (hence @12k per month, D =
144k) or during given time period
Ch = holding cost per item p.a. (oftenexpressed as a %age p.a. of the unit cost)
Note: at EOQ, Total Ch = Total Co
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E l
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Example68
The following data relates to a particular stock item: Demand 1000 units per month
Ordering Cost $350 per order
Unit Cost $8 Carrying Cost 15% per annum
Calculate (a) The EOQ (Ans = 2,646)
(b) Total holding cost (Ans = $1,587.60) (c) Total ordering costs (Ans = $1,587.60)
(d) Total cost (Ans = $3,174.90)
Factors Influencing Choice of Order
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Factors Influencing Choice of OrderQuantity
Shortage of future supplies
Future price increases
Obsolescence
Steps to reduce safety stocks (eg new supplier
with promise of quicker and more reliable
delivery)
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Economic Batch Quantity
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Economic Batch Quantity(EBQ) Formula
EOQ = 2 x Co x D / Ch (1 D/R)
R = production rate per time period
Q = the amount produced in each batch
D = usage per time period
Co = the set up cost per batch Ch = holding cost per unit of inventory per
period of time
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EBQ
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EBQ
Ave. Inventory
= Q(1 - D/R) / 2
Total Holding Cost
= [Q(1 - D/R) / 2] x Ch
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I t f Q tit Di t
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Impact of Quantity Discount
Assumption of known, constant ordering priceviolated and so alternate approach required
Total Cost= (D/Q x Co) + (Q/2 x Ch) + (D x Unit Price)
Table prepared showing total cost at alternate
values of Q Value of Q at which total cost is at a minimum is
selected as the optimum ROQ
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Q ti
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Question
A company uses an item of inventory as follows:
Purchase price = $96 per unit
Annual demand = 4,000 units
Ordering cost = $300 Annual holding cost = 10% of purchase price
EOQ = 500 units.
Required:Ascertain whether the company should order the item
1,000 units at a time in order to secure an 8% discount.
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P i di R i S t
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Periodic Review System
Constant Cycle systemVARIABLE QUANTITIES, FIXED TIME
INTERVALS
Stock levels for all parts reviewed at fixedintervals
Where necessary, replacement order issued
Quantity not previously set based on likelydemand until next review, present levels, leadtimes
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R d L l S t
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Reorder Level System
Two-Bin System
FIXED QUANTITIES, VARIABLE TIME INTERVALS
Pre-determined order level set for each item
When stock falls to ROL, replenishment order issued
Replenishment order invariably EOQ
Organizations adopting ROL maintain system that
triggers replenishment order when predetermined
reorder level reached. (explain 2-bin concept).
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Other Systems for Stores Control &
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yReordering
Classification of materials (ABC method) Expensive and medium cost materials subject to
careful stores control
Inexpensive materials stored in large quantities
Pareto (80/20) distribution
80% of value is accounted for by only 20% of
stores These should be monitored closely
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Accounting Entries for Materials
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gCosts
Material Control Account
Payables Control (purchases) X Payable Control(returns to suppliers))
X
WIP(return to stores of materials
issued to production)
X WIP(direct materials issues to
production)
X
Factory Overheads(issues not directly related toproduction)
X
Closing Inventory
(balancing figure)
x
XX XX
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CENTRALIZED STORAGE
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Advantages I (bonus slide)
1. Lower stock on average
2. Less risk of duplication.
3. Higher quality staff may be usefully employedto specialize in various aspects ofstorekeeping
4. Closer control is possible on a central site.
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CENTRALIZED STORAGE
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Advantages 2 (bonus slide)
4. Possibly more security from pilferage.
5. Some aspects of paperwork may be reduced,eg, purchase requisitions
6. Stocktaking is facilitated.
7. Likelihood that more advanced equipment willbe viable, eg, materials handling, visualdisplays.
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CENTRALIZED STORAGE
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Disadvantages (bonus slide)
1. Less convenient for outlyingbranches/departments.
2. Possible loss of local knowledge.
3. Longer delays possible in obtaining materials.
4. Greater internal/external transport costs infetching and carrying materials.
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Example (FIFO LIFO AVCO)
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Example (FIFO, LIFO, AVCO)
Receipts of goods 1/Sep: 50 units @ $10 each
5/Sep: 50 units @ $12 each
13/Sep: 50 units @ $14 each Issue of goods
12/Sep: 50 units sold @ $20 each
Using LIFO, determine the value of closinginventory at the end of the period.
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FIFO LIFO & AVERAGE COST
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FIFO, LIFO & AVERAGE COST
Remember1. You cannot issue/sell what you do not have
2. Transactions must be processed in strict dateorder
3. After each transaction, you must determine the
make-up of your inventory balance
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,(impact of price movements)
Inflationary conditions - rising prices Earlier and lower priced items sold first, therefore
CGS is lower and profits higher
Conversely, higher priced items make up closinginventory, which lowers CGS and makes profitshigher
Under LIFO, the opposite occurs
Deflationary conditions - falling prices Conditions opposite to those under FIFO
Average cost falls between FIFO and LIFO
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Comparison of LIFO vs FIFO
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(inflationary conditions)
CGS Profit CI
FIFO L H H
LIFO H L L
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Comparison of LIFO vs FIFO
7/30/2019 Accounting for Materials (Adobe)
86/92
(deflationary conditions)
CGS Profit CI
FIFO H L L
LIFO L H h
Lorence Brown, UTECH
86
7/30/2019 Accounting for Materials (Adobe)
87/92
FIFO Disadvantages
7/30/2019 Accounting for Materials (Adobe)
88/92
FIFO Disadvantages
Cumbersome to operate (must monitor eachbatch individually)
Managers may find it difficult to comparecosts and make decisions due to varyingprices
During high inflation, issue prices lag behindcurrent market value
Lorence Brown, UTECH
88
LIFO Advantages
7/30/2019 Accounting for Materials (Adobe)
89/92
LIFO Advantages
Goods issued at prices close to current marketvalue
Managers continually aware of recent costswhen making decisions
Lorence Brown, UTECH
89
LIFO Disadvantages
7/30/2019 Accounting for Materials (Adobe)
90/92
LIFO Disadvantages
Cumbersome to operate (must monitor eachbatch individually)
Often opposite to the physical flow of goods(where earlier items used first)
Decision-making difficult because of variations in
prices)
Not accepted by IAS
Lorence Brown, UTECH
90
AVCO Advantages
7/30/2019 Accounting for Materials (Adobe)
91/92
AVCO Advantages
Fluctuations in prices smoothed out
Easier to administer than FIFO or LIFO asthere is no need to identify each batchseparately.
Lorence Brown, UTECH
91
AVCO Disadvantages
7/30/2019 Accounting for Materials (Adobe)
92/92
AVCO Disadvantages
Resulting issue price is rarely an actual price
Prices tend to lag behind current marketvalues under inflationary conditions.
92