Inventory Homework Help

What is inventory?

Inventory or stock is the goods in a business that a business needs to keep in spare or hold in the place for resale. It is the raw materials, work-in-process products and finished goods. They are considered as a part of a business’s assets that are that are ready or will be ready for sale. In accounting turnover of inventory is seen as the primary source of revenue generation and subsequent earnings for the company's shareholders. Therefore, Inventory is counted as one of the most significant assets in a running business.

What is inventory management?

Inventory management is the placement of stocks in a business. It deals with deciding the shape in which the inventory should be set up and managed. It is important to be applied in different locations in a facility or in many locations of supply network.

There is a time gap between production of goods and their reaching to the retails or the selling unit. Inventory management consists of the following:

Replenishment lead time,
carrying costs of inventory,
asset management,
inventory forecasting,
inventory valuation,
inventory visibility,
future inventory price forecasting,
physical inventory,
Available physical space for inventory,
quality management,
Replenishment,
Returns and defective goods,
Demand forecasting.

Why should there be management of inventory in a business?

There are five components which determine the inventory management of a business. They are:

1. Time – there always are time lags in the supply chain as it takes time for production process to complete and then to be transported to its destination. This lag is starts from supplier to user at every stage and hence there arises the requirement of maintaining a certain amount of inventory to use for te time being and for keeping the business going on. Every business needs to maintain a lead time in which it needs to maintain inventory for consumption. This lead time itself can be taken in consideration by ordering that many days in advance.

2. Seasonal Demand: some goods a have a higher demand in a certain season or in a certain part of the year but the producing capability of a producer stays same. It can produce a certain good in a given time only and had limited capability to produce it. There it produces more as it anticipates high demand during a certain part of the year. This can lead to stock accumulation, consider for example how goods consumed only in holidays can lead to accumulation of large stocks on the anticipation of future consumption.

3. Uncertainty – it is not certain that there will be a steady demand of the supply will be at a given time only. Therefore, Inventories are maintained in order to act as a buffers to meet uncertainties in demand, supply and movements of goods.

4. Economies of scale – economies of scale are a concept where it is observed that in production of a specific good there are a lot of cots that are incurred in terms of logistics. Therefore, it is ideal to produce them in bulk to reduce cost and also buy them in bulk for the same reason the transportation is very easy if economies of scale are followed. And hence the concept inventory generates from economies of scale.

5. Appreciation in Value - In some situations, some stock gains the required value when it is kept for some time to allow it reach the desired standard for consumption, or for production.

Important terms included in inventory management.

Stock Keeping Unit (SKU): SKUs are marked on every product of the whole inventory with the purpose of keeping a record of each unit. These are clear, internal identification numbers. Each variant of every product in the whole inventory has it and is unique for every unit. SKUs can be any combination of letters and numbers.
Stock out: stock out is a situation where a business runs out of inventory.
New old stocks (NOS): new old stocks are stocks which are unused and also which have been produced a long time ago and won’t be produced further and should be sold in the present only.it is a term mainly used in a running business to refer to merchandise on sale being manufactured a long time ago and never used.

Types of stocks

Buffer/safety stock
Reorder level
Cycle stock
De-coupling
Anticipation stock
Pipeline stock

Division of Inventory

Inventory is commonly divided into the following by most of the manufacturing organizations:

Raw materials - materials and components used for making a product or processed to be changed into a new product.
Work in process, WIP - materials and components in their early stage and having begun their transformation to finished goods.
Finished goods - goods ready for sale to customers.
Goods for resale - returned goods that are salable.
Stocks in transit.
Consignment stocks.
Maintenance supply.

Costs that might be incurred due to inventory

There are several costs associated with inventory.

Ordering cost
Setup cost
Holding Cost
Shortage Cost

Accounting for inventory

Inventory is recorded in the books of accounts of each country according to their own financial reporting rules. To understand this we take the example of the US where the organizations define inventory according US Generally Accepted Accounting Practices (GAAP), the rules defined by the Financial Accounting Standards Board (FASB) along with other institutions which are then enforced by the U.S. Securities and Exchange Commission (SEC) and other federal and state agencies.

Now we discover that there are two types of factories that exist, one is the ‘one process, factory and the other is the multi process factory. Therefore, the internal costing/valuation of inventory of the factories can be complex. In the earlier times of the industrial evolution there were enterprises running simple on the model of ‘one - process factories’ these one process factories create a market for themselves and establish an independent market value for goods. Multistage - process companies have a complex inventory management as they produce not one but many goods together.

What is the financial accounting of inventory?

Inventory held by a business can be a benefit as well as a liability. It is counted as an asset in the balance sheet but at the same time it also blocks the money or ties it up which could have indeed served for other purposes. also cash is needed for the additional expense fir its protection. Not only this but inventory can incur tax expenses too depending on the country’s laws regarding depreciation of inventory.

Inventory is a current asset for a business as it can be converted into cash by selling it. It is also used a way to manipulate their profit loss statements and other accounting books as some companies hold large quantities of inventory, larger than what their operations need just for the sake of inflating their capital and misleading facts about their profitability.

To deliver large quantities of inventory they first need to stock up and present their worth so that they get bigger orders. If they stock up little they are not in a position to serve to large orders.

Valuation of inventory

There are four methods through which a business can carry out valuation for it inventory. The methods are:

Specific identification of cost
First – in, First – out (FIFO)
Last – in, First – out (LIFO)
Weighted average method

1. Specific Identification Cost: in this method the main feature is that the cost is marked on each unit or it its container or the unit can be located to its purchase invoice or cost record. It is suitable when the purchases are not frequent and when old items can’t be mixed up with the new ones. Here the enterprise sells relatively few items but at high unit cost.

2. First- in First- out (FIFO): in this method it is implied that the inventory first acquired is to be used first and the last acquired be used after the earlier lot is done with. The ending inventory is therefore assumed to be consistent of goods purchased recently. But it is important to remember that this cost flow or good flow need not be true as a physical fact. It is a means for accounting and not the actual physical movement of inventory.

3. Last- in, First- out (LIFO): in this method it is implied that the inventory last acquired is to be used first and the first acquired be used after the current lot is done with. The ending inventory is therefore assumed to be consistent of goods purchased in the very starting at earlier costs. So the cost of goods sold is based on price of recently purchased goods and the ending inventory represents the cost of earlier.

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