BBA Cost Accounting to Direct Material Inventory Control Topic Wise Short Notes Study Material

Bba Cost Accounting to Direct Material Inventory Control, Topic wise Short Notes Study Material

Fixation of Inventory Levels

Various levels of inventory are fixed to see that on excess inventory is carried and simultaneously there will not be any stock outs. The following inventory levels are fixed each item of stock: 

Re-order Level-

It is the level of stock availability when a new order should be raised. The stores department will initiate the purchase of material when the stock of material reaches at this point. This level is fixed between the minimum and maximum stock levels and the following formula is useful for this purpose:

Minimum Stock Level-

It is the lower limit below which the stock of any stock item should not normally be allowed to fall. Their level is also called ‘safety stock’ or ‘buffer stock level’. The main object of establishing this level is to protect against stock-out of particular stock item and in fixation of which average rate of consumption and the time required for replenishment, i.e., lead time are given prime consideration.

Maximum Stock Level-

It represents the upper limit beyond which the quantity of any item is not normally to rise to ensure that unnecessary working capital is not blocked in order quantity. Maximum stock level can be expressed in the formula given below:

Danger Level-

It is fixed below the minimum stock level and if stock reaches below this level, urgent action for replenishment of stock should be taken to prevent stock out position.

Average Stock Level-

It is the average of minimum and maximum stock levels.

Bba Cost Accounting to Direct Material Inventory Control, Topic wise Short Notes Study Material

VED Analysis

VED analysis divides items into three categories in the descending order of their critically as follows:

  • ‘V’ stands for vital item and their stock analysis requires more attention, because out-of-stock situation will result in stoppage of production. Thus, ‘v’ items must be stored adequately to ensure smooth operation of the plant.
  • ‘E’ means essential items. Such items are considered essential for efficient running but without these items the system would not fail. Care must be taken to see that they are always in stock.
  • ‘D’ stands for desirable items which do not affect the production immediately but availability of such items will lead to more efficiency and less fatigue.

VED analysis can be very useful to capital intensive process industries. As it analyses items based on their importance and it can be used for those special raw materials which are difficult to procure.

Bba Cost Accounting to Direct Material Inventory Control, Topic wise Short Notes Study Material

FNSD Analysis

Age of inventory indicates during of inventory in organisation. It shows moving position of inventory during the year. If age of inventory is minimum it means, the turnover position of that particular item of inventory is satisfactory. If the age of any particular item of inventory, it indicates the slow moving of stock which may be due to lower demand for the product, inefficiency in stocking policy, excessive stocking etc. the excessive investment in stocks means, high investment is locked-up in inventory leads to lower profitability of the firm due to excess carrying costs. FNSD analysis divides the items into four categories in the descending order of their usage rate as follows:

  • ‘F’ stands for fast moving items and stocks of such items are consumed in a short span of time. Stocks of fast moving items must be observed constantly and replenishment orders be placed in time to avoid stock-out situations.
  • ‘N’ means normal moving items and such items are exhausted over a period of a year or so. The order levels and quantities for such items should be on the basis of a new estimate of future demand, to minimize the risks of a surplus stock.
  • ‘S’ indicates slow moving items, existing stock of which would last for two years or more at the current rate of usage but it is still expected to be used up. Slow moving stock must be reviewed very carefully before any replenishment orders are placed.
  • ‘D’ stands for dead stock and for its existing stocks no further demand can be foreseen. Dead stock figures in the inventory represents money spent that cannot be realized but it occupies useful space. Hence, once such items are identified, efforts must be made to find all alternative uses for it. Otherwise, it must be disposed of.

Bba Cost Accounting to Direct Material Inventory Control Topic wise Short Notes Study Material

ABC Analysis

In this technique, the items of inventory are classified according to value of usage. The higher value items have lower safety stocks, because the cost of production is very high in respect of higher value of items. The lower value items carry higher safety stocks. ABC analysis divides the total inventory list into three classes A, B, and C using the rupee volume, as follows:

  • Items in class ‘A’ constitute the most important class of inventories so far as the proportion in the total value of inventory. The ‘A’ items consists of approximately 15% of the total items, accounts for 80%of the total material usage.
  • Items in class ‘B’ constitute an intermediate position, which constitute approximately 35% of the total items, accounts for approximately 15% of the total material consumption.
  • Items in class ‘C’ are quite negligible. It consists remaining 50% items, accounting only 5% of the monetary value of total material usage.

The numbers are just indicative and actual break-up will vary from situation to situation. The above categorization is represented in the table given below:

Figure shows ABC analysis of inventory class ‘A’ is made up of inventory items which are either very expensive or used in massive quantities. Thus these items, though few in number contribute a high proportion of the value of inventories. Class ‘B’ items are not so few in number, but also they are not too many either. Value wise also, they are neither very expensive nor very cheap. Moreover, they are used in moderate quantities. ‘Class ‘C’ contains a relatively large number item. But they are either very inexpensive items or used in very small quantities so that they do not constitute more than a negligible fraction of the total values of inventories. The control of inventory through ABC analysis is exercised as follows:

  • ‘A’ class items merit a tightly controlled inventory system with constant attention by the purchase and stores management. A larger effort per item on only a few items will cost only moderately, but the effort can result in large savings.
  • ‘B’ class items merit a formalized inventory system and periodic attention by the purchase and stores management.
  • For ‘C’ class items still relaxed inventory procedures are used.

The table below shows how an organisation treats the various classes of items according to their consumption value. For ‘A’ class items, the inventory policy, i.e., order quantity and re-order point should be carefully determined and the close control over the usage of materials is desirable. For ‘B’ class items the economic order quantities and re-order level calculations can be done and larger stocks can be maintained. The review of these items may be done quarterly or half-yearly. In case of ‘C’ class items generally one year supply can be maintained. Periodic review once a year may be sufficient.

The technique tries to analyse the distribution of any characteristics by stock values of importance in order to determine its priority. The technique can be applied in all facets of organisation. Many organisations are applying this technique in materials management and spare parts management to identify the contribution made by the materials/spares in the total inventory value. On the basis of stock value, materials procurement strategy and consumption strategy is decided.

Bba Cost Accounting to Direct Material Inventory Control, Topic wise Short Notes Study Material

Pareto Analysis

Pareto analysis is based on theory that a small percentage of totals can have a large effect on the rest. It is also called as ‘80/20 rule’. It is based on observation that a small portion of items usually accounts for the majority value. Pareto analysis recommends that the management should focus on key issues of decision making to simplify the decision making process. It will help the management to put their energy and effort towards the majority areas requiring utmost attention. The major applications of the technique are as follows:

Inventory Control-

In working capital management Pareto analysis (80: 20) rule is important for management of inventory. According to the rule 20% of the stocks will represent 80% of the turnover value. Therefore, the management should concentrate on 20% items which represent 80% value, to frame inventory control measures and should be kept under close scrutiny. The technique is similar to that of ABC analysis of inventory.

 Receivable Management-

Normally 20% of customers accounts represents for 80% of the debtors balance. The management should concentrate on the 20% accounts for the timely collection of debtor’s balance, which helps in improving the organisation’s liquidity, as well as, profitability.

 Product Pricing-

Pareto analysis can be applied to the firms whose portfolio of products is too large. It helps in analyzing the firm’s estimated sales revenue from various products, and it might indicate that approximately 80% of the total sales turnover is generated by 20% of its products and the management should carefully price those 20% products to maximize profitability of the organisation. This helps in company’s survival and growth.

Customer Relationship-

The Pareto analysis suggests that approximately 20% of firm’s customers cause to generate 80% of its total turnover. The top management should identify those 20% customers to maximize customer satisfaction through customer relationship management to improve the profitability of the organisation.

Quality Management-

Normally, 80% of the reported quality problems are traceable to 20% of the underlying process defects. Therefore, the management should concentrate on rectification of those 20% defects, which will have greater impact on product quality, customer satisfaction and organisation’s profitability.

Activity Based Costing-

The concept of activity based costing is based on the identification of appropriate drivers for its overheads. Pareto analysis suggests that 20% of the firm’s cost drivers cause to incur 80% overheads. By careful identification of those 20% cost drivers helps in better allocation of overheads and to ascertain accurate product cost.

Bba Cost Accounting to Direct Material Inventory Control, Topic wise Short Notes Study Material

Just-in- Time and Inventory Management

The major emphasis of just in time (JIT) is inventory management. It aims at eliminating as far as possible all manufacturing and finished goods inventories. The major focus upon the idea of producing in response to need rather than as a consequence of plans and forecasts. It tries to ensure that nothing is processed that is not needed. Instead of pushing inventory into the system in order to make product they turned the process round and used the pull from the market place or the next operation. JIT system involves the total quality management, redesign of plant layout, reschedule of receipts of raw materials and the delivery of finished goods. It eliminates unnecessary waste due to over production. It attempts to minimize inventories through small incremental reductions rather than particular techniques and methodologies. A JIT system calls for the steady and frequent delivery of parts and materials from suppliers. It requires a reduction in the lead times of suppliers so that the manufacturer can tune the supplier’s material release to the actual consumption rates in the process. JIT does not accept processing time as a constant and tries to reduce it as much as any other kind of time. The reduction in set-up time, flexibility in manufacture, shorter lead times and reduced inventories are the basic aims of JIT system. JIT system enables material requirement planning and production scheduling to eliminate the production bottlenecks.

  • The overriding feature of JIT is that materials or parts are generated in the exact quantity required and just at the time they are needed. A classic JIT system consists of a series of manufacturing units each delivering to one another in successive stage of production. The amount delivered by each unit to the next unit is exactly what the needs for the next production period (usually one day). There are no safety margins in the form of buffer stocks, live storage or work-in-progress. The JIT system minimizes inventory and its associated costs within the whole manufacturing /supply chain. JIT challenges the underlying assumptions of economic batch quantity. In an ideal JIT system, the throughput time for a part or product will exactly equal to its processing time. The benefits of JIT include:
  • The right quantities are purchased or produced at the right time.
  • The cost-effective of higher –quality standards and better levels of customer service both to internal and external customers.
  • The minimization of inventory work-in –progress and waste.
  • The systematic identification of operational problems and the development of technology based tools for correcting identified problems.
  • The production of goods which meet exactly the needs of customers immediately on demand.

Bba Cost Accounting to Direct Material Inventory Control, Topic wise Short Notes Study Material

Supply Chain and Inventory Management

Supply chain management solves purchasing problems by foregoing the short-term benefits of competitive bidding in order to develop special long-term relationships. In exchange, the vendor coincides his production schedule and quality standards to the plant’s needs, thus reducing uncertainty and hence the need for excess inventories. A supply chain management system cal for the steady and frequent delivery of parts and material from suppliers. It therefore requires a reduction in the lead times of suppliers so that the manufactures can tune the supplier’s material releases to the actual consumption rates in the factory. The release and scheduling process with suppliers consists of four steps:

  • Make a long – term purchase commitment to suppliers.
  • Give suppliers a monthly forecast for a rolling period of six months.
  • Establish with the supplier a monthly firm release for the next month of production.
  • Make an agreement with the supplier on the policy for changing delivery dates.

Bba Cost Accounting to Direct Material Inventory Control, Topic wise Short Notes Study Material

Summary

  • The inventory of a manufacturing concern consists of raw material stock, work-in-process stock, finished goods stock, stock of stores and consumables etc.
  • Inventory management looks into the aspects of optimisation of investment in inventory, proper accounting and control of inventory, avoid stock –out situation, avoid over-stocking regular monitoring of stocks levels, availability of material in time etc.
  • Stock control is defined as the systematic regulation of stock level by concentrating in the areas of ordering, purchase, receipt, storage and issues.
  • Input-output ratio indicates the relationship between the quantity of material used in production and the quantity of final output.
  • Stock turnover ratio indicates the number of times the average stock is held as compared to the annual consumption of raw materials.
  • Economic order quantity is the optimum size of the order for a particular item of inventory at that point the ordering costs and carrying costs of inventory are minimized.
  • The inventory levels like re-order level, minimum stock level, maximum stock level, and damager level are fixed to see that no excess inventory is carried and simultaneously there will be no stock-outs.
  • VED analysis classifies the inventory into vital items essential items and desirable items, to know the critical stock items.
  • FNSD analysis classifies the inventory into fast moving items, normal moving items, slow moving items and dormant items to analyse the turnover position of each item of inventory.
  • ABC analysis divides the inventory into three classes, A, B and C in order of the consumption value. ‘A’ class items are tightly controlled. ‘B’ class items are moderately controlled, and ‘C’ class items are controlled by adopting relaxed control procedures.
  • In Pareto analysis, the total items of inventory are classified using 80: 20 rule the rule says 20% items represents 80% of value and management should concentrate on those 20% items, leaving the 80% items to lose control.
  • The emphasis in just-in-time is that materials or parts are generated in the exact quantity required and just at the time they are needed and aims at eliminating as far as possible, all manufacturing and finished goods inventories, by purchasing at right time and produced at right time.
  • Supply chain management suggests to develop special long-term relationship with the suppliers of materials so that vendors supplies coincides with production schedules of there by reducing uncertainty and excess carrying of inventories .

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