INVENTORY

COSTING
BY:- Dr. Narendranath
Sengupta
 INVENTORY SYSTEM

PERPETUAL PERIODIC
INVENTORY INVENTORY
SYSTEM SYSTEM
 INVENTORY SYSTEM
Perpetual Inventory System:-This method is
widely used. It is a method of recording inventory
balances after every receipt & issue, to facilitate
regular checking and to obviate closing down for
stock taking. Thus, this system gives a complete
record of inventory quantities & valuation on
continuous basis.
Periodic Inventory System:-Under this the quantity
& value of inventory are reviewed at a fixed time
interval, such as weekly, monthly, quarterly or the
like. However, in the actual practice usually this
review takes place at the end of the accounting
period.
 METHOD OF INVENTORY VALUATION

HISTORICAL LOWER
COST OF
METHOD COST

AVERAGE BASE
SPECIFIC
FIFO LIFO COST HIFO NIFO STOCK
IDENTIFICATION
METHOD METHOD
 First in first out (FIFO) method
This method uses the most recent price paid for
the goods as a basis for valuation. The basis
philosophy behind this approach of inventory
valuation is that the first units purchased are
considered the first units issued/consumed.
Thus, according to FIFO method as it is
frequently called the physical flow of the units
follow a chronological order. This method is
most appropriate for perishable products like
milk, vegetables and fruits.
 Advantages & disadvantages of FIFO
Advantages of FIFO:-
Its application is simple.
It does not allow management to manipulate income.
Its tend to produce an ending inventory cost valuation
which approximates the current market value.
It provides a reasonable approximation of the actual flow
of good.
Disadvantage of FIFO:-
It attracts heavier tax burden if applied under inflationary
income.
It involves complicated calculation and therefore,
it is more sensitive to clerical errors.
 Numerical of FIFO method
Following information is available regarding
procurement and issue of an item for the month of
February 2006:-

Feb 1 Opening inventory 150 units @ Rest.10 each.

Feb 7 Purchased 700 units @ Rs. 12 each.
Feb 13 Issued 400 units.
Feb 21 Purchased 200 units @ Rs. 14 each.
Feb 28 Issued 300 units.
You are required to calculate the value of the
inventory according to FIFO method.
 Last in first out (LIFO) method
LIFO METHOD:- This inventory valuation method is
based on the assumption that the last item purchased
is the first item used or sold. Thus under this method
the units of the earliest purchases form the ending
inventory which results in matching of cost of current
purchases against current sales in the profit & loss
a/c. LIFO method is appropriate during the inflationary
conditions as it shows inventory at a lower value in the
balance-sheet and results in the reduction of profits &
income-tax. The special feature of this method is that
basis of valuation remains unchanged despite of price
changes. It also tends to stabilize income by
minimizing the effects on profits of inventory price
changes.
 Advantages and disadvantages of
LIFO method

Advantages of LIFO:-
LIFO attempts to reduce distortions in the profit
and loss a/c attributable to inflation.
It is appropriate method of involuntary valuation
during inventory period.
Disadvantages of LIFO:-
It permits management to manipulate income.
It is dramatically opposed to the flow of goods.
 Numerical of LIFO method
Form the information for the year May 2006 relating
to Seema & co. Ltd., calculate the value of
inventory on 30th May as per LIFO method.:-

May 1 Opening stock 300 units @ Rs. 6 each.

May 7 Purchased 300 units @ Rs. 8 each.
May 13 Issued 400 units.
May 21 Purchased 300 units @ Rs. 9 each.
May 26 Issued 400 units.
May 30 Issued 50 units.
 ILLUSTRATION
‘AT’ Ltd. furnishes the following store transactions for
September, 2006 :
1-9-06 Opening balance 25 units value Rs. 162.50
4-9-06 Issues Req. No. 85 8 units
6-9-06 Receipts from B & Co. GRN No. 26 50 units @ Rs.
5.75 per unit
7-9-06 Issues Req. No. 97 12 units
10-9-06 Return to B & Co. 10 units
12-9-06 Issues Req. No. 108 15 units
13-9-06 Issues Req. No. 110 20 units
15-9-06 Receipts from M & Co. GRN. No. 33 25 units @ Rs.
6.10 per unit
17-9-06 Issues Req. No. 12 10 units
19-9-06 Received replacement from B & Co.
GRN No. 38 10 units
20-9-06 Returned from department, material of
M & Co. MRR No. 45 units
22-9-06 Transfer from Job 182 to Job 187 in the
dept. MTR 6 5 units
26-9-06 Issues Req. No. 146 10 units
29-9-06 Transfer from Dept. “A” to Dept. “B” MTR 10
5 units
30-9-06 Shortage in stock taking 2 units
Write up the priced stores ledger on FIFO method and discuss
how would you treat the shortage in stock taking.
 HIGHEST IN FIRST OUT(HIFO) METHOD
The HIFO method is based on the assumption that the
highest priced goods are sold first of irrespective of
the date of their purchase. As its name implies the
highest in, first out method (HIFO) assigns to goods
sold the costs of highest priced material in store. By
the closing time the highest priced material is
exhausted &, therefore, ending inventory is valued at a
lower cost than its current cost. This method of
inventory valuation is appropriate for FLACTUATING
MARKET as it tends to provide opportunity to
management to recover the cost of heavily priced
goods from the sales made at the earliest.
 Replacement cost method
Replacement cost suggest to value the inventory
at the replacement cost. The replacement cost
represents the market at which, on the date of
the issue of the material, the goods can be
replaced by purchasing the identical goods
from the market. Thus, goods issued are
valued at the market price on the date of their
issue. This method helps inflating profit in a
period of rising prices & deflating it in a period
of declining prices. It is an appropriate valuation
method where management is interested to
reflect current price condition in costs.
 HOW MUCH TO ORDER?? EOQ
ECONOMIC ORDERING QUANTITY:- One of
the major decisions in the area of inventory
management is HOW MUCH (QUANTITY) TO
ORDER AT ONE TIME. Number of techniques
have been developed in which most popular
method is EOQ which represent the size of an
order for which total cost is minimum & thereby
maximum economy in purchasing.
There are two type of EOQ:-
ORDERING COST.
CARRYING COST.
 TYPES OF EOQ
TYPES
OF
EOQ

ORDERING CARRYING

COST COST
 ORDERING COSTS
It is the cost of getting an item into the firm’s
inventory. At the time of placing an order for
stock replenishment, certain cost are involved
which are known as known as ordering costs.
They include costs like requisition & purchase
costs, follow-up costs, inspection checking &
handling costs &so on. Such costs vary with the
number of orders placed and the number of
items ordered. The more frequently the orders
are placed, & fewer quantities purchased on
each other, the greater will be ordering costs
and vise-verse.
 CARRYING COST
Carrying costs:- These are those cost which are
incurred in maintaining an inventory including
storage, warehousing, insurance, & interest on
capital invested in inventory. There are two ways of
calculating EOQ.:-
Mathematical approach.
Graphic approach.
METHODS OF CALCULATING
EOQ

MATHEMATICAL GRAPHIC
APPROACH APPROACH
 ASSUMPTIONS FOR EOQ’S
MODEL
The forecasted usage per demand for a
given period is known.
It is even throughout the year.
Inventory can be replenished immediately.
The cost per order is constant.
The cost for carrying is fixed for average
level of inventory.
Average level of inventory=
Q+0 = Q
2 2
Ordering cost = UF
Q
U x F = UF
Q Q
Carrying cost = Q x P x C
2
 MATHEMATICAL APPROACH
Under mathematical approach, it can be
expressed as:-

EOQ = 2 UF
(IN UNITS) P*C

Where, U = Annual usage in units.

F = Cost of placing an order/Fixed cost
P = Cost per unit/Purchasing cost
C = Carrying cost as a percentage of average
inventory.
 GRAPHIC APPROACH

TOTAL COST
c CARRYING
o COST
s
t

ORDERING COST

E.O.Q
Order size (quantity)
 NUMERICAL ON EOQ
FROM THE FIGURES GIVEN BELOW,
CALCULATE ECONOMIC ORDER
QUANTITY.:-
TOTAL CONSUMPTION ON MATERIAL
1800 UNITS.
ORDERING COST OF Rest. 20 PER
ORDER.
CARRYING COST 10% ON AVERAGE
INVENTORY.
PRICE PER UNIT Rs. 40
 NUMERICAL
A company requires 10000 units of a certain item
annually. The purchase price per order is Rs.
20 and the fixed cost per order is Rs. 150. The
inventory carrying cost is 25% per year.
a) Calculate EOQ.
b) Suppose the supplier offers you following
discount—
if you order above 1000 units you will get a 2%
discount. Now what decision should be taken.
 SOLUTION
a) EOQ = 2UF
PC
U=10000, F=150, P=20, C=25% or 0.25

EOQ = 2x10000x150
20 x 0.25

EOQ = 775 UNITS

Our EOQ = 775 Units

Q1P2C = 775x20x0.25 = 1937.5 old

2 2
Q2P2C = 1000x19.6x0.25 = 2450 new
2 2
Increase in carrying cost = 512.50(2450-
1937.5)
BENEFIT:
Discount = 20X2 = 0.40
100
0.40 X 10000 = 4,000
Reduction in ordering cost
UF = UF = 10000X150 = 1935.48 old
Q EOQ 775
Reduction in OC = 1935.48(old)-1500(new)
= 435.48
Total benefit = 4435.48 (Disc + Red in OC)
Net benefit = 3923.48 (TBenefit – TCost)

If somebody offers you 2% discount, it would be

better to change EOQ. EOQ in manufacturing
is not a ultimate final word.
 STATEMENT OF INVENTORY
RECEIPTS ISSUES BALANCES
DATES RATE VALUE RATE VALUE RATE VALUE
UNITS UNITS UNITS
(Rs.) (Rs.) (RS.) (Rs.) (Rs.) (Rs.)