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CHAPTER 5- Inventory Control

LEARNING OBJECTIVES:

At the end of this chapter, the student should be able to:

1. Define Inventory Management System and Inventory Control

2. Explain the objectives of Inventory Control

3. Define and explain the classes of inventory

4. Define and explain the concepts of consignment

5. Explain the Accounting for Inventories

Inventory Management System

“Anyone can sell a product and make money for it. But, without a control for its inventory, a person
wouldn't know if he is really making money or just losing it. Though Inventor control may not seem the
most exciting subject, it cannot be denied that it is a vital part of the business. Knowing where your
products are and how fast they can be turned-over means having your fingers on the pulse of your
business.”

Inventory control - is the implementation of management's inventory policies in a manner that assures
that the goals of inventory management are met. Wise control of inventory is often a critical factor in the
success of businesses in which inventories are significant. The goal of inventory control is to be sure that
optimum levels of inventories are available, that there are minimal stockouts (i.e., running out of stock),
and that inventory is maintained in a safe, secure place and is always readily accessible to the proper
personnel.

Inventory control –is also the monitoring the supplies, raw materials, work-in-process, and finished
goods by various accounting and reporting methods. Some controls are the maintenance of detailed stock
records showing receipts and issuances; inventory ledger showing quantities and dollars; and written
policies regarding purchasing, receiving, inspection, and handling.

Objectives of Inventory Control

Inventory Control is designed to support the requisition processing, inventory management,

purchasing, and physical inventory reconciliation functions of inventory management through a
set of highly interactive capabilities. The design of Inventory Control is based on the following
key objectives:

➢ To provide information on the availability of stocked items and the status of stocked
requisitions
➢ To facilitate timely requisition processing

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 ➢ To automatically record and service backorders
➢ To help minimize inventory investments consistent with service objectives by basing
purchasing decisions on usage history
➢ To provide automated tools to assist servicing, purchasing, and management of the inventory
➢ To improve financial control of the inventory by chargebacks to the user organizations
➢ To improve financial control of the inventory by periodic reconciliation of the inventory
balances with the physical counts.

Definition of Inventories is as follows:

“Inventories are assets which are held for sale in the ordinary course of business, in the process of
production for such sale or in the form of materials or supplies to be consumed in the production process
or in the rendering of service.”

Inventories encompasses goods purchased and are held for resale including for example, merchandise
purchased by a retailer and held for resale, or land and other property held for resale by subdivision
company and real estate developer. It also encompass finished goods produced, goods in process and
materials and supplies awaiting use in the production process.

In case of service provider, inventories include the cost of the service for which the entity has not yet
recognized the related revenue. The cost of the service consists primarily of the labor and the other cost of
personnel directly engaged in providing the service, including supervisory personnel and the attributable
overhead.

CLASSES of INVENTORY

Inventories are broadly classified into two, namely inventories of a trading concern and inventories of
manufacturing concern.

Trading concern is one that buys and sells goods in the same form purchased. The term “merchandise
inventory” is generally applied to goods held by trading concern.

Manufacturing concern is one that buys goods which are altered or converted into another form before
they are made available for sale. The terms “finished goods”, “goods in process”, “raw materials”, and
“factory of manufacturing supplies” refer to inventories of manufacturing concern.

➢ Finished goods are completed products which are ready for sale.
➢ Goods in process or work in process are partially completed products which require further
process or work before they can be sold.
➢ Raw materials are goods that are to be used in the production process. No work or process has
been done on them as yet by the company inventorying them.
➢ Factory of manufacturing supplies are similar to raw materials but their relationship to the end-
product is indirect. These supplies may be referred to as indirect materials.

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Goods Includible in the Inventory

As a rule, all goods to which the company has title should be included in the inventory, regardless of the
location. Where title has already passed from the seller to the buyer, the goods form part of the inventory
of the latter.

The phrase “passing of title” is a legal language which means “the point in time at which the ownership
changes’.

Therefore, the legal test is as follows: Is the company the owner of the goods to be inventoried? If the
answer is in the affirmative, the goods should be included in the inventory. If the answer is in the
negative, the goods should be included in the inventory.

Exception to the Legal Test

Installment contracts may provide for retention of title by the seller until the selling price is fully
collected. Following the legal test the goods sold on the installment basis are still property of the
seller and therefore normally includible in his inventory.

However, in such a case, it is an accepted accounting procedure to record the installment sale as a
regular sale involving deferred income on the part of the seller and as a regular purchase on the part
of the buyer. Thus, the good sold on installment are included in the inventory of the buyer and
excluded from that of the seller, the legal test to the contrary notwithstanding.

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Who is the owner of goods in transit?

This will depend on the terms, whether FOB destination or FOB shipping point. FOB means Free
on Board.

Under the FOB shipping point, ownership of the goods is transferred upon shipment of the goods
and therefore, the goods in transit are the property of the buyer. It means that the title of the
ownership passes to the buyer as soon as seller as deliver the goods to the buyer.
.
Under the FOB destination, ownership of the goods purchased is transferred upon receipt of the
goods by the buyer at the point of the destination. Therefore, the seller is liable for the freight and is
still considered the owner of goods until it reaches the buyer.

The accountant should carefully analyze the invoice terms of the goods that are in transit at the end
of the accounting period to determine who has legal title.

Accordingly, adjustments are in order if errors are committed in recording purchases and sales.

Consigned Goods

Consignment is a method of marketing goods in which the owner called the consignor transfers
physical possession of certain goods to an agent called the consignee who sells them in the owner’s
behalf.

Consigned goods should be included in the consignor’s inventory and excluded from the
consignee’s inventory.

Freight and other handling charges on the goods out on consignment are part of the cost of goods
consigned.

Consigned goods are recorded by the consignor by means of memorandum entry.

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ACCOUNTING for INVENTORIES

The two accounting systems offered for accounting inventories are:

The periodic system which calls for the physical counting of the goods on hand at the end of the
accounting period to determine quantities. The quantities are then multiplied by the corresponding unit
costs to get the inventory value for the balance sheet purposes. This approach gives actual or physical
inventories.

On the other hand, the perpetual system requires the maintenance of records called stock cards that
usually
offer a running summary of the inventory inflow and outflow. Inventory increases and decreases are
reflected in the stock cads and the resulting balance represents the inventory.

Trade Discounts and Cash Discounts

Trade discounts are deductions from the list or catalog price in order to arrive at the invoice price which
is the amount actually charged to the buyer.
A Receiving report contains the
Cash discounts are the deductions from the invoice price when paymenct eirstifm
icaatidoen owfitthheinontehien dchisarcgoeuthnatt
period. the quantities with specified
description have been received and
that inspection has been done.

Inventory Control Process

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 A purchase order (PO) is a
commercial document issued
by a buyer to a seller,
indicating types, quantities,
and agreed prices for products
or services the seller will
A Material requisition is a written
provide to the buyer. Sending request usually sent to inform the
a PO to a supplier constitutes
purchasing department of a need for
a legal offer to buy products
materials or supplies.

MEASUREMENT of INVENTORY

The following are principles concerning measurement of inventory:

• Inventories shall be measured at the lower of cost or net realizable value.

• The cost of inventories shall be determined by using either the FIFO method or weighted average
method.

The cost of inventories that are not ordinarily interchangeable and the inventories that are segregated for
specific projects shall be determined by using specific identification method

Cost of Inventories

The cost of inventories shall comprise:

➢ Cost of Purchase
➢ Cost of Conversion
➢ Other cost incurred in bringing the inventories to their present location

a. Cost of purchase -Comprises the purchase price, import duties and taxes, freight, handling and
other costs directly attributable to the acquisition of finished goods, materials and services. Trade
discounts, rebates and other similar items are deducted in determining the cost of purchase.

b. Cost of Conversion - Includes cost directly related to the units of production such as direct labor.
It also includes a systematic allocation of fixed and variable production overhead that is incurred
in converting materials into finished goods.

c. Other cost - Other Cost is included in the cost of inventories only to the extent that it is incurred
in bringing the inventories to their present location and condition

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Cost Formulas

The cost of inventories shall be assigned by using either:

First In, First Out(FIFO) method

- This method assumes that “the goods first purchased are first sold “and consequently the goods
remaining in the inventory at the end of the period are those among recently purchased or produced.

Weighted Average Method

✓ Weighted Average- Periodic

- The average unit cost is computed by dividing the total cost of goods available for sale by the total
number of units available for sale.

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 REFERENCES:

Kumar, Anil S & Suresh N. (2023). Production and Operations Management. New Delhi, India:
New Age International Limited Publishers

Russell, Roberta & Taylor III, Bernard W. (2023) . Operations Management.Creating Value
among the Supply Chain. USA: Courier/ Kendallville

Gupta Sushil & Starr Martin. (2023). Production and Operations Management System. Broken
Sound Parkway NW Suite 300: CRC Press

The harder you work for something, the greater you’ll feel when you achieve
it.
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