INVENTORY DEFINED

Jessop and Morrison (2004) defined inventory as goods which are held by organizations in bulk
intended for use in connection with production or operating activities and it also covers finished
products awaiting dispatch to customers, scrap, goods awaiting point of sale display and package
held pending return to suppliers.
Thus, inventory is the aggregate of those items of tangible personal property which are held for
sale in the ordinary course of business, in the process of production for such sales, or are to be
consumed in the production of goods or services to be available for sale. It is a term used to
cover the stocks of raw materials, components, work-in-progress and finished goods.
INVENTORY CONTROL DEFINED
Lucey (2002) also defined inventory control as the system used in a firm to control the firms
investment in stock. This includes the recording and monitoring of stock levels, forecasting
future demands and deciding when and how many to order.
According to the CIMA Official Terminology of Management Accounting (2002) Control over
stock is necessary as holding costs of stock can be considerable. The stock control function may
be quite an important position in some manufacturing operations: without efficient stock control,
an organizations manufacturing processes might be subject to sudden interruptions. If raw
materials are lacking, or a great deal of expense can be incurred on stock with short shelf life.

OBJECTIVES OF INVENTORY CONTROL

The aims of inventory management as summarized by Jessop and Morrison (2004) are:
To ensure a constant flow of materials into the organization;
To maintain sufficient inventory for operations;
To minimize the carrying cost and time;
To maintain a minimum investment in inventories to maximize profit;
To control investment in inventories and keep it at an optimum level;
Maximize customer service.
THE COST ASSOCIATED WITH STOCK
According to Lucey (2006) the overall objective of inventory control is to minimize, in total, the
cost associated with stock. These costs can be categorized into three groups:
Carrying cost;
Cost of obtaining stock (ordering cost);
Cost of being without stock (stock out costs);
1. Carrying costs
Interest on capital invested in cost;
Storage charges (rent, lighting, heating, refrigeration and air conditioning);
Deterioration and obsolescence;
Stores staffing, equipment, maintenance and running costs.
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2. Cost of obtaining stock (ordering cost)

Transport costs;
Clerical and administration cost of purchasing, accounting and good reception.
3. Stock out cost
Stock out cost is the cost associated with running out of inventory. These costs are:
Loss of future sales because customers may go elsewhere;
Lost contribution through the lost sale cause by the stock out;
Extra costs associated with urgent, often small quantity, replenishment orders;
Costs of production stoppages caused by stock outs of WIP and raw material.
INVENTORY CONTROL PROCEDURES
Supplier Search
Search for possible suppliers using own records, directories, Associations and if possible
from business associates and insider information from competitors.
Request for Tenders
All the suppliers who meet the business requirements must be contacted to tender. These
suppliers must be made aware of the businesses requirements. Here, sole sourcing can also
be done.
Receipt of Quotation
This is the point where quotations are received and vetting done in order to identify the
supplier who meets the requirements of the business.
Supplier Selection
This involves the best supplier based on the tender.
Purchase Order
At this stage purchase order is dispatched to the supplier and copies thereof are sent to the
Accounts/Costing department/Production Control department/Stores
Progress Chasing, monitoring and Delivery
The business will monitor the order and ensure that they are safely delivered.
Receipt of Goods
On receipt of the goods from the supplier inspection made to identify if it meets quality
standards. if meets the quality standards then a goods received note (GRN) will be raised by
the purchasing department and signed. Copies of the GRN are sent to the Accounts Payable,
Purchasing office, production control, and stores
STOCK CONTROL LEVELS
In order to ensure that the flow of production is not impaired by the lack of materials as well as
excessive capital is not tied up in stocks, it is important to ensure that the stock level held always
lie between certain limits. The levels include the following as stated by Oduro (2009).
Economic order Quantity (EOQ).
Re-order level;
Minimum stock level;
Maximum stock level;
Average stock level;
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Economic order Quantity (EOQ)

According to Lyson (2003) economic order quantity is the order quantity, which minimizes the
balance of costs between stock holding costs and ordering cost. It is the quantity which is most
economical to order. Thus economic order quantity is that size of the order which gives
maximum economy in purchasing any material and ultimately contributes toward maintaining
the material at the optimum level and at minimum cost. It is calculated as:
EOQ =

2.Co.D
Cc

Where

Co = ordering cost per order

D = Demand per annum
Cc = Carrying cost per item per annum

Where a firm produces its own stocks instead of buying, then EOQ would be calculated as
follows:

EOQ =

2.Co.D
Cc (1-D/R)

Where

Co = ordering cost per order

D = Demand per annum
Cc = Carrying cost per item per annum
R = Production Run

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Re-order level
This is the level at which it is necessary to place an order for new stocks. It is fixed below
maximum stock level but above minimum stock level. The re-order level is dependent on the reorder period (lead time) and the rate of consumption/demand during the re-order period. It is
calculated as:
Re-order level = Maximum Consumption (usage) Maximum lead time (re-order period)
Minimum stock level
This is sometimes called buffer stock or safety stock. It is the stock level below which the stock
should not normally be allowed to fall if the requirement of production is to be met. Immediate
replenishment (replacement) is needed when stocks reach this level. This level is essentially a
safety stock and is not normally touched. The formula is given as:
Re-order level (Average Consumption Average lead time)
Maximum stock level
This is the level of stock above which stocks should not normally be allowed to rise. Keeping
stock above this level may mean locking up capital in stock as well as including high storage
cost such as insurance, warehouse cooling or heating, etc. The maximum level may however be
exceeded in certain cases when for example, unusual favourable purchasing condition arise. It is
calculated as:
Re-order level + Economic order quantity - (Minimum Consumption Minimum lead time)
Average stock level
It is the stock level which represents the midpoint between minimum stock level and maximum
stock level. Average stock level is the level at which the storekeeper starts the preparation to
initiate ordering for replenishment. This level should be higher than the re-order level so that by
the time the ordering gets approval and purchase order is placed, the stock might have reached
the re-order level. There are two ways in calculating Average stock level:
i.
ii.

Maximum stock level + Minimum stock level

2
(Re-order quantity) + Minimum stock level

TOTAL COST
Total Cost
=

[EOQ/2 x Holding Cost] + [(Annual Demand/EOQ) x Ordering Cost]

ILLUSTRATION 1
You have just been employed as the Management Accountant of AXY Ltd, a manufacturing
company. You have been given the following information in order to help you calculate the
various stock levels.
Minimum Usage
Maximum Usage

200 units
500 units

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Lead time
Daily demand
Cost per order
Holding Cost
Assume 250 days working days in a year

20 to 35 days
50 units
GHS 10
GHS 15

Calculate the relevant stock levels and Total cost.

ILLUSTRATION 2
You have just been employed as the Management Accountant of AXY Ltd, a manufacturing
company. You have been given the following information in order to help you calculate the
various stock levels.
Minimum Usage
Maximum Usage
Average Usage
Lead time
Annual demand
Cost per order
Holding Cost

200 units
400 units
350 units
15 to 30 days
50,000 units
GHS 5
GHS 10

A supplier has recently offered a quantity discount of GHS 0.30 per unit on a current price of
GHS 30 for orders of 250 units or more.
Calculate the relevant stock levels and Total cost. Should the company take advantage of the
discount? Give reason for your answer.
STOCK TAKING
Stock taking involves counting the physical stock on hand at a certain date, and then checking
this against the balance shown in the clerical records. Stocktaking is one of the most essential
ways of controlling stock in organizations. It can also be defined as a complete process of
verifying the quantity balances of the entire range of items held in stock (Aremu, 2003).
Types/Method of stock-taking
Periodic stock-taking, and
Continuous stock-taking.
Periodic stock-taking:
This is usually carried out annually and the objective is to count all items of stock on a specific
date. It is a very important exercise and the following steps would usually be taken.
i.
All staff involved should be issued with stocktaking instructions well before the date of
actual count. Often non-stores staff will be involved in the count;
ii.
A cut-off time should be set after which no movement of stock is allowed until the
count has been completed;
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iii.
iv.
v.
vi.
vii.

A team of stock-checkers should be allocated to count all stock in one area, to ensure that
all stock is counted once, and that no omission or duplication occur;
Stock checkers should enter amount counted on pre-printed stock sheets;
In the office, the completed stock sheets should be collated and totaled and the qualities
check against the stock records;
Any stock showing discrepancies should be recounted, and if still not resolved should be
reported to management;
Senior staff or auditors should perform sample checks on a number of items.

Continuous stocktaking:
This involves a specialist team counting and checking a number of stock items each day, so that
each item is checked at least once a year. Valuable items could be checked more frequently. The
advantages of this system compared to periodic stocktaking are as follows.
i.
The annual stocktaking is unnecessary and the disruption it causes is avoided;
ii.
Regular skilled stock takers can be employed, reducing likely errors;
iii.
More time is available, reducing error and allowing investigation;
iv. Deficiencies and losses are revealed sooner than they would be if stock taking were
limited to an annual check;
v. Staff morale is improved and standard raised;
vi.
Control over stock levels is improved, and there is less likelihood of overstocking or
running out of stock.

STOCK VALUATION METHOD

Stock valuation deals with the pricing of issues of materials. It can also be referred to as stock
pricing. According to Oduro (2009) there are a number of methods of pricing materials. They
include among others:
First in First out (FIFO) method;
Last in First out (LIFO) method;
Simple Average method;
Weighted average method;
Standard cost method.
First-In-First-Out (FIFO)
Where this method is used, goods (materials) are issued at actual cost (price) and
the pricing
follows order by which its prices we received. Thus, the prices that are received first are the first
to leave the store before the subsequent ones. Some characteristics of FIFO method are;
i.
Stocks are issued at their actual prices;
ii.
The system is administratively clumsy because of the necessity to keep track of each
stock item;
iii.
Unrealized profit or losses do not arise since stocks are issued at actual prices;
iv. It is a good representation of sound storekeeping practice whereby oldest item are issued
first;
v. The stock valuation is based on the more recent acquired material thus more nearly
approaches current market value.
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Last-In-First-Out (LIFO) Method

Under this method of pricing, goods issued are priced at the latest price in the store. Some
characteristic of LIFO method are;
Stocks are valued at the oldest prices;
It is administratively clumsy;
Like FIFO, cost comparison between jobs may be difficult;
It is an actual cost system. Thus stocks are issued at their actual prices;
Product costs will tend to be based fairly closely on current prices and therefore be more
realistic.
Simple Average method
Goods are issued without taking into consideration the quantity in store. The issue price is
calculated as total price of material in stock from which the material to be priced could have
been drawn or total price of materials in stock at the time of the issued divided by the total
number of purchase.
Thus issued price = Total number of different price in stock
Total number of purchase
Some characteristics of simple average method are;
i.
It is simple to understand and operate;
ii.
Unrealized profits and losses may occur since stocks are not issued at actual price;
iii.
It may give reasonable accurate result if prices do not fluctuate very much;
iv. Where prices fluctuates very much a lot of clerical work may be done.
Weighted average method
Under the weighted average approach, both inventory and the cost of goods sold are based upon
the average cost of all units currently in stock at the time of reporting. When inventory turns over
rapidly this approach will more resemble FIFO than LIFO. Some characteristics of the weighted
average method are:

It is acceptable by the tax authority;

The need to calculate new issue price arises only when new materials is received;
A considerable amount of operation is involved for calculating new issue price;
The material cost is not charged out at actual cost and therefore a profit or loss may arise as a result of
pricing.

5. Standard cost method

Under the standard costing method approach, both inventory and the cost of goods sold are based
on the standard fixed cost assigned to the items within the item manager at the time of reporting.

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The following is a copy of a tally card of THE BLUES Manufacturing Company Ltd.
Staple remover bin card

Particulars

Date

Quantity

Unit Cost /
Unit Selling
Price

Total Cost

Opening balance

01/05/2010

100

GHS2.00

GHS200

Receipts

03/05/2010

400

GHS2.10

GHS840

Issues

04/05/2010

200

GHS10.00

Receipts

09/05/2010

300

GHS2.12

Issues

11/05/2010

400

GHS10.00

Receipts

18/05/2010

100

GHS2.40

Issues

20/05/2010

100

GHS10.00

Closing balance

31/05/2010

200

GHS636

GHS240

(1) You are required account for the issues of materials and closing stock using:
a. First-in-first-out (FIFO)
b. Last-in-first-out (LIFO)
c. Weighted Average / Average Cost Method
(2) (a) Prepare Income Statement for the year ended 31 st May, 2010 assuming total
expenses was GHS 120 based the three methods of stock valuation. Give advice to
management on the favourable method.
(b)Will your advice be different if you were the Commissioner of Internal Revenue
Service?

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INVENTORY CONTROL SYSTEMS

According to Mowen (2008) inventory control system is concern with maintaining information
about activity within firms that ensure the delivery of product to customers. The system that
performs this function includes sales, manufacturing warehouse, ordering and receiving. In
different form the activities associated with each of this areas may not be strictly contain within
separate system, but this function must be performed in a sequential order to have a well run
inventory control system.
1. Red-Line Method Inventory items are stocked in a bin, and a red line is drawn around the
inside of the bin at the level of the re-order point. Fresh order is placed when the red line
shows.
2. The Two-bin Method Inventory items are stocked in two bins. When the working bin is
empty, an order is placed and inventory is drawn from the second bin. Lyson (2003).
3. Computerized System The computer starts with an inventory count in memory. As
withdrawals are made, they are recorded by the computer and the balance is updated. When
re-order point is reached, the computer automatically places an order, and when the order is
received, the recorded balance is increased. The computerized tracking system is the key
component of business strategies aimed at increasing productivity and maintaining
competitiveness.
4. Just-in-Time- System Van (2004) define Just- in- time as all materials and products
becoming available at the very moment when they are needed. E.g. In a car manufacturing
firm, delivery of components is tied to the speed of the assembly line, and parts are generally
delivered not more than a few hours before they are used. This system reduces the need of
having to carry large inventories, but it requires a great deal of co-ordination between the
supplier and the purchaser both in the timing of deliveries and qualities. The JIT system is
mostly suitable for manufacturing companies, retailing firms but it may be suitable for
companies or firms which deal in wholesaling. Some items like anti-biotic are not frequently
purchased and because of that management would not like to tie up their capital in such drug
(i.e. investing /buying the drug in bulk to be stored); they would rather wait for a requisition
from the customers before an order will be made for that customer.
The JIT method of controlling stock will be profitable, economical and beneficial to
companies or firms which deal in both retailing and wholesaling.
5. Out-Sourcing This is the practice of purchasing components rather than making them inhouse. This option is much more influenced by cost considerations rather than inventory
policy.

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