Provide a comparative analysis of inventory systems
One of our clients is considering changing from a periodic inventory system to a perpetual inventory system. These concerns are related to stock valuation, which is an important process for a company as it can have direct effects on profit figures. With regards to stock valuation, there are different methods, which will produce different valuations, this is because in practise there will be a delay between buying the materials and it being used and price variances could be extracted at either point in time. This report will discuss the methods available, FIFO, LIFO and AVCO providing a comparative analysis of these.
Discussion shall then move on to the advantages and disadvantages of each inventory system, the main points regarding cost and accuracy. Figures are produced to show what the valuations for the company would be for each stock valuation method and inventory system. Finally recommendations are made to the company based on our findings. Our recommendations suggest what the best option would be, but there is a limit to what we can say as we are not provided with relevant information as to what methods are in place at the moment. Time limits for the report and lack of background information in to the company also may effect our final recommendations from being as accurate as possible.
1.0 The Importance of Stock Valuation. According to Wood and Sangster, 2002, most Businesses want to know how much each item has cost to make in order to make more sensible decisions about what should be done to aid the progress of the business towards its objectives. This expenditure control is one of the most important features of cost accounting. But what organisations need to consider is that control of expenditure is only possible if you can trace the costs down and trace the route they pass through.
A convenient approach to collect these costs is through ‘cost centres’, for example production locations, functions, activities or items of equipment. Figure1. Flow of Costs into Unit Cost. As a product travels through its stages of manufacturing it attracts cost in each ‘cost centre’. These need to be established for other activities linked closely to production but not actually creating the end product itself.
One of these cost centres will be raw materials or stock and it is necessary to place a value on the item so analysis can be done. Woods and Sangster, 2002, state that most people assume that when a value is placed upon stock, it is the only figure possible, but this is not true. Wright, 1996, acknowledges that in practise there will be a delay between buying the materials and it being used and that price variances could be extracted at either point in time. Barfield et al, 1991, also realises the difficulty with the cost valuation of material issues. Each same type of material may have been bought at different times at different prices and when it comes to the end period, which price should be used?