Controlling and Costing Materials

8/13/2019 Controlling and Costing Materials

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Controlling and Costing Materials:

Effective materials management is essential in order to (1) provide the best service to customers, (2)produce at maximum efficiency, and (3) manage inventories at predetermined levels to stabilizeinvestments in inventories.

Successful materials management requires the development of a highly integrated and coordinatedsystem involving sales forecasting, purchasing, receiving, storage, production, shipping, and actual sales.Both the theory of costing materials and inventories and the practical mechanics of cost calculations andrecord keeping must be considered.

Costing materials present some important, often complex, and sometime highly controversial questionsconcerning the costing of materials used in production and the cost of inventory remaining to beconsumed in a future period. In financial accounting, the subject is usually presented as a problem ofinventory valuation; in cost accounting, the primary problem is the determination of the cost of variousmaterials consumed in production and a proper charge to cost of goods sold.

The discussion of materials management in this chapter deals with:

Procedures for materials procurement and use.

Materials costing methods.

Cost of materials in inventory at the end of a period.

Costing procedures for scrap, spoiled goods, and defective work

Summary of materials management

Procedures for Materials Procurement and Use:

Although production processes and materials requirements vary, the cycle of procurement and use ofmaterials usually involves the following steps:


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Engineering and planning determine the design of the product, the materials specifications, and therequirements at each stage of operations. Engineering and planning not only determine the maximumand minimum quantities to run and the bill of materials for given products and quantities but alsocooperate in developing standards where applicable.

The production budget provides the master plan from which details concerning materials requirementsare eventually developed.

The purchase requisition informs the purchasing agent concerning the quantity and type of materialsneeded.

The purchase order contracts for appropriate quantities to be delivered at specified dates to assureuninterrupted operations.

The receiving report certifies quantities received and may report results of inspection and testing forquality.

The materials requisition notifies the storeroom or warehouse to deliver specified time or is theauthorization for the storeroom to issue material to departments.

The materials ledger cards record the receipt and the issuance of each class of materials and provide aperpetual inventory record.

Accounting procedures for materials procurement and use involve forms and records necessary forgeneral ledger financial accounting as well as those necessary for costing a job, process or department,and for maintaining perpetual inventories and other statistical summaries. The purchase requisition,purchase order, receiving report, materials requisition, bill of materials, scrap report, returned materials

report, materials ledger cards, and summary of materials used are some of the forms used for materialscontrol under a cost system. The purchases journal, the cash payments journal, the general journal, andthe general ledger control accounts are also used.

The discussion here is not based on any particular type or size of industry. It is, rather a generaldescription of the accounting and controlling procedure involved in the procurement and use ofmaterials. To understand the detailed procedure of purchasing, receiving stocking, and using materials(materials procurement and use) click on the following links:

Purchases of productive material.

Purchases of supplies, services, and repairs.

Materials purchasing forms.

Receiving materials.


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When the cost basis is used in costing inventories for financial statements and income tax returns, thesum total of the materials ledger cards must agree with the general ledger materials control accountwhich, in turn, is the materials inventory figure on the balance sheet. Unless a shift from the cost basis is

made in valuing the year end inventory, the method used for costing materials issued is the methodused for assigning dollars to inventory.

Inventory valuation at cost or market whichever is lower

American Institute of Certified Public Accountant (AICPA) cost or market rules

Adjustments for departures from the costing method used

Inventory pricing and interim financial reporting

Transfer of materials cost to finished production

Physical inventory

Adjusting Materials Ledger Cards and Accounts to Conform to Inventory Accounts

Costing procedures for scrap, spoiled goods, and defective work:

Generally, manufacturing operations cannot escape the occurrence of certain losses or output reduction

due to scrap, spoilage, or defective work management and the entire personnel of an organizationshould cooperate to reduce such losses to a minimum. As long as they occur, however, they must bereported and controlled.

Scrap and waste

Spoiled goods

Defective work

Discussion Questions and Answers about Controlling and Costing Materials

Summary of Materials Management:


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Materials managers are constantly confronted with these problems and requirements:

Inventories account for a large portion of the working capital requirements of most businesses. This factmakes materials or inventory management a major problem requiring constant attention by all threemanagement levels (top, middle and low).

At present, the problem of materials management has become even more acute due to marketconditions and inflation.

Effective materials management and materials control is found in an organization in which individualshave been vested with responsibility for, and authority over, the various details of procuring,maintaining, and disposing off inventory. Such a person or persons must have the ability to obtain,coordinate, and evaluate the necessary facts and to take actions when and where needed.

Remarks:

Cost Accounting Definition:

Different authorities have defined the term "cost accounting" which help in reflecting the multi-sidedmeaning the subject contains. The definition given by J. W. Neuner is considered more satisfactory andconcise which is as following:

"Cost accounting is an expanded phase of the general or financial accounting of a business concernwhich provides management promptly with the cost of producing or selling each article or of rendering aparticular service". In other words, cost accounting is a step further to and a refinement of financialaccounting. in which cost of manufacturing and selling each product or job or rendering service isdetermined, not at the time of accounting period but at the time when the product is manufactured orany service is rendered. In simple words, costing is a systematic procedure for determining the unit costof output produced or services rendered. It provides for an analysis of the expenditure which enablesthe management to know not only the total cost but also its constituents.

In short, cost accounting is the process of accounting for cost, which begins with regarding andclassifying of incomes and expenditures and ends with the preparation of periodical statements andreports for ascertaining and controlling costs.

As predicted today, cost accounting may be defined as the process of measuring, analyzing, computing,and reporting the cost, profitability and performance of operations.


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Cost of Goods Sold (COGS) Definition:

Cost of goods sold, COGS, or "cost of sales", includes the direct costs attributable to the production ofthe goods sold by a company.

Figure representing the cost of buying raw materials and producing finished goods.

The amount paid for the goods sold during an accounting period.

The total cost of purchasing raw materials and manufacturing finished goods. Equal to the beginninginventory plus the cost of goods purchased during some period minus the ending inventory.

Determined for the period by counting the merchandise left at the end of the period (physical inventory)and subtracting its cost from the total cost of merchandise available for sale.

the total cost to the business of the goods sold during an accounting period. In its simplest form this isthe sum of the opening stock plus all purchases less the closing stock.

Production Budget Definition:

Production budget is a detailed plan showing the number of units that must be produced during aperiod in order to meet both sales and inventory needs.

This page only defines the term click here for detailed study about production budget.

Perpetual Inventory System Definition:

Perpetual inventory system may be defined as a method of recording stores balances after every receiptand issue to facilitate regular checking and to obviate closing down for stock taking." So perpetualinventory system implies continuous maintenance of stock records and in its broad sense it covers bothcontinuous stock taking as well as up to date recording of stores books. The balance of the same item ofstore in bin card should correspond with that shown in the materials or store ledger card and a frequentchecking of these two records should be made and compared with the actual or physical quantity ofmaterials in stock.


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Materials/Store Ledger Card Definition:

Materials or store ledger card provides a continuous record of materials received, issued and balance atany time both in quantity and value.

In other words, This card shows the detailed information regarding receipts, issues and the balance inhand for each kind of materials at any time. The receiving report and material requisition or the bill ofmaterials serves as the original source of information for making entries on the card.

Bill of materials Definition:

Bill of materials is a document that shows the type and quantity of each major item of materialsrequired to make a product.

Need for Materials Control:

One of the first step in the installation of cost and management accounting system is planning the

proper control of materials and supplies from the time orders are placed with supplier until they havebeen consumed in the plant and office operation or have been sold as merchandise.

Materials represent an important asset and is the largest single item of cost in almost every business;accordingly the success or failure of a concern may depend largely upon efficient material purchasing,storage, accounting, utilization and control.

Where materials are not properly controlled, excess stock of some items are likely to occur with a resultunnecessary tying up of capital and loss through deterioration and obsolescence. Shortages of othermaterials may arise at the time when they are urgently needed and production will then be delayed.

The purchasing of materials is a highly specialized function. By ordering the right quantity and quality ofmaterials at the most favorable price, and by ensuring that it arrives at the right time, the efficient buyer


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is able to make a valuable contribution to the success of a business. The efficient material control costsout losses and forms of waste that otherwise ten to pass unnoticed. Theft, misappropriation,deterioration, breakage and additional storage costs can be reduced to a minimum by proper controls,and much avoid idle time in the factory will be cut out if materials are available to meet the demands ofthe production staff. Finally and most important to the cost accountant, it is impossible to produce

reliable costing information if the records of materials issue are unsatisfactory, because a coststatement cannot be more accurate than the information on which it is based.

You may also be interested in other articles from "materials and inventory cost control" chapter.

Need for Materials Control

Requirements of a System of Materials control

Stock Control

Ordering Level or Ordering Point or Re-order Level

Minimum Level or Minimum Limit

Maximum Level or Maximum Limit

Danger Level

Economic Order Quantity EOQ

Requirements of a System of Materials Control:

The important requirements or essentials of adequate satisfactory system of materials control are asfollows:

Proper Coordination

Competent Purchasing Agent

Use of Standard Forms

Control by Budgeting Materials and Equipment


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Storage Location

Operation of Perpetual Inventory

Standards or Level to be Fixed

Storage Control and Issue

Internal Check

Development of Controlling Accounts and Subsidiary Records

Regular Reports

Proper Coordination:

Proper coordination of all departments involved, in material purchasing, receiving, testing, approving,storage, issue and accounting is essential.

Competent Purchasing Agent:

Centralization of purchasing in a purchasing department under the direct and authority of a competenttrained purchasing agent is also considered essential.

Use of Standard Forms:

The use of standard forms for orders, requisition etc., upon which written and signed instructions aregiven are essential for proper control of materials.

Control by Budgeting Materials and Equipment:

Use of materials, supplies and equipment budgets so that the economy in purchasing and use ofmaterials can be realized, is important factor for adequate control of materials.


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Storage Location:

Storage of all materials and supplies should be in a designated location properly safe guarded undersupervision and proper planning should be there for storing and issuing of materials.

Operation of Perpetual Inventory:

Operation of proper perpetual inventory system should be used so that it is possible to determine at anytime the amount and value of each kind of materials in stock. It also enables the comparison of bookinventory with the result of physical counting.

Standards or Level to be Fixed:

A minimum quantity of each item of materials, below which point the inventory is not allowed to drop,and a maximum quantity, above which stock is not carried should be fixed. In the same manner orderinglevel and economic order quantity may be determined.

Storage Control and Issue:

The proper operation of a system of stores control and issue is introduced so that there will be deliveryof materials upon requisitions to departments in the right amount at the time they are needed.

Internal Check:

The operation of internal check should be introduced to ensure that transactions involving materials andequipment are checked by reliable and independent officials.

Development of Controlling Accounts and Subsidiary Records:


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Controlling accounts and subsidiary records reveal summary of detailed materials costs at each stage ofmaterials receipt and consumption from the storeroom to finished goods.

Regular Reports:

Regular reports and information should be provided for the management in connection with thepurchase of materials, issues from stock, inventory balances, obsolete stock, goods returned to vendors,and spoiled of defective units.

Stock Control:

Definition and Explanation:

The materials purchased by a concern may be classified as stock items which are taken into store andheld until required, or as direct deliveries to the point of consumption. The control of those materials

which are stock items is known as stock control.

The function of stock control is to obtain the maximum stock turnover consistent with the maintenanceof sufficient stocks to meet all requirements. Stock turnover is the ratio which the cost of the materialsused per annum bears to the average stock of raw materials. Discussions with regard to the quantity ofmaterials stocked are reached after may consideration such as:

The availability of capital for the provisions of stocks

The storage space available

The cost of storage

Risk of loss due to fall in prices, deterioration, obsolescence, theft etc.

Economic order quantities


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Delivery delays

For effective control of materials, it is important to decide upon different levels of materials. Theselevels are maximum limit or level, minimum limit or level and re-order level or ordering point orordering level. Maximum, minimum and re-order levels are not static. They must be varied to suit the

changing circumstances. Thus, alteration will take place if the usage of certain materials is increased ordecreased. If the re-order period changes, or if, in the light of a review of capital available, it is decidedthat the overall inventory must be increased or decreased.

You may also be interested in other articles from "materials and inventory cost control" chapter.



Stock Control




Danger Level


Re-order Level or Ordering Point or Ordering Level:

Definition and explanation of re-order point

Formula of re-order level or ordering point

Examples

Definition and explanation:

This is that level of materials at which a new order for supply of materials is to be placed. In otherwords, at this level a purchase requisition is made out. This level is fixed somewhere between maximum


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and minimum levels. Order points are based on usage during time necessary to requisition order, andreceive materials, plus an allowance for protection against stock out.

The order point is reached when inventory on hand and quantities due in are equal to the lead timeusage quantity plus the safety stock quantity.

Formula of Re-order Level or Ordering Point:

The following two formulas are used for the calculation of reorder level or point.

Ordering point or re-order level = Maximum daily or weekly or monthly usage Lead time

The above formula is used when usage and lead time are known with certainty; therefore, no safetystock is provided. When safety stock is provided then the following formula will be applicable:

Ordering point or re-order level = Maximum daily or weekly or monthly usage Lead time + Safety stock

Examples:

Example 1:

Minimum daily requirement 800 units

Time required to receive emergency supplies 4 days

Average daily requirement 700 units

Minimum daily requirement 600 units

Time required for refresh supplies One month (30 days)


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Calculate ordering point or re-order level

Calculation:

Ordering point = Ordering point or re-order level = Maximum daily or weekly or monthly usage Leadtime

= 800 30

= 24,000 units

Example 2:

Tow types of materials are used as follows:

Minimum usage

20 units per week each

Maximum usage 40 units per week each

Normal usage 60 units per week each

Re-order period or Lead time

Material A:

Material B

3 to 5 weeks

2 to 4 weeks


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Calculate re order point for two types of materials.

Calculation:

Ordering point or re-order level = Maximum daily or weekly or monthly usage Maximum re-orderperiod

A: 60 5 = 300 units

B: 60 4 = 240 units

Minimum Limit or Minimum Level of Stock:

Learning Objective:

Definite and explain minimum limit or minimum level of stock.

How is minimum limit or minimum level calculated?


The minimum level or minimum stock is that level of stock below which stock should not be allowed tofall. In case of any item falling below this level, there is danger of stopping of production and, therefore,the management should give top priority to the acquisition of new supplies.

Formula:

Minimum level or minimum limit can be calculated by the following formula or equation:


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Minimum limit or level = Re-order level or ordering point Average or normal usage Normal re-orderperiod

Or the formula can be written as:

Minimum limit or level = Re-order level or ordering point Average usage for Normal period

Example:

Normal usage 100 units per day

Maximum usage 130 units per day

Minimum usage 70 units per day

Re-order period 25 to 30 days

Calculate: minimum limit or level

To calculate minimum limit of materials we must calculate re-order point or re-order level first.

Calculation:

Ordering point or re-order level = Maximum daily or weekly or monthly usage Maximum re-order

= 130 30

= 3,900 units


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Minimum limit or level = Re-order level or ordering point Average or normal usage Normal re-orderperiod

= 3900 (100 27.5*)

1150 units

*(25 + 30 ) / 2

Maximum Level or Maximum Limit of Stock:

Learning Objective:

Definite and explain maximum limit or maximum level of stock.

How is maximum limit or maximum level calculated?


The maximum stock limit is upper level of the inventory and the quantity that must not be exceededwithout specific authority from management. In other words, the maximum stock level is that quantityof material above which the stock of any item should not normally be allowed to go. This level is fixedafter taking into account such factors as: capital, rate of consumption of materials, storage spaceavailable, insurance cost, risk of deterioration and obsolescence and economic order quantity.

Formula:

Maximum level or maximum limit can be calculated by the help of following formula:


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Maximum limit or level = Re-order level or ordering point Minimum usage Minimum re-order period+ Economic order quantity

Example:

Normal usage 100 units per day




Economic order quantity 5,000 units

Calculate maximum limit or level.

In order to calculate maximum limit of stock we must calculate re-order point or re-order level first.

Ordering point or re-order level = Maximum daily or weekly or monthly usage Maximum re-order

= 130 30

= 39,000 units

Calculation:

Maximum limit or level = Re-order level or ordering point Minimum quantity used in re-order periodusage + Economic order quantity

= 3900 (70 25) + 5,000


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= 7150 units

Danger Level of Materials or Inventory Stock:


Some enterprise also calculate danger level. When this level of stock is reached, then emergency stepsare taken by the management to acquire material supplies.

When danger level is reached, the try is made to purchase materials from the nearest possible source orplace so that the workers and plant and machinery may not remain idle due to shortage of materialssupplies.

Formula:

Danger level can be calculated by the help of the following formula or equation:

Danger level = Average daily requirement Time required to get emergency supply

Example:

Normal usage or average requirement 700 units per day




Time required to receive emergency supplies 4 Days


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Calculate danger level.

Calculation:

Danger level = Average daily requirement Time required to get emergency supply

= 700 4

= 2,800 units

Economic Order Quantity (EOQ):

Learning Objective:

Definite and explain economic order quantity (EOQ).

How is economic order quantity (EOQ) calculated?

Definition of EOQ

Formula

Example:


Economic order quantity (EOQ) is that size of the order which gives maximum economy in purchasingany material and ultimately contributes towards maintaining the materials at the optimum level and atthe minimum cost.

In other words, the economic order quantity (EOQ) is the amount of inventory to be ordered at one timefor purposes of minimizing annual inventory cost.


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The quantity to order at a given time must be determined by balancing two factors: (1) the cost ofpossessing or carrying materials and (2) the cost of acquiring or ordering materials. Purchasing largerquantities may decrease the unit cost of acquisition, but this saving may not be more than offset by the

cost of carrying materials in stock for a longer period of time.

The carrying cost of inventory may include:

Interest on investment of working capital

Property tax and insurance

Storage cost, handling cost

Deterioration and shrinkage of stocks

Obsolescence of stocks.

Formula of Economic Order Quantity (EOQ):

The different formulas have been developed for the calculation of economic order quantity (EOQ). Thefollowing formula is usually used for the calculation of EOQ.

A = Demand for the year

Cp = Cost to place a single order

Ch = Cost to hold one unit inventory for a year

* =

Example:


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Pam runs a mail-order business for gym equipment. Annual demand for the TricoFlexers is 16,000. Theannual holding cost per unit is $2.50 and the cost to place an order is $50.

Calculate economic order quantity (EOQ)

Calculation:

Underlying Assumptions of Economic Order Quantity:

The ordering cost is constant.

The rate of demand is constant

The lead time is fixed

The purchase price of the item is constant i.e no discount is available

The replenishment is made instantaneously, the whole batch is delivered at once.

Materials and Inventory Cost Control:

After studying this chapter you should be able to:

Materials control is the system that ensures the provision of the required quantity and quality at therequired time with in the minimum of investment. It covers the following functions:

Stock control

Scheduling of requirements


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Purchasing

Receiving and inspecting

Storing and issuing



Stock Control




Danger Level


Activity Based Costing System

A Tool for Management to Aid Decision Making:

Learning Objectives:

Define and explain activity based costing (ABC) system.

How various manufacturing and non-manufacturing costs are treated under activity based costingsystem?

What are advantages and disadvantages of ABC system

Definition and Explanation of Activity Based Costing System

Treatment of Manufacturing, Non-manufacturing and Idle Capacity Costs Under Activity Based CostingSystem


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Activity Based Costing And Top Management

Activity Based Costing System and External Reports

Designing and Implementing Activity Based Costing System

Targeting Process Improvements (Activity Based Costing + Activity Based Management)

Advantages or Benefits | Disadvantages or Limitations of Activity Based Costing System

Activity Based Costing Example

Standard Costing and Variance Analysis:

After studying this chapter you should be able to:

Explain how direct materials standard and direct labor standards are set.

Compute the direct materials price and quantity variances and explain their significance.

Compute the direct labor rate and efficiency variance and explain their significance.

Compute the manufacturing overhead spending and efficiency variance.

In this section of the website we study management control and performance measures. Quite often,these terms carry with them negative connotations - we may have a tendency to think of performancemeasurement as something to be feared. And indeed, performance measurements can be used in verynegative ways - to cast blame and to punish. However, that is not the way they should be used.Performance measurement serves a vital function in both personal life and in organizations.Performance measurement can provide feedback concerning what works and what does not work, andit can help motivate people to sustain their efforts.

In this section we see how various measures are used to control operations and to evaluateperformance. Even though we are starting with the lowest levels in the organization, keep in mind thatperformance measures should be derived from the organization's overall strategy. For example, acompany like Sony that bases its strategy on rapid introduction of innovative consumer products shoulduse different performance measures than a company like Federal Express where on-time delivery,customer convenience, and low cost are key competitive advantages. Sony may want to keep close trackof the percentage of revenues from products introduced within the last year; whereas Federal Expressmay want to closely monitor the percentage of packages delivered on time. Later in this section when


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we discuss the balance scorecard, we will have more to say concerning the role of strategy in theselection of performance measures. But first we will see how standard costs are used by managers tohelp control costs.

Company in highly competitive industries like Federal Express, Southwest airlines, Dell Computer, ShellOil, and Toyota must be able to provide high quality goods and services at low cost. If they do not, theywill perish. Stated in the starkest terms, managers must obtain inputs such as raw materials andelectricity at the lowest possible prices and must use them as effectively as possible - while maintainingor increasing the quality of the output. If inputs are purchased at prices that are too high or more inputsare used than is really necessary, higher costs will result.

How do managers control the prices that are paid for inputs and the quantities that are used? They

could examine every transaction in detail, but this obviously would be an inefficient use of managementtime. For many companies, the answer to this control problem lies at least partially in standard costingsystem.

Standard Costs and Management By Exception:

A standard cost is the predetermined cost of manufacturing a single unit or a number of product unitsduring a specific period in the immediate future. It is the planned cost of a product under current and/oranticipated operating conditions. Click here to read full article.

Setting Standard Costs - Ideal Versus Practical Standards:

Setting price and quantity standards requires the combined expertise of all persons who haveresponsibility over input prices and over effective use of inputs. In a manufacturing firm, this mightinclude accountants, purchasing managers, engineers, production supervisors, line mangers, andproduction workers. Past records of purchase prices and input usage can help in setting standards.However, the standards should be designed to encourage efficient future operations, not a repetition ofpast inefficient operations. Click here to read full article.

Direct Materials Standards and Variance Analysis:


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Direct Materials Price and Quantity Standards:

Standard price per unit of direct materials is the price that should be paid for a single unit of materials,including allowances for quality, quantity purchased, shipping, receiving, and other such costs, net ofany discounts allowed. Click her to read full article.

Direct Materials Price Variance:

Direct materials price variance is the difference between the actual purchase price and standard

purchase price of materials. Direct materials price variance is calculated either at the time of purchase ofdirect materials or at the time when the direct materials are used. Click here to read full article

Direct Materials Quantity Variance:

Direct materials quantity variance or Direct materials usage variance measures the difference betweenthe quantity of materials used in production and the quantity that should have been used according tothe standard that has been set. Although the variance is concerned with the physical usage of materials,it is generally stated in dollar terms to help gauge its importance. Click here to read full article.

Direct Labor Standards and Variance Analysis:

Direct Labor Rate and Efficiency Standards:

Direct labor price and quantity standards are usually expressed in terms of a labor rate and labor hours.The standard rate per hour for direct labor includes not only wages earned but also fringe benefit andother labor costs. Click here to read full article.

Direct Labor Rate/Price Variance:


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Direct Labor price variance is also termed as direct labor rate variance. This variance measures anydeviation from standard in the average hourly rate paid to direct labor workers. Click here to read fullarticle.

Direct Labor Efficiency | Usage | Quantity Variance:

The quantity variance for direct labor is generally called direct labor efficiency variance or direct laborusage variance. Click here to read full article.

Manufacturing Overhead Standards and Variance Analysis:

Manufacturing Overhead Standards:

Procedures for the establishing and using standard factory overhead rates are similar to the methods ofdealing with the estimated direct and indirect factory overhead and its application to jobs and products.Click here to read full article.

Factory Overhead Variances:

Jobs or processes are charged with cost on the basis of standard hours allowed multiplied by thestandard factory over head rate. The standard overhead rate or predetermined overhead rate isdiscussed in detail at our job order costing system page. The standard hours allowed figure isdetermined by multiplying the labor hours required to produce one unit (the standard labor hours perunit) times the actual number of units produced during the period. The units produced are theequivalent units of production for the departmental factory overhead cost being analyzed. At the end ofthe month, overhead actually incurred is compared with the expenses charged into process using thestandard factory overhead rate. The difference between these figures is called the overall or net factoryoverhead variance.


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overall or net factory overhead variance needs further analysis to reveal detailed causes for the varianceand to guide management toward remedial action. This analysis may be made by using (1) the twovariance method, (2) the three variance method, or (3) the four variance method.

The two variance method: When an overall or net factory overhead variance is further analyzed by usingtwo variance approach, the following two variances are calculated:

Controllable variance

Volume variance

The three variance method: When an overall or net factory overhead variance is further analyzed byusing three variance approach, the following three variances are calculated:

Spending variance

Idle capacity variance

Efficiency variance

The four variance method: When an overall or net factory overhead variance is further analyzed byusing four variance approach, the following four variances are calculated:

Spending variance

Variable efficiency variance

Fixed efficiency variance

Idle capacity variance

Mix and Yield Variance - Definition and Explanation:

Basically, the establishment of standard product cost requires the determination of price and quantitystandards. In many industries, particularly of the process type, materials mix and materials yield playsignificant parts in the final product cost, in cost reduction, and in profit improvement. Click here to readfull article


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Calculation of Mix and Yield Variances:

Materials Mix and Yield Variance

Labor Yield Variance

Factory Overhead Yield variance

Variance Analysis and Management By Exception:

Variance analysis and performance reports are important elements of management by exception.Simply put, management by exception means that the manager's attention should be directed towardthose parts of the organization where plans are not working out for reason or another.

Managerial importance and usefulness of variance analysis:

Costs of production are effected by internal factors over which management has a large degree ofcontrol. An important job of executive management is to help the members of various managementlevels understand that all of them are part of the management team. Click here to read full article.

Advantages and Disadvantages of Standard Costing System:

The use of standard costs is a key element in a management by exception approach. If costs remainwithin the standards, Managers can focus on other issues. Click here to read full article

Standard Costing Discussion Questions and Answers:

Find answers of various important questions about standard costing system. Click here.

Standard Costing and Variance Analysis Formulas:


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A collection of variance formulas / equations which can help you calculate variances for direct materials,direct labor, and factory overhead. Click here to read full article

Standard Costing and Variance Analysis Problems and Solution:

Find a collection of comprehensive problems about standard costing and variance analysis. We have alsoprovided the solution. Click here

Standard Costing and Variance Analysis Case Study:

Click here for the study of cases about standard costing and variance analysis

ISO 9001 Inventory Control Summary

If your company is manufacturing or distributing products, then inventory control is a critical part ofyour business. Even if you have perfectly trained people and perfectly designed product, you must havethe right parts at the right time to build or ship your products. Inventory ties up capitol that can be usedbetter in other areas and slow moving inventory can go absolute forcing the company to take a loss onthe cost of goods. This is why companies spend billions of dollars for Enterprise Resources Management(ERP) and Materials Requirement Planning (MRP) software.

The people at ISO understand that you cannot have a customer focus without having an inventory focus.Although they not have any inventory accuracy requirements, they do require that you take certainprecautions with your inventory.

First you must use a controlled purchasing process to ensure that you order the correct parts. Once theparts come into your facility through your receiving area, they must be controlled. On this web site, theinventory control process covers any inventory from the point it enters the facility as part (includingcustomer supplied good, raw goods, sub-assembles or finished goods) and leaves the facility as part of

customer fulfillment.

The ISO 9001 standard requires that certified companies address the following areas:

Segregate good and bad parts


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Using incoming inspection, in-process testing and non-conforming materials management the companymust separate conforming and non-conforming parts. Non-conforming materials should be managedusing the standard non-conforming materials procedure while conforming materials are managed using

the standard inventory procedure.

Assure That Only Good Parts Are Used

The company must have system in place to assure that non-conforming parts are not used inproduction. Non-conforming part must be identified as non-conforming and protected from accidentaluse. This is managed using the Non-conforming materials (NCM) procedure.

Unique Identification Of Every Part

The engineering design process should create unique part number for every component and assembly.These part numbers should be clearly labeled on the parts or part storage areas.

Identification Of Every Parts Status

As parts are tested and measured, their status should be obvious. This is simple for non-conformingmaterials that are tagged as bad parts. The most vulnerable area is where parts are in-process and mayhave failed testing but are not yet tagged. If a second operator starts working on a set of parts, it mustbe obvious that the parts are good.

Proper Handling Of Parts And Assemblies

All inventory must be handled to reduce damage to the parts or assemblies. This can include theinstallation of special Electro Static Discharge (ESD) equipment to in electronic assembly areas. It alsoincludes boxing and packaging of finished assemblies to ensure that they arrive at the customer withoutdamage.


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Protection of inventory

This is much harder than it sounds. Many parts have special requirements that must be covered in yourinventory control system and procedure. The following parts should be addressed in the inventorycontrol procedure

o Item with special handling issues like ESD sensitive component or fragile component.

o Item with special environmental (temperature or humidity) requirement. Some item may requirerefrigeration or minimum temperature to keep the product from expiring. Even items like a pump mayrequire special environmental requirement because they can be damaged if they freeze.

Stock with a shelf life

Item with a defined shelf-life should be labeled in a clear way so that the item is not used past theexpiration date. This should be part of the incoming inspection procedures. Part should not be put intostock (placed on the shelves) until they have been labeled according to their special needs. Labels,adhesives are glues are a good example of a part that requires special attention. Some electroniccomponent (batteries, solder) also have a shelf-life.

All inventory should be rotated. Stock must be rotated to make sure that the older stock is used first.This is called First-In First-Out or FIFO.

Customer Supplied Inventory

You may not think you have customer supplied inventory but if your organization service the productsthat you sell, then you do. Any product that is sold to the customer and then returned is consideredcustomer supplied inventory. This inventory must be protected and labeled to assure it in not damaged.

Lot Traceably


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For critical component and assemblies, the company must have lot irascibility. An example of this wouldbe a electronic assembly that is potted for safety reasons. If you found at a later date that the pottingcompound was defective, the company must recall all defective product in that production lot. For thesame reason, you may also need to track lots on some incoming parts like heater or detectors.

Lot traceability is especially critical for final assemblies. If the company has products that are serialized,then the company must maintain records so that serialized assemblies can be recalled.

Summary

All or none of these special situations may be applicable at your facility. They are listed here to generateideas about your inventory before you write or update your inventory control procedure.

Sample Inventory Control Procedure

Sample ISO 9001 Inventory Control Procedure

The following procedure is best suited for manufacturing company. It is free to use and edit but shouldnot be re-published on the web.

1. Procedure/Instructions

1.1. Measuring & Test Equipment

The measuring and test equipment used to evaluate revision-controlled parts must be able to accuratelymeasure the quality parameter being tested. Test equipment should be maintained per the calibrationand maintenance procedure and referenced documentation must be maintained in good workingcondition and made available to the Incoming Inspector.

1.2. Precautions, Hazards

Precautions, such as static control, cleanliness and handling of hazardous materials, must be observedwhen performing the Incoming Inspection for the followingitems:

* Active Electrical components

* Passive Electrical components

* Electrical subassemblies


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* Electromechanical parts

* Pneumatic components

* Resale parts (computer equipment)

* Hazardous materials

1.3. Identification of Items

When a shipment is received for a Revision Controlled Procurement item, the following key attributesmust be inspected and/or verified using the procedure below:

Identification Procedure:

1. Log onto the Acme Manufacturing system.

2. Select item #3 from the Main Menu (Purchasing Support System).

3. Select item #2 from the Purchasing System Main Menu (Purchase Order Processing).

4. Enter the purchase order number from the packing list into the "Purchase Order" field.

5. Verify the Vendor Name against the packing list or invoice.

6. Go to the "Vendor Reference Number" field.

7. Use the F4 key to bring up the Vendor Reference Number Window.

A. If you are entering a new reference number:

1. Select

2. Type in the new reference number and select

3. Once back to the Vendor Reference Screen, highlight the new entry and select .

B. If you want to use an existing reference number, highlight the appropriate entry and select .

8. View the purchase order detail (ALT + 1).

9. Use page up (F7) or page down (F8) to select the appropriate item number.

10. Verify the following for each item received from the vendor.

ACME Part Number: Verified against ACME Purchase Order Screen and packing list

Description: Verified against ACME Purchase Order Screen and packing list

Vendor Part Number: Verified against ACME Purchase Order Screen and packing list.


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Quantity Received: Verified against ACME Purchase Order Screen and packing list.

11. View the Parts Specification Window and verify the following:

Revision Controlled: Verify that this field is marked.

BAM Source: If this field is marked the item manufacturer must match the Acme ApprovedManufacturer Listed.

Specifications: Read this field and verify the item matches the specifications listed.

NOTE

If a part specification has not been completed for a part that must be received, enter NAVinto theIncoming QC cell database for all attributes that cannot be verified. Notify QA Manager immediately torequest completion of the Part Specification for that part.

12. Read the information in the ECR/DCN field to be sure this part is not under ECR.

NOTE

ECRs typically affect the ACME drafting documentation used to manufacture or receive a part. Be sure tocontact Engineering before receiving a part that is under ECR/DCN.

13. View the Manufacturers Information window. Read the information listed. Each of the items listed

below must match exactly.

Manufacturer Field: Part must be produced by a listed manufacturer. Further, if the part requires a BAMsource the manufacturer of the part must be one of the manufacturers flagged as BAM in theManufacturers window.

Manufacturer Part Number: Must match a listed manufacturer part number exactly.

Revision: Must match a listed manufacturer revision exactly. Since all Acme Specified parts are revisioncontrolled, this field will often contain the revision of the current ACME fabrication print for the item.

Vendor: Must be a valid ACME Vendor Code

Vendor Part Number: Must match exactly.


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Vendor Letter of Compliance: Must be signed by the vendor, and cite the correct documentation for thepart as identified in the Document Set window of the Part Specification. The signed copy is then filed inthe Vendor Quality History file maintained by the QC department.

14. View the Document Sets window. Revision controlled items must be verified against all documents

listed in this window.

15. View the Order Notes window. Verify that the vendor has complied with all special notes mentionedfor this order.

1.4. Inspection

1.4.1. Spot Check

1. Perform a Spot Check of the Dimensions, Finish and Artwork. These qualities must be checked againstthe Artwork listed in the Document Number field, and any supplementary information in theSpecifications field of the Part Specification. Use the Sampling Plan below to determine the appropriatesample size.

Lot Size First Sample Accept No. Rej.No. Second Sample Accept No. Rej.No. Total Sample Accept No.Rej.No.

1-10 ALL

11-50 10 0 1

51-100 15 0 1

101-500 20 0 2 25 1 2 45 1 2

501-1000 25 0 3 50 2 3 75 2 3

OVER1000 35 1 3 50 2 3 85 2 3

Table 1. Sampling Plan 1

1.4.2. Complete Check

The following qualities will be completely checked on all revision controlled items.

1. View the Document Set window of the Part Specification.

2. Using the AutoCAD viewing utility, open the fabrication print (an '003drawing or the PPO flaggeddocument) for the current item. Verify the Appearance, Assembly and Function of each item.


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Appearance: Damage due to handling.

Assembly (Required Parts): Some assemblies have specific markings or parts that must be present tomaintain an approval rating. Any such parts or markings are listed on the fabrication print or in theSpecifications field of the Part Specification.

NOTE

If a required part or marking is missing or substituted, the assembly must be rejected and returned tothe vendor.

Function: Some revision controlled assemblies may require special functional tests. If special testing isrequired for an item, a Test diagram (a "009" drawing) will be listed in the Document Set window.

1.4.3. Incoming Inspection Documentation

The results of all incoming inspection procedures will be recorded in both the Acme Manufacturingsystem and the Incoming Inspection Cell database.

1.4.3.1. Acme Manufacturing System

Only three types of information will be entered into the Acme Manufacturing System. These are:

- Number of Items Accepted

- Number of Items Rejected

- Reason for rejection or rejection code

From the purchase order detail screen, Select . In this screen enter the number of itemsaccepted, number of items rejected, and reason for rejection if applicable.

in the "Reason" field, use the F4 key to bring up the rejection code list. Select the primary reason for therejection. Rejection codes in the manufacturing system are generic in nature and will be detailed in theincoming cell database.


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1.4.3.2. Incoming Cell Database

Each quality listed in this Work Procedure will be addressed and quantified on a per lot basis in theIncoming Cell database. Overall vendor performance for each quality specification will be quantified bysummarizing:

- Number of items passing criteria.

- Number of items failing criteria.

- Number returned to vendor.

- Specifications used

- Overall Quality Comments.

Distribution

1. The original Incoming Inspection Report will be filed electronically in the Incoming Inspection Celldatabase.

2. If an incoming inspection yields rejected items, a Discrepant Materials Report (DMR) will be generatedand attached to a copy of the packing list. The rejected items and the paperwork will then be returned

to the vendor.

1.5. Acceptance

Only items meeting all Quality Specifications can be accepted into stock.

1.6. Stocking

The Incoming Inspector will deliver the accepted, released items to stock area. Accepted items will bereleased to Stock for shelving. New inventory must be properly stored based on the part requirements.This includes use of Storage boxes, Min cards and FIFO for every part.

4.6.1 Labeling of parts

All parts and assemblies must be labeled to allow error-free retrieval. Larger parts or parts in packagingshould be labeled with the part number on the package or on tape applied to the item. This is not


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possible with smaller parts. All part storage areas must be labeled with a part number that matches theparts or assembles.

4.6.2 FIFO

First In First Out. Stock should be rotated with the most recently received stock placed in the back andoldest stock in front. This is especially critical for any items with a shelf life.

4.6.3 Min Cards.

The min quantity (listed on the min card) should be placed behind or beneath the min card. Based onFIFO, this will always be the just received parts.

In addition, provisions must be made for parts with special requirements including storage temperature,ESD sensitive components, limited shelf life components, and component that require special processes:

4.6.4 Limited-shelf-life items

If the item has a limited shelf life, then add a "Limited Shelf Life: Use before _______" label to the itemand write the expiration date on the label in large print.

4.6.5 Temperature Sensitive Component

Components that are sensitive to cold like batteries or liquid filled components shall be stored inside thebuilding or in a temperature controlled area. Items that require refrigeration shall be stored in atemperature controlled area.

4.6.6 ESD

Components that are sensitive to electrostatic discharge shall be stored in an appropriate protectiveenvelope or enclosure

4.6.7 Parts that must be cleaned

Any metal or plastic parts that must be clean when they are put into an assembly shall be cleanedbefore they are placed into stock.

4.6.8 other special requirements

The manufacturing system will list any other special requirements for stocking in the "Doc Sets" for thepart number.

1.7. Non-conforming Items


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Items that do not conform to all quality specifications will be managed using the non-conformingmaterial system. If possible the part will be returned to the vendor for warranty replacement. Partsreturned to the vendor for warranty replacement must be accompanied by:

* a copy of the Packing List,

* an Acme Discrepant Materials Report (DMR).

The DMR requests that the vendor fill-in the type of corrective action taken (i.e., parts repaired, partsreplaced, account credited, etc.) On an area of the DMR dedicated to the vendor's comments.

Nonconforming materials may also generate an Engineering Change Request (ECR) if the problem is aresult of documentation or the vendor needs additional information to provide a quality product.

1.8. Inspection of Parts Replaced by the Vendor Under Warranty

When the vendor delivers replacement parts, it must be accompanied by the completed DMR detailingthe corrective action taken by the vendor. The DMR is then filed in the Vendor History File. If parts arereturned, the Incoming Inspection is then repeated on the replaced parts using the procedure andsampling plan outlined in this document.

Trial II Inspection of Replacement Parts

A "Trial II" inspection occurs when a replacement part is returned to Acme after the first qualityrejection. The results of a Trial II inspection will be entered into the Incoming Inspection report in theTrial II block associated with the original Purchase Order number. This information will be used to trackthe quality of a part replaced under warranty.

Trial III Inspection of Replacement Parts

Should a Trial II inspection yield discrepant materials, they must be returned to the vendor forreplacement. When the replacement part is again presented for Incoming Inspection, a "Trial III"inspection is performed. The results of a Trial III inspection will be entered into the Incoming Inspectionreport in the Trial III block associated with the original Purchase Order number. Vendors that do notprovide a sufficient number of quality parts to satisfy the original Purchase Order within three IncomingInspection trials, must be reported to the Quality Assurance Manager for action.

ISO 9001 Resources About Inventory Control

The requirement for inventory control at an ISO 9001 certified organization are often significantly morestringent that systems used by non-ISO certified organizations. Although the inventory system is morecomplex, a well maintained inventory can result in a cost saving for the organization.


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Inventory control means maintaining your inventory in a way that will maintain consistent productionquality. This is one area that is not applicable to organizations that do not maintain inventory (like pureservice organizations). If the organization maintains any components or finished goods, then this portionof the standard is required.

These articles will give you some information about how to create your own inventory control processesand procedures. Most organizations have a central computer system that controls inventory includingpurchasing and shipping. For this reason, the examples on this site are very basic. Most organizationsalready have a standard operation procedure for inventory control that is based on their specificsoftware.

It is the goal of the ISO 9001 standard to promote best practices in inventory control because poorinventory control can:

Waste resources

Create delivery problems

Contribute to failures in the final product

Reduce customer satisfaction

ISO 9001 has some special requirement for maintaining stock under proper conditions. This includesstock rotation (FIFO) and marking any special inventory. Marking and controlling the inventory includesspecific systems for:

Part numbers or identifier for every component

Non-conforming materials

Marking the status of products in process (WIP)

Products with special handling requirement (like fragile or ESD sensitive components)

Part with a limited lifespan (like glue, solder, batteries, etc.)


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The Inventory Control system must also integrate with a corrective and preventive actions system thatincludes the engineering change process. Some high level statements about inventory control areincluded in the quality manual so inventory is one of the most highly integrated requirements of thestandard. During a certification audit, the auditors typically will try to find every possible type ofinventory and confirm that it is controlled properly.

ISO 9001 Corrective And Preventive Actions Articles

The corrective and preventive actions system is one part of an ISO 9001 quality system that can make orbreak the success of the system. If the CAPA system is too complex, engineering quality improvementswill grind to a halt and product quality will drop If the system is too simple, it will not have enoughcontrol to avoid serious failures. It must be efficient and effective.

Corrective and Preventive actions are used to adjust the manufacturing processes, quality system andproduct documentation to continuously improve product and service quality. This process never ends.Corrective and preventive actions are usually based on an engineering change request and engineeringchange order system. In general it is recommended that all feedback from internal and external sourcesbe entered into the engineering change request system. This can include customer survey results,customer complaints, nonconforming material data, field failure data, work-in-process testing results,internal audit results, external audit results and suggestions from personnel. The inputs are thenentered into the Engineering Change Request System. This system is used to queue workload for theengineering and quality problem solvers. The engineering manager or quality manager then reviews this

bulk of requests for prioritization. The highest priority issues are assigned to personnel who create anengineering change order to correct the problem. Some engineering change requests will be denied andthe denial will be justified in the ECR system before the item is closed. Other requests will generate anEngineering Change Order that includes an assignment to a project manager. The engineering changeorder will include complete details on how to correct the problem and when the change will take effect.This system is a closed loop system that will continuously improve quality. The status of the ECR andECO systems should be used as input for the management review meetings.


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The process of managing this data usually requires a database since priorities change on a daily basisand the amount of input can be very large, even at small companies. A database is also advised since thesystem can be used to generate automated reports that are used in the management reviews. Withoutconstant supervision, engineering requests and change orders can pile up and start dragging down thecompany. A database and procedure for managing engineering change requests and change orders isincluded with our QMS in a box product.

Physical inventory procedures

Physical inventory and purposes; three phases: planning and preparation, execution, and analysis ofresults; methods of conducting physical inventory such as bar-code readers, count cards, and countsheets.


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1. Goals and reasons for conducting physical inventories

There is one day in the year when you and/or a group of your employees go to the warehouses andattentively count (quantity, weight, etc.) and record every item (goods, materials, supplies, etc.) there.

Then any differences are investigated and necessary adjustments are made. You probably agree that this

is an expensive, hard and not very pleasant, but very necessary process an annual physicalinventory. So lets consider why it is important to conduct a phy sical inventory.

The most obvious reason is that you conduct a physical inventory to check if the inventory accounting

records are accurate and complete at a particular time (every item found in the warehouses is recordedand every recorded item is found in the accounting records). However, physical inventory is not only an

accounting requirement. When your accounting records show an accurate stock quantity, your business

is more likely to be profitable and successful as a whole. Customer relations will be good because youcan quickly ship required quantity of products to them. You will also have better control of your stock

levels and companys money; you will be able to order the goods in the right quantity at the proper time

avoiding over- or understock. So the goal of the annual inventory count is to obtain accurate informationabout inventories on hand, which will help you to make right business decision.

As there are advantages presented above, a full physical inventory has its disadvantages:

Physical inventories may be time and resource consuming (e.g. personnel costs).

Physical inventories are more effective when manufacturing, shipping and receiving activities arestopped, which again brings in the cost factor (e.g. lost production).

Physical inventories are usually performed one or several times a year (normally once) and thus,accounting records are adjusted to match actual quantities on hand just a few times during a year. Allother time, there may be differences between accounting records and physical quantities.

An alternative to a full physical inventory when all inventory is counted at a point in time is inventory cycle

counts when you count inventory in portions throughout a year. Cycle counts will be covered in greater

detail in another article.

There are three phases of a physical inventory:

1. Planning and preparation

2. Execution

3. Analysis of results

2. Physical inventory planning and preparation

As we mentioned, a physical inventory may be a time- and resources consuming procedure, whichrequires proper planning. The planning helps you to make your annual inventory count more effective.You should have a written policy regarding the inventory count process (inventory plan, inventoryinstructions). In this policy you determine a date of conducting the physical inventory, assign responsiblepersons and describe the methods to be used. You can use different approaches (full inventory count or


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cycle count) to count different types of inventory; for example, one method for finished goods, andanother method for work-in-process (WIP) or for raw materials. You also should publish the proceduresand policies regarding recording the counts, reconciling discrepancies, unknown items, emergency orrush shipments, and auditor's approval requirements. Establishment and documentation of countingprocedures will allow you to control and supervise physical inventory properly.

It is beneficial to plan and prepare a physical inventory in advance:

First, you should determine a date and time of conducting a physical inventory and inform youremployees about it. Maybe your inventory counting will take place on different days in case you haveseveral remote warehouses. Select a day when your company activities are at a low point.

Second, you should form a counting team(s). At this stage, pay attention to employees' experience andunderstanding of a physical inventory process. Let the experienced people make all counts andnecessary calculations and less experienced record the results of counting. Some training about materialtypes, counting methods, documentation will be also useful.

Third, choose the method of conducting a physical inventory. You should use the information in thefollowing table and decide which method is suitable for your company.

Illustration 1: Methods of counting inventories

Method

Description

Advantages

Disadvantages

Bar-code readers

Use of bar-code readers allows reading and recording the counts directly to a computer.

The most efficient method.

Makes the physical inventory process more simple and accurate. Counters can quickly read and recordinformation. Reduces human error; eliminates counting in teams; minimizes shutdown time.

Expensive; special computer software and bar-code labels are required.

Count cards / tags

Index cards with information about individual product and location are used during counting.


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Not so expensive as bar-code readers; help discover lost and misplaced material.

More advance preparation is needed (all cards must be in the warehouse before the count begins).

Count sheets

Pre-printed lists of inventory (usually generated by company's software) are used to record on handcounts.

The easiest and cheapest method.

More time consuming (searching, counting, comparing). No logical order of items in count sheets.

A lot of time spent to find particular item during "wall to wall" counts. Items which are not in the listingor not in their place could be missed.

It is important to ensure that all transactions (receipts, customer returns, adjustments, etc.) have been

recorded before you prepare and print count cards or sheets for physical inventory. Any rushtransactions could be entered or processed only after the completion of physical inventory. When yougenerate count sheets and cards, leave spaces for names and signatures of the counting team membersfor future accountability and tracking.

You should also prepare the warehouse(s). Make sure that all materials/products are in their properplaces and can be clearly identified, clean up the store area, label all shelves and locations. Slow-movingitems can be counted and marked a day before a full physical inventory. Identify damaged, discountedand obsolete classes of items; place them separately from other inventory (vendor return area). Prepareand provide the plan(s) of stock locations.

If you spend enough time on the preparation of a count and explanation of the importance of physicalinventory to involved personnel, you will perform the count quicker and will have an accurate countwith minimum re-counts.

3. Executing a physical inventory

There are some rules you need to follow to achieve an accurate and effective count:

An employee who supervised or performed a physical inventory process must be an independent person.It means that an independent person cannot be responsible for check in and sign receiving reports, forthe daily security and accountability of the inventory. You should rotate your personnel so they count theareas for which they are not responsible directly. You can use the third party inventory services to be sureof independence of your staff (particularly if you suspect an internal theft).

Counting employees should not be given access to the inventory quantities recorded in the accountingrecords. This is called a blind count and helps to eliminate guessing on the part of counters, as theywould not know what the quantity is.

Stop your business operations (inventory transactions) on the day of counting or exercise proper controlover movement of inventories. Do not make any movement of items/products either into or out of the


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warehouses (even if they are misplaced). Do not fill orders or receive goods during the count process.There is a great risk of missing any items or their double count.

Proper control over count cards (tags) / sheets is needed. Ensure that all cards / sheets issued tocounting teams are sequentially numbered, accounted for and returned after the counting process isfinished including those which were voided or unused. Also each tag may have two (or three) copies, oneof which is left on the counted inventory and one is returned to Finance to enter into the system.

Immediately compare your counts with accounting records, audit the counts and conduct recounts if thereare unacceptable differences (i.e. deviation from accounting records is greater than a defined threshold indollars or units as stipulated in the company's policy).

Mark counted items and locations. This will allow you to ensure inventory completeness (i.e., no missingitems or items counted twice), which is an important aspect of any physical inventories.

When verifying your counts, pay special attention to fast-moving and volume items. Such items usually

have a greater risk of counting errors in comparison to slow-moving items.

As soon as you or other responsible employee verifies that the counts in the warehouses are accurate,

the quantities can be entered in your computer. If you find several counting errors in an area, the entiresection should be recounted. When verification is successfully completed, all counts are entered into thecomputer.The next step you need to do is to print the discrepancy reports and review it thoroughly. Sometimeserrors could be made when counts are entered in your computer system; for instance, there may be aposting error or a measure error such as an item is counted in tons, pieces or meters, but is maintainedin units in the system.

4. Analyzing physical inventory results

After you have identified all differences, it's time to investigate them. First of all, you need to determine

the source of discrepancies, and, then decide how to reduce them in the future. Let's consider possiblesources of differences. They can be the following:

Internal theft is a typical problem for retailers. As we mentioned above, you should use externalinventory specialists to identify internal theft. Good internal control is needed to prevent this issue inthe future. Such internal control includes use of security cameras, control over store access, thereceiving room and the back door, and control over trash disposal. Also, the owner (a manager) shouldlead by example and maintain appropriate discipline over recording the transactions.

Shoplifting. Use of security cameras and sensor tags will be very helpful to significantly reduce thisproblem; and certainly proper customer service can prevent shoplifting.

Administrative error can be identified through comparison of the differences among locations (may bethere is a shortage in one and the overage in another location at the same time).

Vendor fraud. For example, a vendor sends a shipment of inventories and indicates a quantity sent (inpacked boxes) higher than what is actually in the shipment. In such cases, the best control is to count all


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inventories received to ensure that the actual quantity matches the number provided by the vendor inthe shipping documents.

Analysing the differences, you should estimate the effect they have on your business. Some of themmay have little effect; other may have significant effect and show the areas where improvements are

needed. You should have your method to trace an accuracy of your inventory and identify theweaknesses. Two methods of accuracy tracking are on-hand method and transactional method. On-hand method shows you a percentage of error at the concrete point of time. Using this method, youdivide total difference amount by the total on-hand inventory amount. For example, after counting youhave a shortage of 15 items, when your total inventory amounted 150 items; thus, the accuracy rate is10% (=15 150 x100%). Transactional method shows the accuracy of your operations; it is a correlationof the difference amount and total consumed inventory amount during the period. For instance, youhave the same shortage of 15 units, and you determined that the consumed inventory amount duringthe count period is 250 units, so the accuracy rate is 6% (=15 250 x 100%). In practice, if inventoryaccuracy is within 3%, you may consider your inventory management to be effective.

You are also recommended to save the results of previous physical counts for the reason of comparingcurrent and last count results and seeing the effect of improvements in inventory management process.

After you have carefully investigated the discrepancies, you need to make adjustments. Adjustmentsneed to be made in the inventory listing (sub-ledger, perpetual inventory records) and the ledger. Forexample, your physical inventory result shows $17,200, while book inventory is $17,500. The $300difference will be adjusted in the sub-ledger (detailed inventory listing) by changing inventory parts withdifferences for correct unit quantities. You should also make a following entry: debit inventory shortageand credit inventory for $300. Note, however, that sometimes accounting software will make anadjusting entry in the ledger automatically after you have made necessary changes in the inventory sub-ledger. Consult your accounting software documentation for more guidance.

Finally, it will be useful for you to analyze the inventory count process in total and receive feedback fromyour employees. You can take into account this information when planning the count for the next yearand updating your inventory count policies and procedures.

Reconciling Cycle Counts

by Jon Schreibfeder

Cycle counting is the process of verifying the on-hand quantity of a specific number of stock productsevery day. In previous articles, I have described how to set up and maintain an effective cycle countingprogram and why this process is usually better than a full physical inventory for maintaining an accurate


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perpetual inventory in your computer system. But verifying on-hand quantities is only one of theadvantages of cycle counting. The other benefit of a cycle counting program is to improve your businessprocesses, including:

Making sure that all material movement is properly recorded.

Ensuring that stock receipts are put away in the proper location.

Verifying that the right quantity of the right item is shipped on outgoing orders or is pulled from stockfor an assembly.

Preventing shrinkage from theft and the mishandling of stocked items.

Process improvement results from carefully analyzing significant stock discrepancies. A discrepancy isthe percentage difference between the actual quantity physically counted and the stock level in thecomputer system at the time of the count:

[Absolute Value of (Quantity Counted Current Stock Level)] Current Stock Level

Including the "absolute value" of "Quantity Counted Current Stock Level" in this equation signifies thata discrepancy should be analyzed if significantly more or less inventory is found during the cyclecounting process. For example, assume that a distributor has a cycle count tolerance percentage of 5%.

Note: Most distributors, manufacturers, and retailers use a cycle count tolerance percentage of 2% - 5%.The percentage may vary by item. Inexpensive items that are stocked in bulk quantities should have ahigher tolerance percentage than expensive items that normally have few pieces in stock.

This means that any actual count that is more than 5% greater or more than 5% less than the currentstock level should be analyzed and investigated:

Item Stock


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Level Counted

Quantity Difference (%) Need to

Investigate?

A1005 100 91 -9.0% Yes

B7324 55 54 -1.8% No

A4509 18 16 -11.1% Yes

C3467 24 31 +29.2% Yes

Many distributors will also investigate discrepancies if the difference in monetary value between thestock level and the counted quantity exceeds a certain number of dollars.

Investigating cycle count discrepancies can uncover procedural mistakes made in your warehouse,including:

Wrong quantity taken to fill an order.

Wrong product taken to fill an order.

Products filled from the wrong stocking location.

Stock put away in the wrong bin location.

Units of measure confused or misrepresented.

Data entry errors.

Damaged material mixed with good stock.

Material movement not properly recorded.

Let's discuss some of the things that can indicate these specific reasons behind inaccurate stock levels,and actions you can take to improve material-handling policies and prevent future stock discrepancies.

Wrong Quantity Taken to Fill an Order


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Indicator:

There is no offsetting quantity of a similar inventory item.

Actions to Take:

Review recent transactions. Did the order picker(s) count out the pieces to be shipped, or did he or sheship sealed cartons?

Are specific pickers associated with frequent discrepancies?

Can you detect a pattern of sealed cartons from a specific vendor not containing the proper quantity ofa product?

Make sure employees know how to properly measure or count quantities to fill orders.

Allow only certain employees to fill orders for hard-to-count items.

"Spot check" quantities in sealed containers from questionable vendors.

Increase the frequency of cycle counting these items.

Wrong Product Taken to Fill an Order

Indicators:

There is an offsetting quantity of a similar item.

There is an offsetting quantity of an unrelated item in a nearby bin location.

There is an offsetting quantity of an item that is normally substituted for this item.

Actions to Take:

Monitor how often each picker makes this type of error.


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Ensure that bin locations and/or products are clearly marked.

Do not store very similar items next to each other. If items have long or complicated vendor partnumbers, consider adding a four-character randomly generated identification number to the descriptionof the item and place the same number on the bin. This will help pickers verify that they are picking the

right item.

Train employees in the differences between similar items.

Simplify the process of recording when one item is substituted for another.

Products Filled from the Wrong Stocking Location (in systems where quantities are maintained by binlocation)

Indicator:

There is an offsetting quantity of the item in another location that contains the same product.

Actions to Take:

Emphasize the importance of filling orders from the proper bin location.

Increase the frequency of replenishing stock in the primary bin location from bulk storage that is, don'tgive pickers the opportunity to pick the item from the wrong location.

Stock Put Away in the Wrong Bin Location

Indicators:

There is an offsetting quantity of the item in another bin containing the item.

There is an offsetting quantity of the item in a bin assigned to another product.

A bin location contains a quantity of this or another item that belongs in another bin.


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Actions to Take:

Ensure that your most experienced warehouse people are assigned to receiving, stock put-away, andverifying the accuracy of picked orders.

Have new employees pick orders under careful supervision.

Ensure that bin locations are logically assigned and well marked.

Establish a "no-fault" area in your warehouse. If an employee does not know where material belongs, heor she may place it in the no-fault area. Every day, an experienced warehouse person puts away anymaterial that has been placed in the no-fault area.

Unit of Measure Confused or Misrepresented

Indicators:

The count quantity matches the stock level expressed in a different unit of measure.

The product involved is purchased in one unit of measure and is issued in a different unit of measure.

Actions to Take:

Instruct all employees in the difference between the purchasing and issuing units of measure.

Place a warning message in the bin containing the item emphasizing the proper issuing unit of measure.

Data Entry Errors

Indicator:

An actual count quantity agrees with the stock level but was incorrectly entered into the computersystem.


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Actions to Take:

Provide more training in data entry.

Use a method like "check digits" to verify that data is being correctly entered into the system. Forexample, the operator might have to compare the sum of the count quantities listed on the cycle countsheet to the sum of the quantities he or she has entered into the computer system.

Record material movement with bar code readers, eliminating the need for manual data entry.

Damaged Material Mixed with Good Stock

Indicator:

The count is accurate, but some or all of the material is not in usable condition.

Actions to Take:

Simplify the procedure for separating damaged material from "good" inventory.

Discuss with employees the importance of properly identifying and accounting for damaged stock.

Material Movement Not Properly Recorded

Indicator:

You have no idea why material is missing.

Actions to Take:


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Ensure that you have documented procedures and paperwork for every type of material movement. Askemployees to think of ways material can be removed from stock without being properly recorded. Andwhenever possible, simplify the process of recording transactions.

Conduct a security check of your warehouse. Determine how easy is it for employees, customers, and/or

outsiders to remove material without the proper paperwork and without being detected.

Establish an unbreakable policy: No material ever leaves your warehouse without the properpaperwork. Violating this policy is grounds for immediate dismissal or arrest.

It is impossible to achieve effective inventory management without accurate stock levels in yourcomputer system. A comprehensive cycle counting program is a valuable tool for ensuring that thequantities in your computer system agree with what is physically in the warehouse. But to be certainthat stock levels remain accurate over time, you must investigate significant stock discrepancies and

take corrective action to prevent similar problems from reoccurring in the future that is, you mustutilize cycle counting to improve the way you run your business!

2003, Effective Inventory Management, Inc. All rights reserved. This article cannot be reprinted orreproduced, in whole or in part, without the expressed written permission of Effective InventoryManagement, Inc.

Your Ideal Inventory Investment

by Jon Schreibfeder

How do you know if you have too much, too little, or just the right amount of stock inventory? One wayis to compare the value of your current inventory to an "ideal inventory investment." In this article wewill discuss how to calculate the value of this "right" amount of inventory. As with many of our otherinventory analysis tools, calculating the ideal inventory investment requires that we first separate thoseinventory items with recurring demand from those items with sporadic usage.

Recurring Usage Items


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Recurring usage products are sold or used on a regular basis. Typically these items:

Have had usage in at least eight of the last twelve months.

Have had usage in at least four continuous months in the last twelve months

Controlling and Costing Materials

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Transcript of Controlling and Costing Materials