INVENTORY VALUATION METHODS IN INDIAN …SPJIMR Mumbai Email: [email protected] ... the SME for...
Transcript of INVENTORY VALUATION METHODS IN INDIAN …SPJIMR Mumbai Email: [email protected] ... the SME for...
Volume 6, Issue 12 (December, 2017) UGC APPROVED Online ISSN-2277-1166
1 Available online on www.abhinavjournal.com
Published by: Abhinav Publication
Abhinav National Monthly Refereed Journal of Research in Commerce & Management
INVENTORY VALUATION METHODS IN INDIAN MANUFACTURING SECTOR SMES - AN EMPIRICAL STUDY
Lakshminarayanan Latha Assistant Professor (Adjunct)
SPJIMR Mumbai
Email: [email protected]
ABSTRACT
A review of economic activity across the world in the past two decades reveals that the contribution of
the SMEs towards economic growth of a country has been steadily increasing in terms of its
contribution towards GDP, employment opportunity and exports. Adopting well-structured and
appropriate practices in their manufacturing operations and accounting and control functions will
enable the Indian SMEs in the manufacturing sector to achieve sustained growth and profitability. An
important activity in the control function is inventory valuation. Inventory consumed in the production
process amounts to greater than 50% of the total cost of the product. Hence inventory valuation is a
topic of significant relevance to SMEs in the manufacturing sector. Furthermore, with the onset of
GST, their current practices will not be sustainable from legal and regulatory point of view. With this
background, this Study aims at (a) ascertaining the existing Inventory Valuation Methods in Indian
SMEs in the manufacturing sector. (b )comparing the ideal method with the method currently used by
the SME for inventory valuation to evaluate the appropriateness of the method to the industrial sector
the SME belongs to. This Study has been conducted through structured interviews preceded by a
Survey Questionnaire which was administered to 100 respondents selected through purposive
sampling. The Study finds that majority of the respondents irrespective of the industry they were
operating in, applied the FIFO method of inventory valuation. It concludes that majority of the
respondents do not use inventory valuation method appropriate to the industry in which they operate.
Keywords: inventory, valuation, SMEs, manufacturing
INTRODUCTION
According to International Federation of Accountants (IFAC, 1998), Cost Management function also
known as Management Accounting function has four major roles to play in a business organisation
which are given below in the order as it evolved as part of evolution of Management Accounting
1. Cost determination and financial control.
2. Providing information for Management planning and control.
3. Reduction of waste of business resources
4. Creation of value through effective use of resources. This four roles and how each one has led to
the next one is nicely encapsulated by IFAC in Fig 1 given below.
Inventory forms a major part of costs in the manufacturing sector. Hence, recording of external and
internal transactions of inventory correctly for (a) determining costs,(b) planning and decision making
relating to inventory, (c) pricing of finished products,(d) determining accurate profit for a specific
financial period.
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Inventory Valuation is an important part of both cost determination and financial control and this paper
aims to study this important aspect with reference to the SMEs in the Indian Manufacturing sector.
DEFINITION OF SME
In India, a manufacturing enterprise with investment in plant and machinery less than or equal to Rs.10
crore is defined as an SME, as per SME Chamber of India. (http ://www.smechamberofindia.com)
This plant and machinery could be either owned by the SME or rented/leased by the SME. As per a
report titled “SMEs’ Role in Indian Manufacturing sector” (www.ibef.org) and an article in the
Economic Times, (Venkatachalam, 2012) , there are about 48 million SMEs in the Indian
Manufacturing Sector. This article also mentions that the SMEs contribute significantly to the Indian
economy. Their contribution to industrial output is 45%, 42 million to employment, 40% share of total
exports and 17% to the GDP of India with more than 7500 quality products. For a manufacturing
sector enterprise, raw material costs and Direct Labour costs constitute up to 70% to 80% of their total
cost.
MEANING OF INVENTORY
In the manufacturing Sector, Inventory is of three types: Inventory of Raw Material, Inventory of
Work-in-progress or semi-finished goods, and inventory of finished goods. Ind AS 2 describes in brief
the treatment of inventories in reporting the financial statements. When inventories are sold, the
carrying amount of those inventories shall be recognised as an expense in the period in which the
related revenue is recognised. The amount of any write-down of inventories to net realisable value and
all losses of inventories shall be recognised as an expense in the period the write-down or loss occurs.
The amount of any reversal of any write-down of inventories, arising from an increase in net realisable
value, shall be recognised as a reduction in the amount of inventories recognised as an expense in the
period in which the reversal occurs. Recognition of Inventory value for calculating the cost of goods
sold as an expense has a direct impact on the profit before tax of the period. This incorrect value of the
closing inventory of this period, becomes the opening stock of the next period. Thus the error in
inventory valuation affects not only the profits of the current period, but also of the following period.
Hence, inventory valuation is a very critical activity and function of the cost and management
accounting function in the manufacturing sector.
The study has been done based on the inventory valuation methods of 100 SMEs in the manufacturing
sector. These 100 SMEs have been selected from 29 industrial sectors and are geographically from pan
India. The study has collected data based on structured interviews aided by a Survey Questionnaire
which was administered to these SMEs with questions relating to Inventory Valuation. The study
attempts to compare the correct inventory valuation method vis a vis the current valuation method
being followed by these SMEs based on the researcher’s academic interaction with the SMEs and a
decade of experience in the corporate sector dealing with SME vendors in the manufacturing sector.
LITERATURE REVIEW
Since the study covered the topic of Inventory Valuation methods, it was necessary to review the
extant literature on the subject and the same has been covered in this section. An existing study of Cost
Management Systems and Practices in SMEs undertaken in UK, Japan, Malaysia, provide insights on
the significance of cost information for managerial decisions and measuring business performance.
The study covered the areas of inventory control, costing concepts and accounting information systems
(Edison, Manuere and Joseph, 2012) and the findings indicated that cost benefit analysis, lack of
government support, financial constraints, complexity of Accounting Information Systems .strongly
influence non adoption of AISs by SMEs. A study (Ngubane, Mayekiao, et al, 2015 ) on a similar
topic found that although majority of the respondent SMEs were aware of formal inventory
management systems, they did not extensively make use of them but ironically the informal inventory
management systems which were used by these respondents, were found to be working for them.
Another study (Hall and McPeak, 2011)., indicates that the SMEs tend to be cash flow-strapped
because of inventory in the supply chain -both outbound and inbound, suffer from extended accounts
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receivables, often as a result of retailers taking advantage of their small size. Another study examined
a case of the lock manufacturing industry in the Aligarh district, Uttar Pradesh. The investigations
revealed that lock manufacturing units, by-and-large, were either unaware of even the fundamental
techniques of inventory management or did not practice them for one reason or the other. (Farooquie
and Khan, 2010). An attempt to ascertain the role and importance of inventory management practices
and performance of SMEs in the machine tool industry in the city of Bangalore, brings out the fact that
formal inventory management practices have a positive impact on the inventory cost and therefore, the
performance of SMEs.(Narayana Pillai,2010).
The review of literature above reveals that some studies have been done in the area of Inventory
Control and optimizing inventory costs. However there is no empirical paper available on the
Inventory valuation methods used by Indian SMEs in the manufacturing sector. This paper is an
attempt to address this gap.
RESEARCH OBJECTIVES The following are the research objectives of this paper:
1. Ascertaining the existing Inventory Valuation Methods in Indian SMEs in the manufacturing
sector.
2. Comparing the ideal method with the method used by the SME for inventory valuation to
evaluate the appropriateness of the method to the industrial sector the SME belongs to.
RESEARCH QUESTIONS
The study aims to address the following two Research Questions:
1. What inventory valuation methods are the SME respondent firms currently using in their
business?
2. Is the method they use appropriate with respect to the ideal method used as per the concepts of
Inventory valuation for the SMEs’ industrial sector?
RESEARCH METHODOLOGY
This section covers the methodology of research undertaken for this Study, a brief description of
which has been given below.
RESEARCH DESIGN
This Study uses the Qualitative method of research. Structured interviews, (face to face or telephonic,
depending on geographical location), were held with the respondents with specific questions regarding
their Inventory valuation methods. The interviews were aided by a Survey Questionnaire, which was
administered to the respondents in advance of the interviews. The questions were aimed at getting
primary data, viz. inventory valuation methods used by the respondent SMEs. The topic of inventory
valuation is associated with costs and such data is treated to be confidential by these SMEs. Hence
there is very little information in the public domain on this topic and so no secondary data could be
used for this study.
SAMPLING METHOD AND SAMPLE SIZE
The scenario for the sample selection was complicated due to the target population size for the study.
Indian economy has a large contribution from the SMEs. The number of SMEs in the manufacturing
sector is about 48.6 million. A random sampling of this huge population would not be economically
feasible for the researcher. Moreover,the research title deals with inventory management or valuation
comes under the area of “Cost” and “Costing Systems” generally considered confidential and internal
information by most business firms whether large scale or SMEs. Hence, Purposive Sampling method
was used for selecting the sample respondents.
The sample size has been worked out using 95% confidence level and an error margin of +/-10%. The
sample size calculator available in the url: https://www.surveysystem.com/sscalc.htm has been used
for this calculation and a snapshot of the output window is posted below:
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Based on the above, the sample size chosen for this Study was 96, rounded off to 100 to facilitate Data
Analysis.
DATA ANALYSIS
The analysis of data has been covered in two parts:
RESPONSE ANALYSIS
The process of data collection for this Study was by means of the responses received from the
respondents during the structured interviews conducted with the aid of the Survey Questionnaire. The
selected respondents were from pan India geographically and also covered a diverse range of industries
in the manufacturing sector
Table 1 below gives the diverse sectors which this study covered whereas Table 2 covers the
geographical diversity of the respondents.
Table 1 List of Industries covered in this Study
SECTOR NO. OF RESPONDENTS
Agricultural Equipment 1
Beverage 3
Cables & Wires 4
Cement 2
Chemicals 2
Cigarettes, Bidis 1
Construction Material 2
Consumer Durables 2
Cosmetics 1
Dairy 1
Electrical Equipment 2
Food Industry 4
Forgings 1
Furniture 2
Household décor 2
Iron & Steel products 12
Jewellery 2
Lighting & Luminaires 1
Mfg Equipments & Parts 18
Non Ferrous Products 2
Oil & Lubricants 1
Paper - Packaging & other
applications
5
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Table 2: Geographical Diversity of the respondent SMEs
Central Total 11 South Total 16
Bhopal 1 Bangalore 6
Indore 5 Belgaum 1
Nagpur 2 Chennai 3
Ratlam 1 Coimbatore 1
Shivpuri [MP] 1 Hyderabad 1
Neemuch [MP] 1 Madurai 1
North Total 18 Nuzvid [AP] 1
Ahmedabad 3 Tirupur 2
Ankleshwar 1 West Total 49
Baroda 2 Ahmedabad 1
Delhi 2 Halol-Gujrat 1
Faridabad 2 Mumbai 33
Gujarat 1 Nanded 1
Jaipur 3 Nashik 3
Kanpur 1 Navi Mumbai 1
NOIDA 1 Pune 4
Rajkot 1 Sangli 1
Silvassa 1 Surat 1
East Total 6 Thane 3
Kolkatta 4
Total 100 Siliguri 1
Sundergarh, Orissa 1
ANALYSIS OF INVENTORY VALUATION METHODS
As per Ind AS 2, the widely used Inventory Valuation Methods in businesses are FIFO, LIFO,
Weighted Average Method, Simple Average method and a brief description is given below:
The FIFO Method: The FIFO formula assumes that the items of inventory that were purchased or
produced first are sold first, and consequently the items remaining in inventory at the end of the period
are those most recently purchased or produced.
The LIFO Method: Under the LIFO method the inventory that were purchased or produced recently
are sold first and those items that are left in the inventory are those purchased the earliest.
Perfumes 1
Pharmaceuticals 7
Plastic 10
Power Distribution
Equipment
2
Rubber products 2
Textiles 6
Toys 1
TOTAL 100
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The Weighted Average Method: Under the weighted average cost formula, the cost of each item is
determined from the weighted average of the cost of similar items at the beginning of a period and the
cost of similar items purchased or produced during the period. The average may be calculated on a
periodic basis, or as each additional shipment is received, depending upon the circumstances of the
entity.
Based on the responses received from the Survey, Table 3 below gives the data about the method of
inventory valuation used by the respondents. The data shows that 62% of the respondents use the
FIFO method.
Table 3 Types of inventory valuation methods used by Respondent SMEs
Type FIFO LIFO Wtd. Avg Others*
Percentage of
Respondents
62 4 27 7
*Actual cost. Simple Average
Every industry based on its typical nature of production and products, has an ideal inventory valuation
method. For example in the iron and steel industry, FIFO is best suited because the oldest stock has to
be sold out first, else there will be loss of material owing to rusting of inventory. SMEs may not be
using the ideal method of inventory valuation suited to their industry owing to lack of awareness and
continue using traditional systems handed over to them from the previous generation owners. This
study has reviewed the current inventory valuation of the firm and commented on whether the
valuation system used by the respondents is appropriate to the ideal method. This comparative
evaluation has been presented in the Table 4 below. Analysis of the data from the table shows that
65% of the firms use an Inventory Valuation method different from the view of the researcher.
Table 4: Researcher’s Comparative Evaluation on the methods used by each respondent
Sr.
No.
Product
Manufactured
Inventory
Valuation
Method
Researcher's comments *Logical , means the Researcher agrees to the
respondent firm’s method for inventory valuation.
1
Steel
Processing(Decoil
ing, slitting and
Blanking of steel
coils)
FIFO
FIFO will reflect reality, if the firm is operating on
bare minimum inventory; If it has high amount of
RM, then Wtd. average will be more closer to reality
2 Pharma [API] FIFO FIFO has to be followed, as it is expected to be
consumed physically as FIFO. Hence Logical.*
3
SS kitchen
equipment and
bakery equipment
FIFO
Being a discrete manufacturing process, stock levels
are supposed to be lower and physically used by
FIFO. Hence, Logical
4 Fashion[Pure Silk
Fabrics] FIFO Logical
5 Pneumatic Tools FIFO Logical
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6
High voltage
Elec.Equipments,
Grid automation,
Reactors,Transfor
mers,Line
Traps,Capacitor
Banks,SVCs,….
FIFO
One to one tracking is appropriate as it is more of a
project industry. FIFO can be a reasonable
approximation
7
Bulletproof
Equipments for
Defence &
Elec.Insulation for
Power & Railway
sector
Wtd.Avg. Logical
8 Granite slabs,
Tiles &Artefacts FIFO Logical
9
Consumer
durables[Mixer
Grinder, Food
Processors, Juicer
mixer,etc.
Wtd.Avg.
FIFO will reflect reality, if the firm is operating on
bare minimum inventory; If it has high amount of
RM, then Wtd. average will be more closer to reality.
10 Pre Cast Concrete
Products Wtd.Avg.
Logical
11 Mattress FIFO Logical
12
Plastic household
products and
packaging
Wtd.Avg. Logical
13 Industrial Valves Wtd.Avg.
One to one tracking is appropriate as it is more of a
project industry which is a B2B industry. Hence,
FIFO can be a reasonable approximation
14
Pre Anodized
Aluminium
Coils/Sheets for
the lighting
industry.
FIFO
FIFO will reflect reality, if the firm is operating on
bare minimum inventory; If it has high amount of
RM, then Wtd. average will be more closer to reality.
15 Colour Melange &
Fancy Yarns Wtd.Avg.
FIFO will reflect reality, if the firm is operating on
bare minimum inventory; If it has high amount of
RM, then Wtd. average will be more closer to reality.
16 Kraft Paper FIFO
FIFO will reflect reality, if the firm is operating on
bare minimum inventory; If it has high amount of
RM, then Wtd. average will be more closer to reality.
17 Polishing
Compounds FIFO
FIFO will reflect reality, if the firm is operating on
bare minimum inventory; If it has high amount of
RM, then Wtd. average will be more closer to reality.
18 Auto parts FIFO Logical
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19 Agricultural Eq. &
spares Wtd.Avg.
For Equipment FIFO is closer to reality and if possible
one to one tracking; For spares Wtd average is logical
20 Chemicals and
Veterninery drugs. FIFO
FIFO will reflect reality, if we are hand to mouth; If I
have high amount of RM, then Wtd average may be
more closer to reality
21
Pharmaceutical
Bulk drug and API
mfg.
Wtd.Avg. FIFO has to be followed, as it is expected to be
consumed physically as FIFO
22 Precision Turned
Components FIFO Logical
23 Plastic pipes and
fittings Average
FIFO will reflect reality, if the firm is operating on
bare minimum inventory; If it has high amount of
RM, then Wtd. average will be more closer to reality
24 Laboratory
Testing equipment LIFO
Lab Testing Equipment have shelf life. Hence FIFO is
more appropriate
25
Household
consumer goods
Wtd.Avg.
FIFO to be followed
26 Furniture
components LIFO Wtd. average will be appropriate
27 Industrial Heaters FIFO Logical
28 Bearings & Auto
components FIFO Logical
29 Clay Tiles LIFO Logical
30 Electrical engg.
Switchgear FIFO
For Equipment ,FIFO is closer to reality and if
possible one to one tracking; For spares Wtd average
is logical
31
Material Handling
systems, Process
automation for
biscuit and
confectionery
industry.
FIFO
For Equipment, FIFO is closer to reality and if
possible one to one tracking; For spares, Wtd.
average is logical
32 Herbal Extracts FIFO
FIFO, if physical FIFO is followed; Otherwise Wtd
average (especially if the stock levels are high) If
inputs have shelf life, FIFO is closer to reality
33 Diamond
Polishing Wtd.Avg. Logical
34 Corrugated boxes FIFO Wtd Average is more appropriate
35 Ferrous Castings FIFO
FIFO, if physical FIFO is followed; Otherwise
Wtdaverage (especially if the stock level are high) If
inputs have shelf life, FIFO is closer to reality.
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36
Flexible
Multilayer
laminates for
Electrical
insulation, Cable
Wraps and Solar
Photovoltic
Backsheets.
Wtd.Avg. Logical
37 Rigid PVC Pipes Wtd.Avg. Logical
38 Cement Wtd.Avg. Logical
39 Plastic Stationery Wtd.Avg. Logical
40 Plastic pipes and
fittings Average
Wtd Average is more appropriate, as it also takes into
account the Quantity of the material while calculating
the rate.
41 Pharma IV fluids. FIFO Logical
42
Precision
Mchinery parts &
Locomotive
Components
FIFO Logical
43
MS Pipes & Tubes
used in hydraulic
systems, fuel
injections,m/c
mfg,etc.
FIFO
If the products are standard products , then FIFO is
Logical . However if the product is made-to-order and
customized then physical tracking one to one is
possible on FIFO basis.
44 Not Available FIFO
45
EPC Process
Equipments,
Reactors, Heat
Exchangers,
Pressure Vessels,
Storage Tanks,
Structural
Fabrication&Erect
ion
Wtd.Avg. FIFO or one to one tracking is more logical
46 Energy Meters FIFO Logical
47 Steel Wires FIFO Logical (or if the stock levels are high - Wtd average)
48 Printing &
Packaging FIFO Logical (or if the stock levels are high - Wtd average)
49
Herbal products
for skin care, oral
care and hair care
FIFO
These products have a shelf life. Hence FIFO is
appropriate. However if stock levels are high then wtd
average is more appropriate.
50 Stainless Steel
Fasteners Wtd.Avg. Logical
51 Speciality Tea Bags FIFO Logical
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52 Empty hard
capsules FIFO Logical
53 Fabrication FIFO Logical (or if the stock levels are high - Wtd average)
54 Yarn FIFO Logical
55 Food ingredients,
nutraceuticals Wtd.Avg.
FIFO is more closer to ground reality, unless the stock
levels are very high
56 Anti Vibration
Mounts FIFO Logical
57
Transformers &
control relay
panels
FIFO Logical
58
Sheet metal
fabrication &
Light fixtures
FIFO Logical (or if the stock levels are high - Wtd average)
59 Corrugated boxes FIFO Logical (or if the stock levels are high - Wtd average)
60 Sweets and
Snacks FIFO Logical (or if the stock levels are high - Wtd average)
61 Furnishings and
Upholstery FIFO Wtd Average is more appropriate
62 Dairy Wtd.Avg. FIFO is more closer to ground reality, unless the stock
levels are very high
63
Liquid Ring
Vacuum Pumps,
Centrifugal
blowers, Arial
flow fans.
FIFO Logical
64 Printed Cartons FIFO Logical (or if the stock levels are high - Wtd average)
65 Iron&Steel FIFO
FIFO will reflect reality, if the firm operates on bare
minimum inventory; If the firm has high amount of
RM, then Wtd average may be more closer to reality
66
Gold and
Diamond
Jewellery
LIFO Wtd Average is more appropriate
67 Shirts,Trousers,Su
its for MEN Wtd.Avg. FIFO is closer to reality
68
Rubber Products
for Oil & Gas
Industry.
Wtd.Avg. Logical
69 Teas
Net
Realisable
Value
Logical (but NRV or cost which ever is lesser)
70 Perfumes FIFO Logical (or if the stock levels are high - Wtd average)
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71 PP/HDPE Woven
sacks,Jumbo bags. FIFO Logical (or if the stock levels are high - Wtd average)
72 kids' cycles FIFO Logical
73 Forgings,Fittings,
Valves
Actual
Cost
Wrong method. Tracking inventory values in this
industry at Actual cost is not possible. Wtd average is
more appropriate
74 Wool felt and Felt
Products
Actual
Cost Wrong method. FIFO is more appropriate
75 Mfg. Blow wheels
for motor industry Wtd.Avg. Logical
76
Components for
Automotive &
Electronics
Industry
FIFO Logical (or if the stock levels are high - Wtd average)
77 Food products Wtd.Avg. FIFO is closer to reality
78
Customised
engineering
equipments and
spares
Wtd.Avg. FIFO or one to one tracking is more logical
79
Engineering spare
parts and
components
Just in
Time
Just in time is not an inventory valuation method. It is
an inventory control method. Wtd.average is more
appropriate for this firm.
80 I&Steel(TMT
bars, Wire Rods) Wtd.Avg.
FIFO will reflect reality, if the firm operates on bare
minimum inventory; If the firm has high amount of
RM, then Wtd average may be more closer to reality
81 Alloy Steel Billets
& rolled products FIFO
FIFO will reflect reality, if the firm operates on bare
minimum inventory; If the firm has high amount of
RM, then Wtd average may be more closer to reality
82 Mild Steel Wires FIFO
FIFO will reflect reality, if the firm operates on bare
minimum inventory; If the firm has high amount of
RM, then Wtd average may be more closer to reality
83 Plastic bags FIFO
FIFO will reflect reality, if the firm operates on bare
minimum inventory; If the firm has high amount of
RM, then Wtd average may be more closer to reality
84 Ice Blocks FIFO Logical
85 Rubber Products. FIFO
FIFO will reflect reality, if the firm operates on bare
minimum inventory; If the firm has high amount of
RM, then Wtd average may be more closer to reality
86 Cables FIFO
FIFO will reflect reality, if the firm operates on bare
minimum inventory; If the firm has high amount of
RM, then Wtd average may be more closer to reality
87
Electrical panels,
transformers &
Enclosures
FIFO
Logical
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88 Teas FIFO Logical
89 BIOFUEL
(Chemical) Wtd. Avg.
FIFO will reflect reality, if the firm operates on bare
minimum inventory; If the firm has high amount of
RM, then Wtd average may be more closer to reality
90 Bidis&Hand made
cigarettes Wtd. Avg.
FIFO will reflect reality, if the firm operates on bare
minimum inventory; If the firm has high amount of
RM, then Wtd average may be more closer to reality
91 Furniture FIFO Logical (or if the stock levels are high - Wtd average)
92
Lubricating Oil,
Specialty Oil,
Greases
FIFO Logical (or if the stock levels are high - Wtd average)
93
Machinery for
Pulp,Paper&board
. Individual
equipments&Turn
key projects
FIFO FIFO or one to one tracking is more logical
94 Jari FIFO
FIFO will reflect reality, if the firm operates on bare
minimum inventory; If the firm has high amount of
RM, then Wtd average may be more closer to reality
95 Special Purpose
Machines
Project
based
One to one tracking is appropriate as it is more of a
project industry. FIFO can be a reasonable
approximation
96 Plastic Household
goods FIFO
FIFO will reflect reality, if the firm operates on bare
minimum inventory; If the firm has high amount of
RM, then Wtd average may be more closer to reality
97
Aluminium &
Plastic caps for
Pharmaceutical
companies
Wtd. Avg.
FIFO will reflect reality, if the firm operates on bare
minimum inventory; If the firm has high amount of
RM, then Wtd average may be more closer to reality
98 Steel Wires FIFO
FIFO will reflect reality, if the firm operates on bare
minimum inventory; If the firm has high amount of
RM, then Wtd average may be more closer to reality
99 Brass & Copper
Sheets FIFO
FIFO will reflect reality, if the firm operates on bare
minimum inventory; If the firm has high amount of
RM, then Wtd average may be more closer to reality
100 Plastic
components FIFO
FIFO will reflect reality, if the firm operates on bare
minimum inventory; If the firm has high amount of
RM, then Wtd average may be more closer to reality
FINDINGS AND LIMITATION
FINDINGS
1. 62% of the firms use FIFO method whether relevant or not. They use this method
because they are able to maintain records in simple Microsoft excel formats. Out of these
62% , 15% do use local ERP systems, yet have built in their systems, the FIFO method
because they are able to understand it faster and better and can verify the calculations
with a calculator. 4% use LIFO method, 27% use Weighted Average method and the
balance 7% use other methods such as Actual Cost, Simple Average cost, etc.
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2. Based on the questions asked during the face to face interviews with the respondent
firms, it was found that 73% of the firms do not know the significance of the
mathematical relationship between PBT and its closing Inventory Value. As long as they
are making a profit they are not concerned about the method used for inventory valuation.
3. 65% of the firms use an Inventory Valuation method different from the view of the
researcher.
LIMITATIONS
The study could not tap the data of the unregistered SMEs in this sector.
CONCLUSION
Inventory valuation is an important parameter in the cost management function of a firm. An
incorrect inventory valuation method will lead to incorrect profit reporting. The use of
incorrect inventory values for inventory control activities and decisions will lead to high risks
for the SMEs in terms of their sales plan, pricing decisions and future profits. More over
SMEs who have taken working capital loans will have to justify to their bankers, in case such
incorrect inventory values are noticed by them during periodic reviews. Also wrong profit
reporting in the firm’s profit / loss account on account of wrong inventory valuation method
can be tracked by Income Tax authorities during tax audits for the firms who may classify it
as non-compliance.
Also, the owner-managers of the SMEs who follow wrong inventory valuation methods will
find it difficult to take optimal decisions relating to their operations like purchase planning,
sales planning and production planning. Every business decision which requires inventory
value as a piece of critical decision making will be affected due to the incorrect inventory
valuation.
This Study concludes that majority of SMEs in the manufacturing sector, are not following the
method ideally suited to the industry in which the SME firm is operating in. This is due to
lack of awareness of impact of inventory valuation method on the profit of the firm. This issue
can be addressed by organisations like MSME and other industrial associations, by organizing
training programmes, specially for SMEs, on inventory valuation methods and their impact on
business performance.
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