FINM6221 LU5
FINM6221 LU5 – Controlling inventory &
overhead costs
5.2 Inventory Concepts
Trading organization:
Inventory = items purchased with the intention of selling them at a profit
Manufacturing organization:
Inventory consists of 3 components:
1. Direct material / Raw 2. Work-in-progress / 3. Finished goods /
material / Primary incomplete work / completed goods
material half-finished work
5.3 Inventory piling
= gathering or stockpiling the inventory items that a business needs to operate. Main reason of
inventory piling is to avoid a stock-out.
Types & purposes of inventory common in inventory piling:
Normal stock: Material in the process of production, is about to enter the production process, or
has just been completed.
Buffer stock: Material that forms a buffer between production and usage where production is
constant, but where the supply of raw material takes place irregularly
Safety stock: Like buffer stock but is specifically aimed at ensuring the org can continue w
production as usual if a specific raw material is not delivered w/in the normal delivery time.
Speculative stock: Stock held for financial reasons - expected rise in the price of stock
Stock-in-transit: Stock that has already been ordered and paid for but is still being delivered.
Maximum stock: The highest possible stock volume that can be carried by the org and is limited by
storage space available. Usually occurs when an order is delivered earlier than expected.
Overstocking: Org has too much stock that is not needed
Understocking: Too little stock
Average stock: Stock levels are always changing, so it not possible to calculate the average
amount of stock held during any period of time accurately, but the following formula are used:
Average stock = (Opening stock + Closing stock) ÷ 2
Average stock = (Order size ÷ 2) + Safety stock
1
,FINM6221 LU5
5.4 Material Cost Control
Material cost control involves monitoring the cost and usage of raw materials to prevent losses.
Companies use stock takes to identify any inventory loss. In simple manufacturing setups, material
costs can be easily traced through supplier invoices. However, in more complex operations with
many different materials, tracking becomes more difficult. To avoid production delays and additional
costs, materials are purchased regularly to ensure they are always available when needed.
5.5 Valuing inventory
2 methods of inventory valuation:
1. First in first out (FIFO) 2. Weighted average method
You must state the method you chose in the notes to your financial statements.
5.5.1 First in first out
Units of inventory that were bought first will be sold first.
5.5.2 Weighted average cost
When a company buys inventory at different prices over time, the weighted average cost method
calculates a new average cost per unit each time a new batch of inventory is bought.
New Purchase: A new batch of stock is bought at a different price.
Recalculation: The cost per unit is updated using the weighted average formula:
Total Cost of all inventory
New Weighted Average cost per unit=
total units∈inventory
Cost of Sales: When inventory is sold, the new average cost per unit is used to calculate the
cost of sales (COGS).
5.5.3 How he 2 Different Inventory Systems Influence the Valuation of Closing Inventory
An inventory valuation method = used to value inventory –> FIFO and Weighted average cost
An inventory system = used to record inventory –> perpetual and periodic
Perpetual inventory system is applied continuously - the value of the inventory is calculated after
each transaction. Cost of inventory purchased is debited to an inventory account.
Periodic inventory system, the value of the inventory is only calculated at the end of a specific
period. All inventory related expenses are recorded in the purchases account.
2
, FINM6221 LU5
Example 5.1
X trade a single homogeneous product. On April 1st 2003, there were 5200 units with a selling price
of R3 each (20% mark up). X uses perpetual inventory system.
Date Transactions
2 Purchased 2 000 units @ R 2.75 each
8 Sold 6 000 units @ R 5.41 each
13 Purchased 1 000 units @ R 2.85 each
18 Purchased 4 000 units @ R 2.63 each
24 Sold 5 100 units @ R 5.41 each
30 Purchased 1 500 units @ R 2.87 each
Calculate the following for each FIFO and weighted average cost inventory control methods:
1.Value of closing inventory on 30 April 3.Cost of sales for April 2003
2003 4.Gross profit for April 2003
2.Sales revenue for April 2003
FIFO Method
1. Value of closing inventory
Date Purchases Issues Balance
1 5200 @ R2.50
2 2000 @ R2.75 5200 @ R2.50
2000 @ R2.75
8 5200 @ R2.50 1200 @2.75
800 @ R2.75
13 1000 @ R2.85 1200 @2.75
1000 @ R2.85
18 4000 @ R2.63 1200 @2.75
1000 @ R2.85
4000 @ R2.63
24 1200 @2.75 1100 @ R2.63
1000 @ R2.85
2900 @ R2.63
30 1500 @ R2.87 1100 @ R2.63
1500 @ R2.87
Value of closing inventory = (1100 x 2.63) + (1500 x 2.87) = R7198
2. Sales Revenue
(6000 x 5.41) + (5100 x 5.41) = R60051
3. Cost of Sales 90
(5200 x 2.50) + (800 x 2.75) + (1200 x 2.75) + (1000 x 2.85) + (2900 x 2.63) = R28977
4. Gross profit (Sales – COS)
3
FINM6221 LU5 – Controlling inventory &
overhead costs
5.2 Inventory Concepts
Trading organization:
Inventory = items purchased with the intention of selling them at a profit
Manufacturing organization:
Inventory consists of 3 components:
1. Direct material / Raw 2. Work-in-progress / 3. Finished goods /
material / Primary incomplete work / completed goods
material half-finished work
5.3 Inventory piling
= gathering or stockpiling the inventory items that a business needs to operate. Main reason of
inventory piling is to avoid a stock-out.
Types & purposes of inventory common in inventory piling:
Normal stock: Material in the process of production, is about to enter the production process, or
has just been completed.
Buffer stock: Material that forms a buffer between production and usage where production is
constant, but where the supply of raw material takes place irregularly
Safety stock: Like buffer stock but is specifically aimed at ensuring the org can continue w
production as usual if a specific raw material is not delivered w/in the normal delivery time.
Speculative stock: Stock held for financial reasons - expected rise in the price of stock
Stock-in-transit: Stock that has already been ordered and paid for but is still being delivered.
Maximum stock: The highest possible stock volume that can be carried by the org and is limited by
storage space available. Usually occurs when an order is delivered earlier than expected.
Overstocking: Org has too much stock that is not needed
Understocking: Too little stock
Average stock: Stock levels are always changing, so it not possible to calculate the average
amount of stock held during any period of time accurately, but the following formula are used:
Average stock = (Opening stock + Closing stock) ÷ 2
Average stock = (Order size ÷ 2) + Safety stock
1
,FINM6221 LU5
5.4 Material Cost Control
Material cost control involves monitoring the cost and usage of raw materials to prevent losses.
Companies use stock takes to identify any inventory loss. In simple manufacturing setups, material
costs can be easily traced through supplier invoices. However, in more complex operations with
many different materials, tracking becomes more difficult. To avoid production delays and additional
costs, materials are purchased regularly to ensure they are always available when needed.
5.5 Valuing inventory
2 methods of inventory valuation:
1. First in first out (FIFO) 2. Weighted average method
You must state the method you chose in the notes to your financial statements.
5.5.1 First in first out
Units of inventory that were bought first will be sold first.
5.5.2 Weighted average cost
When a company buys inventory at different prices over time, the weighted average cost method
calculates a new average cost per unit each time a new batch of inventory is bought.
New Purchase: A new batch of stock is bought at a different price.
Recalculation: The cost per unit is updated using the weighted average formula:
Total Cost of all inventory
New Weighted Average cost per unit=
total units∈inventory
Cost of Sales: When inventory is sold, the new average cost per unit is used to calculate the
cost of sales (COGS).
5.5.3 How he 2 Different Inventory Systems Influence the Valuation of Closing Inventory
An inventory valuation method = used to value inventory –> FIFO and Weighted average cost
An inventory system = used to record inventory –> perpetual and periodic
Perpetual inventory system is applied continuously - the value of the inventory is calculated after
each transaction. Cost of inventory purchased is debited to an inventory account.
Periodic inventory system, the value of the inventory is only calculated at the end of a specific
period. All inventory related expenses are recorded in the purchases account.
2
, FINM6221 LU5
Example 5.1
X trade a single homogeneous product. On April 1st 2003, there were 5200 units with a selling price
of R3 each (20% mark up). X uses perpetual inventory system.
Date Transactions
2 Purchased 2 000 units @ R 2.75 each
8 Sold 6 000 units @ R 5.41 each
13 Purchased 1 000 units @ R 2.85 each
18 Purchased 4 000 units @ R 2.63 each
24 Sold 5 100 units @ R 5.41 each
30 Purchased 1 500 units @ R 2.87 each
Calculate the following for each FIFO and weighted average cost inventory control methods:
1.Value of closing inventory on 30 April 3.Cost of sales for April 2003
2003 4.Gross profit for April 2003
2.Sales revenue for April 2003
FIFO Method
1. Value of closing inventory
Date Purchases Issues Balance
1 5200 @ R2.50
2 2000 @ R2.75 5200 @ R2.50
2000 @ R2.75
8 5200 @ R2.50 1200 @2.75
800 @ R2.75
13 1000 @ R2.85 1200 @2.75
1000 @ R2.85
18 4000 @ R2.63 1200 @2.75
1000 @ R2.85
4000 @ R2.63
24 1200 @2.75 1100 @ R2.63
1000 @ R2.85
2900 @ R2.63
30 1500 @ R2.87 1100 @ R2.63
1500 @ R2.87
Value of closing inventory = (1100 x 2.63) + (1500 x 2.87) = R7198
2. Sales Revenue
(6000 x 5.41) + (5100 x 5.41) = R60051
3. Cost of Sales 90
(5200 x 2.50) + (800 x 2.75) + (1200 x 2.75) + (1000 x 2.85) + (2900 x 2.63) = R28977
4. Gross profit (Sales – COS)
3
