Inventory Management and Cost Accounting Report

Inventory and warehouse management

A company requires an adequate supply of inventory for the smooth running of its processes. To ensure that this is fulfilled, companies incur warehousing costs; Hendon garden furniture has found itself in the dilemma of deciding on how to manage its stocks as it minimizes warehousing costs. There are two options for consideration; buying a warehouse space of sq 25,000 at £125,000 and renting space of 50,000sq @ £12,000 per annum.

Let’s analyze the two options in terms of liquidity, profitability, breakeven point;

Liquidity

This is the availability of funds to meet short term and long term financial liabilities as they fall due. The decision to buy will have the following effects;

1. There will be money outflow; this is in terms of rents or loan payments and interest repayments
2. The constant flow of income as a result of continued production (Williams, 2001).

The company will have increased financial responsibility; this will reduce working capital as follows;

Rent option, current liabilities increases by £12,000

Buying option long term liabilities increased by £25,000

Profitability

The decision to rent warehouse will rise to an expense to the company expenses reduce the amount of profit that the company makes in a certain year;

For example; the furniture garden profits are £100,000 per annum, this is the profit before the additional warehouse has been added. When the new warehouse is rented, then the profits will reduce by the amount of rent payable (assuming that the new warehouse does not lead to increased production)

New profit will be £100,000

Fewer warehouses rent £ 12,000

Net profit £88,000

If the option of buying the asset has been made, the effect it has on the trading profit is dependent on the source of financing. If the company decides to buy in cash terms; then the transitions are will be considered an asset acquisition project. Its effect in the trading account will only be an increased depreciation of the facility. If the purchase is bought through a loan financing policy, the balance sheet will have increased expenses in terms of depreciation and interest charges ( Weygand, Kimmel & Kieso, 2010).

Let’s assume that the facility will depreciate at a rate of 5% per annum straight-line method and the interest from loan financing the project is at 5% straight-line method;

Depreciation = 5/100* £125,000 =6,250

Interest on loan = 5/100*£125,000 = 6,250

The effects will be as follows;

When bought cash (this means that the company used its reserved fund to buy the asset);

Net profit

£100,000

Less depreciation £6,250

Total net profit of £93,750

When the warehouse is bought through loan finance

Net profit £100,000

Less depreciation £6,250

Less interest payable £6250

Total net profit £87, 000

Breakeven point

This is the point where the total cost of operation equals to total benefits;

Breakeven point = total cost = total revenue

The decision to buy or rent a warehouse will lead to an increase in operational cost and thus the duration taken to attain break-even will be increased.

Each product in the company produces an income of £ 15. When the additional facility is added, then this amount will reduce as there will be a cost that will go to this effect thus reducing the income contribution of each unit.

My recommendation

Analyzing the two options available for the company, I recommend that the company should acquire the additional warehouse by purchasing it; this is because of the following reasons;

1. When you compare the space that the company need, which is 5,000 sq, and the space that can be bought, then there will be an extra 20,000sq
2. The cost of renting the assets compared to the purchase cost is higher; eventually, the asset will be owned by the company
3. The company can utilize the extra space by renting to other traders; if the same rate as quoted is used in lending out the extra space then the company is likely to earn a maximum extra revenue of £48, 000 (4* 12,000) (Wheelen $ Hunger,1999).

Stock Valuation

FIFO (First In First Out method)

This method assumes that stocks that got into the company first are the stocks which have been utilized in production first. In this method the value of the stock at hand is equal to the balance of the recently purchased stocks;

For example;

Company A had the following transactions for January 2010

1. 5^th Bought stock @ £40 per units 100 units
2. 10^th Bought stock @ 50 per unit 50units
3. 15^th produced goods which utilized 120 units of raw materials

Calculating the value of the stock at the end of the month;

Total units utilized 120;

First 100 from the supply of 5^th 100

Balance supply 20 (this will be units from 10^th supplies and left a remainder of 30 units)

The value of the stock will be 30 units at 50 per unit = £1,500

Advantages

It is simple to understand and easy to use.

It is a logical method since it utilizes assumes that the first stocks in a business are the ones to be used.

It is a good method in price failures.

Disadvantages

• The method can lead to underpricing of goods if the cost of material is increasing.
• The method increases the possibility of clerical errors (Anthony, Hawkin, & Merchant, 1999).

LIFO (last in First Out)

In this method, it assumes that the units that got into the company last are the ones that will be utilized first in production. The value of a stock is the value of stock gotten earlier; using the above example then;

Utilized raw materials 120

First units from 10^th 50

Balance 70 units from 70 (there will be a balance of 30 units)

The value of the stock will be 30 units @ 40 units = £1200

Advantage

• The method is simple and straight forward.
• It recovers costs from production because the actual cost is charged to production benefits.
• The cost charged in the manufacturing account is the recent cost of production.
• In times of rising the method is responsive to the changing prices.

Disadvantages

• The method leads to clerical error since every time the new stock is bought then there must be an adjustment.
• Determining the Pricing of the product poses difficulty since the cost of producing them is different (Barry & Jermakowicz, 2010).

Average cost

Using this cost method, the value of a stock is calculated as an average; a unit value is calculated. It takes a more central position where it considers the current price and past price of materials. In the above example then;

Total units in the store 150 units

Total cost (100*40) + (50*50) = 6500

The unit value is 6500/150

The balance value after production is 30 units

The value of the units is 30*6500/150 = £1300.

Advantages

• the method adopts to raw material costs fluctuations.
• When using the method determining the price of products is easy and straight forward since the input cost is the same.
• The cost of raw materials.

Disadvantages

• The method is hard to calculate the cost of stock; it is only understood by accountants (Horngren, Srikant & George, 2006).

My Recommendations (Average cost)

Due to the fluctuating prices of materials, I would recommend the use of the Average cost method since it incorporates the price changes. At any one time, the costs of production are kept at a predictable amount which assists in easy price determination after production. The weakness that it can only be well understood by accountants is an advantage to a company since it demands professionalism in a business. With professionalism, the business will be effectively conducted.

Cost reduction strategy evaluation

Reducing costs by losing financial/ management accountant

A move to remove the position of a financial accountant to reduce operational costs will result in a major loss to the company. Management accountant undertakes a general overview of fund and project management in a company. He is involved in making current and futuristic decisions that involve funds in a company. The decision to do away with a management accountant will make the company lose the following services of the accountant;

Forecasting and planning

The financial manager is mandated with the task of estimating financial cost requirements for working capital, which are short-term and medium-term and capital investment. He is also responsible for budget-making to ensure that there is an efficient allocation of funds in the organization in the current and future (Lindquist & Smith, 2009).

Financial decisions

Finances in organizations are limited and thus managing them to ensure that they are well utilized is important. The financial decision includes investment decisions, credit management, and working capital management. This assists in fund management. A company that has well-managed funds can meet its obligations as they fall due and make sound attainable decisions. If the company loses this service, then the company will suffer a lack of good financial management (Weetman, 2010).

Investment Decision

Making the right decision on the kind of investment to make is a challenge to a business. Establishing an investment to make is crucial to a company. A balance should be made to ensure that funds are well diversified to reduce risks. Short term, medium, and long term investment projects should be taken. This is the work of financial management. If the company loses the functions of the manager, it is likely to invest its resources to places that are not viable and which can lead to a loss in the company (Dury, 2006).

Cash and credit management

Managing cash is one of the daily tasks of a financial manager, he should ensure that there is a good flow of money in all places; there is a need for short term and long term cash obligations. A good credit policy assists a company in managing its credit to suppliers and managing debts owed by its customers. When a company retains a financial manager, he is responsible for developing a policy that benefits the entire company (Imam, Richard, Clubb, 2008).

A company with well-managed finances has a comparative advantage in that it develops policies that lead to high efficiency, low cost of production, and ensuring that a firm can meet its financial obligations as they fall due. As much as an organization is making sales, to have report profits money in the firm must be well managed. If the company loses the functions of management accountant, it is likely to suffer financial difficulties, increased costs of production, excess or strained working capital, and be unable to meet its short term and long term financial obligations as they fall due (Fred, 2008)

References

Anthony, R., Hawkins, D. & Merchant, K. (1999) Accounting: text and cases. 10 the ed. Boston: McGraw Hill.

Barry J. and Jermakowicz, K. (2010). Wiley IFRS 2010: Interpretation and Application of International Financial Reporting Standards. New York: John Wiley and Sons.

Dury C. (2006). Management Accounting for business. Thomson Learning, ISBN 0-471-17067-4.

Fred, D. (2008). Strategic Management: Concepts and Cases. New Jersey: Pearson Education.

Horngren, T., Srikant M., and George F.(2006). Cost accounting: A managerial emphasis. Boston, MA: Pearson Prentice Hall.

Lindquist, T., & Smith, G. (2009). Journal of Management Accounting Research: Content and Citation Analysis of the First 20 Years. Journal of Management Accounting Research, 21249-292. Retrieved from Business Source Complete database.

Imam, S., Richard B. and Clubb, C. (2008). “The Use of Valuation Models by UK Investment Analysts”. European Accounting Review. 17(3):503-535.

Weetman, P. (2010). Financial and Management Accounting. Wiley. ISBN13: 9780273718413.

Weygand, J., Kimmel, P. and Kieso, A. (2010). Financial Accounting: IFRS, 1st edition. Illinois: Northern Illinois University.

Wheelen, L., $ Hunger, J.(1999). Strategic Management and Business Policy: Entering 21st Century Global Society. Massachusetts: Addison Wesley.

Williams, S. (2001). Making better business decisions: understanding and improving critical thinking and problem-solving skills. London: Sage.