Inventory: Definition and Features | Accounting

In this article we will discuss about the definition and features of inventory.

Definition of Inventory:

ICAI has defined inventory as “tangible property held (i) for sale in the ordinary course of business or (ii) in the process of production for sale or (iii) for consumption in the production of goods or service for sale, including maintenance supplies and consumable other than machinery spares.”

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In a manufacturing unit usually about 20 to 30% of the total assets are in the form of inventory and any effort in stock control will bring major benefits for the enterprise. An efficient management of inventory is an essential requirement for the success of the enterprise. The classification of inventory of a particular firm depends upon the nature of business it carries. For a spinning mill, cotton is the raw material and yarn is the finished product.

But in case of textile mill, yarn is the raw material and fabric is the finished product. A manufacturing concern’s inventory consist of all the above three types of inventory but in case of a trading concern, the first two categories will not appear in their stocks.

The Production manager and Finance manager of a manufacturing company should know the items of inventory, classification of inventory and costs related to each item of inventory before taking any step for efficient management of inventory.

The efficiency shown in inventory will have direct impact on profitability of a business enterprise. In our study about management of inventory, here, we only discuss about the first category of inventory i.e., raw materials.

The inventory of a manufacturing concern is classified into the following types:

Raw Materials:

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It includes direct material used in the manufacture of a product and it also includes the components, fuel etc. used in the manufacture.

Work-in-Progress:

It includes partly finished goods and materials, subassemblies etc. held between manufacturing stages. Stock of work-in-progress are in the process of production.

Finished Goods:

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The goods ready for sale or distribution will come under this category.

Features of Ideal Inventory Policy:

An ideal inventory policy should consist of the following features:

(1) There should be proper accounting and physical controls.

(2) The inventory should be stored properly to avoid the losses like breakage, spoilage, wastage, damage, deterioration, pilferage etc.

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(3) Fixation of inventory levels like, minimum, maximum and reorder levels and economic order quantity to ensure the optimum level of stocks.

(4) Proper care should be taken to avoid stock-out situations.

(5) Continuous supply of material should be ensured at the right time and right cost.

(6) The investment in inventory should be optimized by avoiding overstocking.

(7) Regular monitoring of stock movements and reduce the investments in dormant and slow moving stocks.

Requirements of Stock Control:

CIMA defines stock control as ‘the systematic regulation of stock level’:

The material stock control covers the following areas:

(a) Ordering,

(b) Purchase,

(c) Receipt,

(d) Storage, and

(e) Issues.

The requirements for a better control over stocks are given below:

(a) Centralized purchase function i e., all the purchases should be through purchase department.

(b) Material is purchased with prior authority.

(c) Proper planning of purchase function.

(d) Materials purchased should be of proper quality and specification.

(e) Standardization of materials.

(f) Materials should be properly received and inspected.

(g) Planned storage of all materials in stores.

(h) Selection of suppliers keeping in view the quality, price and delivery.

(i) Direct materials used in production should be charged to production on an appropriate and consistent pricing basis.

(j) Indirect materials used in production and service departments should be appropriately apportioned and absorbed into product cost.

(k) Proper documentation and accounting of material receipts and issues.

(l) Material issues to be made only with proper authority.

(m) Maintenance of bin cards and stores ledger and regular reconciliation of both the records.

(n) Adoption of perpetual inventory system and continuous stock taking.

(o) Fixation inventory levels i.e., maximum, minimum, reorder and danger levels.

(p) Proper internal checks.

(q) Proper procedures in dealing with shortages and discrepancies.

(r) Proper classification and coding of materials.

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