Value of Stock &

ABC
Classifcatio
Lecture #
9

Date:22n

Introduction

From a fnancial point of view,

inventory is an
asset and represents money that is
As
we
know,
inventory
has
a
carrying
tied up and
costthe
cannot be used for other purposes.
costs of capital, storage, and risk.
Finance wants as little inventory as
possible and
needs some measure of the level of
Total
inventory investment is one
inventory.
measure, but in

Introduction

Two measures that do relate to the

inventory
and day of supply:
sales areturns
ratio
Inventory
turns

Days of
supply

Inventory Turns

Ideally, a manufacturer carries no

inventory.

This is impractical, since inventory is needed to

support

manufacturing and often to supply customers.

How much inventory is enough? There is no
one

answer.
A convenient measure of how effectively
inventories

are being used is the inventory turns ratio:

Inventory turns =annual cost of goods sold / average inventory in
dollars

Inventory Turns
For example, if the annual cost of goods
sold is $1
million and the average inventory is
$500,000, then
Inventory
turns =$ 1,000,000 / $ 500,000
What does this
=
mean?
2 means that $500,000
At the very least, it
inventory a company is able to generate
$1 million in
with
of
sales.
If, through better materials management,
the firm is
able to increase its turns ratio to 10, the
same sales are

Days of supply

Days of supply is a measure of the

equivalent number of days of
inventory on hand, based on usage.
The equation to calculate the days of

supply
is:

Days of supply=

inventory on hand /

COGS & Gross Proft

The cost of materials sold is the

total price
paid, or cost of acquiring, the units
that
were
Gross
proft=net sales revenuecost
of products
later
sold. Then the gross proft
sold
comes
from:
Cost of products sold=opening
stock + net
purchasesclosing stock

Example of an Entry in
Trading
Account
s

An example of stock value in product

costing

Value of Stock

Organizations need accurate values

for their
assets including stock as this
Any
errors
can
bring
serious
directly affects
consequences.
At
their reported performance.
times of high infation, for example, the
valuation
stocks
often
low and
a return
of
This
may is
give
an too
artifcially
high
company
on assets,appears
to
have
fewer assets
it really
and
in extreme
casesthan
allows
the has.

Value of
Actual cost

Stock

identifes each unit in stock with the price actually paid

for it.
First-In-First-Out
(FIFO)

This assumes that the frst units arriving in stock

are the frst
sold, so the value of remaining stock is set by the

amount paid
Last-In-First-Out (LIFO)
for the last units bought.
assumes that the latest units added to stock are
used frst, so
the value of remaining stock is set by the amount
paid for the

Weighted average cost

earliest units bought.
fnds the average unit cost over a typical

FIFO (Example)

A grocery store purchases milk at

regular
intervals to stock its shelves. As
newer milk behind those cartons. The
of
customers
milk with the nearest expiration dates are
the
ones first
purchase
milk,sold,
the whereas
stockers the
pushlater
cartons
expiration
thus
the oldest
dates
are
older
product.
product
tosold
the after
front the
of the
fridge
This
and replace
ensures that older products are sold
before they

Exampl

e
During her frst job on
a graduate trainee
scheme, Madeleine
Fraser was given the
following record of
transactions for an
item and asked for her
views on the proft.

Solution

At
the end of June the closing
closing
stock=opening stock + purchases
stock
is:

sales

=80+(60+80)(20+40+50+20)=90
The
value of these units depends on the
units
assumption used. She does not have
enough
information to use actual costs, but she can

Solutio

FIFO:

assumes the 90 units remaining in

stock are the last 90 bought, and this
values stock at:
(8040)+(1030)=3,500 or 38.89
a unit

Solutio

LIFO:

assumes the 90 units remaining in stock are

the
frst units bought after allowing for sales.
Only

20 units of the opening stock can remain, as

the
remaining 60 units were sold in January and

Solutio

Weighted average cost

fnds
Weighted
Average
Cost:
purchases as:

the average
cost

Total cost/units
[(80x20)+(60x30)+(80x4 (80 + 60 +
purchased
80)
0)]/
30 a unit

This values stock at

9030=2,700

of all

Solution

gross proft=sales revenuecost of units

sold
sales
cost
of units sold=total cost of
all unitsprese
revenue=2030+4040+5050+206
0=5,900
buying
nt
value of stock
total cost of buying all
units=8020+6030+8040=

6,600
Gross proft=5,900[6,600present value of
stock]

Solution

frst-in-frst-out: gross
proft=5,900[6,6003,500
]=2,800
last-in-frst-out: gross
proft=5,900[6,6003,100]=

2,400
weighted average cost: gross
proft=5,900[6,6002,700]=

ABC Analysis of Stocks

Another useful set of accounting information
comes from
Inventory
control can take a lot of effort and so
an ABC analysis.
for some
items, especially cheap ones, this effort is not
Very
few organizations, for example,
worthwhile.
include routine
stationery or coffee in their formal stock
At
the other end of the scale are very
systems.
that
expensive items
need special care above the routine
It
would be useful to fnd the amount of
calculations.
effort worth
putting into the control of any item.
An ABC analysis gives some guidelines for

ABC Analysis of Stocks

The origin of the ABC analysis

sometimes called
In inventory control terms it means
Pareto analysis, or the rule of 8020
that 20 per
cent of the inventory items need 80
per cent of
the attention, while the remaining 80
In particular,
per
cent of ABC analyses defne the
items
need 20 per cent of the
following:

attention.
A items are the few most expensive ones

that need
special care.

ABC Analysis of Stocks

Typically an organization might

use an automated system to deal
with all B items.
A items are more important, and

the

although
automated system might make some

suggestions, managers make the fnal

C
items are
very
cheap andreview
are of left out
decisions
after
a thorough
of the automatic system, to be dealt with
usually
circumstances.

ABC Analysis of Stocks

An ABC analysis starts by taking each

item and
multiplying the number of units used in
This
gives
the
total
annual
use
of
a year by
items
in cost.
terms
the unit
of value.
Usually, a few expensive items account
for a lot of
use, while many cheap ones account for
If
we use.
list the items in order of
little
decreasing annual
use by value, A items are at the top of
the list and

ABC Analysis of
Stocks

ABC Analysis of
Stocks

Exampl

the followingcost and annua demands

A small store
s with 10
l
categories of item has

Do an ABC
of these items. How
stocks of each category be
analysis
might
controlled?

Solutio

Step # 1

Calculate weekly usage

(Unit Cost

Demand

Weekly )
Step
Sort #
the2data from largest smallest
of weekl
usag

to

value

Step # 3
Calculate % of weekly usage (weekly
usage of item/
sum of weekly usage for all items)x100

Solutio
Step # 4

Calculate Cumulative % of weekly

usage

of
preceding

% weekly usage of item + %

weekly usage
(Quantity of
of quantit of all items)x10
item

items/sum
#5
Step

Step # 6

Calculate % of items of items

Calculate Cumulative

%
Step
#7

Plot Cumulative % of items on x- Cumulativ % of

axis and
e

Question
Belgrave Furnishing Retail
categories
of
with
the
followingcost
Ltd has 20
and annua demands
furniture
l
:

Do an ABC analysis Belgrave. If

are limited, which items should they give
for
resources
most

Item Name

Questio

Annual Usage in Units

Unit Cost ($)

n
1
2
8.00

1.50

3
5
4
6
8
7
9

5,000
1,500
10,000

10.50

7,500
6,000

0.50
2.00

6,000

13.60
0.75

1.25

4,500
5,000
7,000

2.50