Inventory Costing

Inventory costing is a very important part of the Cost Accountant's position.

The production inventory represents a major investment for most companies. Since inventory is valued as an asset, it is recorded on the balance sheet in the asset section.It is critical to assign proper value and properly report it to management. If the value of the parts in inventory is not accurate, a future write-down of the inventory holding value may be necessary.

A very large inventory costing revaluation can have a very large effect on the financial statements. Any correction to the inventory value either increases or decreases asset values and either adds to or subtracts from expenses.

For example: if we found that some of the parts in our inventory were over-valued by $3 each, and we have 10,000 parts in inventory, we then need reduce the inventory value by $30,000 to correct the inventory. The entry to do this would be to expense $30,000 and reduce inventory by $30,000.

Inventory Components:

  • Raw inventory consists of purchased parts. These parts can be components that are made by vendors, or any kind of raw materials that are sold to us.
  • Work in process or WIP inventory are raw parts that are in the process of being manufactured. These parts will have labor and burden costs added as operations are completed.
  • Finished goods inventory is the location of our manufactured parts that are complete and ready to be shipped to our customers.
Inventory parts are costed based on the part routings and bill of materials

Warehouse illustration for inventory costing How to value parts in inventory:
  • Value usable, non-obsolete parts at the same cost as current production parts.

  • Assure that accounting cost elements are valued properly.  

What about parts that are produced at a loss?
  • The carrying value of parts produced at a loss must reflect the market value (i.e. sales price), not cost.  This is the lower of cost or market rule.

  • After calculation of the lower of cost or market, an adjusting entry is needed to adjust inventory to the proper value.

If burden cost is going to change in the new year:
  • A dramatic change in the new year's volume of parts or the product mix causes a BIG change in the inventory costing valuation and a change in burden cost.

  • As the volume of business changes, so does our burden allocation, and therefore our inventory valuation.

  • This is not the fault of the Cost Accountant; this is a change in business.

  • Be sure to alert the management as soon as you find out, so they can prepare to explain the change.

Obsolete parts in inventory:
  • Obsolete parts usually are scrapped or kept at zero inventory value, according to management decision.

  • Sometimes parts are kept for many years, just in case they are ever needed. Of course, this is dependent on room available in the warehouse.