Process of purchasing and receiving goods
Purchase procedure differs from business to business, but all of them follow a general pattern or procedure. There should be proper Purchase Procedure to ensure that right type of material is purchased at right time, in right quantity, at right prices and at right place. All these things require a well-defined procedure of purchasing. The steps in Purchase Procedure are explained below.
Purchase Requisition: A form known as ‘Purchase Requisition’ is commonly used as a format requesting the purchase department to purchase the required material. Normally the purchase requisition is issued the Stores Department when the quantity of the concerned material reaches the minimum level. Only in the cases of materials, which are not kept in the stores on regular basis, the requisition is issued the concerned department. Purchase requisition has information like the quantity required, the expected date of receipt, the department in which the material is required, description of material etc. Copies of the purchase requisition are sent to the Accounts department and the concerned department who is in need of the material.
Purchase Order: After the receipt of purchase requisition, the purchase department places an order with a supplier, offering to buy certain material at stated price and terms. However before issuing the purchase order, quotations may be invited from various suppliers for arriving at the best deal. The purchase department usually keeps a list of suppliers from whom the quotations are invited. The quotations received are examined on various parameters like price, delivery period, terms and conditions, quality of material etc. After this, purchase order is issued to the selected supplier. It should be remembered that a purchase order is a legal document and it results into a contract between the company and the supplier. Hence the terms and conditions in the purchase order should be drafted clearly without any ambiguity.
Receiving the Materials: The receiving department performs the function of unloading and unpacking materials which are received an organization. This will need an inspection report which is sometimes incorporated in the receiving report, indicating the items accepted and rejected with reasons. Copies of the receiving report along with the inspection report are sent to various departments like purchase, stores, concerned department, accounts department and costing department.
Approval of invoice: Approval of invoice indicates that goods according to the purchase order have been received and payments can be made for the same. However if the goods are not according to the quality ordered or are in excess of the quantity specified or are damaged or are of inferior quality, payment is withheld.
Making the Payment: After the invoice is approved the payment is made to the supplier. The purchase procedure is completed with the payment released.
Inventory or Store Control
Inventory control means to monitor the stock of goods used for production, distribution and captive (self) consumption. For a specific time period, stocks of goods are placed at some particular location. Stock of goods includes raw-materials, work in progress, finished goods, packaging, spares, components, consumable items, etc. Inventory Control means maintaining the inventory at a desired level. The desired-level keeps on fluctuating as per the demand and supply of goods.
According to Gordon Carson, “Inventory control is the process where the investment in materials and parts carried in stocks is regulated, within pre-determined limits set in accordance with the inventory policy established the management.”
Simply “Inventory control is a method to identify those stocks of goods, which can be used for the production of finished goods. It shall be supported a schedule which gives details regarding; opening stock, receipt of raw-materials, issue of materials, closing stock, and scrap generated.”
Objectives of store control:
The following are the important objectives of store control
- to make available the right type of raw material at the right time in order to have smooth and continuous flow of production;
- to ensure effective utilization of material;
- to prevent over stocking of materials and consequent locking up of working capital;
- to procure appropriate quality of raw materials at reasonable price;
- to prevent losses during storage of materials;
- to supply information to the management regarding the cost of materials and the availability of stock;
Essential of store control:
The following at the essentials of good system of material control.
- There should be proper co-operation and co-ordination among the departments dealing with materials.
- All purchases must be centralized and must be made through an expert purchase manager.
- All items in the stores should be classified with codes.
- Receiving and inspection procedure should be chalked out.
- Ideal storage and preservation facilities will have to be provided.
- Stores control measures like ABC analysis, perpetual inventory system, stock verification should be introduced.
- There should be an efficient system of internal audit and internal check.
- Maximum level, minimum level and re-order level of stock should be fixed to avoid over-stocking or shortage of materials.
- Appropriate records should be maintained to control issues and utilization of stores in production.
- There should be a system of regular reporting to management regarding materials purchases, storage and utilization.
Significance/Advantages of Inventory control
- Protects from fluctuations in demand: There are always chances of fluctuations in the demand of a material. These fluctuations can be adjusted if there are sufficient items in the stock of inventory. Therefore, proper inventory control protects the company from fluctuations in demand.
- Better services to customers: If the company maintains a proper inventory of raw-materials, then it can complete its production in time. So, it can deliver the finished goods to the customers in time. Similarly, if the company has a proper inventory of finished goods, then it can satisfy the additional demand of the customers.
- Continuity of production operations: Proper inventory control helps to maintain continuity of production operations. This is because it maintains a smooth flow of raw materials. So, there are no shortages of raw-materials required for production process.
- Reduces the risk of loss: Proper inventory control helps to reduce the risk of loss due to obsolescence (outdated) or deterioration of items. This is because it checks all the items regularly.
- Minimizes the administrative workload: Proper inventory control helps to minimize the administrative work load of purchasing, inspection, warehousing, etc. This will reduce the manpower requirement and will minimize the labour cost too.
- Protects fluctuation in output: Inventory control tries to reduce the gap between planned production and actual production. There are cases where the production schedule cannot be followed because of Sudden breakdown of machines, Problems in supply of materials, Sudden labour strikes, Loss due to failure of power supply, etc.
In such cases, the difference between planned production and actual production can be bridged inventories held in stock.
- Effective use of working capital: Proper inventory control helps to make effective use of working capital. Inventory control helps in maintaining the right amount of stocks of materials, components, etc. Over stocking is avoided. Therefore, the working capital will not be blocked in excess inventory.
- Check on loss of materials: Inventory control helps to maintain a check on the loss of materials due to carelessness or pilferage. If there is no proper inventory control, then there are more chances of carelessness and pilferage the employees, especially in the store-keeping department.
- Facilitates cost accounting activities: Inventory control facilitates cost accounting activities. This is because, inventory control provides a means of allocating materials cost of products, departments or other operating accounts.
- Avoids duplication in ordering: Inventory control avoids duplication in ordering of stock. This is done maintaining a separate purchase department.
INVENTORY CONTROL TECHNIQUES
Techniques of Inventory Control
The techniques or the tools generally used to effect control over the inventory are the following:
- Budgetary techniques for inventory planning;
- A-B-C. System of inventory control; (SHORT NOTE)
- Economic Order Quantity (E.O.Q.) i.e., how much to purchase at one time economically; (SHORT NOTE)
- VED Analysis;
- Perpetual inventory system and the system of store verification; (SHORT AND BROAD QUESTION)
- Fixation of Stock Level;
- Control Ratios.
1) Budgetary Techniques: For the purchase of raw materials and stocks, what we required is a purchase Budged to be prepared in terms of quantities and values involved. The sales stipulated as per sales Budget of the corresponding period generally works out to be the key factor to decide the production quantum during the budget period, which ultimately decides the purchases to be made and the inventories to be planned.
2) ABC Analysis: ABC System: In this technique, the items of inventory are classified according to the value of usage. Materials are classified as A, B and C according to their value.
Items in class ‘A’ constitute the most important class of inventories so far as the proportion in the total value of inventory is concerned. The ‘A’ items constitute roughly about 5-10% of the total items while its value may be about 80% of the total value of the inventory.
Items in class ‘B’ constitute intermediate position. These items may be about 20-25% of the total items while the usage value may be about 15% of the total value.
Items in class ‘C’ are the most negligible in value, about 65-75% of the total quantity but the value may be about 5% of the total usage value of the inventory.
The numbers given above are just indicative, actual numbers may vary from situation to situation. The principle to be followed is that the high value items should be controlled more carefully while items having small value though large in numbers can be controlled periodically.
Advantages of ABC analysis
- Reduction in investment:under ABC analysis, the materials from group ‘A’ are purchase in lower quantities as much as possible. With this, the effort to reduce the delivery period is also made. These in turn help to reduce the investment in material.
- Optimization of Inventory management function: Each class of the inventory gets management attention as per its value and accordingly, manpower is allocated and expenses are incurred to manage it. It ensures that most important items are regularly monitored and closely observed whereas such efforts are expended with for the less important items.
- Control on high value material:under ABC analysis, strict control can be exercised to the materials in group ‘A’ that have higher value.
- Reduction in Storage cost:Since Class “A” material is of high value and are purchase in lower quantities as much as possible, it reduces the total storage cost.
- Saving in time and cost: Since a signification effort is made for management of the material from group ‘A’, it helps to save time as well as cost.
- Opportunity to convert Class B items into Class A: As Class B items hold potential for growth, the business may tap into this opportunity and convert it frequent yet low-value customers into regular, high-value customers to Class A.
Disadvantage of ABC analysis
- No Proper classification of material: ABC analysis will not be effective if the material are not classified into the groups properly.
- Not suitable if materials are of same value: It is not suitable for the organization where the costs of materials do not vary significantly.
- No scientific base: There is no any scientific base for the classification of material under ABC analysis.
- Not suitable for small organisation: The classification of the materials into different groups may lead to extra cost. Hence, it may not be suitable for small organization.
3) Economics order quantity: Economics order quantity represents the size of the order for which both order, ordering and carrying costs together are minimum. If purchases are made in large quantities, inventory carrying cost will be high. If the order size is small, ordering cost will be high. Hence, it is necessary to determine the order quantity for which ordering and carrying costs are minimum. The formula used for determining economics order quantity is a s follows:
A is the annual consumption of material in units.
O is the cost of placing an order (ordering cost per unit)
C is the cost of interest and storing one unit of material for the one year (carrying cost per unit per annum).
4) VED Analysis: VED – Vital, Essential, Desirable – analysis is used primarily for control of spare parts. The spare, parts can be divided into three categories – vital, essential or desirable – keeping in view the critically to production.
5) Perpetual Inventory System: Perpetual Inventory system means continuous stock taking. CIMA defines perpetual inventory system as ‘the recording as they occur of receipts, issues and the resulting balances of individual items of stock in either quantity or quantity and value’. Under this system, a continuous record of receipt and issue of materials is maintained the stores department and the information about the stock of materials is always available. Entries in the Bin Card and the Stores Ledger are made after every receipt and issue and the balance is reconciled on regular basis with the physical stock. The main advantage of this system is that it avoids disruptions in the production caused periodic stock taking. Similarly it helps in having a detailed and more reliable check on the stocks. The stock records are more reliable and stock discrepancies are investigated and appropriate action is taken immediately.
Salient features of perpetual inventory system
- It requires more efforts to maintain inventory under this method.
- Quantity balances shown the store ledger and bin cards are reconciled.
- A number of items are physically checked systematically and rotation.
- The method is comparatively costly as compared to periodical inventory system.
- Store ledger and bin cards keeps inventory record up-to date and decent.
- The method applies to those concerns usually that sell high-value items (Such as car, personal computer, equipments etc.) not at a large quantity as compared to items under periodic system.
- Causes for difference between physical balances and book balances can be explored.
- Making corrective entries in case of discrepancies.
- Removing the causes of discrepancies between physical quantities and book balances.
Advantages of Perpetual Inventory System
- Easy detection of errors – Errors and frauds can be easily detected at an early date. It helps in preventing their occurrence.
- Better control over stores- The system exercises better control over all receipts and issues in such a manner so as to give a complete picture of both quantities and values of stock in hand at all times.
- No interruption of production process- Production process is not interrupted as the physical verification of stock is made on a planned and regular basis.
- Acts as internal check- Under the system, records are made simultaneously in the bin cards and stores ledger accounts which acts as a system of internal check for detection of errors as and when they are committed.
- Investment in materials kept under control – The investment in materials is kept at a minimum level as the actual stock is continuously compared with the maximum level and minimum level.
- Early detection of loss of stock- Loss of stock due to shrinkage, evaporation, accident, fire, theft, etc. can be easily detected.
- Accurate and up-to-date accounting records- Due to continuous stocktaking, the store-keeper and stores accountant become more vigilant in their works and they maintain accurate and up-to-date records.
- Easy to prepare interim accounts- It is possible to prepare periodical profit and loss account and balance sheet without physical stock-taking being made.
- Availability of correct stock data- Correct stock data is readily available for settlement of insurance claims.
6) Fixation of stock level: The object of fixing stock levels for each item of material is to maintain required quantity of materials in the store and therethe expenses may be reduced. The different stock levels are: (1) Minimum stock level (2) Maximum stock level (3) Reorder stock level
- Minimum stock level: It represents the minimum quantity of an item of material to be kept in the store at any time. Material should not be allowed to fall below this level. If the stock goes below this level, production may be held up for want of materials. This stock is also known as safety stock level or buffer stock.
- Maximum stock level: It is the stock level above which stock should not be allowed to rise. This is the maximum quantity of stock of raw materials which can be had in the stock. It is goes above, it will be overstocking.
- Reorder stock level: It is the point at which the storekeeper should initiate purchase requisition for fresh supply. This level lies between the maximum level and the minimum level.
7) Control Ratios: The control ratios are mainly two:
- Inventory Turnover Ratio which we have studied and
- Input-output Ratio.
Inventory Turnover: Inventory Turnover is a ratio of the value of the materials consumed during a period to the average value of inventory held during that period.
If the inventory turnover rate in terms of value of materials is high, or if the length of the inventory turnover period is short, the material is said to be fast moving. So if the rate of consumption is fast or if the inventory turnover rate is good, it is a healthy measure of efficiency of materials control, as the capital employed is properly utilized.
Input-output Ratio: The Input-output Ratio is the ratio of the raw material put into manufacture and the standard raw materials content of the actual output. This ratio enables one to find out whether the usage of the materials is favourable or not. A standard ratio of input of materials and output of material should be determined and the actual ratio should be compared with the standard ratio.
Difference between ABC analysis, Perpectual Inventory system and VED analysis
|ABC analysis||Perpectual Inventory System||VED analysis|
|Its main objective is to reduce the investment in material.||Its main objective is physical verification of all items.||Its main objective is to prevent stoppage of production due to shortage of essential material.|
|In this system, stocks are classified on the basis of value.||There is no classification of stock.||The analysis classifies items on the basis of their criticality for the industry or company – vital, essential and desirable.|
|It will not pay equal attention to all types of inventory.||Equal attention is given to all types of inventory.||More attention is given to essential inventory.|
|ABC analysis is applicable when there is small variety of stock.||This system is applicable whether or not stocks are of large varieties or small varieties.||VED analysis is specially applied in the case when there is a large variety of stocks such as spare parts inventory, medical stores etc.|
|Store ledger and bin card is not prepared in this analysis.||Store ledger and bin card is prepared in this system.||Store ledger and bin card is not prepared in this analysis.|
Store Ledger and Bin Card
Store Ledger: Store ledger is a document showing the quantity and value of materials received, issued and in balance at the end. One stores ledger is allotted to each component of material. Entries are made in this ledger the costing clerk with reference to goods received note, material requisition note, material returned note etc. It is very similar to the bin card except it contains additional columns showing the prices and value of materials received, issued and balance in hand. It gives the value of closing stock at any time. Besides, a store ledger contain information like name of the material, code number, different stock levels etc.
Bin Card: Bin is a place where materials are kept in. It may be a rack, container, shelf or space where stores are kept. Bin card is a document showing the particulars of materials kept in the bin. It is a document attached to the bin disclosing the quantitative details of materials received, issued and the closing balance. A bin card is used for each item of material. Each receipt and issue is recorded on the bin card in a chronological order and the latest balance is shown after each receipt and issue. Bin card is maintained the store keeper. It indicates information like different stock levels. No, name of material, material code number, stores ledger folio number, quantity of materials received, issued and the balance in hand.
Difference between Store Ledger and Bin Card
|Store Ledger||Bin Card|
|1. It is a record of both quantity and value.
2. It is maintained the cost clerk.
3. It is kept in the cost office.
4. Entries are made the cost clerk.
5. Entries are made on the basis of documents like goods received note, material requisition note etc.
6. Posting are made after the transactions.
7. Transactions are periodically recorded.
8. Inter departmental transactions are recorded for costing purpose.
9. Facilitates physical verification of closing stock.
|1. It is a record of quantity only.
2. It is maintained the storekeeper.
3. It is attached to the bin.
4. Entries are made the store keeper.
5. Entries are made on the basis of actual quantity received and issued.
6. Postings are made before the transactions.
7. Individual transactions are recorded.
8. Inter departmental transfers are not shown.
9. Facilitates physical verification of closing stock.
METHODS OF PRICING OF MATERIAL
A number of methods are used for pricing material issues. Each method has its own advantages and disadvantages. As such, it is impossible to say which method is the best. Each organisation should choose a particular method best suited to it. While choosing a method, it is necessary to see that the method chosen is simple, effective and realistic. At the same time, it is equally necessary to consider the effect of the method on production cost and inventory valuation. The following are the different methods of pricing the material issues:
First In First Out Method (FIFO)
According to this method the units first entering the process are completed first. Thus the units completed during a period would consist partly of the units which were incomplete at the beginning of the period and partly of the units introduced during the period. The cost of completed units is affected the value of the opening inventory, which is based on the cost of the previous period. The closing inventory of work-in-process is valued at its current cost.
- This method is simple to understand and easy to operate.
- The closing stock is valued at the current market price.
- Since issues are priced at cost, no profit or loss arises from pricing.
- This method is more suitable in times of falling prices.
- Deterioration and obsolescence can be avoided.
- When prices fluctuate, calculation becomes complicated. This increases the possibility of clerical errors.
- b. During the period of price fluctuations, material charged to jobs vary. Therefore, comparison between jobs is difficult.
- During the period of rising prices, product costs are under stated and profits are overstated. This may result in payment of higher dividend out of capital.
Last In First Out Method (LIFO)
According to this method units last entering the process are to be completed first. The completed units will be shown at their current cost and the closing-work in process will continue to appear at the cost of the opening inventory of work-in-progress along with current cost of work in progress if any.
- Issues are based on actual cost.
- Issue price reflects current market price.
- Product cost will be based on current market price and hence will be more realistic.
- There is no unrealized profit or loss.
- e. Simple to operate if purchases are not many and prices are steady or rising.
- f. When prices are raising this method is helpful in preparation of quotation or estimates.
- This method involves considerable clerical work.
- Under felling price, issues are priced at lower prices and stocks are valued at higher rates.
- Stock of material shown in the balance sheet will not reflect market price.
- Due to variation in prices, comparison of cost of similar job is difficult.
- This method is not accepted the income tax authorities.
Simple Average Method
The simple average is determined adding different prices of materials in stock and dividing the total number of prices. Quantity purchased in each lot is ignored.
- This method is simple to understand and easy to operate.
- It reduces clerical work.
- It is suitable when price are stable.
- It does not take into account the quantities purchased.
- The value of closing stock becomes unrealistic.
- Material cost does not represent actual cost price.
- When prices fluctuate, this method will give incorrect result.
Weighted Average Method:
This is an improvement over the simple average method. This method takes into account both quantity and price for arriving at the average price. The weighted average is obtained dividing the total cost of material in the stock total quantity of material in the stock.
- It gives more accurate results than simple average price because it considers both quantity as well as price.
- It evens out the effect of price fluctuations. All jobs are charged a average price. So, comparison between jobs is more easy and realistic.
- It is suitable in the case of materials subject to wide price fluctuations.
- It is acceptable to income tax authorities.
- Stock on hand does not represent current market price.
- When large numbers of purchases are made at different rates, the calculation is tedious. So, there are more chances of clerical error.
- With some approximation in average price, there will be profit or loss due to over or under charging of material cost to jobs.