Table of Contents:-
- Meaning of Inventory
- Definition of Inventory
- Elements of Inventory
- Motives for Holding Inventories
- Types of Inventory
Meaning of Inventory
The dictionary meaning of inventory is ‘stock of goods’. Authors interpret the term “Inventory” in different ways. In accounting terminology, it may refer solely to the stock of finished goods. A manufacturing concern may include raw materials, work in process and stores, etc.
Definition of Inventory
The International Accounting Standard Committee (L.A.S.C) defines inventories as “Tangible property
1) Held for sale in the ordinary course of business,
2) In the process of production for such sale or,
3) To be consumed in the process of production of goods or services for sale”.
The American Institute of Certified Public Account (AICPA) defines “inventory in the sense of tangible goods, which are held for sale, in the process of production and available for ready consumption”.
According to Bolten S.E., “Inventory refers to stock-pile of product, a firm is offering for sale and components that make up the product“.
Elements of Inventory
Inventory includes the following things:
- Raw Material
- Stores and Spares
- Finished Goods
1) Raw Material
It includes direct material used in the manufacturing process of a product. The purpose of holding raw materials is to ensure uninterrupted production in the event of delayed delivery. The amount of raw materials to be kept by a firm depends on various factors such as the speed with which raw materials are to be ordered and procured and uncertainty in the supply of these raw materials.
i) Direct Material: Direct material is the primary classification for raw materials in manufacturing operations. It has a direct correlation to the end product. It is only the material that, after manufacturing processes are applied, ships out to a distributor or the final customer. If, e.g., the company manufactures hammers, then steel would be its primary direct material.
ii) Indirect Material: Indirect material is the class of materials in the manufacturing process that does not ship to the customer as part of the final product. For example, the gas used to beat the furnaces that melt the steel in the manufacture of hammers is an indirect material. Similarly, the water that cools the metal can also be classified as an indirect material.
Consumables are products that consumers frequently purchase, such as items that are used up or disposed of. For example, consumable office supplies encompass items like paper, pens, file folders, post-it notes, computer disks, and toner or ink cartridges. This category does not include capital goods such as computers, fax machines, other business machines, or office furniture.
It includes partly finished goods and materials held between manufacturing stages. It can also be stated that those raw materials which are used in the production process but are not finally converted into the final product are work-in-progress.
4) Stores and Spares
This category includes those products, which are accessories to the main products produced for sale. For example, stores and spare items are bolts, nuts, clamps, screws, etc. These spare parts are usually bought externally, although there are cases where the company manufactures them in-house as well.
5) Finished Goods
The goods ready for sale or distribution come under this class. It helps to reduce the risk associated with a stoppage in output on account of strikes, breakdowns, shortage of material, etc.
- nature of business meaning
- nature of international business
- scope of international marketing
- determinants of economic development
- nature of capital budgeting
- nature of international marketing
Motives for Holding Inventories
The motives for holding inventories are given as follows:
1) Speculative Motive
The firm may be tempted to keep some inventory to capitalize on an opportunity to make a profit e.g., a sufficient level of inventory may help the firm to earn extra profit in case of an expected shortage in the market.
2) Transaction Motive
Every company needs to maintain a certain level of inventory to meet daily sales, production demands, customer requirements, and so on. This motive makes the firm keep an inventory of finished goods as well as raw materials. Maintaining an appropriate inventory level ensures the smooth operation of the company. A business firm exists for business transactions which require a stock of goods and raw materials.
3) Precautionary Motive
A firm should keep some inventory for unforeseen circumstances. For example, the fresh supply of raw material may not reach the factory due to strikes by the transporters or due to natural calamities in a particular area. There may be labour problems in the factory and the production process may halt. Therefore, the company should maintain inventories of both raw materials and finished goods to address such unexpected situations.
Types of Inventory
There are various types of inventory which are given as follows:
1) Anticipation Inventories
Anticipation inventories are held for the reason that a future demand for the product is anticipated. Production of specialized times like crackers well before Diwali, umbrellas and raincoats before rains set in, fans while summers are approaching, or the piling up of inventory stocks when a strike is on the anvil, are all examples of anticipation inventories.
2) Cycle Inventories
Cycle inventories are held for the reason that purchases are usually made in lots rather than for the exact amounts which may be needed at a point in time. Certainly, if all purchases are made precisely when the item is needed, there would be no cycle inventories. But, practically, purchases are made in lots, the reason being that if purchases are made frequently and in small numbers, then the cost involved in obtaining the items would be very large.
3) Movement Inventories
Movement inventories are also called transit or pipeline inventories. They exist because there is a transportation time required when moving significant quantities of resources. For example, when coal is transported from the coalfields to an industrial town by trains, the coal, while in transit, cannot provide any service to the customers for power generation or for burning in furnaces.
4) Buffer Inventories
Buffer inventories are held to protect against the uncertainties of demand and supply. An organization generally knows the average demand for various items that it needs. However, the actual demand may not precisely align with the average and could even surpass it. To meet this kind of situation, inventories may be held more than the average for expected demand. Similarly, the average delivery time (that is, the time elapsing between placing an order and having the goods in stock ready for use, technically called the lead time) may be known.
However unpredictable events could cause the delivery time to exceed the average. Thus, excess stocks might be kept to meet the demand during the time for which the delivery is delayed. These inventories which are more than those necessary just to meet the average demand (during the average lead period), held for protecting against the fluctuations in demand and lead-time are known also by the term safety stocks.
5) Decoupling Inventories
The idea of decoupling inventories is to decouple, or disengage, different parts of the production system. As we can observe easily, different machines/equipment and people normally work at different rates; some slower and some faster. A machine, for example, might be producing half the output of the machine on which the item being handled is to be processed the Inventories in between the various machines are held to disengage the processing on those machines. In the absence of such inventories, different machines and people cannot work simultaneously continuously. When maintaining these inventories, even in the event of a machine breakdown, work on other machines would not come to a halt.
6) Dependent Demand Inventory
Inventory item whose demand is related to (or dependent upon) some higher-level item. The demand for such items is typically considered as derived demand. Dependent demand inventory items are usually thought of as the materials, parts, components, and assemblies that make up the finished product.
7) Independent Demand Inventory
Inventory item whose demand is not related to (or dependent upon) some higher-level item. The demand for such items is often referred to as forecasted demand, while independent demand inventory items are typically considered as finished products.