1. © BMA Inc. 2008. All rights reserved. Inventory valuation Lean reporting & control

2. © BMA Inc. 2008. All rights reserved. Inventory valuation As Lean methods take hold within a company inventory levels fall substantially and come under good control. The financial risk of inaccurate inventory valuation decreases significantly, lowering the materiality of misstatement of profits. Simpler methods of inventory valuation can be used.

3. © BMA Inc. 2008. All rights reserved. Benefits of simpler inventory valuation methods Less work for operations and finance Do not require complex computer systems to track & maintain information Simpler methods support and enhance visual inventory management

4. © BMA Inc. 2008. All rights reserved. Factors in inventory valuation Amount of Inventory – if inventory is less than 30 days, simpler methods can be used. Visual Control – if visual controls are in place, it can be quick & easy to count inventory. Tracking in ERP – quantities on hand can be used from systems if the number of parts is too great for visual control. Inventory Mix is different from Sales Mix – if this exists, it may make if more difficult to implement simpler systems.

5. © BMA Inc. 2008. All rights reserved. How do we value inventory? Raw Material Inventory –Expense the material on receipt. Inventory value is zero. –If material must be valued use the average actual cost or the cost from the blanket purchase order. Work-in-Process Inventory –Don’t track it and don’t include in material value. –If WIP is significant, then value it based on the number of kanbans. Change the value only when the number of kanbans or the products change. Finished Goods –If there is finished goods, use the average actual cost for the value stream product family. –Alternatively, hold finished goods at direct material cost only. –Balance sheet adjustment based upon days of inventory.

6. © BMA Inc. 2008. All rights reserved. Simpler inventory valuation methods Days of Inventory –Count the inventory, calculate the days, calculate the value from the number of days. Inventory as % of Total Production –Calculate the number of units in finished goods as a percentage of total production that month. Inventory value will be that percentage of the total value stream costs. Change in Average Cost –Take the inventory value last month-end and adjust it for the number of units and the change in average cost during the current month. Features & Characteristics Product Cost –Calculate a product cost for each item from the value stream average cost and a simple table relating product features & characteristics to the rate of flow of the product through the value stream.

7. © BMA Inc. 2008. All rights reserved. Inventory valuation methods 1 & 2 Inventory If you have high levels of inventory –Greater than 60 days is a good benchmark And if you are tracking inventory quantities in detail on the computer systems Applicable method(s) Method #1 –Continue to use a standard cost and calculate the inventory value –Calculate the value at standard cost and then apply adjustments to account for variances and other changes Method #2 –Use the features & characteristics method of calculating actual product cost –Use actual product cost for valuing the inventory. These are largely traditional methods and are suitable for inventory that is not under good control.

8. © BMA Inc. 2008. All rights reserved. Inventory valuation methods 3 & 4 Inventory If you have lower levels of inventory –Less than 60 days is a good benchmark And if you are tracking inventory quantities in detail on the computer systems Move to actual cost on the system and set the labor & overhead rates in the system to zero. –This means that you have the inventory value in the system, but including actual material costs only Applicable method(s) To add the conversion costs into the inventory value there are two methods –Number of days –Number of units Method #3 –Calculate the number of inventory days for raw material, WIP, and finished goods. –Using a single journal entry apply the value for the number of days of finished goods and WIP Method #4 –This is the same, except you use the number units rather than the number of days These methods work well for inventory that is still tracked on the computer but is under good control.

9. © BMA Inc. 2008. All rights reserved. Inventory valuation methods 5 & 6 Inventory If you have lower levels of inventory –Less than 60 days is a good benchmark –Less than 30 days in FG And if you are NOT tracking inventory quantities in detail on the computer systems –Using visual supermarkets and pull systems for materials replenishment and control You will now be expensing materials purchased on receipt and need to put the inventory value onto the BS at month-end. Applicable Method(s) To calculate the inventory value there are two methods –Number of days –Number of units Method #5 –Calculate the number of inventory days for raw material, WIP, and finished goods. –Using a single journal entry apply the value for the number of days of finished goods and WIP Method #6 –This is the same, except you use the number units rather than the number of days These methods work well for inventory that is low and not tracked on the computer. These are the simplest methods and they require a stock count each month.

10. © BMA Inc. 2008. All rights reserved. Inventory valuation method 7 Inventory type If you have higher levels of inventory –Greater than 30 days of finished goods And if you are NOT tracking inventory quantities in detail on the computer systems –Using visual supermarkets and pull systems for materials replenishment and control Inventory is under good visual control Applicable method Method #7 –Use the monthly average cost for products that were manufactured in each month. –If you have 1500 units of finished goods and WIP representing 45 days of inventory. If this month had 30 days, then 1000 of the units were manufactured this month, and 500 last month. –The inventory value will be calculated using the average cost of this for the 1000, and the average cost for last month for the 500. This method works well when raw material is low and finished goods higher. The inventory must be under very good control and easy to count each month.

11. © BMA Inc. 2008. All rights reserved. Inventory valuation in practice: Examples / Exercises