• held for sale in the ordinary course of a business (Finished Goods)
• held in the production process (Work in process)
• consumed in the production process (Raw Materials)

It includes –

• Raw Material
• Consumables
• Finished goods
• Supplies and spares
• Equipment and Components

According to Bolten S.E., “It refers to a stock-pile of a product, a firm is offering for sale and components that make up the product.”

Motives for Holding Inventory

• Transaction Motive i.e. finished goods for the purpose of sale, raw materials for production.
• Precautionary Motive i.e. raw materials and finished goods to meet unforeseen circumstances or emergencies
• Speculative Motive i.e. to capitalize on market opportunities (shortage in market) and make profit

Types of Inventory

(1) Movement Inventory – It refers to stock of goods that take substantial amount of time to be transported from one place to another. They are also known as transit inventories.

(2) Buffer Inventory – Goods held in stock to meet the uncertainties related to demand and supply of goods are called buffer inventories. These are goods that require a substantial lead time (time taken between placing an order and having the good ready for use) and hence are held in excess of the expected demand to meet emergency situations and fluctuations in demand or supply.

(3) Anticipation Inventories – It refers to stock of goods that are held in bulk due to an anticipated shortage or expected demand rise in the future. For e.g. Rain coats and Umbrellas kept in stock just before a rainy season, or stock of Air conditioners before summers.

(4) Decoupling Inventories – Stock of goods held between different stages in a production process to decouple or disengage one stage from the other are known as decoupling inventories. The main purpose of holding such goods is to ensure smooth running of the production process, therefore, even if one machine required for a particular stage breaks down, work on other stages in production won’t be hampered.

(5) Cycle Inventories – Cycle inventories are maintained for goods that are sold in bulk or big quantities, therefore, rather than making frequent purchases in small amounts which increases the cost of obtaining the products, goods are bought in very large lots to reduce to cost of obtaining goods.

Inventory Costs

• Purchase Costs – Cost of purchasing raw materials from various sources.
• Ordering Cost / Procurement Cost – Cost associated with replenishment of raw material i.e. processing of order, transportation, quality inspection etc.
• Carrying Cost / Holding Cost – Cost related to storage of goods like rent of warehouse, electricity, heating and lighting, staff salaries etc.
• Stock Out Cost – Cost associated with lack of goods or not serving the customers due to shortage of goods

Inventory Control

It refers to the process employed to maximize a company’s inventory.  It is a systematic control and regulation of purchases, storage and usage of materials to maintain a smooth flow in production and to avoid excessive investment in inventory.

Inventory System / Policy – A set of policies and controls that monitor stock levels and determine

• What inventory level should be maintained?
• When stock should be replenished?
• Quantity of stock that should be purchases?

Methods of Inventory Control

• FIFO (first in first out) – This method assumes that goods that are added to the inventory first must also be removed from the inventory first i.e. goods that are bought first must be sold first. This method is generally used by firms dealing with perishable goods or goods that are subjected to quick obsolescence.
• LIFO (last in first out) – This method assumes that goods that are added to the inventory last must be sold first or removed from the inventory first. This method is usually used by firms dealing with goods that are not perishable or do not become obsolete quickly.

Techniques of Inventory Control

• EOQ Model – Economic Order Quantity
• ABC Analysis – Always Better Control
• HML Analysis – High, Medium, Low
• VED analysis – Vital, Essential, Desirable
• MRP – Material Requirement Planning
• Max Mini System
• Two Bin system
• Buffer Stock
• JIT – Just in Time etc.

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According to I.C.W.A, “A budget is a financial and/or quantitative statement prepared prior to a defined period of time, of the policy to be pursued during that period for the purpose of attaining a given objective.”

Features of a Budget

• It is a financial and quantitative statement of a plan of action
• It is always expressed in terms of money and/or quantity
• It is prepared prior to the implementation of the operational plan
• It is based on pre-determined management policy
• It is prepared to achieve specific financial objectives
• It indicates the costs and revenues, capital to be employed, incremental effects on former budgets etc.

Budgeting

Budgeting refers to the process of preparation, implementation and operation of budgets. It involves formulation of operational plans for a given future period and expressing it in monetary terms.

Types of Budget

On the Basis of Time

• Long Term Budget – Budget prepared for a period of 5 to 10 years.
• Short Term Budget – Budget prepared for a period of 1 to 2 years.
• Current Budget – Budget prepared for a period of less than 6 months.

On the Basis of Activity

• Fixed Budget – Budget that is fixed for a given level of activity or time period and does not change with changing business situations.
• Flexible Budget – Budget that is flexible and can be revised from time to time according to the changing business needs and situations.

On the Basis of Nature of transaction

• Capital Budget– Budget prepared for the capital expenditures of a business.
• Operating Budget – Budget prepared to meet the day to day expenses of a business.

On the Basis of Functions

Master Budget – Various functional budgets are integrated together to form a master budget.

Financial Budgets – Budgets related to various costs and revenues of the organization.

• Cash Budget
• Working Capital Budget
• Capital Expenditure Budget
• Income Statement
• Budgeted Balance Sheet
• Retained Earnings

Operational Budgets – Budgets prepared for different activities or operations of the organization.

• Sales Budget
• Production Budget
• Purchase Budget
• Materials Budget
• Personnel Budget
• Plant Utilization Budget
• Marketing Budget
• Administrative & Selling expenses budget
• Manufacturing Expenses budget

Budgetary Control 

Budgetary Control is the process of determining various budgeted figures for an organization for the future period and then comparing the budgeted figures with actual figures for calculating deviations and taking remedial measures to minimize deviations. It is a continuous process that helps in planning and controlling costs.

According to Howard and Brown, “Budgetary control is a system of controlling costs which includes preparation of budgets, coordination of departments, comparison of actual performance with budgeted performance and acting upon the results to achieve maximum profitability.”

Requirements of a Good Budgetary System

• Budgeting process must be backed by the Chief Executive of an organization
• Organizational goals must be clearly stated and quantified and further divided into functional goals
• People responsible for execution of budget must be involved in its preparation
• Budgets must be realistic, continuous and must cover all relevant aspects
• Budgeting system must be based on information, communication and participation
• Clear responsibilities for effective budget implementation must be established

Essentials of Budgetary Control

(1)Organization Structure

(2) Budget Centers – It may be a department or a group of people in a department, who are responsible for preparation of a budget.

(3) Budget Manual – It is a written document containing rules, regulation, policies and guidelines for preparing budgets.

(4) Budget Officer (Coordinator) – The person responsible for scrutinizing, evaluating and finalizing the budgets prepared by different functional heads.

(5) Budget period – Time period for which budget is prepared.

(6) Budget Committee – Group of people responsible for preparation and execution of budgets

(7) Determining Key Factor – Principle factor that influences all budgets

Steps in Budgetary Control System

Advantages of Budgetary control

• Effective budgetary control leads to maximization of profit
• It facilitates coordination between different functional departments
• It acts as a tool for measuring (financial and operational) performance
• It helps in eliminating wastages and taking corrective actions
• It helps in reducing costs
• It helps to take decisions regarding performance appraisal of employees

Also Read:

• Zero Based Budgeting
• Performance Budgeting
• Responsibility Accounting

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It refers to the monetary expenditure which a firm has to incur in order to purchase or hire the factors of production. It is the expense of purchasing or hiring factor services for production and other business activities.

Classification of Cost / Types of Cost

There are various types of cost:

On the basis of Nature of Costs –

• Fixed Cost – It is the cost of fixed inputs used in production. These costs do not vary with the change in volume of production.
• Variable Cost – It is the cost of variable inputs used in production. These costs vary with the change in volume of production.
• Semi Variable Cost – It refers to costs which are partly fixed and partly variable. These types of cost do not directly affect the level of production but may vary with change in production facilities e.g. administrative cost, maintenance cost, depreciation cost etc.
• Total Cost – It refers to the total cost of production.

Total cost = Fixed cost + Variable Cost

• Marginal Cost – It refers to the cost of producing one extra unit of a product.

MC = TC_n – TC_n-1

TC_n = Total cost of producing n products, TC_n-1 = Total cost of producing n-1 products

On the basis of Expense –

• Material Cost – It refers to the cost of procurement and use of any raw material used for production.
• Labour Cost – It refers to the payments made to permanent and temporary workers for their services.
• Overhead cost – It refers to costs which are semi-variable and vary with the level of production like administrative expenses, cost of indirect material and labour, indirect expenses etc.

On the Basis of Control:

• Controllable cost – It refers to costs which can be influenced or controlled by the actions of the organization members.
• Uncontrollable cost – It refers to costs which cannot be controlled by the actions of the organizations members.

According to Functions or Operations of a Business:

• Preliminary Cost – costs incurred before the commencement of the actual business e.g. rent, interest, product trial, underwriting costs etc.
• Cost of Production – cost of material, labour, overheads etc.
• Cost of Marketing and Selling – cost of marketing, selling promotion, advertising, distribution etc.
• Cost Research and Development – cost of innovation, new or improved products, advance production facilities etc.

According to behaviour of cost:

• Direct Cost – It refers to costs which involve a direct expense and are easily traceable.
• Indirect Cost – It refers to costs which are indirect and not easily traceable.
• Explicit or Accounting Cost – It refers to the payments made in monetary terms by a firm, to the owners of factor services required for production.
• Implicit or Economic Cost – It refers to the estimated value of all the inputs owned and put to use for production by a firm.

On the basis of relevance in Decision Making:

• Opportunity Cost – It refers to the cost of the next best alternative action that is sacrificed in order to pursue the chosen action.
• Sunk Cost – It is the cost which is not altered by a change in current business activity. It can be understood as an irrevocable cost of the past business activity which has to be incurred now and is irrelevant to the current business scenario.
• Replacement Cost – It is the cost of replacing an asset, plant, machinery, equipment etc.
• Imputed cost – These are hypothetical costs which are considered just for the purpose of decision making and do not involve any actual cash outflow.
• Real Cost – It refers to the cost of all efforts and sacrifices made by the owners of factors of production in production of a commodity.
• Social Cost – It refers to the cost of hardships and sacrifices that a society has to bear due to operation of business activities.
• Conversion Cost – It refers to the cost involved in transforming raw materials into finished products. These types of cost do not include the actual cost of raw material. It includes the cost of direct and indirect labour, overheads and expenses.

Other Types of Cost:

• Historical Cost – It refers to the actual cost of acquiring an asset or producing a product or service.
• Normal Cost – It is a cost which normally incurred in achieving a certain level of output under certain conditions.
• Abnormal Cost – It is the cost which is not normally incurred at a given level of output under normal conditions. It is an irregular cost which would not exist in ideal conditions.
• Differential Cost – It is the change in cost due to change in level of production.
• Incremental Cost – It is the additional cost in relation to a change in the level or nature of business activity.

IC = TC2 – TC1

TC2 = Cost after change, TC1 = Cost before change

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