Inventory Integration and Valuation

Overview#

Because QuickEasy BOS Professional is flexible, you might face complex setup choices. This guide assists you to make well-informed choices when setting up your inventory systems in BOS Professional.

Specifically, this guide focuses on two issues: Inventory Integration and Inventory Valuation.

Inventory Integration#

When setting up BOS Professional you can choose to integrate your production system with your accounting system or to keep them separate.

Integrated (Perpetual) System#

With an integrated system, all the transactions are posted to the Ledger in real time.

Process

1. Purchase materials: Entered as Stock on Hand.
2. Issue the materials to a job: Transfer the materials from Stock of Hand to WIP.
3. The job is complete: Transfer the materials from WIP to Cost of Sales, and any remaining materials back to Stock on Hand.

Advantages of an Integrated System

• No month-end procedure: All the entries are entered in real time.

Disadvantages of an Integrated System

• Mismatch between income and expenses: Costs may be recognised before the job is invoiced. This mismatch could distort the gross profit margin.
• Extra ledger transactions:
  • Inventory must be transferred from Stock on Hand to Stock: WIP and then from Stock: WIP to Cost of Sales.
  • When a job is complete, unused inventory must be transferred from Stock: WIP back to Stock on Hand.

Periodic System#

With a periodic system, all the transactions are posted to accrual accounts. The inventory movements are handled in the respective modules and posted to the Ledger once a month.

Process

1. All the Cost of Sales and Inventory entries are posted to Accrual or Suspense Accounts.
2. Periodically (e.g. once a month), journal entries are made to clear the Accrual Accounts. These entries include:
   1. Transferring inventory used in production or sold to Cost of Sales.
   2. Transferring the remainder of inventory purchased to various Stock on Hand accounts.

Advantages of a Periodic System

• Fewer ledger entries: Instead of hundreds of small transactions, you have only a few journal entries.

Disadvantages of a Periodic System

• Periodic journal entries are needed: 
  • A bookkeeper must process journal entries to record the Cost of Sales and Inventory.
  • (However, the transactions and amounts are provided by reports in BOS Professional, which simplifies the process.)
• Financial statements are not updated in real time
  • Until the periodic journal entries are made, the financial statements are inaccurate.
  • (However, a Cost of Sales report shows accurate sales and cost of sales data in real time.)

Which Integration Method to Choose?#

• Choose perpetual (integrated) if most of your invoicing involves simple processes, such as selling finished goods, or offering a service.
• Choose periodic if your organisation has complex processes, assembles goods for resale or uses only a portion of an item (e.g. half a reel). The periodic system prevents an abundance of unnecessary entries in your Ledger (that your auditors may need to check).

Inventory Valuation#

When setting up QuickEasy BOS Professional you must decide if you want to enable automatic costing, and if so, which method to choose.

• If you disable automatic costing, you must calculate and enter the inventory values yourself.
• If you choose to let BOS Professional handle this task for you (recommended), you must choose between the Weighted Average Costing (WAC) Method with the Last Price Method.

Weighted Average Costing (WAC)#

WAC calculates the cost of Inventory based on the average cost of all similar items in inventory at the time of valuation.

Process

1. Sum the Total Cost of all units in Inventory.
2. Sum the total number of units in Inventory.
3. Divide the Total Cost by the total number of units to get the Average Cost per unit.
4. Assign this Average Cost to each unit of Inventory.

Example

• Opening Inventory: 100 units @ $10 each
• Purchase: 200 units @ $15 each
• Total Cost = (100 x $10) + (200 x $15) = $4 000
• Total Units = 300
• Weighted Average Cost per Unit = $4 000 / 300 = $13.33

Advantages of WAC

• It is simpler and easier to use: The WAC averages the cost of all similar units in inventory making it a quick method for valuing inventory.
• It evens out price fluctuations: The method averages out the costs of goods purchased at different prices. This averaging minimises the impact of price volatility or fluctuations on the cost of goods sold (COGS).
• It provides consistency: WAC provides a consistent method for valuing inventory over time.
• It reduces the potential for manipulating the financial statements: Methods such as Last In, First Out (LIFO) or First In, First Out (FIFO) can be manipulated based on the timing of purchases or sales. The WAC method does not rely on specific transaction timing, so it is harder to manipulate reported profits in the short term.
• It removes the need to track individual units: The WAC method does not require each individual item’s cost to be tracked separately. This method can reduce the complexity of inventory management when dealing with large volumes of similar items.

Disadvantages of WAC

• It does not reflect current market conditions: It may not reflect the true current cost of inventory.
• It loses specificity: WAC loses the ability to match specific costs with specific inventory items, which could be useful for companies dealing with expensive or unique items.
• It can distort the financial statements: The averaging process can obscure the financial reality for companies experiencing significant price changes.

Last Price Method#

The Last Price Method values Inventory at the cost of the most recent purchase.

Process

1. Determine the cost of the most recent Inventory purchase.
2. Assign this cost to all units of Inventory until a new purchase is made.

Example

• Purchase 1: 100 units @ $10 each
• Purchase 2: 200 units @ $15 each
• Inventory Value = 300 units @ $15 each (assuming the last purchase is the latest cost)

Advantages of the Last Price Method

• It can bring tax benefits during inflation: If prices rise, the Last Price Method deducts the higher cost of items thereby reducing the organisation's profitability, and its tax.
• It more accurately measures current costs: The Last Price Method more accurately reflects the current market conditions, because it uses the latest prices.
• It acts as a natural hedge against inflation: The Last Price Method accounts for the most recent (higher) prices, so the rising costs of goods are immediately reflected in the COGS. This method can help protect profit margins from the negative impact of inflation.

Disadvantages of the Last Price Method

• It is not globally accepted: This method is not accepted under the International Financial Reporting Standards (IFRS).
• It obscures the true value of inventory: The Last Price Method can distort the value of a company’s inventory. For example, older inventory (purchased at lower costs) may remain on the balance sheet, leading to an overstated value for the inventory compared to its real-world market value.
• It can distort the financial statements: In times of declining prices or when inventory costs are dropping, the Last Price Method can result in lower inventory values and understated profits. These lower values arise because the latest, lower-cost items are considered sold first.
• It increases volatility in earnings: Since the most recent (higher) costs are recognised immediately in COGS, it can cause sharp fluctuations in reported profits from period to period. This volatility can affect a company's valuation and make it harder to forecast future performance.

Which Valuation Method to Choose?#

• Only use the Last Price method if your inventory prices rise dramatically and you need the tax break.
• In all other cases, the Weighted Average Method provides a more balanced view of your organisation's financial performance. It can also improve your organisation's financial standing because this valuation method is globally accepted.

About Inventory Pricing#

• Inventory Prices are updated when the applicable Material is received in the Materials Movement module.
• Inventory Prices are for accounting purposes only; they do not determine the Cost price in an estimate or the Selling Price in a Sales transaction.
• When the Inventory Price is updated, it is updated for the Location into which the Stock is received only. This update means you can have different prices for the same material in different Locations.
• When a Receive transaction is deleted, the Unit Price reverts to the old price.
• Price updates can be viewed in the Price History tab of a Material's setup.

Costing Setting#

The General Setting Enable automatic costing on Inventory Items selects the method (see Settings):

• No: the unit price is never updated automatically.
• Weighted Average Price (the default for new databases).
• Last Received Price.

How the Price Is Updated#

Only receipts update the unit price. Issues, returns and transfers use the price but do not change it.

• Weighted Average Price: The new price is (stock value before the receipt + value received) divided by (quantity before the receipt + quantity received).
  • The stock before the receipt is counted up to the end of the previous day, so a receipt is treated as the first transaction of its day.
  • When there is no stock on hand (zero or less), the new price is the received price.
• Last Received Price: The new price is the price of the latest receipt.
• Each change is recorded in the Material's Price History, with the old and new price and the date.

Valuation on a Past Date#

When an inventory report or a Stock Check values stock on an earlier date, it uses the unit price in force on that date:

• The latest Price History entry on or before that date.
• If the date is before the first entry, the oldest price in the history.
• If the item has no Price History, its current unit price.