INVENTORY POLICIES: TYPES, HOW THEY ARE ESTABLISHED AND EXAMPLE - DUDAS - 2025

The inventory policies are written instructions from senior management on the level and location of the inventory must have a business. Inventory is the term used in manufacturing and logistics to describe materials that are inputs for production, finished products, or products that are in the manufacturing process.

The main purpose of inventory policies is to increase the profits of the company, seeking to ensure adequate levels of inventory at all times. The procedures used to accomplish this will vary by type of business.

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The most valuable asset of a company is usually the value of the inventory it owns. Policies and procedures are used to protect those assets against expiration, theft, or other types of loss.

In addition to protecting inventory, companies want to make sure they have enough inventory to meet demand, otherwise they could lose sales. On the other hand, keeping too much inventory is expensive, not only because of the risk of damage or loss, but because of the space required to store it.

Types

Cost flow

The FIFO (First In First Out) cost stream assumes that the oldest inventory is sold first.

Since costs tend to increase over time, FIFO uses the lowest costs to calculate the cost of merchandise sold. This maximizes profits and therefore creates a higher tax liability.

The LIFO (Last In First Out) cost stream has the opposite effect: it minimizes taxable profits when prices rise.

Inventory valuation

This policy seeks to ensure that the inventory is controlled and properly calculated, thus avoiding losses or shortages, both of the work in progress and of the finished products.

Likewise, for those supplies acquired to be converted as part of the merchandise to be sold.

This policy analyzes the least cost or market valuation method, establishing that it must be applied to the actual quantities of the inventory, in order to determine the value of each item.

Inventory reserve

Accounting principles require that expenses correspond to the income generated and the accounting period.

This can be done with the expense for loss of inventory, establishing an inventory reserve contra-account.

The amount of losses and damages that will be suffered in the period is calculated, amortizing at the beginning of the period. This is done by debiting the costs of merchandise sold and crediting the inventory reserve.

Upon realizing the losses, the reserve account is debited and inventory is credited.

Perpetual vs periodic

If a perpetual inventory system is used, the records are continually updated when inventory changes, using a computerized system. The cost of merchandise sold is always up to date.

A periodic system is based on physical counts. It is easier and cheaper, but it does not provide information in real time. Updates the costs of merchandise sold as a lump sum at the end of the period.

How are inventory policies established?

The requirements of each area of ​​the company must be evaluated, seeking a balance between them. The variables to take into account are:

Costs

The first aspect refers to the cost of keeping the products in storage. You should examine the amount to be paid for the warehouse, and the personnel who manage and monitor the inventory.

The second point is the obsolescence costs, which correspond to the case of perishable food products or medicines. These have a short life span, since they expire after a certain time and cannot be traded.

Third are the costs of the order, concerning the administrative organization that is responsible for making purchases.

Service level

This variable takes into account what expectations customers have regarding the service, what percentage of complete orders are delivered to the customer, and what is the promised delivery time that the company has met.

Provider restrictions

Take into account the conditions to be met to obtain the product. For example, if the supplier requires a minimum quantity to buy, if it is a flexible and reliable company, if it offers discounts according to the volume of the order.

Likewise, if the supplier has the required quantity available, and if the products are dispatched from their inventory or start their production process after placing the order.

Replenishment time

It corresponds to the period of time from when it is revealed that a product must be ordered and the moment when this product is available for the company to use it.

Five periods are involved in this process: inventory check, purchase management, supplier order management, transportation, and entry into the company's system.

Demand patterns

It is related to the number of customers who regularly buy the products, in order to evaluate their sales frequency and place orders according to the average sales.

These schemes are not conclusive and can change at any time. Therefore, a safety inventory must be kept.

Example

The following is an example of the inventory policy model for a university.

Policy statement

Inventories are defined as stationery, spare parts, laboratory materials, chemical products, consignment stock and minor equipment, sold to students or the general public.

Inventory management

Each area that has inventory is required to have a record-keeping system to record:

- Additions.

- Sales or transfers.

- Returns.

Inventory records should be kept by people who are not responsible for the physical handling of the stock in the warehouse.

A physical inspection and inventory count should be performed annually to verify and confirm inventory records. Shortages, surpluses, obsolete and damaged stocks must be identified.

Obsolete items must be disposed of, obtaining the approval of the officially authorized official through the financial delegation procedure.

When an inventory count reveals a discrepancy between the theoretical and physical stock levels, the inventory records should be modified as soon as the physical count is verified.

All adjustment entries must be approved by the officially authorized representative under the financial delegation procedure.

Organizational units must ensure safe storage of stocks, including security against theft, fire, and other damage. Access to storage areas is restricted.

Assessment

All inventories that are valued for the purpose of inclusion in the financial statements must be valued at least cost and net realizable value. When practical, the cost of inventories for particular items will be allocated on a FIFO basis.

References

1. Eric Bank (2019). Inventory Accounting Policies. Small Business - Chron. Taken from: smallbusiness.chron.com.
2. The University of Queensland (2019). UQ Policy and Procedures Library. Taken from: ppl.app.uq.edu.au.
3. Study (2019). Inventory Control: Policies & Procedures. Taken from: study.com.
4. Adriana Carolina Leal (2018). Inventory policies in a company. I follow. Taken from: siigo.com.
5. Jsw Training (2019). Stock Control Policies and Procedures. Taken from: jsw.org.au.