In industries, other than operating profits, the inventory costing and capacity are relevant items of managerial aspects of accounting that needs correct analysis. Inventories are quite special for manufacturing businesses and even merchandising firms. It follows that inventories are defined as an itemized list, report, detailed or record of things that are in one's possess including, goods and materials in stock. Companies may require upfront profitable investments in capacity, relevant decisions made on this fixed investment and the extent at which capacity is utilized to meet the demands of customers have posted a substantial effect on corporate profits. Management decisions may focus to benefit earnings which are short-term at the expense of company's long-term healthiness that may be induced by reward systems and inventory costing methods (Da Silva Etges, Grenon, De Souza, Kliemann Neto, " Felix, 2018, p. 103).
Management in industries and companies having high fixed costs, like, manufacturing companies have no otherwise but to properly manage capacity levels and making decisions on uses of capacity available. Always, capacity is the actual ability one can do based on assets one has. The accounting choices and decisions managers may make shall affect and influence operating incomes of any manufacturing company. This research work intends to expound on inventory costing and capacity and the relations of these managerial accounting aspects to the current accounting standards alongside various findings on the latest experiences of current company’s managerial accounting matters. This research entails findings on the available two managerial choices of inventory-costing choice and denominator-level capacity choice. The inventory costing choice include; absorption costing approach, variable costing approach or throughput costing approach. On the capacity analysis grounds, the capacity utilization levels include; budget capacity, theoretical capacity, standard capacity, and practical capacity levels. The research goes further on various opportunities regarding inventory costing and capacity.
1. The inventory-costing choice.
This accounting management concept is basically to determine specific manufacturing costs which are treatable as inventory costs regarding of inventory cost as all cost of a given product regarded as an asset whenever they are incurred or any expense treated as the cost of goods whenever a product is sold (Biddle, 2016, p. 235). In the current accounting standard, there are three types of inventory costing methods including; abortion costing method, throughput costing method, and variable costing method.
a) Absorption costing method
Absorption method of costing remains a type of inventory method of costing whereby all costs in manufacturing which are variable together with all fixed costs in manufacturing are strictly included considerably as inventoriable cost. It entails the fact that the inventory in its costing absorbs costs of manufacturing completely. The relevant example of absorption costing in the current accounting standards is the job costing system of accounting. Therefore, absorption method of costing means manufacturing costs in total are absorbed whereby units produced, that is, all cost of finished goods transferred to inventory include direct labor cost, direct materials cost and also of fixed as well as variable overhead on manufacturing costs. Therefore, absorption type of costing is referred to as the full method of costing or full costing. This type of costing method is always used for financial reporting which is external, that is, preparing report statements for external reporting and income tax report. This is because product cost, from US GAAP, all product costs that are incurred shall be expressed as the cost of inventory sold and therefore should be attached usually against revenues as soon as the goods are sold (Biddle, 2016, p. 235). Besides, manufactured goods cost can thereafter be incurred at one product and acknowledged in another different product. An example is where cost is incurred whenever products are being manufactured in addition to later recognize when goods are sold. However, period cost like selling and administration expenses are recognized as soon as they are incurred primarily because they usually have no future benefits.
For the purpose of internal reporting, the absorption approach of costing is usable in order to save possible additional costs occurring when preparing reports. This is because the absorption approach of costing is usually restricted that it must be used in external reporting purposes at any accounting case especially for long-term planning. Therefore, under absorption approach of costing, there is only one period costs, that is, cost only expressed when incurred, which is SG"A expenses. The inventory costs here include; fixed overheads, Variable overheads, direct materials, and direct labor costs. The absorption costing approach is used mostly for external reporting under GAAP guidelines (Biddle, 2016, p. 235).
b) Throughput costing method
The throughput approach of coasting is also acknowledged as the super-variable approach of costing and it’a form of the variable method of costing whereby direct materials gets to be the only item included as the only inventoriable costs (Nagao, Takahashi, Morikawa, " Hirotani, 2011, p. 126). It, therefore, follows that other remaining costs are of the exact period at which they were incurred. And are deducted as the period expenses. Besides, like the variable costing method, throughput coasting approach is used for internal financial reporting purposes, especially for short-term planning. Besides, this costing approach reduces management incentives to build up the inventory to a level that is inappropriate. This is because this method usually includes only direct material costs as inventory cost. Typically, as the direct labor, as well as all manufacturing overheads as a cost, are always treated like period costs considered under throughput approach of costing and methodology making managers tend to control such costs on that ground, more sensibly. It is worth noting that, under throughput approach of costing, direct materials are the only items that are recorded or classified as inventory costs whereas all remaining manufacturing costs are in totality expressed as a period cost, that is, expressed when incurred. Under throughput approach of costing, period costs include direct labor cost, variable overhead, SG"A expenses and fixed overheads (Nagao, Takahashi, Morikawa, " Hirotani, 2011, p. 140). Here, there is only one inventory cost which is direct material costs. Finally, it is worth noticing that throughput costing approach is used primarily for short-term capacity decisions.
c) Variable costing method
This costing method is an inventory costing method whereby variable factory costs, both indirect as well as indirect costs are all regarded as inventory costs. Here, entirely fixed manufacturing expenditures are not included in inventory costs but rather later treated as cost attributed to the exact period at which they are specifically incurred. The variable cost is always a not more than term used at describing inventory costing approach basically because strictly, only manufacturing variable costs are inventoriable and the non-manufacturing variable costs are treated expense (Desai, 2017, p. 262). This costing method is also described as direct costing. It is as well contradicting, being costing here considers manufacturing overhead which is variably regarded as indirect cost recognized as inventoriable but excluding direct marketing cost. Under direct costing or variable costing, the fixed manufacturing overhead costs usually are not assigned to or allocated to the goods manufactured. Thus, in variable costing, overheads are not absorbed. This coasting approach is always appropriate for the purposes of short-term planning in manufacturing companies accounting reporting. This is because usually fixed costs which are fixed by nature always do not change within any relevant range resulting from any short-term decisions.
Therefore, under variable costing approach, the period costs include; fixed SG"A expenses and fixed overhead. There is also inventory cost which includes; variable SG"A expenses, variable expenses, direct material, and direct labor costs. The variable method of costing is used in internal reporting especially for performance evaluation and for the purpose of decision making (Desai, 2017, p.269).
2. Denominator-level capacity choice
The capacity level choice is found to be focusing specifically on cost allocation which is based in setting budget fixed manufacturing cost rates (Da Silva Etges, Grenon, De Souza, Kliemann Neto, " Felix, 2018, p.107). The alternative denominator activity levels at any choice can be chosen usually as a basis for the known overhead rate calculations. With regard to the current accounting standards, there are four recognized possible choices based on capacity level, that is; theoretical capacity, practical capacity, normal capacity as well as, budget capacity.
a) Theoretical capacity
Theoretical capacity stands to be that level in capacity which is based on production in totality at full efficiency in a continual basis. Besides, it’s so theoretical to the extent that it does not give room for; shutdown periods, maintenance of plants, interruptions or any factors (Chaplin, 2016, p. 61). This utilization represents ideal goals in capacity utilization. It is also known as maximum capacity definable as that annual output that the firm can produce when it is assumed that there are perfect conditions. That is, if there could be no problems like idle time or downtime that was coursed by shortages in inputs or even breakdowns in plants and machinery, all could be accomplished at the right time. The theoretical levels are usually not attainable in the real world though they provide a ground of target that company can aspire.
b) Practical capacity
It is defined as a somehow low level of output that assumes the effective operations besides giving room for a bit of certain idle time or downtime. It is the level of capacity which tends to reduce theoretical capacity by putting into consideration operational interruptions that are unavoidable (Chaplin, 2016, p. 70). Its example can be; shut-downs purposed for holidays, scheduled maintenance time and many other. This as well, theoretical capacity both measures the capacity levels specifically in terms of what a plant or an entity can supply at the tune of available capacity.
c) Normal capacity utilization
Normal capacity should be defined as the state of an average output level that is expected spread over the next many years. This is a level of capital that is needed in order to meet demand by customers for years. Thus it’s derived from customer orders. This capacity measures any level in terms of output demand of a plant, that is, the available in its total amount that the plant may expect to consume based on the demand on its products.
In most cases, the demand which is budgeted is below capacity available on production. Therefore, Norman capacity is specified to be the level at capacity utilization which can satisfy ordinary and middle customer demand spread at a period including cyclical, seasons and tendency factors (Desai, 2017, p. 276). Therefore, using the so-called normal capacity as preferred denominator can result, in most cases the unfavorable volume of production variances in different years and at a given time favorable variables in other years.
d) Budget capacity utilization
This is the capacity utilization level that is expected and that which is needed for the current budget. Therefore, it is that capacity utilization level which managers anticipate specifically for contemporary budget period, for example, one year. This type of capacity utility is likewise called planned capacity that is symbolized by a given number of scalar or units that the entity plans to harvest specifically during that year as may be stated within the specified master budget (Da Silva Etges, Grenon, De Souza, Kliemann Neto, " Felix, 2018, p. 106).
Choosing a capacity level
At the beginning of every financial year, management especially cost accountants determine any different denominator levels targeting different capacity concepts, thereafter making relevant calculations of all budgeted fixed manufacturing costs for every unit. There must always be consideration of possible problems with and effects of all denominator level choices designed for different purposes including; pricing, tax requirements, product costing and capacity management and performance evaluation (Biddle, 2016, p. 235). A relevant example is that using master-budget capacity utilization which is also known as the planned capacity eliminates unaccountable for production volume variations, that is, it does away with production volume variances, and it tends to attempt minimization of the actual production volume variances. As well, full or practical capacity for above rates producing more and highly accurate product costs alongside avoiding the so-called ‘death spiral' effect that is always likely to occur whenever planned capacity is preferred and used.
In general, it may not usually clear why certain firms may not or may choose a specific denominator, the choice for any denominator activity is likely to have a very significant impact on product cost and even absorption costing net income.
Opportunities in regard to inventory costing and capacity.
The possible opportunities as inventory and capacity are concerned to include, benchmark supply performance and various capacities in the business of the company units and any other functions against a different company. This may entail for example performance exchange with automatic translation of information from ERP systems in order to automate the analysis of the performance of the company and against any procurement benchmark database (Desai, 2017, p. 269).
Another possible example of opportunities in regard to inventory costing and capacity include translation of demand variation to supply variation especially during supply planning and even during sourcing. During supply planning, demand variation is translated to supply required variation in order to upstream; capital planning, inventory planning, and even commercial risk handling decisions are made intelligently. Besides, during sourcing, the best practice is practice is significantly to present large and bigger market baskets to supplies in order for them to flexibly bid for the requirements best suitable to their capacity (Da Silva Etges, Grenon, De Souza, Kliemann Neto, " Felix, 2018, p. 107).
Conclusion
It, therefore, follows that, with regard to the current accounting standards, inventory costing methods including absorption costing method, throughput costing method, and variable costing method. These methods are all applicable by a firm at the firm's convenience over its accounting records. Besides, a company's accounting system can adopt any capacity utilization level that is concluded to be best for its smooth accounting run, usually on cost allocations. However, companies prefer any given inventory costing method and adopt any capacity analysis level based on the type of goods or products that they manufacture or the nature of their marke
References
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Chaplin, S. (2016). Accounting Education and the Prerequisite Skills of Accounting Graduates: Are Accounting Firms’ Moving the Boundaries? Australian Accounting Review, 27(1), 61-70.
Da Silva Etges, A. P., Grenon, V., De Souza, J. S., Kliemann Neto, F. J., " Felix, E. A. (2018). ERM for Health Care Organizations: An Economic Enterprise Risk Management Innovation Program (E2RMhealth care). The value in Health Regional Issues, 17, 102-108.
Desai, A. (2017). Inventory Analysis and Costing. Production Economics, 257-276.
Nagao, H., Takahashi, K., Morikawa, K., " Hirotani, D. (2011). An Inventory Control Policy with Tracking Information for Dual-Channel Supply Chains. Brazilian Journal of Operations " Production Management, 8(2), 121-146.
