On the previous post we have discussed Budgeting for Raw
Materials Inventory, now let’s go on
for Work-In-Process (WIP) Inventory. The inventory of goods actually in process
of production between stocking points can be best estimated by applying
standard turnover rates to budgeted production. This may be expressed either in units of production or
dollars and may be calculated for individual processes and departments or for
the factory as a whole. The former is more accurate. To illustrate this
procedure, assume the following inventory and production data for a particular
process or department:
Process inventory estimated for January = 1 500
units (a)
Production budgeted for month of January = 1,200 units (b)
Standard rate of turnover (per month) = 4 times (c)
Average value per unit of goods in this process = $10
Production budgeted for month of January = 1,200 units (b)
Standard rate of turnover (per month) = 4 times (c)
Average value per unit of goods in this process = $10
With a standard turnover rate of four times per month: the average inventory should be 300 units
(1,200 ( 4). To produce an average inventory of 300 units, the ending inventory should be 100 units:
500 + 100
———–— = 300
2
———–— = 300
2
Using the symbol X to denote the quantity to be budgeted as
ending inventory, the following formula can be applied:
2b 2(1200)
X = (–) –––—– x a = —————- (–) 500 = 100 units
c 4
X = (–) –––—– x a = —————- (–) 500 = 100 units
c 4
Value of ending inventory is $1,000 (100 ×
$10)
Where the formula produces a minus quantity (as it will if
beginning inventory is excessive), the case should be studied as an individual
problem, and a specific estimate should be made for the process or department
in question.
Control over the work-in-process inventories can be exercised by
a continuous check of turnover rates. Where the individual processes, departments, or plants are
revealed to be excessive, they should then be subjected to individual
investigation.
The control of work-in-process inventories has been sorely
neglected in many concerns. The time between
which material enters the factory and emerges as the finished product is often
much longer than necessary for efficient production. An extensive study of the
automobile tire industry revealed an amazing spread of time among five leading
manufacturers, one company having an inventory float six times that of another.
This study also indicated, by an analysis of the causes of the float time that
substantial reductions could be made in all five of the companies without
interfering with production efficiency. Thus, budgeting for work-in-process
inventory is an excellent area in which to incorporate an active program of
inventory reduction activities, usually through a program of incorporating
just-in-time concepts into the production process.
Although it is desirable to reduce the investment in goods
actually being processed to a minimum consistent with efficient production, it
is often desirable to maintain substantial inventories of parts and partially
finished goods as a means of reducing finished inventories.
Parts, partial assemblies, processed stock, or any type of
work-in-process that is stocked at certain points should be budgeted and
controlled in the same manner as materials. That is, inventory quantities should be set for each
individual item, based on the production plan; or inventory limits should be
set that will conform to standard rates of turnover. In the former case,
control must be exercised through the enforcement of the production plan; in
the latter case, maximum and minimum quantities must be established and
enforced for each individual item.
With the planned cost input to work-in-process known from the
materials usage budget, the direct labor budget, and the manufacturing expense
budget, and the quantities of planned completed goods furnished by
manufacturing, the inventory accountant may develop the planned work-in-process
time-phased (condensed) budge. The reasonableness of the budgeted inventory level should be
tested by comparing it to historical inventory turnover levels.
