December 8, 2011

Costing for Inventory Management, JIT and Backflush Costing

The most commonly used methods for inventory costing in manufacturing companies are absorption costing and variable costing. In many countries, absorption costing is the prescribed method for external reporting and tax accounting.

Throughput costing also referred to as super-variable costing is being advocated by Eliyahu Goldratt.

Absorption costing of inventories

In absorption costing, all variable manufacturing costs and all fixed manufacturing costs are included in finished goods and work-in-progress (WIP) inventory costs. That means, inventory absorbs all the costs incurred to manufacture the items to semi-finished or finished state.

Variable Costing of Inventories

In variable costing, only variable manufacturing costs are included as inventoriable costs. All fixed manufacturing costs are treated as period costs and are shown in the period's expenses.

Throughput costing

The advocates of throughput costing suggest that only direct material is treated as inventoriable cost and all other expenses including direct labor are treated as period expenses. Such a treatment removes any incentive for creating inventory for showing a better financial picture on the balance sheet or profit and loss account. Inventory then will be created only serve the market in the coming periods if it is anticipated that capacity will be short at that point in time.

Originally posted at
http://knol.google.com/k/narayana-rao/inventory-costing/2utb2lsm2k7a/3157

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