Last Updated on March 11, 2024 by admin
Valuing Inventories at Standard
Decision-making and responsible management accounting require that variances from plan are reported where they occurred. This is where corrective actions must first be determined and implemented if the targeted result is to be achieved (see the post “Management Cycle“). This can be achieved if all stock receipts and issues are valued at proportional planned production costs and if the cost center activities are only passed on to products and other cost centers valued at the proportional planned cost rate.
The following rules must be observed:
-
- All purchased material is valued at the planned purchase price (according to annual planning) during the entire year at warehouse entry or exit
- The difference between the planned purchase price and the actual price paid is disclosed as a purchase price variance in the monthly reporting and can thus also be reported on time in financial accounting. Purchasing is responsible for this.
- Withdrawals from stock of raw materials and supplies are also debited to the production orders and the consuming cost centers at planned purchase prices Purchase price variances remain with Purchasing.
- Manufactured semi-finished and finished products are valuated at proportional planned production costs of the respective item at the time of stock receipt (variances remain in the production orders or in the cost centers performing the work).
- Fixed costs are period costs and consequently cannot be allocated to an individual manufactured unit according to the cause.
- Stock withdrawals of semi-finished products for processing in further production stages are valuated at proportional planned production costs, i.e. at standard. This is because any variances were already disclosed in the preliminary stage.
- Stock withdrawals for sales are also made at proportional planned production costs of finished products (variances were already disclosed in the semi-finished products and in the cost centers). In addition, the sales department is rarely responsible for production variances.
This consistent passing on of the services rendered at proportional production costs or at proportional planned cost rates of the cost centers shows all variances from the plan or from the flexible budget where they originally occurred. This is where corrective actions mainly must be found. The respective managers always have the comparison available between the services rendered at standard and the costs for which they are responsible. Variances from preliminary stages remain there because they also have to be eliminated there. All production and cost center managers can thus assess whether they have complied with their planned costs, taking into account the actual activities performed. This is because they are responsible for the costs they can influence directly.
At the turn of the year, the planned purchase prices and the proportional planned costs of the following year must be applied. This is because the processes and thus the production costs can change in the cost centers and other purchase prices must be provided. Although this requires a revaluation of inventories at the beginning of the year (can largely be automated), it also produces the figures in the following year to be able to present target to actual comparisons relevant for decision-making.
Accounting for Management means providing all managers with the systems and data to enable them to plan and control in a target-oriented manner in their area of responsibility and for the company as a whole. The focus is always on decision-relevant internal reporting and the successful management of the individual divisions.
What about external reporting?
The decision and responsibility-based approach pursued here often does not comply with the valuation rules of accounting standards such as IFRS, US GAAP or national tax law requirements. These rules mostly require the presentation of results in the form of full cost accounting and an externally oriented valuation of inventories.
We compiled the legally binding rules and analyzed their impact on the design of corporate accounting for many countries. In particular, we wanted to know whether legal requirements or accounting standards prohibit or prevent the design of a management accounting system that is uncompromisingly focused on decision making and internal accountability.
This analysis was revised and updated several times. Download the 2019 version with the link below (sorry, until now only available in German): Lukas Rieder, Markus Berger-Vogel: “Fixed Cost Allocations: one or none?”
Here we anticipate the key findings from this analysis:
There are no statutory accounting requirements or international reporting standards that prohibit or otherwise prescribe the structure of the decision- and responsibility-driven management isaccounting system recommended in this blog.
In management accounting, the starting points are the individual item, the processes and cost centers and the people working in them. These elements must be planned and controlled in detail if a company is to remain successful in the long term. Evaluations are mostly condensations on higher observation levels, which deny the view of the control-relevant details.
With reference to the valuation of inventories and thus the determination of the externally reported annual result, it makes sense to always value all inventory receipts and issues at proportional planned production costs. It is easy to adjust inventory valuations to accounting rules in an automated side-by-side calculation to generate external reports. However, financial success is generated in the market and internally, not through external reporting.