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CHAPTER 1 INTRODCUTION

Inventory control system is a very important system that is used by the companies to

control the inventory in and out in their daily transaction. How important the inventory

control system for the company and influence their sales? It is the topic that will go to

touch on this research. Keeping track of units of inventory and their associated costs is

important to the management of the firm. Information concerning the units sold and those

in inventory is an essential basis for intelligent decision about pricing, production and

reordering. An inventory system is needed to keep track of this information. (Robert E.

Hoskin, 1997) They have two types of inventory control system, perpetual inventory

system and periodic inventory system. (Warren, Reeve, Fees, 1997)

Perpetual Inventory System

Perpetual inventory system is a system of inventory accounting in which both the

revenue from sales and the cost of merchandise sold are recorded each time a sale

is made, so that the record continually discloses the amount of the inventory on

hand. (Warren et al., 1997)

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Periodic Inventory System

Periodic inventory system is a system of inventory accounting in which only the

revenue from sales is recorded each time a sale is made. The cost of merchandise

on hand at the end of a period is determined by a detailed listing (physical

inventory) of the merchandise on hand. (Warren et al., 1997)

Inventory control system can be defined as the whole system of the inventory control. It

was control of work in progress and finished good inventories also presents a firm with

exceptional opportunities for savings. (Hansen & Mowen, 1995) Inventory is the quality

of raw materials, in-progress goods, or finished goods on hand; serves as a buffer

between different rates of flow associated with the operating system. (Rue & Byars,

1997) The several methods can be used in inventory control are FIFO (First-In-First-

Out), LIFO (Last-In-First-Out), Weighted Average, JIT (Just In Time) etc.

However, the result will be collected to elaborate and comment during the research. This

research tries to give the opinion of how effectively the company controls their inventory

system and how well the inventory control system helps them to generate sales.

Requirements for Effective Inventory Management

Management has two basic functions concerning inventory. One is to establish a system

of keeping track of items in inventory, and the other is to make decisions about how

much and when to order. To be effective, management must have the following:
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• A system used to keep track of the inventory on hand and order.

• A reliable forecast of demand that includes an indication of possible forecast

error.

• Knowledge of lead times and lead-time variability.

• Reasonable estimates of inventory holding costs, ordering costs and shortage

costs.

• A classification system for inventory items.

The few methods used in inventory control systems are as follows:

FIFO (First-In-First-Out)

The first-in-first-out, or FIFO method matches the first costs with the first units

sold. This means that ending inventory units will be matched with the costs of the

most recent purchases. FIFO describes fairly accurately the physical flow of

goods in most businesses. (Robert E. Hoskin, 1997) The FIFO method is used

when the costs of the units sold are assumed to be in the order in which they were

incurred. During periods of inflation or rising prices, the earlier unit costs are
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lower than the more recent unit costs. Much of the benefit of the larger amount of

gross profit is lost, however, because the inventory must be replaced at ever-

higher prices. When the rate of inflation reaches double digits, as it did during the

1970’s, the larger gross profits that result from the FIFO method are often called

inventory profits or illusory profits. Compared with other methods, FIFO method

yields the lowest amount of gross profit. A major criticism of the FIFO method is

its tendency to pass through the effects of inflationary and deflationary trends to

gross profit. An advantage of the FIFO method, however, is that the balance sheet

will report the ending merchandise inventory at an amount that is about the same

as its current replacement cost. (Warren et al., 1997)

LIFO (Last-In-First-Out)

The last-in-first-out, or LIFO, method matches the last costs in with the first units

sold. Ending inventory, therefore, is assigned the costs associated with the first

purchases (or beginning inventory). (Robert E. Hoskin, 1997) The LIFO method

is used during a period of inflation or rising prices, the results are opposite of

those of the other two methods. The reason for these effects is that the costs of the

most recently acquired units most nearly approximate the cost of their

replacement. In the period of inflation, the more recent unit costs are higher than

the earlier unit costs Thus, it can be argued that the LIFO method more nearly

matches current costs with current revenues. A criticism of using LIFO is that the
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ending merchandise inventory on the balance sheet may be quite different from its

current replacement cost. (Warren et al., 1997)

Weighted Average Method

The weighted average method computes an average cost for all the units available

for sale in a given period and assigns that average cost to both the units that are

sold during the period and those that remain in ending inventory. The weighted

average method produces results on the income statement and balance sheet that

are intermediate between those of LIFO and FIFO. Because of this, analysis of the

effects of the various methods is restricted to a comparison of the LIFO and FIFO

methods. (Robert E. Hoskin, 1997)

JIT (Just-In-Time)

Just-in-time (JIT) is a philosophy centered on the reduction of costs through

elimination of inventory. All materials and components should arrive at a

workstation when they are needed- no earlier and no later. Elimination of

inventory of eliminates storage and carrying costs; however, it also eliminates the

cushion against production errors. As a result, high quality and balanced

workloads are required in a JIT system to avoid costly shutdowns and customer ill

will. Because of the need for quality and balanced production, JIT has come to be

closely identified with efforts to eliminate waste in all its forms, and thus it is an
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important part of many total quality management (TQM) efforts. The most visible

aspect of JIT is the effort to reduce inventories of work in process and raw

materials. Most writings on JIT concentrate on this one aspect, which is called

stockless production, lean production or zero inventory production. (Hammer,

Carter, Usry, 1994)

1.1 Problem Statement

The inventory control system is an important tool in controlling the business

operation. The first step in this process is to determine the quantity of each kind of

merchandise owned by the business. The specific procedures for determining

inventory quantities and assembling the data differ among companies. A common

practice is to use teams made up of two persons. One person counts, weighs or

otherwise determines quantity and the other lists the description and the quantity

on the inventory count sheets. A second count team may check the quantities

indicated for high-cost items during the inventory-taking process. The second

count team should also check quantities of other items selected at random from

the inventory count sheets. (Warren et al., 1997)

Any errors in the inventory count will affect both the balance sheet and the

income statement. For example, an error in the physical inventory will misstate

the ending inventory, current assets, and total assets on the balance sheet. This is
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because the physical inventory is the basis for recording the adjusting entry for

inventory shrinkage.

Other than that, an error also taking the physical inventory misstates the cost of

goods sold, gross profit and net income on the income statement. In addition,

because net income is closed to retained earnings at the end of the period, retained

earnings will equal the misstatement of the ending inventory, current assets, total

assets and stockholders equity. (Warren et al., 1997)

When a company uses the perpetual inventory system, errors in the physical

inventory are infrequent. In addition, when errors such as the one just described

do occur, they are normally detected in the next. In this case, the financial

statements of the prior year must be corrected. The effect of misstated inventory

on the financial statements used to defraud investors and others. (Warren et al.,

1997)

The preceding comparisons show the importance attached to the selection of the

inventory costing method. Often enterprises apply one method to one class of

inventory and a different method to another class. For example, a computer

retailer and wholesaler might use the FIFO method for its microcomputer

inventory and the LIFO method for software and other inventory. The

management has to make decision on which methods used is most suitable to

them. The methods used may also be changed for a valid reason. The effect of any
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change in method and the reason for the change should be disclosed in the

financial statements for the period in which the change occurred. (Warren et al.,

1997)

The few problems will occur in the inventory control system and it will affect the

discrepancies for the system control. The few problems are stated as following.

• Stolen of raw material and finished good

• Unreported delivery shortages from suppliers

• Collusion with suppliers regarding invoices and receiving reports

• Unreported storage and handling losses, such as breakages, spillage etc

• Obsolete stock not accounted for until the physical inventory is taken

• Obsolete previously disposed of, but still carried in the perpetual inventory

• Obsolete stock carried at full value on the books, but priced out at a lower

value in the physical inventory

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• Under-reporting on the perpetual inventory of transfers from storeroom to

the shop

• Bookkeeping errors during recording to the business operation transaction,

somehow the entering received goods twice will be occurred

• Over-costing the perpetual inventory or under-costing the physical

inventory

• Failure to subtract the value of goods returned to suppliers from the

perpetual inventory

• The lack or poor management control to the inventory control system

1.2 Research Objective

The main research objectives of the research are as follows:

1. To know how effectively the company controls its’ inventory with the

inventory control system and the services provided to the customers on the

sales transaction.
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2. To know which method the company managed to use in adjusting it’s

inventory and how effectiveness for those methods influence the company

sales and record, e.g. FIFO, LIFO, Weighted Average Method, Just-in-

Time, Economic Order Quantity (EOQ) etc.

3. To analyse the advantages or disadvantages of the inventory control

system based on the Cross-tabulations and Chi-square analysis.

4. To identify whether the theoretical methods are applied in the real

environment of the firm or not.

1.3 Limitation of Research

There are the several limitations of the research that can be identified such as:

1.3.1 Accuracy of Data Collected

The primary data collected more accurate than the secondary data that collected

from the journal, internet, textbook etc. The secondary data obtained more

sources of data compared with the primary data. Some of the data collected from

the primary was not very accurate because during the interviewing, the managers

also hiding some information from the researcher. The questionnaires distribution
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also cannot fully reliable because some of them were not pay full attention for the

question asked in questionnaires. Although the primary data has some

weaknesses but it was more accurate than the secondary data that collected from

secondary data.

1.3.2 Lack of experience

The research of dissertation is the new project for the researcher, the researcher

feel difficult and lack of experience to get start in this research. The researcher

has no idea in the formats and stages in the research report from the beginning but

with the guidance from the supervisor, finally it can keep continue in the

research.