How can inventory costing assessments help manufacturers manage production levels?
Manufacturers continued to encounter challenges over the past year in a number of areas including the continuing gap of skilled labor, supply chain disruptions, changes in customer demand, and continuing inflation. As a result of this environment, manufacturers are constantly struggling with forecasting and managing production level fluctuations.
Variable Production Overhead and Normal Capacity
While variable production overhead is generally allocated based on the units produced, fixed overhead costs are allocated based on the normal capacity expectations of the production facilities. Normal capacity is a range of outcomes expected to be achieved over a number of periods under normal circumstances. Normal capacity ranges can be unique to certain business or industries. Common issues that lead to abnormal production periods include significant changes to demand, labor or material shortages, and unplanned production downtime.
Accounting for Production Levels and Inventory Valuation Issues
Production outside this normal range could lead to inventory valuation issues. When production levels are abnormally high the fixed overhead allocated to each item should be reduced to better reflect to amount of expense actually applied to each unit and that the inventory population in total is not measured above actual costs incurred.
However, when production levels are abnormally low, the amount of fixed overhead applied should not be increased to each unit manufactured. Expensing the remaining fixed overhead costs and not allocating additional fixed overhead keeps inventory within an appropriate lower of cost or net realizable value.
Both U.S. GAAP and the International Financial Reporting Standards are aligned in this accounting. This treatment also aligns with the conservative principle of accounting under both standards. In addition, abnormal costs relating to freight, handing and wasted materials should be included in current period costs rather than being deferred by being capitalized into inventory.
The Benefits of Inventory Costing Assessments
Having accurate inventory costing provides decision-makers with the appropriate information to manage operations. Inventory correctly capitalized at the end of the period also recognizes issues when they occur and sets up appropriate margins on future sales. This assessment is particularly important at the end of the year and other reporting period ends.
Looking for more information or assistance with assessing inventory costing? Schneider Downs provides accounting advisory services as well as assurance, and a full range of tax services for Manufacturers. For more information on our manufacturing services, please visit our industry page Schneider Downs Manufacturing or email us at [email protected].
About Schneider Downs Manufacturing Services
Schneider Downs understands the manufacturing industry from a regional, national and international perspective. Our experience in engineering-based cost segregation studies, state and local tax services, including nexus studies, as well as research and development tax credits, provides manufacturers the expertise needed to run their businesses more effectively.
To learn more, visit our Manufacturing Industry Group page.
