Paying for Inventory

Once inventory has been received at the warehouse and that receipt has been documented in the NCAS, appropriate payment can be issued to the vendor. Although the Accounts Payable department is responsible for payment to vendors, inventory managers must understand how unit price differences between the invoice and the purchase order affect the average cost of an item. These price differences are known as price variances.

Price variances are caused by a discrepancy in the handling of freight, additional costs and discounts on the purchase order and the invoice. In the NCAS, the buyer does not usually include freight, additional costs and discounts within the unit price for the item. These elements are reflected separately on the purchase order. When determining the cost of the items, the system does not recognize these elements as part of the purchase order unit price.

Because North Carolina operates on a cash basis, the inventory value will not reflect freight, additional costs and discounts until the invoice is paid, which could be 30 or more days after the goods have been recorded as received in the NCAS. Therefore, between the time of receipt and that of payment, the item will be issued to customers at an average cost that excludes the impact of freight, additional cost and discount.

For example, your agency’s inventory buyer purchased 10 tubes of burn ointment. The unit price recorded on the purchase order line is $2.00 per tube. Although this price includes tax, it does not include freight, additional costs and discounts that may be associated with the purchase of the items. Therefore, at this point, your warehouse will issue the burn ointment at a unit price of $2.00 per tube.

When a price variance is finally recognized at the time of payment, the NCAS automatically adjusts the average cost of the item to reflect the variance. The adjustment is applied to the quantity remaining in inventory at the time of the adjustment, not to the quantity originally received. Applying the variance to the quantity remaining in inventory can result in temporarily high or low average costs. The item will now be billed out to the customer at the adjusted (and possibly severely skewed) average cost.

The NCAS calculates the new average cost as follows:

                                 New Avg     =             Current Avg + Total Variance
                                 Cost                     Cost Quantity Remaining in Inventory

For example, the vendor’s invoice for the burn ointment shows a unit price of $2.30 per tube after freight costs are accounted for. Recall that the unit price on the purchase order line is $2.00. Therefore, the invoice reflects a total variance of $3.00 ($0.30 variance per tube multiplied by 10 tubes). The vendor is paid 30 days after the ointment is received at the warehouse. At this time, five tubes have already been issued to customers. Therefore, your warehouse only has five tubes of ointment remaining in inventory. The NCAS will adjust the average cost of the remaining five tubes to reflect the total variance of $3.00. The new average cost for the five tubes remaining in inventory is calculated as follows:

New Average Cost         =         ($2.00) + ($3.00)
                                  &nbs p;                       5

                                    ; =             $2.00 + $0.60

New Average Cost          =     $2.60 per tube of ointment

The remaining five tubes will now be issued to customers at a unit cost of $2.60 per tube of ointment.

The average cost adjustment is made during the nightly offline cycle on the date of payment. The transactions for average cost adjustments appear on the Valued Transaction Register by Warehouse (CRVTRW) report. The new average cost calculation is also shown on the Average Cost Changes due to AP Variances (CVARFIX) report.

The Valued Transaction Register by Warehouse Report (CRVTRW) is located in RMDS in the report group IN261-1, and the Average Cost Changes due to AP Variances (CVARFIX) report is located in RMDS in the report group IN285-1. For more information on accessing RMDS reports, refer to Viewing and Printing RMDS Reports Step-by-Step.

Agencies can eliminate the most common cause of price variances by changing the way freight, additional costs and discounts are handled on an inventory purchase order. To ensure that inventory is received and recorded at its full delivered cost, the buyer should include freight, additional cost and discount in the purchase order unit price for the item. In other words, the buyer should increase the buyer’s quoted price by the amount of the freight and additional costs. For example, the buyer could quote the free-on-board (FOB) price on the purchase order. With the FOB price, the freight is prepaid by the vendor and included in the unit price. Similarly, if a discount is offered on the item, the buyer can reflect the discounted price instead of the gross price on the purchase order line. Warehouse managers should work with their agency’s Purchasing departments to resolve this issue.

Your agency has two options when the average cost of an item is severely skewed:

1.  The item can be issued to the customer at the skewed price. As additional items are received into the warehouse, the average cost of the item will become less skewed.
2. You can manually adjust the average cost of the item to the appropriate price using the Average Cost Change (ACC) screen. However, manually changing the average cost has significant accounting implications. Before you exercise this option, consult with your agency’s inventory accountants. An explanation of manual cost changes can also be found in the Inventory Accounting course.

 

 

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