Case Study: Inventory Costing for Manufacturing Company

Overview

Decosimo was engaged to perform financial due diligence on a manufacturing company located in the Southeastern United States. The Company had reported profitable operations in the current and prior years.

About the Manufacturing Company

The Company manufactured and distributed playground equipment primarily to schools and other governmental entities throughout the United States. The Company also sold to distributors and other end-users.

Client Objectives

The Company had reported profits, but wanted a review performed of their inventory costing policies and procedures and the methodology being used to calculate the cost of their inventory. The Company was reporting inventory variance amounts each month that they felt were in excess of acceptable levels.

Disciplined Process

We started the process by reviewing the current and prior year audited financial statements, as well as detailed information on the costs of goods sold and gross margin reported by the Company. Inventory reported by the Company had increased each of the prior three years and margins had increased even though revenues had remained stable and most of the material and labor costs had increased slightly each of the last three years.

We discussed the inventory costing process with management and obtained a copy of the inventory detail for each of the last three years. Our procedures included assessing the costing method the Company had used to value their inventory and recalculating the inventory valuations. It became apparent the inventory amounts reported by the Company were overstated. The costing methodology used by the Company had not been updated in several years and the amount of labor and overhead being applied to the finished goods inventory, as well as work in process inventory, was significantly higher than the costs being incurred by the company to produce their products.

Our procedures also revealed a significant amount of obsolete inventory on hand that had not been written down to fair market value. Over the last couple of years, the Company had reevaluated its product lines and discontinued several of its products but had continued to value these inventory items at full cost.

Using outdated standard cost information for their labor and material costs was causing the Company to report significant variances that were being recorded in their monthly income statements. We also evaluated the amount of overhead being allocated to inventory and determined that with the reduction in product lines and the change in the product mix of the Company these overhead calculations needed to be recalculated to reflect the current manufacturing volume being produced by the Company along with the current product mix.

We assisted the Company in updating their standard costs by product line and provided guidance to assist them in recalculating their overhead rates based on the current level of manufacturing activity being produced in their facility. We also helped them establish guidelines for assessing older and obsolete inventory amounts and assisted the Company in writing policies and procedures for the write off of inventory and inventory costing procedures.

Proven Results

Our initial procedures resulted in the Company making large adjustments to their financial statements with inventory and net income being decreased significantly. However, once the Company began implementing the policies and procedures that we assisted them in putting in place the Company’s financial statements became more reliable and the large inventory variances were reduced significantly. The Company was able to identify the actual cost of producing its products and manage their inventory and business accordingly. 

We Can Help

If you need help assessing the costing methods used by your company, contact Decosimo's manufacturing team and ask us how we can help. Click here to contact us.