eThesis - School of Business electronic theses

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Efficient product costing and inventory valuation are much emphasized in today’s manufacturing environment because of their importance in management decisions. However, especially volatile raw material prices bring challenges to reliability of product costing and inventory valuation. This relatively little regarded, but important viewpoint is investigated in this research.

The research problem is stated as follows: how should raw material flow around raw material inventory be valuated? In literature review eight factors that should be considered when choosing inventory valuation and product costing methods were determined. Based on these factors three variables that affect the efficiency of raw material inventory valuation and product costing were defined, and they were tax shield benefits, product costing accurateness and how well information reflects the performance of a company. For the empirical part a framework was formed based on these three variables.

In the empirical part a simulation model was built and based on the model raw material inventory valuation methods were evaluated. A scenario analysis was done in order to analyze generality and robustness of raw material inventory valuation methods. Using the simulation model and the scenario analysis different raw material inventory valuation methods are evaluated in a real company environment, and results that cannot be derived analytically are disclosed.

By using a correct raw material inventory valuation method business can be much improved. In the case company on which the simulation model is based, product costing error can be decreased by 14 % of product costs and inventory value fluctuation by 7 % of inventory value by just choosing adequate inventory valuation method. The main determinant of the magnitude in improvements is raw material price behavior. In the case of high inflation the benefits of using correct inventory valuation method can be very great. Also volatility of raw material prices affects results significantly.

The main contribution of this research is the investigation of the effects of uncertain raw material prices in the context of product costing and inventory valuation. The main result that contradicts current research is that FIFO (first-in first-out) should not be used for raw material accounting. In general, LIFO (last-in last-out) and market prices are efficient raw material inventory valuation methods. Yet, the choice between these two depends on objectives of management accounting. However, it was observed that material flow behavior has no significant effect on the ranking of different raw material inventory valuation methods, and thus the main results can be generalized to different companies.