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Hi sir, how are you? sir please explain me further the following statement ,i could’t completely get it;
As regards the valuation of inventory, the throughput philosophy is that no value is added to inventory items and no profit is earned until the items are actually sold. Thus inventory is valued at its material cost only until it is sold. The traditional approach encourages managers to produce output just to add to work in progress or finished goods inventory, since this helps with the absorption of overheads and boosts reported profits.
Sir i have read the throughput in your notes as well as lecture and open tuition course notes but confused about this.
I will explain with a little example.
Suppose a company has demand for 100 units, and their overheads at $1,000.
If they produce 100 units (and therefore have no inventory), then the overheads are 1000/100 = $10 per unit.
Suppose instead they produce 200 units. They are only selling 100, and so they will have 100 units in inventory. However, the overheads per unit are 1000/200 = $5. So the units are cheaper and they report more profit.
The more they produce the cheaper it will be per unit and therefore the more profit they will report.
But this is silly – we don’t want them producing more than they can sell! Better to value inventory simply at the material cost and not add any overheads – then the above will not happen.
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