Accounting for Material

19 May 2018 07:20

Cost associated with material

Purchase cost Cost of ordering

Whatever paid on initial purchase All cost associated with ordering
Documentation
Delivery.
Bank Charges.

Stockout cost Cost of holding

Cost of not having inventory (opportunity cost) Cost associated with holding inventory
Contribution on lost sales of product and related Rent
Loss of customer goodwill Expire
Obsolete (out of date)
Depreciation
Theft
Destroyed

Keep above 4 cost as low as possible

There is one technique which will help lower CO and CH

EOQ Economic Ordering Quantity

How much to order?

Co= cost per order

Ch= cost of holding/unit/year
D= Annual Demand
Co=80
Ch=15 163
D= 2500

((2x80x2500) / (15))=163

CH CO

Accounting for Material Page 1

Proof

TCH total cost of holding Average Inventory

When inventory is bought its not kept forever it sold so reduces
Average inventory x CH

Average inventory = OQ/2

TCO Total cost of ordering

Orders x CO

Orders = D/OQ

163

TCH 163/2=81.5 81.5x15=1,222.5 1222.5+1226.992=2449.492

TCO 2500/163=15.3374 15.3374x80=1,226.992

150

150/2=75 75x15=1,125 1125+1333.336=2458.336

2500/150=16.6667 16.6667x80=1,333.336

90

90/2=45 45x15=675 675+2222.224=2897.224

2500/90=27.7778 27.7778x80=2,222.224

Accounting for Material Page 2

20 May 2018 07:12

CO= 10
Ch= .10x12=1.2
D= 5400

TCH

300/2 x1.2=180

TCO
((2x10x5400) / (1.2))=300 5400/300 x10=180

180x2=360

180

300

Accounting for Material Page 3

 In this situation the purchase price changes so we consider it as well

160 300

Purchase price 1800x25=45000 Purchase price 1800x25x.98=44100

TCH 160/2x4.5= 360 TCH 300/2X4.5=675

TCO 1800/160x32=360 TCO 1800/300X32=192

Total 45000+360+360=45720 Total cost 44100+675+192=44967

45720-44967=753 (extra saving on bulk purchase)

Decision Purchase 300 because its saving is 753 more than EOQ

Conclusion= When there is no bulk discount then always EOQ but if there is bulk
discount we compare the purchase price, TCO and TCH and whichever gives lowest cost.

Accounting for Material Page 4

 20 May 2018 07:30

When to order?
REORDER LEVEL

Reorder Level: The inventory level at which order for new inventory should be placed

Reorder Level = To avoid stockout normally stockout happens because of two reasons

1 Inventory demand was higher

2 Inventory did not arrive on time

Reorder Level= Maximum use X Maximum Time

95x18=1,710

How much is too much inventory? How much is too little inventory?

The maximum Inventory level The minimum Inventory level

Two reason acceptable if there is too much inventory

1 Sales less than expected Minimum inventory Level=
2 New order arriving early Reorder Order-( Average use x Average time)

1710-(75x15)=585
Maximum Level:- Reorder Level- (min use x min time) + OQ
If inventory level reaches 585 then we should look for
1710-(50x12)+1750=2860 contingency
Inventory shouldn't be more than 2860 at any point
12+18=30 30/2=15

Accounting for Material Page 5

21 May 2018 07:10

Inventory Terms

Free inventory: Inventory available for sales

Physical inventory: Actual number of units physically existing in warehouse

Inventory on sales orders: Inventory that is sold but not yet taken by the customer

Inventory on purchase orders : Inventory bought from supplier but not yet arrived

Inventory doesn't need to be physically available to sell it

Free inventory= Physical inventory + on Purchase orders - on Sales orders

Free inventory= P.I + P.O- S.O

Free inventory - P.O + S.O= P.I

13000-27500+16250=1750

Buffer/Safety Stock: Inventory kept in separate place not used regularly it is kept for
unexpected demand

Holding cost on buffer stock comes whole year because it is kept whole year

Checking Reversing the answer 6000/2+400=3400

OQ/2= Average Inventory (when there is no safety stock)

OQ/2 +Safety stock= Average Inventory (when there is safety stock)

6000/2 +?= 3400

3000+? = 3400 3400-3000=400 Safety stock

Accounting for Material Page 6

21 May 2018 07:30

When should company stop production?

Economic Batch Quantity.

Time period is week

R= 4000 (rate of production per time period)

D=2000 (demand per time period)
CO= 50(setup cost per production run)
CH= .001(cost of holding/unit/time period

((2x50x2000) /(.001x(1-(2000/4000))))=20000

Accounting for Material Page 7