Management accounting F2

Inventory(stocks)
Inventory includes Raw materials, WIP , Finished goods.
Reasons for holding stocks
1. To meet anticipated demands. 3. To absorb seasonal fluctuations
2. To provide between production processes 4. Intentional policy in times of inflation
Stock holding costs
1.Interest on capital invested 4. Handling costs
2. Storage costs 5. Insurance costs
3. Cost of staff 6. Pilferage
Cost of obtaining stock
1. Clerical and administrative costs
2. Transport
3. Set up costs with each production run (if produced)
Costs of running out of stock
-contribution loss -loss of goodwill
-Loss of customers -Production stoppages- labour frustration
Terminology relevant to inventory
-Lead or procurement time-Time lag between ordering and replenishment
-Economic order quantity-Calculated ordering quantity which minimizes balance of cost
between reordering cost and stockholding cost.
-Buffer stock/Safety stock/minimum stock-Stock kept to allow for errors in lead time
-Maximum stock-Maximum desirable level of stock not to be exceeded.
-Reorder level-The level of stock at which replenishment order is placed
-Reorder quantity-Amount ordered-sometimes similar to EOQ
Stock control systems
o Periodic review –each item of stock is reviewed at regular intervals and if necessary
replenishment orders issued
Variable quantities ordered at fixed intervals
Advantages
 The whole stock is reviewed
 Obsolete items identified and eliminated
 Larger discounts with a large range of stocks
 Lower set up costs
Disadvantages
 Reorder quantities may not be EOQ
 Difficult to determine the time intervals

1 Inventory and EOQ

 Management accounting F2

o Reorder level- A predetermined reorder level is set. When stock reaches that level an
order is placed.
Fixed quantities are ordered at irregular intervals
Advantages
 Lower stocks kept
 EOQ applied
Disadvantages
 Many items might reach reorder level at the same time. Overload of work.
 EOQ might not be accurate-variable demand and ordering costs
Economic order quantity
It is an ordering quantity which minimizes balance of cost between inventory holding costs
and reorder costs.
EOQ is calculated based on the following assumptions:
 Known constant stockholding costs  Known constant price per unit-no
 Known constant ordering costs price discounts
 Known constant rates of demand  Replenishment is done for whole
order instantaneously

EOQ is calculated as follows:

EOQ = 2CoD
Cc
Where:
Co= ordering costs D= Demand Cc=Carrying costs per annum.
Example: A company uses 50000widgets per annum and buys them for $10 each. the ordering
and handling costs are $150 per order and carrying costs are 15% per annum.
Calculate the EOQ.
EOQ = 2 × 150× 50000 = 3162
1.5
EOQ where gradual replenishment is applied
(Usually applied when produced)

Where R represents the production rate per annum.

Assume R= 250000/annum.CalculateEOQ

EOQ = = 3535 units

2 Inventory and EOQ