MANAGEMENT II

FINAL REVIEW OF CHAPTER 6

 LEARNING OUTCOMES

1. Inventory management
goals
2. Economic Order Quantity
(EOQ)
3. Periodic Inventory system
and inventory methods:
FIFO, LIFO, and WAC
4. ABC methods
 INVENTORY MANAGEMENT GOALS

❖ Cost is a concern for every business.

❖ Inventory is one of the most critical assets, so it requires
intense control and management.
❖ Inventory management helps to balance the benefits of
holding small amounts of inventory with those of holding large
amounts of inventory.
❖ In other words, the objective of inventory control is to
minimize the costs of carrying inventory. Two key questions
must be asked: How much to order? And when to order?
 ECONOMIC ORDER QUANTITY (EOQ)
The economic order quantity (EOQ) is the optimal order quantity
a firm should purchase to minimize its inventory costs, such as
holding costs, shortage costs, and order costs.
❖ reduce ordering costs by placing fewer but larger orders
❖ reduce holding costs by keeping less inventory on hand
❖ prevent stockouts and overstocks by refilling your inventory at the right
time and ordering only what you need.

Where :
Q = quantity to be ordered
𝟐 × 𝐂𝐨 × 𝐃
𝐐= Co = cost of one order
𝐂𝐡
Ch = holding cost per inventory unit
per annum
D = demand
 PERIODIC SYSTEM AND INVENTORY METHODS
Periodic Inventory System
❖ no detailed records of inventory are maintained.
❖ EI values and COGS are determined at the end of the period
based on the physical inventory count:
COGS = BI + Purchase - EI

Method Assumption COGS consists of… EI consists of…

FIFO The first items purchased first purchased most recent
are the first to be sold purchases
WAC Items sold are a mix of average cost of all average cost of all
purchases items items
LIFO The items last purchased last purchased earliest purchases
are the first to be sold
 ABC METHOD

▪ Activity-based costing (ABC) is a costing method that first

assigns costs to activities and then assigns them to products
based on the products’ consumption of activities.
➢ Stage 1: Assign costs to activities.
➢ Stage 2: Assign costs to products based on the use of each
activity.
* An activity is any discrete task that an organization undertakes to make or deliver a product or service.

▪ ABC is a management method that uses ABC information to

satisfy customers and improve profits.
▪ ABC is used for pricing, cost reduction, planning, and managing
activities.
 PROBLEM 1
For many years the Honey Lake Weekly Cost
Summer Camp had used the number Supervisor's salary $400
of campers per week to estimate Cook's salary 300
weekly costs. The summer camp is Camp counselor salaries (1 for each
occupied cabin, each of which holds 10
open for ten weeks during the 1,000
campers) (5 counselors ×
summer with a different number of $200/counselor)
campers each week. July is busiest Food (50 campers × $100/camper) 5,000
with June and the end of August least Supplies (50 campers × $20/camper) 1,000
busy. Costs from the last week of Utilities (50 campers × $10/camper) 500
summer camp in Year 1 are used to Insurance (50 campers × $20/camper) 1,000
estimate costs for Year 2 for pricing Property tax ($10,000/10 weeks) 1,000
purposes. The following costs occurred Weekly total $12,200
during the last week of Year 1 and the
Required:
costs of each cost category are
expected to be the same for Year 2. a. What is the expected cost of that
week using the average cost?
Cost per camper: $12,200/50 campers
= $244/camper. The Honey Lake b. What is the expected cost of that
Summer Camp expects 75 campers week using ABC?
during the second week of July.
 PROBLEM 1 SOLUTION
a. The average cost per camper using last year's last week of camp is
$204/camper. The total expected cost using that average cost is:

b. ABC recognizes how the costs would change with different uses of activities
and changing numbers of campers:
Weekly Cost
Supervisor's salary
Cook's salary
Camp counselor salaries (1 for each occupied cabin, each of
which holds 10 campers) (8 counselors × $200/counselor)
Food (75 campers × $100/camper)
Supplies (75 campers × $20/camper)
Utilities (75 campers × $10/camper)
Insurance (75 campers × $20/camper)
Property tax ($10,000/10 weeks)
Weekly total
 PROBLEM 2
Green Hill Restaurant lost all of its inventory in a fire on December 26,
2020. The accounting records showed the following gross profit data for
November and December.
The restaurant is December
November (to Dec 26)
fully insured for Net sales $600,000 $700,000
fire losses but Beginning inventory 32,000 36,000
must prepare a Purchases 389,000 420,000
report for the Purchase returns and allowances 13,300 14,900
insurance Purchase discounts 8,500 9,500
Freight-in 8,800 9,900
company. Ending inventory 36,000 ?

Required:
a. Compute the gross profit percentage for November.
b. Using the gross profit percentage for November, determine the
estimated cost of the inventory lost in the fire.
 PROBLEM 2 > SOLUTION
a. Compute the gross profit percentage for November:
November
Net sales
COGS
Gross profit
Gross profit percentage

b. Using the gross profit percentage for November, determine the

estimated cost of the inventory lost in the fire.
December
(to Dec 26)
Net sales
Gross profit
COGS
Ending inventory
The estimated cost of the inventory lost in the fire is …..
The End