Inventory Management

Presented by
Muhammad Arshad

05/15/2020
Inventory Management
What is inventory
Inventory is the raw materials,
component parts, work-in-
process, or finished products that
are held at a location in the
supply chain.
The expenses associated with
financing and maintaining
inventories are a substantial part
of the cost of doing business (i.e.,
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Inventory Management
 Objective
 The objective of inventory management is to
strike a balance between inventory
investment and customer service

 Inventory Management involves planning,

coordinating, and controlling the acquisition,
storage, handling, movement, distribution,
and possible sale of raw materials, component
parts and subassemblies, supplies and tools,
replacement parts, and other assets that are
needed to meet customer wants and needs.

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Inventory Management
 Types of inventory in a business
 Raw materials, component parts,
subassemblies, and supplies are inputs to
manufacturing and service-delivery processes.
 Work-in-process (WIP) inventory consists
of partially finished products in various stages
of completion that are awaiting further
processing.
 Finished goods inventory is completed
products ready for distribution or sale to
customers.

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Inventory Management
Dimensions of inventory management

Inventory Costing

Inventory Control

Inventory Analysis

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 Inventory Management
Inventory Costing

Inventory costing is systematic allocation of cost to the

inventories purchased, sold or at hand

Objective of inventory cost

 Income determination
 Balance sheet analysis
 Financial decisions

Based on these objective Two accounting models are there for

inventory costing

1 Perpetual
 detailed records
 cost of each item maintained
 cost of each item sold is determined when sale occurs
2 Periodic
Cost models for Inventory
There are three models in
perpetual costing system

FIRST IN FIRST OUT MEHTOD

(FIFO)
LAST IN FIRST OUT MEHTOD
(LIFO)
AVEARGE METHOD

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 FIFO
The FIFO method
◦ earliest goods purchased are the first to be sold.
◦ often parallels the actual physical flow of
merchandise.
◦ the costs of the earliest goods purchased are the
first to be recognized as cost of goods sold.
 Perpetual
Perpetual Inventory
Inventory Costs
Costs
Inventory
Inventorycost
costdata
datato
todemonstrate
demonstrate
FIFO
FIFOand
andLIFO
LIFOPerpetual
PerpetualSystems
Systems
Item
Item127B
127B Units
Units Cost
Cost Price
Price
Jan.
Jan. 11 Inventory
Inventory 10
10 $20
$20
4Cost
4 Saleof
Sale 77 $30
$30
10
10 Purchase
Mdse. Sold
Purchase 88 21
21
22
22 Sale
Sale 44 31
31
28
28 Sale
Sale 22 32
32
30
30 Purchase
Purchase 10
10 22
22
 FIFO Perpetual Inventory Account
Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 10 20 200

The firm begins the year with 10

units of Item 127B on hand at a
total cost of $200.
 FIFO Perpetual Inventory Account
Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 10 20 200
4 7 20 140 3 20 60
10 8 21 168 3 20 60
8 21 168
22 3 20 60
1 21 21 7 21 147
28 2 21 42 5 21 105
30 10 22 220 5 21 105
10 22 220
Totals 18 $388 13 $263 15 $325
 LIFO
The LIFO method assumes that the latest
goods purchased are the first to be sold.
LIFO seldom coincides with the actual
physical flow of inventory.
Under LIFO, the costs of the latest goods
purchased are the first goods to be sold.
 LIFO Perpetual Inventory Account
Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 10 20 200
4 7 20 140 3 20 60
10 8 21 168 3 20 60
8 21 168
22 4 21 84 3 20 60
4 21 84
28 2 21 42 3 20 60
2 21 42
30 10 22 220 3 20 60
2 21 42
10 22 220
Totals 18 $388 13 $266 15 $322
 AVERAGE COST

The average cost method

◦ assumes goods available for sale are homogeneous.
◦ the cost of goods available for sale is allocated on
the basis of the weighted average unit cost
incurred.
◦ weighted average unit cost is applied to the units on
hand to determine cost of the ending inventory.
 Periodic Inventory System

Revenues from the sale of merchandise are

recorded when sales are made in the same way
as in a perpetual system.
No calculation of cost of goods sold is made at
the time of sale of the merchandise.
Physical inventories are taken at end of period to
determine:
◦ the cost of merchandise on hand
◦ the cost of the goods sold during the period
 ALLOCATING INVENTORIABLE COSTS

 Inventory costs- periodic inventory system

◦ allocated between ending inventory and cost of goods sold
◦ allocation is made at the end of the accounting period
1. the costs assignable to the ending inventory are
determined
2. the cost of the ending inventory is subtracted
from the cost of goods available for sale to
determine the cost of goods sold
3. cost of goods sold is then deducted from sales
revenues in accordance with the matching
principle to get gross profit
FIFO
FIFO Periodic
Periodic

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 Fifo
Fifo Periodic
Periodic
200 units @ $9 Jan. 1 Beginning
Inventory
300 units @ $10 Mar. 10 Purchase

400 units @ $11 Sept. 21 Purchase

100 units @ $12 Nov. 18 Purchase

1,000 units available
for sale during
year
 Fifo
Fifo Periodic
Periodic
200 units @ $9 = $1,800 Jan. 1

300 units @ $10 = 3,000 Mar. 10

400 units @ $11 = 4,400 Sept. 21

100 units @ $12 = 1,200 Nov. 18

1,000 units available $10,400
for sale during
year Cost of merchandise
available for sale
 Fifo
Fifo Periodic
Periodic
A
Aphysical
physical count
count on
on
December
December 3131 reveals
reveals that
that
700
700 of
of the
the 1,000
1,000 units
units
have
have been
been sold.
sold.

Using
Using fifo,
fifo, the
the first
first units
units
purchased
purchased are are theoretically
theoretically thethe
first
first units
units sold.
sold. WeWe begin
begin the
the
count
count with
with January
January 1. 1.
 Summary of Fifo Periodic
Cost of
Merchandise Merchandise
Available Sold
Purchases for Sale
$1,800 200 units at $9
Jan. 1
200 units at $9 $1,800
$3,000 300 units at $10
Mar. 10
300 units at $10 $3,000 200 units at $11
$2,200
Sep. 21
$7,000 700 units
400 units at $11 $4,400
Merchandise
Nov. 18
100 units at $12 $1,200 Inventory
$2,200 200 units at $11
1,000 units $10,400
$1,200 100 units at $12

$3,400 300 units

LIFO PERIODIC
 Lifo
Lifo Periodic
Periodic
200 units @ $9 Jan. 1 Beginning
Inventory
300 units @ $10 Mar. 10 Purchase

400 units @ $11 Sept. 21 Purchase

100 units @ $12 Nov. 18 Purchase

1,000 units lifo,
Using
Using available
lifo, the
the most
most recent
recent batch
batch
for sale during
purchased
purchased isis considered
considered the
the first
first
year
batch
batch of
of merchandise
merchandise sold.
sold.
 Lifo
Lifo Periodic
Periodic
200 units @ $9 Jan. 1 Beginning
Inventory
300 units @ $10 Mar. 10 Purchase

400 units @ $11 Sept. 21 Purchase

100 units @ $12 Nov. 18 Purchase

1,000 units available Assume
Assume again
again that
that
for sale during 700
700 units
units were
were sold
sold
year during
during the
the year.
year.
 Summary
Summary of
of Lifo
Lifo Periodic
Periodic
Cost of
Merchandise Merchandise Sold
Available
Purchases for Sale $1,800 200 units at $9
$1,800
Jan. 1 $1,000 100 units at $10
200 units at $9 $1,800
$2,800 300 units
Mar. 10
300 units at $10 $3,000 Cost of
Merchandise
Sep. 21 Sold
400 units at $11 $4,400
$2,000 200 units at $10
Nov. 18
100 units at $12 $1,200
$4,400 400 units at $11

1,000 units $10,400

$1,200 100 units at $12

$7,600 700 units

 Average
Average Cost
Cost Periodic
Periodic

200 units @ $9 Jan. 1 Beginning

Inventory
300 units @ $10 Mar. 10 Purchase

400 units @ $11 Sept. 21 Purchase

100 units @ $12 Nov. 18 Purchase

1,000 units available The
The average
average cost
cost periodic
periodic
for sale during method
method isis based
based onon the
the
year average
average cost
cost ofof identical
identical
units.
 Average
Average Cost
Cost Periodic
Periodic
200 units @ $9 = $ 1,800

300 units @ $10 = $ 3,000

400 units @ $11 = $ 4,400

100 units @ $11 = $ 1,200

1,000 units available $10,400 Cost of

for sale during merchandise
year available for
sale
 Average
Average Cost
Cost Periodic
Periodic
Cost of Merchandise
Available for Sale
= Average Unit Cost
Units Available for Sale
During Year

$10,400
= $10.40 per Unit
1,000 Units
 Average
Average Cost
Cost Periodic
Periodic

Cost
Cost of
of merchandise
merchandise available
available for
for sale
sale $10,400
$10,400
Less
Less ending
ending inventory
inventory ($10.40
($10.40 xx 300)
300) 3,120
3,120
Cost
Cost of
of merchandise
merchandise sold
sold $$ 7,280
7,280
To verify this
amount, multiply
700 units sold
times $10.40 to get
the same $7,280.
 Perpetual versus Periodic
Systems
Perpetual Periodic
 Continuous record of  Only ending inventory
quantities & costs is is counted and priced
maintained as purchases  Cost of goods sold is
and sales are made determined by
 Cost of goods sold is deducting the cost of
accumulated as sales are the ending inventory
made; costs are from the cost of goods
transferred from the available for sale
Merchandise Inventory
account to the Cost of
Goods Sold account
 Cost of ending inventory
is the balance of the
Merchandise Inventory
account
B. Inventory Control
Inventory Control is the supervision
of supply, storage and accessibility of
items in order to ensure an adequate
supply without excessive oversupply.
It can also be referred as internal
control - an accounting procedure or
system designed to promote efficiency
or assure the implementation of a
policy or safeguard assets or avoid
fraud and error etc.

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Purpose of Inventory Control
The purpose of an inventory
control system is, in general, to
reduce holding and ordering
costs while still maintaining
satisfactory customer service.

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Model for inventory Control
The most famous model for controlling
inventory is Economic Order Quantity
model.
(EOQ) model, which helps in determine the
optimal amount of inventory to produce or
purchase at a given time.

Economic order quantity (EOQ) model

implies;
◦ The order size that minimizes total annual
cost

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EOQ
Key Terms used in the model
Lead time: time interval between
ordering and receiving the order
Holding (carrying) costs: cost to
carry an item in inventory for a
length of time, usually a year
Ordering costs: costs of ordering
and receiving inventory

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 Assumptions of EOQ

1. Demand is known, constant,

and independent
2. Lead time is known and
constant
3. Receipt of inventory is
instantaneous and complete
4. Quantity discounts are not
possible
5. Only variable costs are setup
and holding
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Calculation of cost associated
with inventory
Total cost= Carrying cost+
Ordering Cost.
 D  Q 
TC EOQ  
 S 
   H 
Q   2 

Where
TC  total annual cost
D  annual demand
Q  quantity to be ordered
H  annual holding cost
S  ordering or setup cost

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 The EOQ Model Annual setup cost =
D
Q
S
Q
Q = Number of pieces per order Annual holding cost = H
2
Q* = Optimal number of pieces per order (EOQ)
D = Annual demand in units for the inventory item
S = Setup or ordering cost for each order
H = Holding or carrying cost per unit per year

Optimal order quantity is found when annual

setup cost equals annual holding cost

D
S = Q H
Q 2
Solving for Q*
2DS = Q2H
Q2 = 2DS/H
Q* = 2DS/H
An EOQ Example
Determine optimal number of needles to order
D = 1,000 units
S = $10 per order
H = $.50 per unit per year

2DS
Q* =
H
2(1,000)(10)
Q* = = 40,000 = 200 units
0.50
No. of orders (EOQ)
Determine optimal number of needles to order
D = 1,000 units Q* = 200 units
S = $10 per order
H = $.50 per unit per year

Expected Demand D
number of = N = Order quantity =
orders Q*

1,000
N= = 5 orders per year
200
Time to order
Determine optimal number of needles to order
D = 1,000 units Q* = 200 units
S = $10 per order N = 5 orders per year
H = $.50 per unit per year

Number of working
Expected time days per year
between =T= N
orders

250
T= = 50 days between orders
5
Total Cost
Determine optimal number of needles to order
D = 1,000 units Q* = 200 units
S = $10 per order N = 5 orders per year
H = $.50 per unit per year T = 50 days

Total annual cost = Setup cost + Holding cost

D Q
TC = S Q + H2

1,000 200
TC = ($10) 200 + ($.50)
2

TC = (5)($10) + (100)($.50) = $50 + $50 = $100

 The Inventory Cycle

Profile of Inventory Level Over Tim

Q Usage
Quantit rate
y
on
hand

Reorder
point

Time
Receive Place Receive Place Receive
order order order order order
Lead time
When to Reorder
with EOQ Ordering

Reorder Point - When the quantity

on hand of an item drops to this
amount, the item is reordered
Safety Stock - Stock that is held in
excess of expected demand due to
variable demand rate and/or lead
time.
 Determinants of the Reorder
Point
The rate of demand
The lead time
Demand and/or lead time variability
Stock out risk (safety stock)
 Example on reorder point
Assume lead time, L = 3 business
days
Assume 250 business days per year
Then daily demand,
d = 1000 pumps/250 days = 4 pumps
per day

ROP = (4 pumps per day) x (3 days)

= 12 pumps
Determining Safety Stock Level
Need to know:
Probability of demand during lead
time (DDLT)
Cost of a stockout (includes all
costs directly or indirectly
associated, such as cost of a lost
sale and future lost sales)
ABCO Safety Stock Example
ROP = 50 units
Place 6 orders per year
Stock out cost per unit = $40
Ch = $5 per unit per year
DDLT has a discrete distribution
 Safety Stock Example
ROP = 50 units Stockout cost = $40 per frame
Orders per year = 6 Carrying cost = $5 per frame per year

Safety Additional Total

Stock Holding Cost Stockout Cost Cost

(20)($5) = $100 $0
20 $100

(10)($5) = $ 50 (10)(.1)($40)(6) = $240

10 $290
(10)(.2)($40)(6) + (20)(.1)($40)(6) =
0 $ 0
$960 $960

A safety stock of 20 frames gives the lowest total cost

ROP = 50 + 20 = 70 frames

© 2011 Pearson Education, Inc. publishing as

Prentice Hall
 Analyzing the Alternatives
With uncertain DDLT this becomes a
“decision making under risk”
problem
Each of the five possible values of
DDLT represents a decision
alternative for ROP
Need to determine the economic
payoff for each combination of
decision alternative (ROP) and
outcome (DDLT)
Analysis
Analysis of
of Inventory
Inventory

Inventory Turnover Ratio

SO 5 Compute and interpret the inventory turnover ratio.

Analysis
Analysis of
of Inventory
Inventory

Illustration: Data available for Wal-Mart.

Thank you

05/15/2020