Managerial Accouting Topic

2. INVENTORY
PAS 2, paragraph 6, defines inventories as assets
which are held for sale in the ordinary course of
business, in the process of production for such sale
or in the form of materials or supplies to be
consumed in the production process or in the
rendering of services.

3. 2 CLASSES OF INVENTORIES
For manufacturing firms
• Raw materials
• Goods-in-process
• Finished goods
For trading firms
• Merchandise

4. INVENTORY MANAGEMENT
•Inventory management is the management of
inventory and stock. As an element of supply chain
management, inventory management includes
aspects such as controlling and overseeing
ordering inventory, storage of inventory, and
controlling the amount of product for sale.

5. ECONOMIC ORDER QUANTITY
(EOQ) MODEL

6. WHAT IS EOQ??
•The quantity to be ordered which
minimized the sum of ordering and
carrying cost.

7. CARRYING COSTS
•Out-of-pocket costs which includes such items such as
insurance on the value of the inventory, inventory taxes,
rent, obsolescence, record keeping costs, interest, and
spoilage cost.
•Cost of capital which is the opportunity cost of having
funds in inventory rather than in other earning assets.

8. ORDERING COSTS
•decrease with quantity of inventory on hand. These
include costs involved in requisition, purchase
order, receipt of goods, placing of goods in
inventory and processing of payment to suppliers.
Given a constant usage, the greater the inventory
on hand, the less frequently one must order thus,
the lower ordering costs.

9. FORMULA• 𝐸𝑂𝑄 =
2𝑎𝐷
𝐾
• Where:
a = cost of placing one order
(ordering costs)
D = annual demand in units
K = annual costs of carrying one
unit in inventory for one year
• 𝐓𝐨𝐭𝐚𝐥 𝐈𝐧𝐯𝐞𝐧𝐭𝐨𝐫𝐲 𝐂𝐨𝐬𝐭𝐬 =
Total Ordering Costs + Total Carrying Costs
• 𝐓𝐨𝐭𝐚𝐥 𝐎𝐫𝐝𝐞𝐫𝐢𝐧𝐠 𝐂𝐨𝐬𝐭𝐬 =
Annual demand in units
EOQ
x Ordering Costs per order
• 𝐓𝐨𝐭𝐚𝐥 𝐂𝐚𝐫𝐫𝐲𝐢𝐧𝐠 𝐂𝐨𝐬𝐭𝐬 =
Average Inventory x Carrying Costs per unit
• 𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐈𝐧𝐯𝐞𝐧𝐭𝐨𝐫𝐲 =
EOQ
2

10. Illustration:
Assume that a local gift shop is attempting to determine how many sets of wine glass to
order. The store feels it will sell approximately 675 sets in the next year at a price of P18
per set. The wholesale price that the store pays per set is P12. Costs of carrying one set
of wine glass are estimated at P1.50 per year while ordering costs are estimated at P25.
DETERMINE THE
a. EOQ
• 𝐸𝑂𝑄 =
2𝑎𝐷
𝐾
• 𝐸𝑂𝑄 =
2 𝑥 675 𝑥 𝑃25
𝑃1.50
• 𝐸𝑂𝑄 = 150 𝑢𝑛𝑖𝑡𝑠 𝑝𝑒𝑟 𝑜𝑟𝑑𝑒𝑟
a. b. Total Inventory Costs
• 𝑶𝒓𝒅𝒆𝒓𝒊𝒏𝒈 𝑪𝒐𝒔𝒕𝒔 = 675
150 𝑥 𝑃25 = 𝑃112.50
• 𝑪𝒂𝒓𝒓𝒚𝒊𝒏𝒈 𝑪𝒐𝒔𝒕𝒔 = 150
2 𝑥 𝑃1.50 = 𝑃112.50
• Total Inventory Costs = P112.50+P112.50=P225

11. ASSUMPTIONS OF THE EOQ MODEL
• Demand occurs at a constant rate throughout the year.
• The time between placement of the order and the receipt of the
order or lead time is constant.
• The entire quantity ordered is received at one time. In other
words, the inventory from an order arrives in one batch at one
point in time.
• The unit costs of the items ordered are constant; thus there can
be no quantity discounts.
• The only costs that are relevant are ordering cost and carrying
costs.

12. REORDER POINT
(ROP) AND SAFETY
STOCK

13. SAFETY STOCK OR BUFFER STOCK
•Safety stock is an additional quantity of an item
held in inventory in order to reduce the risk that
the item will be out of stock.
•Safety stock acts as a buffer in case the sales
of an item are greater than planned and/or the
supplier is unable to deliver additional units at
the expected time

14. 𝐒𝐚𝐟𝐞𝐭𝐲 𝐬𝐭𝐨𝐜𝐤 = (Maximum daily usage – Average daily usage) x Lead time
Illustration
The purchasing agent responsible for ordering Product X for Cheesy Company has
come up with the following information:
• Maximum daily usage 100 units
• Average daily usage 80 units
• Lead time 9 days
• Economic order quantity 3, 500 units
𝑺𝒂𝒇𝒆𝒕𝒚 𝑺𝒕𝒐𝒄𝒌 = 𝟏𝟎𝟎 − 𝟖𝟎 𝒙 𝟗
𝑺𝒂𝒇𝒆𝒕𝒚 𝑺𝒕𝒐𝒄𝒌 = 𝟏𝟖𝟎 𝒖𝒏𝒊𝒕𝒔

15. REORDER POINT (ROP)
• The reorder point (ROP) is
the level of inventory
which triggers an action to
replenish that particular
inventory stock. It is a
minimum amount of an
item which a firm holds in
stock, such that, when
stock falls to this amount,
the item must be
reordered.
ROP

16. This answers the questions – When to order and may be computed
as follows:
• 𝑅𝑂𝑃 = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑙𝑒𝑎𝑑 𝑡𝑖𝑚𝑒 𝑢𝑠𝑎𝑔𝑒 + 𝑆𝑎𝑓𝑒𝑡𝑦 𝑆𝑡𝑜𝑐𝑘
• 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑙𝑒𝑎𝑑 𝑡𝑖𝑚𝑒 𝑢𝑠𝑎𝑔𝑒 = 𝐿𝑒𝑎𝑑 𝑡𝑖𝑚𝑒 𝑥 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑢𝑠𝑎𝑔𝑒 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 𝑜𝑓 𝑡𝑖𝑚𝑒
• 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑢𝑠𝑎𝑔𝑒 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 𝑜𝑓 𝑡𝑖𝑚𝑒 = 𝐴𝑛𝑛𝑢𝑎𝑙 𝑢𝑠𝑎𝑔𝑒 𝑖𝑛 𝑢𝑛𝑖𝑡𝑠
𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝑑𝑎𝑦𝑠 𝑜𝑟 𝑤𝑒𝑒𝑘𝑠 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟
Illustration
A safety stock of 250 has been chosen for Material X. The delivery time is 6
days and the annual usage is 28,600 units.
If there are 220 working days per year, what is the reorder point of Material
X?

17. SOLUTION
𝑅𝑂𝑃 =
𝐴𝑛𝑛𝑢𝑎𝑙 𝑈𝑠𝑎𝑔𝑒 𝑖𝑛 𝑢𝑛𝑖𝑡𝑠
𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝑑𝑎𝑦𝑠 𝑜𝑟 𝑤𝑒𝑒𝑘𝑠 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟
𝑥 𝐿𝑒𝑎𝑑 𝑇𝑖𝑚𝑒 + 𝑆𝑎𝑓𝑒𝑡𝑦 𝑆𝑡𝑜𝑐𝑘
ROP =
28,600 𝑢𝑛𝑖𝑡𝑠
220 𝑑𝑎𝑦𝑠
𝑥 6 𝑑𝑎𝑦𝑠 + 250
𝑅𝑂𝑃 = 130 𝑢𝑛𝑖𝑡𝑠/𝑑𝑎𝑦 𝑥 6 𝑑𝑎𝑦𝑠 + 250 𝑢𝑛𝑖𝑡𝑠
𝑅𝑂𝑃 = 780 𝑢𝑛𝑖𝑡𝑠 + 250 𝑢𝑛𝑖𝑡𝑠
𝑅𝑂𝑃 = 1,030 𝑢𝑛𝑖𝑡𝑠