Control procedures

Objective: Minimize discrepancies and losses

Sensitivity: Internal Management Accounting

 Inventory Order Quantities
and Reorder Levels

Sensitivity: Internal Management Accounting

Reasons for holding inventory

The main reason that an organization will hold inventory is in order to make sure that
customer demands are met as soon as possible.
• If customer demands are met, customers will be happy.
• If customers are happy, sales and, therefore, profits will increase.
• Prevent holdups in the production process of manufacturing companies.

Sensitivity: Internal Management Accounting

Holding costs
Holding costs include the following:
– interest on capital tied up in inventory
– cost of storage space
– cost of insurance.

Buffer inventory is a basic level of inventory held for emergencies and to prevent stock-outs
from occurring. It is also known as safety inventory or the minimum inventory level.

Holding costs can be distinguished between fixed holding costs and variable holding costs.

Fixed holding costs include the cost of
storage space and the cost of insurance.
Note that the cost of storage space may
be a stepped fixed cost if increased
warehousing is needed when higher
volumes of inventory are held.
Variable holding costs include interest on
capital tied up in inventory. The more
inventory that is held, the more capital
that is tied up. Holding costs are often
stated as being valued at a certain
percentage of average inventory held.

Sensitivity: Internal Management Accounting

Ordering costs
Administrative costs of placing an order are usually a fixed cost per order. The total
administrative costs of placing orders will increase in proportion to the number of orders
placed. They therefore exhibit the behavior of variable costs.

Delivery costs are usually a fixed charge per delivery (order). The total delivery costs will also
increase in direct proportion to the number of deliveries in a period, and therefore behave as
variable costs.

Sensitivity: Internal Management Accounting

Ordering & Holding costs – Class Activity

Sensitivity: Internal Management Accounting

The Economic Order Quantity (EOQ)
The EOQ is the reorder quantity which minimizes the total costs associated with holding and
ordering stock.

The formula for the EOQ is as follows:

Sensitivity: Internal Management Accounting

The Economic Order Quantity (EOQ)
The formula for the EOQ is as follows:

Sensitivity: Internal Management Accounting

Economic Order Quantity – Class Activity

a) What is the order quantity that minimizes total costs?

b) With the answer in (a) above, calculate the frequency with which the
order will be placed

Sensitivity: Internal Management Accounting

EOQ with Bulk Discounts
If a quantity discount is accepted this will have the following effects:
– The annual purchase price will decrease
– The annual holding cost will increase
– The annual ordering cost will decrease

EOQ when quantity discounts are available following steps are involved in calculating the Q:
Step 1: Calculate the EOQ, ignoring discounts
Step 2: If the EOQ is smaller than the minimum purchase quantity to obtain a bulk discount,
calculate the total for the EOQ of the annual stockholding costs, stock ordering costs and
stock purchase costs
Step 3: Recalculate the annual stockholding costs, stock ordering costs and stock purchase
costs for a purchase order size that is only just large enough to qualify for the bulk discount.
Step 4: Compare the total costs when the order quantity is the EOQ with the total costs
when the order quantity is just large enough to obtain the discount. Select the minimum cost
alternative
Step 5: If there is a further discount available for an even larger order size, repeat the same
calculations for the higher discount level.

Sensitivity: Internal Management Accounting

EOQ with Bulk Discounts
EOQ when quantity discounts are available following steps are involved in calculating the Q:
Step 1: Calculate the EOQ, ignoring discounts
Step 2: Calculate total costs
Step 3: Recalculate total costs for order size large enough to qualify for discount
Step 4: Compare both total costs and select minimum cost alternative
Step 5: For further discounts, repeat the same calculations

Sensitivity: Internal Management Accounting

EOQ with Bulk Discounts – Class Activity

Sensitivity: Internal Management Accounting

 Do keep in touch!

0345 8506336 amd.aff@gmail.com

Ahmed Jawad Syed Ahmed Jawad Hussaini

ahmedjawad23 Ahmed Hussaini

Sensitivity: Internal Management Accounting