INVENTORIES (PAS 2)

• Are Assets:
• 1. Held in the ordinary course of
business
• 2. in the production process for such
sale
• 3. in the form of materials/supplies to
be consumed in the production
process or rendering of service.
How Important to Managers?
• Managing Inventories is one way
of minimizing cost thereby causing
the Income to increase,
consequently achieving the
primary goal of the organization,
which is to obtain the highest
possible profit.
COST INCURRENCE
• Acquiring, Maintaining, Holding and storing Inventories
constitue cost. These are:

• Interest
• Obsolescence
• Depreciation
• Insurance
• Oppurtunity Cost
• Storage Cost
Role of Inventory?
• TO MEET CUSTOMER DEMAND

• Customers are the foundation of any business’

success

• Managers must think of a way on how they can

meet the needs of customers.

• They must respond to customers’ needs.

SAFETY STOCKS
• Are additional inventory to
compensate for demand
uncertainty.
DEMAND
• Is the essential determinant of effective Inventory
Management is an accurate forecast of demand.

• 2 TYPES:

DEPENDENT DEMAND – items that are used internally to

produce a final product

INDEPENDENT DEMAND- items are final products

demanded by an external cutomers.
INVENTORY COSTS
CARRYING COST
• Carrying costs are cost of holding items in the storage.

• The higher the level of inventories the higher the carrying

cost.

• Carrying Costs can include oppurtunity costs, direct

storage costs, interest, depreciation, obsolescence,
product deterioration and spoilage, breakage, taxes,
pilferage

• Can be expressed as on a per unit basis or as a

percentage of the value of an item or as a percentage of
average inventory value.
CARRYING COSTS Formulas
• Carrying Cost per Unit = Total Carrying Cost/Average
Inventory

• Total Carrying Cost = Carrying cost per unit x Average

Inventory

• Average Inventory = Order Size/2

• Carrying Cost per Unit = Unit Cost x Carrying Costs ratio

• Carrying Cost Ratio = Carrying Cost per Unit/ Unit Cost

SAMPLE
• In 2011, Fit It Company incurred a total of 800,000 for
inventory carrying costs with an average inventory of
200,000 units. What would be the total carrying costs in
2012 if the Order size is 500,000, assuming the company
does not maintain safety stock quantiy.

• Carrying Cost per Unit – P800,000/200 units = P4

• Average Inventory = 500,000 units/2 = 250,000 units

• Total Carrying Cost = P4 x 250,000 = P1,000,000

ORDERING COSTS
• Are the cost associated with replenishing the stocks of
Inventory being held.
• Expressed as dollar amount per order.
• Dependent of Order Size (The more orders were placed,
the higher the Ordering Cost)

• Ordering Costs include requisition cost, purchase orders,

transportation and shipping, receiving, inspection,
handling and placing in storage, and accounting &
auditing.
• React inversely to carrying costs. As the size of Orders
Increases, fewer orders are required, thus reducing
annual ordering costs.
ORDERING COSTS Formulas
• Cost per Order = Total Ordering Costs/ No. Of Orders

• Total Ordering Cost = Cost per Order x No. Of Orders

• No. of Orders = Annual Demand/order sIze

SAMPLE
• Big City Corporation expects to use 10,000 units of
material XPO per month in 2012. Last year, the total
ordering costs amounted to P200,000 for a total of orders.
It is expected that prices in 2012 would be 10% higher
than that of last year. Determine the expected ordering
costs in 2012 if the company orders in a batch of 12,000
Annual demand = 10,000 x 12 months = 120,000 units
• Expected cost per order= P200,000/40 orders x 110% =
P5,500
• No. of Orders = 120,000/12,000 = 10 times
• Cost per Order = P5,500
• Total Ordering Cost = 10 x 5,500 = P55,000
SHORTAGE COSTS
• Also referred as stockout costs
• Occur when customer demand cannot be met
• Loss of profit
• Customer dissatisfaction and a loss of goodwill
compromise future sales
• Failure to meet customers demand or lateness in
meeting demand results in specified penalties in the form
of price discounts an rebates.
 INVENTORY COST CONTROLS
=structure for controlling the level of inventory by
determining how much to order (the level of replenishment)
and when to order.

=is maintained by every firm to manage its inventory

efficiently.
2 types:
Continuous(fixed-order quantity) System
Periodic(fixed-time period) system
CONTINUOUS SYSTEM
• =provides up-to-date inventory balance information and
requiring a reduced level of physical inventory counts.

• =preferred method of tracking inventory, yields reasonably

accurate results on an on-going basis, if properly
managed.

• =helps to prevent stockouts

• =disadvantage: Cost of maintaing of the continual records

PERIODIC SYSTEM
• =inventory on hand are determined on a specific time
intervals. (every week or at the end of each month)

• =Disadvantage: inventories not monitored, less direct

control

• =Advantage: No record keeping

ECONOMIC ORDER QUANTITY
• Underlying assumptions:

1. Demand is known with certainty and is relatively

constant over time
2. No shortages are allowed
3.Lead time for the receipt of orders is constant
4. The order quantity is received all at once.
=refers to the units of materials that should be purchased
to minimize total relevant costs.
=The point where the total ordering cost equals the total
carrying cost.
Graphical Representation of EOQ
ISAM Corporation buys material 101 at the optimum level determined at
10,000 units. Its daily consumption of material 101 is 333.33 units.
Materials are evenly used throughout the year. (a) Show graphical behavior
of material (b) Determine the average inventory balance for 101.
Relationship of OC and CC
ORDER SIZE ORDERING COSTS CARRYING COSTS

INCREASES DECREASES INCREASES

DECREASES INCREASES DECREASES

FORMULA OF EOQ
• AT EOQ,
• TOTAL ORDERING COSTS = TOTAL CARRYING COSTS
CPO x No. of Orders = CCPU x Ave. Inventory
CPO x (AD/OS) = CCPU x (OS/2)
• Simplying:
CPO x AD = CCPU x OS
OS 2
OS2 x CCPU = 2 x AD x CPO
Therefore,
OS2= 2 X AD X CPO
CCPU
OS=√2 X AD X CPO
CCPU
SAMPLE PROBLEM
• Assume an annual requirement of 24,000 unts, a cost per
unit of P20, a cost per order of P750, and a carrying cost
percentage of 20%. Applying the formula to the data, the
EOQ is

• EOQ(units) =√2 𝑥 24,000 𝑥 𝑃750

P4
• = 3,000 units
• EOQ(pesos)= 2𝑥𝑃480,000𝑥𝑃750
20%
= P60,000