Cost Accounting: Inventory Management

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Questions and Answers

What is one of the main goals of cost accounting in relation to inventory management?

To ensure a proper method of cost accumulation is maintained.

According to IAS 2, what types of goods are classified as inventories?

Goods held for sale, in the process of production for sale, or in the form of materials for consumption.

What are the three purposes of holding inventories?

Transaction, speculative, and precautionary purposes.

What is the main concern of companies when ordering inventories?

To strike a balance between minimizing storage costs and maximizing resale quantities. Signup and view all the answers

What are the two classifications of raw materials used in production?

Direct materials and indirect materials. Signup and view all the answers

What is the primary objective of economic order quantity?

To determine the optimal order quantity to minimize storage costs and maximize resale. Signup and view all the answers

Why do companies wish to avoid over-ordering stocks?

Because it increases the cost of storage. Signup and view all the answers

What are the three forms of inventories, according to IAS 2?

Finished goods, work in process, and raw materials. Signup and view all the answers

What are the four categories of inventory costs?

Ordering costs, Holding costs, Manufacturing costs, and Quality costs Signup and view all the answers

What two costs does the Economic Order Quantity (EOQ) formula consider?

Ordering costs and Holding costs Signup and view all the answers

What is the formula for calculating the Economic Order Quantity (EOQ)?

$\sqrt{\frac{2DO}{H}}$ Signup and view all the answers

What is the assumption of the EOQ formula regarding the unit price or production cost?

The unit price or production cost is constant and does not vary with changes in order size Signup and view all the answers

What does the lead time represent in inventory management?

The length of time it takes for material to be received after an order has been placed Signup and view all the answers

What is the maximum inventory level?

The highest amount of inventory to hold at any given time Signup and view all the answers

What is the purpose of the EOQ formula in inventory management?

To determine the optimal order quantity to minimize total inventory costs Signup and view all the answers

What is the replacement for O in the EOQ formula when determining the optimum batch size for production runs?

S, which represents the set-up costs for the production run Signup and view all the answers

What are the potential risks associated with relying on a single supplier?

Shortage of future suppliers, Future Price Increases, Obsolescence Signup and view all the answers

What is the purpose of calculating the total cost of ordering and holding inventory?

To determine the most economic order quantity Signup and view all the answers

How can a company reduce its safety stocks?

By improving forecast accuracy, reducing lead times, and increasing flexibility Signup and view all the answers

What is the economic order quantity (EOQ) of a product?

The order size that minimizes total costs Signup and view all the answers

What is the effect of increasing the order size on the total cost of ordering and holding inventory?

The total cost of ordering decreases, but the total cost of holding increases Signup and view all the answers

How does the price of a raw material affect the total cost of ordering and holding inventory?

A lower price of a raw material reduces the total cost of holding inventory Signup and view all the answers

What is the relationship between the annual demand and the economic order quantity (EOQ)?

The EOQ is a function of the annual demand Signup and view all the answers

What is the purpose of calculating the total cost of ordering and carrying inventory for different order sizes?

To determine the most economic order quantity Signup and view all the answers

What is the formula to calculate the Maximum Inventory?

Maximum Inventory = Reorder level - (Minimum usage X Minimum lead time) + EOQ Signup and view all the answers

What is the purpose of Minimum Inventory?

To represent the lowest level of inventory to hold at any given time Signup and view all the answers

What is the formula to calculate the EOQ?

EOQ = √(2 x Annual Demand x Cost of Ordering / Cost of Holding) Signup and view all the answers

What is the Reorder Level in inventory control?

Reorder Level = Maximum usage x Maximum lead time Signup and view all the answers

What is the formula to calculate the Minimum Level?

Minimum Level = Reorder level - (Average usage x Average lead time) Signup and view all the answers

What is the formula to calculate the Maximum Level?

Maximum Level = Reorder level + EOQ - (Minimum usage x Minimum lead time) Signup and view all the answers

What are the other factors to consider when reordering inventory, apart from cost?

Other factors, such as lead time, usage, and demand, that are not necessarily cost-related Signup and view all the answers

Why is it important to understand the cost of ordering and holding inventories?

Because it is very significant in business and can impact profitability Signup and view all the answers

Study Notes

Inventory Management

One of the primary goals of cost accounting is to ensure proper cost accumulation, including inventory costs such as holding costs and ordering costs.
Inventory includes goods held for sale, in production, or in the form of materials and supplies for production or services.

Classification of Inventories

Inventories can be classified as:
- Finished goods
- Work in process
- Raw materials
Raw materials can be further classified as:
- Direct materials
- Indirect materials

Reasons for Holding Inventories

Transaction purposes
Speculative purposes
Precautionary purposes

Economic Order Quantity (EOQ)

The EOQ is the optimal quantity of goods to order to minimize total inventory costs.
Total inventory costs consist of ordering costs and holding costs.
The EOQ formula is: √(2DO/H), where:
- D is the annual demand
- O is the cost per order
- H is the holding cost per unit

Assumptions of the EOQ Formula

The unit price or production cost is constant and does not vary with changes in order size.
Demand is known with certainty.
Order quantity is constant per order.
Ordering cost per unit is constant.
Lead time for placing and receiving an order is known and constant.

Lead Time and Inventory Control Levels

Lead time is the time it takes to receive material after an order is placed.
Maximum Inventory is the highest amount of inventory to hold at any given time.
Minimum Inventory is the lowest level of inventory to hold at any given time.
Reorder level is calculated as: Maximum Inventory - (Minimum usage x Minimum lead time)

Example Problems

Example 1.1: Calculating EOQ and inventory control levels for Jet Sea.
Example 2: Calculating reorder level, minimum level, and maximum level for Jet Sea.

Practice Questions

Question 1: Calculating total cost of ordering and holding Zirron for Steyn Manufacturing.
Question 2: Calculating the most economic order quantity for Zirron.
Question 3: Calculating the total cost of ordering and carrying Markovitz for Doris Holdings.

Important Factors to Consider

Shortage of future suppliers
Future price increases
Obsolescence
Steps to reduce safety stocks

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Description

This quiz covers the importance of inventory management in cost accounting, including holding costs and ordering costs.