MAC3701-Application Of Management Accounting Techniques SUMMARY STUDY NOTES 2022.

MAC3701-Application Of Management Accounting Techniques SUMMARY STUDY NOTES 2022. STUDY UNIT 1 PLANNING AND CONTROLLING INVENTORY Cost of holding inventory is expensive – capital is needed to create suitable infrastructure (factory, staff, computers, stationery etc) and cash flow also needed for operational activities of entity. Investment in inventory and inventory infrastructure is committed fixed costs which are managed over medium to longterm. Because of high costs and risks of holding inventory entity should keep inventory levels as low as possible – also because any stock item has to be paid for. Inventory Control Basic Objective of inventory control is to release capital for more productive use. For every type of item held in inventory, two questions must be asked: 1. When to order (When should a replenishment order be placed) 2. How much to order (what is the order quantity Q)? Factors Involved In Inventory Analysis 1. Inventory related costs 1. Purchase (or production) costs 2. Ordering (or Setup) costs 3. Carrying (or Holding) costs 4. Shortage (or Stock out ) costs Total cost = Purchase + Ordering + Carrying + Shortage 2. Demand  Customer's demand, size of demand, rate of demand and pattern of demand is important  Size of demand = no. of items demanded per period  Can be deterministic (Static or dynamic) or probabilistic (governed by discrete or continuous probability distribution)  The rate of demand can be variable or constant  Pattern reflects items drawn from inventory -instantaneous (at beginning or end) or gradually at uniform rate © CTM Tutoring 3. Order Cycle  The time period between placements of two orders having two types of review systems:  Continuous review  Periodic review 4. Time Horizon  The period over which inventory level will be controlled ...can be finite or infinite. 5. Lead Time  The time between ordering a replenishment and receiving into inventory ...can be deterministic- constant or variable or probabilistic 6. Stock Replenishment  The rate at which items are added to the inventory... an be instantaneous or uniform rate Economic Order Quantity The economic order quantity (EOQ) is the quantity that minimizes the sum of these two costs. It is based on the following assumptions: 1. The demand for the item is constant and known with certainty. 2. There are no upper or lower limits on the order quantity (lot size). 3. Stockouts are not permitted. 4. There are no quantity discounts. 5. Lead time and supply are known with certainty; lead time is constant. 6. Order quantities for individual items are made independently. If we define C - total annual (period) cost S - fixed cost of placing an order D - annual (period) demand H - annual (period) unit cost of holding inventory © CTM Tutoring Q – order quantity (to be determined) The economic order quantity is calculated by H SD EOQ 2  Answers the question “how much to order” Example ABC Ltd. is engaged in sale of footballs. Its cost per order is $400 and its carrying cost unit is $10 per unit per annum. The company has a demand for 20,000 units per year. Calculated the order size, total orders required during a year, total carrying cost and total ordering cost for the year. Solution EOQ = SQRT(2 × 20,000 × 400/10) = 1,265 units Annual demand is 20,000 units so the company will have to place 16 orders (= annual demand of 20,000 divided by order size of 1,265). Total ordering cost is hence $64,000 ($400 multiplied by 16). Average inventory held is 632.5 ((0+1,265)/2) which means total carrying costs of $6,325 (i.e. 632.5 × $10). The EOQ is used as part of a continuous review inventory system, in which the level of inventory is monitored at all times, and a fixed quantity is ordered each time the inventory level reaches a specific reorder point. The EOQ provides a model for calculating s the appropriate reorder point and the optimal reorder quantity to ensure the instantaneous replenishment of inventory with no shortages. It can be a valuable tool for small business owners who need to make decisions about how much inventory to keep on hand, how many items to order each time, and how often to reorder to incur the lowest possible costs. © CTM Tutoring Re-Order Point and Safety Stock The economic order quantity or production run model indicates how many units to order or produce. But managers are also concerned with the order point. Quantity of Re-order Point and Safety Stock reflects the level of inventory that triggers the placement of an order for additional units. Determination of the order point is based on three factors: 1. Usage – Usage refers to the quantity of inventory used or sold each day 2. Lead Time – The lead time for an order is the time in days it takes from the placement of an order to when the goods arrive or are produced. Many times companies can project a constant, average figure for both usage and lead time 3. Safety Stock – The quantity of inventory kept on hand by a company in the event of fluctuating usage or unusual delays in lead time is called safety stock.