Advanced Managerial Accounting
ACT 5733 – Advanced Managerial Accounting
Chat # 8 – Inventory Management
ACT 5733 - Chat 8 - Felo
ACT 5733 - Chat 8 - Felo
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Chat Outline
- Review HW
- Inventory costs
- Economic-order quantity model
- Reorder point
- Cost of prediction errors
- JIT inventory
ACT 5733 - Chat 8 - Felo
ACT 5733 - Chat 8 - Felo
Costs of Inventory
- Purchasing costs (including in-coming freight costs)
- Ordering costs
- Carrying costs
- Stock-out costs
- Costs of quality
- Shrinkage costs
ACT 5733 - Chat 8 - Felo
ACT 5733 - Chat 8 - Felo
EOQ Decision Model
- What size orders should we place to minimize the sum of ordering and carrying costs?
- Assumes same amount ordered each time, demand, ordering costs, carrying costs, and lead time are known
- Cost per unit unaffected by order size
- No stock-outs occur
ACT 5733 - Chat 8 - Felo
ACT 5733 - Chat 8 - Felo
EOQ Formula
- EOQ = SQRT (2 x D x P / C)
- D = demand for period of time
- P = Relevant costs per purchase order
- C = Relevant carrying costs per unit
- Average inventory is EOQ / 2
- Relevant carrying costs = (EOQ / 2) x C
- # of orders = D / EOQ
- Relevant ordering costs = (D / EOQ) x P
ACT 5733 - Chat 8 - Felo
ACT 5733 - Chat 8 - Felo
EOQ Example
ACT 5733 - Chat 8 - Felo
| Annual Demand | 52,000 units |
| Carrying costs (including ROI on capital) | $2.60 per unit |
| Costs per purchase | $400 |
| Lead time (weeks) | 1 |
| EOQ | 4,000 units |
| # of orders to be placed | 13 orders |
| Total ordering costs | $5,200 |
| Total carrying costs | $5,200 |
ACT 5733 - Chat 8 - Felo
When to Order Inventory?
- With certainty – Units sold per period x Order lead time
- 1,000 units per week x 1 week lead = 1,000 units
- With uncertainty – safety stock should be considered
- Safety stock should minimize sum of carrying and stock-out costs
ACT 5733 - Chat 8 - Felo
ACT 5733 - Chat 8 - Felo
Cost of Prediction Error
- Compare cost of “optimal” decision with cost of decision made with incorrect data
- The magnitude of this can help management determine whether it makes sense to seek out “better” information
ACT 5733 - Chat 8 - Felo
ACT 5733 - Chat 8 - Felo
Prediction Error Example - 1
ACT 5733 - Chat 8 - Felo
| Annual Demand | 52,000 units |
| Carrying costs (including ROI on capital) | $2.60 per unit |
| Actual costs per purchase | $400 |
| Expected costs per purchase | $200 |
| Lead time (weeks) | 1 |
| Expected EOQ | 2,829 units |
| # of orders to be placed | 19 orders |
| Total ordering costs | $7,600 |
| Total carrying costs | $3,678 |
| Total cost with correct information | $10,400 |
| Prediction error | $878 (8%) |
ACT 5733 - Chat 8 - Felo
Prediction Error Example - 2
ACT 5733 - Chat 8 - Felo
| Annual Demand | 52,000 units |
| Carrying costs (including ROI on capital) | $2.60 per unit |
| Actual costs per purchase | $400 |
| Expected costs per purchase | $100 |
| Lead time (weeks) | 1 |
| Expected EOQ | 2,000 units |
| # of orders to be placed | 26 orders |
| Total ordering costs | $10,400 |
| Total carrying costs | $2,600 |
| Total cost with correct information | $10,400 |
| Prediction error | $2,600 (25%) |
ACT 5733 - Chat 8 - Felo
Just-In Time Inventory
- Attempt to acquire inventory (purchase or produce) “just in time” to be used
- “Demand pull” system
- Focus is on carrying costs
- Also can help identify inefficiencies in operations and flaws in forecasts
- Requires cooperation through supply chain (suppliers and customers)
ACT 5733 - Chat 8 - Felo
ACT 5733 - Chat 8 - Felo
Metrics for JIT
- Track information on internal performance & supplier reliability
- On-time delivery %
- Cycle time
- Defect rates or % yield
- Unscheduled downtime
- Sales increase from JIT implementation
- Customer satisfaction
- # of rush shipments required
ACT 5733 - Chat 8 - Felo
ACT 5733 - Chat 8 - Felo
Other Metrics for JIT
- Track information on internal performance & supplier reliability
- % of supplier shipments without defects / errors
- Cost of ownership
- % of supplier shipments on time
- Delays (time lost) due to supplier errors
ACT 5733 - Chat 8 - Felo
ACT 5733 - Chat 8 - Felo