ACCT550
CHAPTER 20
INVENTORY MGT, JIT & BACKFLUSH COSTING
Economic order quantity (EOQ)
1)
EOQ represents the optimal number of inventory units to order with each purchase order.
2)
EOQ attempts to minimize the combined total of ordering costs and carrying costs.
a)
Ordering costs include
i)
Purchasing
ii)
Receiving
iii) Inspecting
iv)
Recordkeeping for the above activities.
b)
Carrying costs include
i)
Storage
ii)
Handling
iii) Insurance
iv)
Obsolescence and spoilage
v)
Opportunity costs of money tied up in inventory (e.g., paying down debt to reduce interest)
3)
Ordering costs and carrying costs move in opposite directions as the order quantity changes.
a)
If order quantity is small
i)
More orders are required during the period, resulting in higher ordering costs.
ii)
Fewer units are carried onhand at any given time, resulting in lower carrying costs.
b)
If order quantity is large
i)
Fewer orders are required during the period, resulting in lower ordering costs.
ii)
More units are carried onhand at any given time, resulting in higher carrying costs.
c)
Again, EOQ attempts to minimize the combined total of ordering costs and carrying costs.
d)
See the graphical presentation on page 694, exhibit 201.
4)
EOQ calculation
a)
Formula
The SQUARE ROOT of:
(2) x (units demanded per period) x (ordering cost per purchase order)
carrying cost per unit per period
b)
Assumptions
i)
The same quantity is ordered each time a purchase order is placed (see reorder point below).
ii)
Demand, ordering costs and carrying costs are known with certainty.
iii)
Purchase price per unit is not affected by purchase order quantity.
This means that purchase
discounts are not taken into consideration in the EOQ formula.
iv)
There will be no stockouts, and therefore no stockout costs.
1
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ACCT550
CHAPTER 20
INVENTORY MGT, JIT & BACKFLUSH COSTING
Reorder point
1)
The reorder point represents a minimum inventory level that triggers a new purchase order when
reached.
2)
Factors in determining reorder point:
a)
Demand
b)
Lead time
c)
Safety stock
3)
Demand represents the number of units sold or consumed per period.
4)
Lead time represents the average time lag between placing and order and receiving the goods.
5)
Safety stock represents a minimum quantity of inventory kept on hand at all times to cover
inaccuracies in estimates and contingencies.
a)
The optimum safety stock minimizes the combined total of carrying costs (of the units of safety
stock) and stockout costs.
b)
See exhibit 203 on page 696 and the related discussion of how a safety stock can be calculated.
6)
The reorder point is calculated as follows:
((units sold per period) x (lead time)) + safety stock units
Relevant costs
1)
Relevant costs change as the activity at hand changes.
a)
Relevant ordering costs change as the number of orders placed each period changes.
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 Spring '09
 SMITH

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