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Inventory Valuation

This document discusses inventory control and calculating the economic order quantity. It provides an example of calculating inventory costs for different order quantities of desks. The costs included are re-order costs, holding costs, and total inventory costs. These costs are plotted on a graph to show how holding costs increase and re-order costs decrease as the order quantity increases. The document then explains how to calculate the economic order quantity by setting the annual re-order costs equal to the annual holding costs.

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Mary Amo
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238 views4 pages

Inventory Valuation

This document discusses inventory control and calculating the economic order quantity. It provides an example of calculating inventory costs for different order quantities of desks. The costs included are re-order costs, holding costs, and total inventory costs. These costs are plotted on a graph to show how holding costs increase and re-order costs decrease as the order quantity increases. The document then explains how to calculate the economic order quantity by setting the annual re-order costs equal to the annual holding costs.

Uploaded by

Mary Amo
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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INVENTORY CONTROLS

Ordering goods from suppliers.


There are many approached in practice. We consider one particular approach.
Ordering fixed quantities each time.
Example: We need 12,000 units per year. We can order:
1. 1,000 each time(12 orders per year)
2. 2,000 each time(6 orders per year)
There are three types of cost involved
a. Purchase Cost
b. Re-order Cost
c. Holding cost

Order Quantity – This is a long-term ordering policy

Example 1
Janis has demand for 40,000 desks p.a. and the purchase price of each desk is $25. There are
ordering costs of $20 for each order placed. Inventory holding costs amount to 10% p.a. of
inventory value.
Calculate the inventory costs p.a. for the following order quantities and plot them on a graph.
a. 500 units
b. 750 units
c. 1,000 units
d. 1250 units
SOLUTION
a) 500 units
Re-order costs:
40,000
= 80 orders x $20 = $1,600
500
Holding cost:
500
= 250 units(average) x (10% x $25) = $625
2
Inventory cost = $1,600 + $600 = $2,225
b) 750 units
Re-order costs:
40,000
= 53.33 orders x $20 = $1,067
750
Holding cost:
750
= 375 units x (10% x $25) = $938
2
Inventory cost = $1,067 + $938 = $2,005
c) 1,000 units
Re-order costs:
40,000
= 40 orders x $20 = $800
1,000
Holding cost:
1,000
= 500 units x (10% x $25) = $1,250
2
Inventory cost = $800 + $1,250 = $2,050
d) 1,250 units
Re-order costs:
40,000
= 32 orders x $20 = $640
1,250
Holding cost:
1,250
= 625 units x (10% x $25) = $1,563
2
Inventory cost = $640 + $1,563 = $2,203

PLOT A GRAPH: DEPICTION


 Holding cost p.a. – As Ordering quantity increases, Holding cost goes up,
 Order cost – As Order quantity goes up, Order cost goes down.
Economic order quantity(EOQ) = Minimise Total inventory cost.
EOQ occurs where ordering cost (per year) = holding cost (per year)
So which order quantity minimizes total cost? We do not know but we can find out.
Ordering Cost = Holding Cost
D Q
x CO = x CH
Q 2
Where D = annual demand CH = Holding cost per unit per year
Q = Order quantity Q = EOQ
CO = Ordering costs
per order

√
2 D CO 2 D CO
Q2 = =Q=
CH CH

a) Q =
√ 2 X 40,000 X $ 20
$ 2.5
= 800 units

b) Minimum cost at EOQ


40,000
Re-order cost = 50 orders x $20 = $1,000
800
800
Holding cost = 400 units x $2.5 = $1,000
2
$2,000

Purchase Cost = 40,000 x $25 = $1,000,000 p.a.


Total cost = $1,000,000 + $2,000 = $1,002,000

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