Inventory

Question 1

TWO reasons why it is necessary for an entity to hold adequate stock levels

Answer 1

1. To avoid excess surpluses and shortages
2. To never run out of stock
3. To satisfy demand
4. To ensure continuous production flow
5. To avoid holding surplus stock, as it leads to waste and inefficiency.

Question 2

List FOUR stock levels that can be calculated as part of inventory control procedures

Answer 2

1. Reorder level: the level of inventory at which a new order is made (= max consumption x max delivery time)
2. Maximum Level: the max quantity of inventory which may be stored, and therefore represents an upper limit (= Reorder Level + Reorder Quantity - (Min. consumption x Min. delivery time)
3. Minimum Level: the lowest level to which inventory should be allowed to fall. a buffer inventory which will not normally be used (= Reorder Level - (Normal consumption x Normal delivery time)
4. Economic Order Qty: the amount of inventory that will be ordered once the order procedure is initiated (= Square Root of (2 x Demand per period x The cost of placing an order) / the cost of holding inventory per unit per period) (square root of 2xDxO / H)

Question 3

Briefly describe the term ‘Economic Order Quantity’, clearly indicating how it is measured

Answer 3

Economic Order Quantity is the re-order quantity. The EOQ represents the quantity of inventory ordered which keeps the total cost of ordering and holding inventory to a minimum. It is the amount of inventory that will be ordered once the order procedure is initiated

It is calculated using the formula: = Square Root of (2 x Demand per period x The cost of placing an order) / the cost of holding inventory per unit per period)

(square root of 2xDxO / H)

Question 4

Discuss the FIFO method of inventory valuation.

Answer 4

First In, First Out: when using this method, for valuation purposes it is assumed that the items received first are those to be issued first. Therefore, issues from inventory are valued at the earliest price available, while the last price available is used to value the inventory units.

In a period of rising prices, this leads to the highest inventory value and also to the highest reported profit.

This system reflects the physical flow of inventory, and inventory is valued at the most up to date prices. However, inflated prices are against the prudence concept.

Question 5

Discuss the AVCO method of inventory valuation.

Answer 5

Average Cost: when using this method for valuation purposes a weighted average price is calculated to value inventory and inventory units.

This method minimises fluctuations in the issue prices of inventory as they are valued at one price. It smoothes out variations in profits which makes comparing more accurate.

However, calculations are more tedious and they do not represent a price that has actually been paid. In times of rising prices, the issue price may not reflect current economic values.

Question 6

Comment on the difference between the perpetual and periodic methods of inventory valuation

Answer 6

A perpetual inventory system involves calculating the value of inventory after every receipt and issue. Therefore, a record is kept of each inventory item and all transactions are recorded immediately. This approach gives an accurate inventory value. However, it could be complex and time consuming to use in non-computerised environments.

A periodic inventory system is one where the value of inventory is calculated only at the end of a specific period, this usually being the end of the accounting period. This system values inventory after stocktaking. It involves a physical count of inventory to determine the quantity of units in stock. The system may include records of the total receipts and issues of inventory for the period. This approach is less accurate than the perpetual system, but easier and faster to use in non-computerised environments.