Session 4

Question 1

Nam the different categories of inventory

Answer 1

1) Raw materials
These are items that we plan to convert (e.g. wood for a desk)

2) Work in progress
This is inventory that is in transition from a raw material to a finished good ( tables unfinished and not sanded or varnished)

3) Finished goods
These are goods that are in a position that someone will buy them from you. (E.g. the finished desk)

Question 2

How to ensure you have proper inventory control

Answer 2

1) Proper system in place for ordering and receipt of raw materials
- This ensures that goods that are ordered are actually required or perceived to be required as someone has signed off on the order.

2) System for the receipt of raw materials
- we need to make sure that the person delivering the goods has delivered the correct goods. Check the order and quality.

3) Correct storage of raw materials
- Storage of raw materials must be good especially if our goods are of high value that need specific storage requirements e.g. ice cream can’t be just dumped in a corner of a warehouse.

4) Proper controlling of inventory levels

Question 3

Why do we control inventory?

Answer 3

1) Holding inventory can be expensive
- We want to make sure we have enough stock at any given time without having too much.

2) Disruption of business
- We want to have enough so business does not get disrupted

3) Obsolete stock
- However too much inventory could lead to some stock becoming obsolete which Is a waste of money and an unn3ccessary expense

Question 4

Consequences of failing to control inventory

Answer 4

1) Incorrect materials being delivered
Very hard to return goods that you have signed for just because you weren’t bothered to see if they were the right goods in the right quality.

2) Incorrect prices being paid
You could have agreed a special price discount with your supplier but if no one controls it then no one makes sure that we are being charged the discounted price.

3) Insufficient quality control
Once again the goods are signed for and that makes them very hard to return because no one bothered to see if they were in decent quality

4) Invoiced amounts could differ in price/quality/quantity from what you actually ordered.

5) Insufficient inventory ordered
This could disrupt your production

6) Excess inventory could have been ordered
This could lead to obsolete stock.

Question 5

Objectives of good store keeping

Answer 5

1) Speedy issue and receipt of materials
- We need to know what we are short of in time so that a delivery can refill it so it doesn’t affect production.

2) Need to know the full identification of all materials at all times
3) Need to know the current location of all materials at all times
4) Need to protect your materials from theft and fire
5) Need to efficiently use your storage space
6) Maintenance of correct inventory levels.
8) Keep correct and up to date records of issues, receipts and inventory levels

Question 6

Why does a firm hold inventory

Answer 6

1) ensure that we have enough goods to meet demand-
2) Provide a safety buffer so production is not effected
3) Meet any future short term shortage of supply
4) Take advantage of bulk purchasing discounts
5) Absorb Seasonal fluctuations in usage/ demand
6) To allow the production process to run as smoothly as possible

Question 7

What are the costs in holding inventory?

Answer 7

1) The cost of storage and store operations
2) Interest charges (money caught up in inventory that could be used elsewhere)
3) Insurance costs
4) Risk of obsolescence and deterioration.

Question 8

Costs involved in holding low levels of inventory

Answer 8

1) Additional transport costs ( low levels therefore more delivery to refill to the low levels of inventory)
2) Additional administration costs. (same as above but more deliveries will result in more invoices etc)

3) Stock out costs
The effect of production stoppages to a firm.

Question 9

What is “Lead time”

Answer 9

Lead time is the time between ordering stock and replenishing your inventory. The longer the lead time the earlier you have to order to not affect production.

Question 10

What is “Economic order quantity”?

Answer 10

EOQ is the reorder quantity which minimizes the cost of ordering and storing.

Question 11

What is the formula for EOQ

Answer 11

the square root of (2OD)/ H

where:
O= order cost per order
D= demand per annum
H= Holding cost per item per anum

Question 12

What is the formula for reorder level

Answer 12

Reorder level = max usage x max lead time

Question 13

What is the formula for min level

Answer 13

Min level = Reorder level - (average usage x avg lead time)

Question 14

What is the formula for maxlevel

Answer 14

Max level = Reorder level + EOQ - (min usage + min lead time)

Question 15

Assumptions of EOQ

Answer 15

1) There is a known constant inventory holding cost
2) There is a known constant ordering cost
3) rate of demand for our product is known
4) Constant price per unit for our product
5) Replenishment of our product is instantaneously

Question 16

Difficulties with pricing materials/ inventory

Answer 16

1) Rapidly changing prices for the materials
2) Inventory is made up of many different deliveries all at different prices.
3) The sensitivity of profit calculations. Inventory impact your COS and therfore effects your GP figure.

Question 17

What are the different ways that you can value your inventory

Answer 17

1) FIFO
- Use the value of the EARLIEST unit received into inventory. The one you want to sell is the one that is longest in stock

2) LIFO
- use the value of the MOST RECENT unit received into inventory. Value your stock at the most recent price. This is not allowed under IAS 2 Inventory.

3) Weighted avg cost (AVCO)
- Use the AVG cost. i.e every time you get goods calculate a new avg cost

Question 18

What are the advantages and disadvantages of FIFO

Answer 18

Advantages
1) Good representation of sound store keeping whereby oldest items get issued first

2) Easy to understand and explain to everyone
3) Closing inventory is close to its current market value
4) It is an acceptable valuations technique by revenue and customs

Disadvantages
1) Cumbersome to operate as each delivery batch needs to be identified separately

2) Difficult to compare Jobs as costs of materials in the jobs will differ
3) If inflation is high then the cost of materials will be understated because you are taking an older price

Question 19

What are the advantages and disadvantages of LIFO

Answer 19

Advantages
1) Cost of materials used will be close to current market value.

2) Managers are aware of recent cost changes when making pricing decisions
3) Product prices will have the most current cost of materials

Disadvantages
1) Cumbersome to operate as each delivery batch needs to be identified separately

2) Difficult to compare Jobs as costs of materials in the jobs will differ
3) Difficult to explain to staff as it is the opposite of what is physically happening.
4) Not acceptable to Revenue or Customs

Question 20

What are the advantages and disadvantages of AVCO

Answer 20

Advantages:
1) Fluctuations in prices are smoothed out over the period which makes pricing decisions and job comparison easier.

2) Easier to administer as each batch doesn’t have to identified separately.
3) Acceptable by revenue and customs

Disadvantages:
1) the resulting cost of materials rarely reflect the true cost of materials in that job.

2) Product prices tend to lag behind current market values in times of inflation.

Question 21

Write a note concerning the EOQ outlining the type of costs included in the model and discuss the limitations.

Answer 21

EOQ incorporates the ordering costs and holding costs and calculates the quantity ordered which will minimise the total of the two costs. As the quantity ordered increases the ordering costs decrease but the holding costs increase so the optimal solution is a trade off between the two costs and occurs when the two costs are equal. The ordering costs would include the costs of the purchasing dept and the holding costs the cost of finance tied up in stock. Two limitations of the basic model are:

1) price remains constant
2) ignores bulk pricing discounts
3) assumes lead time is zero
4) purchases arrive immediately