ACCA Inventory Management Notes by PW

Topic

Key Points and Formula

Purpose of Holding Inventory

Inventory is held to ensure sufficient supply to meet customer demand and prevent production delays. Inventory management focuses on when to place the next order and how much quantity to order.

Purchase Cost

Price paid for inventory, including taxes and charges. PC = Units purchased × Unit purchase price.

Ordering Cost

Costs incurred when placing orders, including transport and administration. OC = Number of orders × Cost per order. Number of orders = Annual demand ÷ Order quantity.

Holding Cost

Costs of storing inventory, including storage, insurance and obsolescence. HC = Average inventory held × Holding cost per unit. Average inventory = OQ/2 + Buffer stock.

Stockout Cost

Costs that arise when inventory is unavailable, such as lost sales and emergency supplies.

Total Inventory Cost

The main inventory costs are combined as TC = PC + OC + HC.

Other Inventory Costs

Obsolescence reduces inventory value because it becomes irrelevant and can lead to write-offs. Deterioration reduces inventory value because of degradation and can also lead to write-offs. Buffer inventory, also called safety stock, helps with unexpected demand spikes or delivery delays.

Reorder Level

The inventory level at which a new order should be placed to prevent stockouts. ROL = (Maximum usage × Maximum lead time) + Buffer stock.

Maximum Inventory Level

Holding inventory above this level results in excessive holding costs. Maximum level = ROL + Reorder quantity − (Minimum usage × Minimum lead time).

Minimum Inventory Level

Inventory below this level carries a severe stockout risk. Minimum level = ROL − (Average usage × Average lead time).

Average Inventory Level

The inventory level falls between the maximum and minimum levels. Average inventory level = Buffer inventory + (Order quantity/2).

EOQ

Economic Order Quantity is the optimal order quantity that minimises total inventory costs by balancing ordering and holding costs. At EOQ, ordering cost = holding cost. EOQ = √(2 × C₀ × D / Cₕ).

EOQ Assumptions

Holding cost per unit is constant, and demand for the period is known and constant. Demand and costs should be expressed on a consistent time basis.

EOQ Related Calculations

Number of orders per year = Demand ÷ EOQ. Total ordering cost = (Demand ÷ EOQ) × C₀. Total holding cost = Average inventory × Cₕ.

EOQ With Discounts

Compare total costs at EOQ with total costs at the discounted order quantity. Consider purchase cost, ordering cost and holding cost before deciding whether the discount should be accepted.

EOQ vs EBQ

EOQ applies when the supplier delivers all goods ordered at the same time. EBQ applies when goods are delivered in parts or as a continuous stream of periodic deliveries.

EBQ

Economic Batch Quantity determines the optimal batch size by balancing machine set-up costs and holding costs. EBQ = √(2 × C₀ × D / [Cₕ × (1 − D/R)]).