Expound on the goals of inventory management. At the end of the chapter, Explain the traditional and modern techniques | Res you should be able to: management. Give examples of inventory ordering costs and carrying costs. Apply the principles and procedures in economic order quantity, optimum production quantity, ABC classification, re order point .model, order cycling ;system, two-bin system, and min-max system. Determine the costs of stockouts in relation to safety stock. * Discuss the concepts of just-in-time inventory system. Determine the optimal safety stock level. Scanned with |\CamScannerINVENTORY MANAGEMENT CHAPTER 18. 898 Inventory Management... A Great Challenge! Inventory management is directly linked to operating management the goal of which Is to provide the best service to customers! When a customer places an order, delivery must be done at the fastest possible time and at the lowest possible costs. Traditionally, companies maintain a large stock of inventories to meet the challenge of serving customers on time. However, under the strategic managerial framework, serving customers on time could be done by applying technology and redesigning the processes of production. A general comparison of these two practices are summarized below: * Table 18.1. Traditional and Strategic Inventory Management Models Objective Deliver sales on time atthe lowest Deliver sales on time at the most possible cost. reasonable price. Primary strategy | Maintain adequate inventory holdings of | Efficient scheduling of production process. x materials and finished goods. (Le, input, throughput output through the use of technology and linkages to I suppliers. Business environment f Production is laborintensive Production Is technology-oriented. Use of mechanical equipment and Use of electronic and mechanical machineries. ‘equipment and machineries. Productoriented: functional inneture __| Process-oriented. Emphasis on company-customer relations | Emphasis on suppler-company-castumer (forward approact). ° relations (integrated approach. Less investment in capital expenditures. | Heavy investments in capital expenditures. Generally. lesser cost of production in the } Generally, lower cost of doing business shoresun. Inthe longsun. Inventory models | Economic order quantity (EO) model | Justintime (JTT) Reorder point Flexible Manufacturing System (FMS) Order eycling method Computer Integrated Manufactoring (CIM) TwoBin system Materials Requirements Planning (MRP) Minmax model ‘Manufacturing Resource Planning (MRP) ABC classification Enterprise Resource Planning (ERP) Inventory management models change as the environment of business changes. But the core goal of inventory management remains the same, that is, ‘make the customer happy" by delivering accurate service on time. The traditional inventory management techniques Traditional inventory management techniques are based on old production processes that include purchase of materials, receipt of materials, materials warehousing, materials issuances to production, materials pre-production inspection, conversion processes, quality . inspection of units produced, finished goods warehousing, pre-shipment inspection and delivery to customers. Traditional inventory management focuses on’ warehousing functions. Materials are Basic comparison between traditional and modem ‘management models. ‘Scanned with |CamScanner899 INVENTORY MANAGEMENT CHAPTER 18 purchased and stored. Finished goods are putiin storage, as well. In this context, the traditional inventory models were developed, such as the economic order quantity (EO) model, the reorder point, the two-bin system, order cycling method, min-max method and the ABC classification. The reorder point method establishes the level of inventory on hand when an order is made. The order cycling method or cycle review methad establishes schedules of periodic or regular review of quantities of inventories (e.g, materials) on hand to determine the number of units to be ordered and bring the stock balance at a desired level. The review cycle time (e.g., 15 days, 30 days, 60 days, 90 days, etc.) varies among companies depending on the types of materials. High-value, critical items normally require a short review cycle. For low-value, noncritical items, the usual review cycle time is longer because the stockout costs is minimal and procurements are done in large quantities. » ‘The min-max method sets definable limits in inventory balances. Here, the minimum inventory level serves as the reorder point. Itincludes the normal quantity to be used from the time an order is placed up to the time the materials are received (i.e, lead time). The safety stock quantity to minimize the occurrence of stockout is also included. The maximum inventory level is the sum of stockout quantity and the order size. One of the practical techniques of min-max method is the two-bin system. Materials are stored in bins, piles, bundles or specific stocking area. Two bins are used; one bin contains ‘the quantities to be used from the date the materials are received up to the time an order isto be placed, and the other bin contains the quantities to be used during the waiting time (orlead “Twobinsystem _ time) and the safety stock. Once the first bin is consumed, the second bin is brought out to rediine system be used in the production process and an order fortwo (2) new bins is automatically placed. ‘The ABC model sorts inventories into three classes, A, B and C. Class "A" includes the high value, critical items; class “B' the middle-value items; and class "C* the low-value items. Relevant principles and [Link] regard to these inventory classes are summarized below. - Table 18.2. The ABC Inventory Model Inventory Class Money value high-value middle-value low-value Quality of control very strict nottoo strict strict = Inventory movement (flows) slow relatively fast fast Level of safety stock low moderate high Quality of personne! bestavailable average fair Quality of records error-free highly reliable reliable Replacement time ASAP normal can be long Inventory tumover low average high ‘ABC Model The ABC Inventory model Is related to the Pareto Law or the 80-20 rule. That Is, 80% of the Inventory value are concentrated in class "A", high-value inventory classification, and the remaining 20% are clustered in class "B" and class ‘C’ classifications. Or, it may also be 80% ey of the Inventory value are concentrated in class “8” andC*, and the remaining 20% In class'A’. Scanned wth G camscannerCHAPTER 18 INVENTORY MANAGEMENT : 900 The EOQ Model ‘The economic order quantity (E0Q) refers to the units of materials that should be purchased to minimize total relevant inventory costs. Total relevant inventory costs include the sum of qiczoG+ GG ordering costs and carrying costs. Total relevant inventory costs do not include the purchase price in analyzing the economic order quantity because the unit purchase price remains the same regardless of the order size the business place as an order. This ends up on the same total amount of purchases regardless of the order sizes to be placed. Ordering costs Total ordering costs include those spent in placing an order, waiting for an order, inspection Oc and receiving costs, setup costs and quantity discounts lost. The total ordering costsis taken from the historical records of the organization. Cost per order is total ordering costs divided by the number of orders made in a year or in a given buisness period. By understanding the relationships of these variables, consider the following expressions: Annual demand represents the annual need or requirements of the business. Order size — refers to the number of units or amount purchased per order batch. Sample Problem 18.1. Ordering Costs Big City Corporation expects to use 10,000 units of material XPO per month in 20CY. Last year, the total ordering costs amounted to P200,000 for a total of 40 orders. It is expected that prices in 20CY would be 10% higher than that of last year. Determine the expected cnet costs in 20CY if the company orders in a batch of 12,000 units or 24,000 units. Solutions/Discussions: “ + The annual demand is 120,000 units (i.e., 10,000 units x 12 months). “The expected cost per order in 20CY is-P5,500 (i.e., P200,000/40 orders x 110%). * — The'total ordering costs based on the 12,000-unit and 24,000-unit order sizes are: Order size 12.000 units ‘Annual demand (AD) 120.000 units weonoouts No. of orders (120,000/12,000) 10 * (120,000/24,000) 5 Cost per order (CPO) P5500 P5500 Total ordering costs (AD x CPO) ‘P55.000 27.500 » — itshould bé observed that the lower the number of orders means lower total ordering ‘costs. The higher the rlumber of orders, the higher the total ordering costs. Scanned wth G camscanner901 INVENTORY MANAGEMENT CHAPTER 18 Carrying costs Carrying costs are those spent in holding, maintaining or warehousing inventories such as warehousing and storage costs, handling and clerical costs, property taxes and insurance, deterioration and shrinkage of stocks, obsolescence of stocks, interest, and return on. investment (e.9,, lost return on investment tied up in inventory). Carrying costs per unit is total canying costs over the average number of units in a year or ina given business period. Also, carrying cost per unit equals cost per unit times the carrying cost ratio (CCR). The following expressions are developed by interrelating the variables of carrying costs: GO = Ave. Invty. X ecPu etry. = O87 Sample Problem 18.2. Total Carrying Costs In 20CY, Halcon Company incurred a total of P800,000 for inventory carrying costs with an average inventory of 200,000 units. What would be the total carrying costs in 20CY if the order size is 500,000 units or 900,000 units, assuming the| ‘company does not maintain safety ‘stock quantity. Solutions/Discussions: * The total carrying costs are determined as follows: Order sizes (given) 500,000 units 900,000 units. * Carrying cost per unit (P800,000/200,000 units) P. P ae Average inventory, in units (500,000 / 2) . 250, ocd (900,000 / 2) 450000 Total carying costs (CPU x Ave. inventory) 7.000000 - P1.go0.000 Average inventory - Average inventory is calculated by dividing the order size by 2 The average inventory is v computed using the simple average method, thatis, beginning balance plus ending balance ‘i divided by 2. The beginning balance is the order size and the ending balance is zero, ey because all of the units ordefed and received are assumed to have been evenly consumed. Hence, average inventory is (order size + 0 / 2) or simply (order size / 2). One important assumption s that the unt received wl be used evenythroughout the production period Scanned with |\CamScannerCHAPTER 18 INVENTORY MANAGEMENT 902 Sample Problem 18.3. Average Inventory - Graphical Method Chelsea Corporation buys Material 101 at the optimum level of 40,000 units. Its daily. consumption of Material 101 is 1,000 units. Materials are evenly used throughout the year. (1.) Show the graphical behavior of Material 101. (2.) Determine the average inventory balance for Material 101. Solutions/Discussions: 1. The 40,000 units will be used in 40 days (i.e., 40,000 units / 1,000 units a day) 2. The graphical presentation as to the use of material 101 is depicted as follows: Fig. 18.1 Graphical Representation of Inventory Balances Units Order Size 40, 000 20,000 Days 0 20 40 60 80 + The next batch of order is expected to arrive on the 40th day before the last unit of + the preceding order is consumed. This explains the vertical increase of the inventory level to 40,000 units on the 40th day. These new units shall be used in the next 40 days, that is, from 41st day to the 80th day, and the cycle goes on. + Essentially, average inventory is beginning inventory divided by 2. Inasmuch as the beginning inventory equals the order size, average inventory is order size divided by 2. Economic order quantity Economic order quantity is the point where the total ordering cost equals the total carrying cost. Also, at this point the total inventory cost is at its minimum. Scanned with |\CamScanner903 INVENTORY MANAGEMENT “CHAPTER 18 Hf, at E0Q.. ‘Computing for the E0Q (order size), we have: Toc = Tec ‘ os? = (2x ADXGPO Then, we could express that: ccPU CPOXNo. of orders = — CCPUX Ave. inventory os = /Zx ADK CPO ccPU, CPO x (AD / 0S) = CCPUx(0S/2) ‘Simplifying the equation, we have: CPOxAD = CPU xOS os = “OS?*xCCPU = 2xADxCPO where:TOC = Total Ordering Cost PO. = Cost Per Order TCC Total Carrying Cost OS = Order Size CCPU = CarryingCostperUnit | AD = AnnualDemand £0Q = Economie Order Quantity ‘[Link] 18.4 - Basic E0Q Assume an annual requirement of 24,000 units, a cost per unit of P20, a cost per order of P750 and a carrying cost percentage of 20%. Applying the formula to these data, the EOQ is faa ee ee 4 Ba | We say. at £00, ordering costs = carrying costs, j Toprve weave: £00 (pesos) = /2-x Pav0.000 x B750 20% | TOC (8 times xP750) P 6,000 | Tee (3,000/2 x P4) foe | =/penooo | Total relevant inventory costs Bazo00 hae ne _ ey ac hoes ean The number of orders is 8 times (., 24,000 units / 3,000 units). The unit cost of inventory is not a relevant cost in the analysis because it remains the same regardless of whether the business buys based on the economic order quantity or not. £0Q (units) = 2x 24000 x P750 i P4 Sample Problem 18.5 ~ Behavior of Ordering Costs and Carrying Costs To further our study of the behavior of ordering costs and carrying costs, let us again assume an annual requirement of 24,000 units, a cost per unit of P20, a cost per order of P750 and a carrying cost percentage of 20%. Considering order sizes of 1,200, 1,500, 2,000, 3,000. 4,000, 6,000, 12,000 and 24,000, determine the total ordering costs and total carrying costs. ‘Scanned with |CamScannerCHAPTER 18 INVENTORY MANAGEMENT 904 ‘The tabulated analysis of the economic oder quantity is as follows: Total ‘Total Carrying Total ‘Total Order [Link] Costper Ordering Average costs per Carrying inventory [1200 20 P750 P15000 600 P4 P2400 P17,400 \1500 16 750 12,000 750 4 3,000 15,000 |2000 12 750 9,000 1,000 4 4000 _ 13,000 3,000 8 7506000 1,500" "4 6,000 12,000 —Eoo TOC = TeC)_| |4000 6 750 4,500 2,000. 4 8,000 12,500 |6000 4 750 3000 3,000 4 12000 15,000 12,0002 750 1,500 6,000 4 249000 25,500 24,0001 750 750 12,000 4 48,000 48,750 No. of orders, = Annual demand / Order size Total ordering costs No. of orders x Cost per order Average inventory Order size /2 ‘At3,000 units, total ordering costs and total carrying costs are equal. As order sizes increase, total ordering costs decrease while total carrying costs increase. The total inventory costs initially decline until the economic order quantity (i.e; optimum level) is reached; and beyond the optimal level the total relevant inventory costs go up. The behavior of ordering costs (OC), carrying costs (CC), and total relevant inventory costs (TRIC) are graphically presented below. Order | Ordering] Carrying Size__| Costs Costs Increases | Decreases| Increases Decreases| Increases| Decreases Variable quantity discounts Fixed quantity discount generally does not affect EQ. However, the E0Q is affected by the Variability of quantity discounts as it reduces the net cost of materials from one order size to another. Originally, at OQ level the sum of ordering costs equals the sum of carrying Costs. With the effects of variable quantity discount, the unit cost changes and becomes a relevant cost in computing the total relevant inventory costs. With variable quantity discount, £00 is at a level where the sum of ordering costs, carrying costs and costs of materials is at the minimum. anned with |CamScanner905 INVENTORY MANAGEMENT CHAPTER 18 ‘Sample Problem 18.6 ~ E0Q with Variable Quantity Discount Let's assume the same data in Sample Problem 18.4: annual demand, 24,000 units; cost per unit, P20, cost per order, P750; carrying cost percentage, 20%; and carrying cost per unit, P4, Additionally, quantity discounts are given by a supplier as follows: Order size Quantity discount Order Size Quantity discount 24,000 10% 6000 3% 12,000 6 2,400 2 8.000 4 1,000 4 The economic order quantity would be the order size that gives the lowest total inventory cost that now includes the ordering costs, carrying costs, and net materials purchase costs. No. of orders (Annual demand / order size) 1 2 3 4 10 15 a. Invoice price per unit P20 Pi Pe CP P20 P 2 'b. Quantity discount 10% 6% a 3% 2% 1% €. Discount price per unit 2. 120 8 60. a 20 4. Net invoice price per unit (2) 18 1880. 1920. 19401960 19.80 Cost per order 750, 750 750 750 750 750 [Link] size 24000 2900] 8000.» 6000-2400 1,600 9. Average inventory in units (08/2) 12000° 6000-4000 3000 1,200 800 [Link] cost pe uit 4 4 4 4 4 4 UTotalorderng costs (no. ofordersx"e") 75015002250 3000780011280 |. Total canrying costs (Ave. invty.x CCPU)’ 48,000 24000 1600012000 ©4800 «-3.200 Net mat. purchases costs (24000 x's") 432000 451200 460800 465600 470400 475200 Total inventory costs (i+ +4) ‘480750 (276700) 479050 480500 482,700 489,650 Notice that the economic order quantity is 12,000 units. It is where the total inventory costs is at the lowest (e.g., P476,700). This EOQ is different from the previous computed EOQ of 3,000 without quantity discount (refer to Sample Problem no. 18.5 on page 903. Buying in larger quantities generates savings in freight charges. This reduces unit costs and increases the economic order quantity level. Trade discount and E0Q We have established at E0Q, the total relevant-inventory cost (TRIC) is at the minimum. A deviation from EQQ level would mean an increase in TRIC. However, if a benefit (e.g., suppliers discount) causes to deviate from E0Q, then the benefit derived from the discount would be compared with the incremental costs of deviating from the E00 level. ‘Sample Problem 18.7 - Trade Discount and E0Q ‘Assume the following data. Annual need, 50,000 units; unit cost of materials, P80; carrying cost percentage, 20%; cost per order, P90. A company’s supplier has offered a 2% trade discount if purchases are made on a quarterly basis. How much is the change in the total relevant inventory cost if purchases are made on a quarterly basis? Should the company buy on a quarterly basis and avail of the 3% trade discount? Scanned wth G camscannerCHAPTER 18 INVENTORY MANAGEMENT 906 Solutions/Discussions: + Let us determine first the economic order size. Then, compute the total relevant inventory costs based on the economic order quantity and on quarterly purchases. Let us also evaluate the relevant costs of inventory between the E0Q level and the quarterly level. Finally, let us determine which alternative ((.e., EQ or quarterly) is more profitable. 2.x 50,000 units x P90 = Z50 units \ P16 Total relevant inventory costs: EOQ £00 level Quarterly level. Ordering costs (§0,000/750xP90) -P_ 6,000 P 360 (4orders x P90) Carrying costs (750/2 x.P16) ——6,000 100,000 (12,5000/2 x 16)* Total relevant inventory costs P.12,000 100,360 Savings (P100,360 - P12,000) 288360 *Under the quarterly basis, the order size would be 12,500 (Le., 50,000 units / 4). Savings from the 3% trade discount (50,000 x P80 x 3%) P 120,000 Increase in relevant inventory costs if purchases are made quarterly’ __88,360 Net advantage of buying in quarterly basis, B_ais4o Deviations from the EOQ level would increase total inventory costs. Itis advantageous for the business to leave the E0Q level provided that the gains offered by the other alternative is greater than the incremental costs in inventory. The Economic Production Run (EPR) or Economic Production Quantity (EPQ), Economic production run, or "economic production quantity’, “optimum production tun’, “optimum lot size’, refers to the size of production where the total costs of materials will be at the minimum. The EOQ formula can be used in determining the optimum production run. In this case the cost per order is substituted by the setup costs and the unit cost of materials purchases is substituted by the variable cost of production. To illustrate, let us assume the annual materials needed is 40,000 units, the set up costs per production is P625, the variable manufacturing cost is P20, and the carrying costs ratio is 10%. The economic production run is computed as follows. Scanned wth G camscanner907 INVENTORY MANAGEMENT CCPU = P20 x 10% = B2 = [2 X 40,000 units x P625 To prove : Setup costs (40,000/5,000 x P625) P 5,000) 5.000 units Carrying costs (5,000/2 x P2) Total relevant inventory costs The optimum production run is where the sum of setup costs and carrying costs is the same. The unit variable manufacturing costs is not a relevant cost in the onsets of optimum production run. E0Q with “back orders” Aback order is a sale made when the items not in stock. If back orders are inventory can be maintained at lower levels. Hence, EOQ is modified for the ¢ of back orders. The effect of the modification is to increase the E0Q beca denominator decreases. The EOQ will now be computed as follows: — Reorder point ( ROP) refers to the i inventoi placed. Reorder point is ee sum of leedt CHAPTER 18 Scanned with |\CamScannerCHAPTER 18 INVENTORY MANAGEMENT 908 Safety stock is set to serve as a margin th case of variations in normal usage and normal lead time. Hence, there is a safety stock for variation in usage and a safety stock for variations in time. The maximum inventory level is the sum of the safety stock quantity and the order size. The minimum quantity is the safety stock quantity. Sample Problem 18.8 — Reorder Point. Pangalaan Corporation has the following production data: Annual requirement 40,000 units Number of working days 320 days Normal lead time 10 days Maximum lead time 16 days Maximum usage 150. units Economic order quantity 5,000 units ? Determine the lead time quantity, safety stock quantities, reorder point and maximum inventory levels. Solutions/Discussions: + The normal daily usage is 125 units computed as 40,000 units divided by 320 days. + ROP is determined as follows: \TQ_ = Normal usage x Normal leadtime = 125 units x 10 days = 1,250 units SSQ = SSQ(inusage) +.SSQ (intime) = 250 units +750 units = 1.000 units ROP = LTQ + SSQ 2.250 units [$$ (inusage) = (150 units ~ 125 unt ys SSQ (intime) = (16 days ~ 10 days) x 125units = + Maximum inventory level = SSQ + OS = 1,000units + 5,000 units = 6,000 units 1,000 units (SSQ) + The graphical representations of the lead time quantity, safety stock quantity, reorder point, and maximum inventory level are shown in Fig. 18.1. + Minimum inventory level aad ith G camscanner909 INVENTORY MANAGEMENT CHAPTER 18 Fig. 18.1. Reorder Point, Lead Time Quantity, and Safety Stock Quantity Units” 10,000 9000 +} 8000 -F Max. Inwty. level 7000 +} 6,000 5,000 4000 3,000 0 11900 ; peepee nage 10 20 30 40 50 60 70 80 90 100 110 120 Optimal Safety Stock Quantity ‘Optimal safety stock quantity is the level where the cost of the safety stock is at the lowest. ‘The cost of the safety stock consists of the carrying cost (CC) and the expected value on stockout costs (EVOSOC). ‘otal stockout costs = Costs of carrying SSQ + Expected value of stockout costs ccs = SSQ x Carrying cost per unit Evosoc = Stockout cost per annum x Probability of stockout Stockout cost per annum = Stockout cost per occurrence x No. of occurrences per year Stockout cost occurrence = Stockout units x Stockout cost per unit Stockout costs Inadequate inventory levels carried by a business have the following costs: Extra purchasing, handling and transportation costs,» > Lost sales and lost of customer goodwill. Additional clerical costs due to keeping of customer-back order records Inflation-oriented increases in prices when inventory purchases are deferred. Frequent stock-outs leading to disruptions of production schedules, overtime, and extra setup time. 7 + Higher price due to small quantities (e.g., extra purchasing on transportation costs). + Foregone suppliers’ discounts. Scanned wth G camscannerCHAPTER 18 INVENTORY MANAGEMENT 910 The costs associated with the Inadequate level of inventory are substantial. Efforts are to bemade to reduce this cost. One of those that greatly contribute to the costs of inadequate inventory is the cost of stockouts. Itincludes the opportunity cost of lost sales, lost customer goodwill, disruptions of production schedules, overtime, increase in set up costs, and higher price due to smalll quantities. Hf normal lead time and normal usage are used in determining the order point, a stockout can be expected on every other order. Reducing stockout occurrences have direct relations with the level of safety stock. The higher the safety stock quantity, the lower the possibility of ‘stockout, and vice-versa. Stockout has two costs, the carrying costs (CC) of safety stock and the expected value of the stockout cots (EVOSOC). The cost of carrying the safety stock is, ‘safety stock quantity times the carrying cost per unit. The EVOSOC is stockout per occurrence times the number of occurrences times the probability of occurrence. These are expressed mathematically as: SSQCosts = CC+EVOSOC Cc = SsQxCCPU EVOSOC = SOCPA x Probabily of stockout occurence EVOSOC = SOCPO x No. of occurrences) x Probability of stockout occurrence EVOSOC = [(SOCPU x Stockout units) x No. of occurrences] x Probability of occurrence where: safety stock quantity carrying costs expected value of stockout costs = stockout coSt per annum = sockout cost per occurrence SOCPU = stockout cost per unit If stockout occurs and production cannot be shifted to another product, production stops. Inthis case, set-up costs increase and the cost of stockout increases by the length of time the facility is shutdown. Sample Problem 18.9. Stockout Costs Toillustrate, assume a Samal Company uses an inventory where it places 12 orders per year, the cost of the stockout is P200 per occurrence, the carrying cost per unit is P2 per year, and the probabilities of stockouts have been estimated for various levels of safety stock as follows: Safety stock Probability of Safety stock Probability of (in units) ‘Stockout (in units) ‘Stockout 0 ‘i 60% 400 20% 100 50 600 10 200 40 Determine the optimal safety stock level. Scanned wth G camscanneron INVENTORY MANAGEMENT CHAPTER 18 Solutions/Discussions: + The total stockout costs is the sum of cost of carrying safety stock quantity and the EVvosoc. ‘ | Total | stock ssa SOCPA Probability EVOSOC SSQCosts | ‘0 @xr2) Po P2400 = ORR 1440 | y00 (iooxP2) = 2002400 50% 1200 1,400 | 200 0x2) 4002400 a0K 96D 1360 | 400 (400xP2) 800-2400 20% eo 1.200[_=oPTIMALSSQ | | 600 (600xP2) 1,200 2,400 10% 240 1,440 | costof earyng ssa = $80 x Caring cost per unit Le, P2) | Expected annual stockout = No. of orders per year (.e.,12) x Probability of occurrence | Evosoc = Expected stockout per year x Stockout cost per occurence (i.e, P200) Total stockout costs . Cost of carrying SSQ + EVOSOC Stockout per annum = P2021? = P2400 t a ees sa i + The analysis above shows the optimum level of safety stock at 400 units. It has the lowest total stockout costs. + Incase stockout cost per occurrence is not given, it is determined as follows: ‘Stockout cost per occurrence = Stockout cost per unit x Stockout units. The Modern Inventory Management Model Modem strategies and techniques of managing inventories depend on efficient scheduling of production processes from the source of materials to the place of customers. These * strategies are developed on account of enormous contributions of technology. Databases of ‘suppliers, company, and customers could now be shared on time and each other's needs could be filled out without waiting for an order. This is done through electronic data interchange (ED). Other applications ofthe marvels of electronic revolution are astonishingly evident in production processes. Letus reveal this important paradigm (:.e., mental) shift by revisiting the traditional, labor and mechanicat-based production processes. Traditionally the following activities are done in an effort to make a sale to customers. Materials requisition is made and approved, a purchase order is approved and sent to suppliers, supplier confirms the order, materials are delivered, inspection is made on received merchandise, materials are transferred, materials storage and warehousing, materials issuances to production, pre-production, inspection, actual materials conversion process, post-production, inspection, goods are transfered to finished goods warehouse, goods are transferred to shipping department, pre-shipment inspections, and, finally, delivery to customers. By identifying the production-conversion activities in an integrated process, we can present the process analysis as shown on Fig. 18.2. Inthe value-added process analysis (or process reengineering) the end goal is to reduce the ‘Scanned withCHAPTER 18 "INVENTORY MANAGEMENT 912 process time (i.e., manufacturing cycle time) spent before a sale is delivered to customers. The time spent in activities are identified as wait time, move time, process time, and inspection time. In relation to this, process activities are also classified as either value-added activities ornon-value-added activities. Value-added activities should be retained and non-value-added activities must be eliminated. The classification matrix is summarized on the next page: Rona ae ee Se a 4 | Value-added time Non value-added activities | | Process time Wait time I I Inspection time I Dette ots ech ee MMe ea Waiting time is idle time. Inspection occurs when there is something doubtful in the processes which should be identified and corrected. Move time consumed in transporting goods from one point to another within the production premises signifies scheduling inefficiencies. Errors should be prevented at source. Fig. 18.2 Production-conversion process mapping/analysis ‘Suppliers Company Processes ~ Customers materials requisition : order copfirmation ~<— purchase order/purchase invoice delivery of materials —> ir move to materials warehouse storage production issuance slip move to production inspection materials conversion finished goods inspection move to finished goods warehouse Z sales issuance slip move to shipping room pre-shipment inspection delivery to custbmers —> — receipt of delivery After eliminating all non-value-added activities, the new delivery cycle process would appear as presented below: Fig. 18.3 Value-added production process analysis Suppliers Company Customers delivery of materials —» conversion (production)process | delivety to dustomers .——» _ receiptodelvary [tins "EWaACMA-Ued | | vaaangi | anned with |CamScannera3 INVENTORY MANAGEMENT CHAPTER 18 ‘Note that the production process is shortened significantly. Deliveries could be made on time, products could be of superior quality and thus customers are happier. This is done by instituting quality environment in an integrated manufacturing process using the best strategies, systems, and standards such as: + Selecting and dealing with reliable suppliers. + Online sharing of inventory and production databases online among suppliers, the company, and customers (¢.g., application of electronic data interchange, P2P MRP1, MRP Il, ERP etc.). Equipment maintenance program: Effective and continuous personnel training. ‘Application of statistical quality control techniques Periodic review and testing processes Open and effective customer services programs + Alot of listening from customers Because of these conditions, the following inventory management models are now in practice: Just-inctiie (JIT) Computer-Integrated Manufacturing (CIM) Materials Requirements Planning (MRP) Manufacturing Resource Planning (MRP-II) Enterprise Resource Planning P2P system JIT inventory system The just-in-time inventory model is anchored on the premise that materials should be received just-in-time they are needed for production, and finished goods are completed just-in-time ‘they are needed by customers. A quality principle states, “the best warehouse is a clean warehouse’. This principle aims to eventually eliminate warehousing and reduce costs of inventory holding. The fundamental objective of JIT is to produce and deliver what is needed, when it is needed, at all stages of the production process [Link]-time to be fabricated, assembled and shipped tothe customer. It forces strong quality relationships between the supplier, the company and its customers, It speeds up delivery to customers at the best possible production quaiity and productivity. The benefits of JIT includes lower inventory level, faster response time, higher ‘output per input (say, per employee), and fewer floor space requirements. JIT is a “pull system’, inventories are pulled through production by current demand, not pushed through by anticipated demand. Plant layout in a JIT production is not designed by functional department process but by “manufacturing cells”. Cells are group of machines, often grouped in semicircles, that produce a given product or product type. Each worker in ‘acell must be able to operate all machines, and probably, to perform support tasks such as set-up activities, preventive maintenance, movement of work-In-process within the cell, and quality inspection. Manufacturing cycle time and setup time are reduced. Central support [CSUANDREW| Scanned wth G camscannerCHAPTER 18 INVENTORY MANAGEMENT 914 departments are reduced or eliminated, space Is saved, fewer and smaller factories may be required, and materials and tools are brought close to the point of use. As a result, on time delivery performance and response to markets are improved, and production of customized goods in small lots become possible. In a manufacturing cell set-up, teamwork is paramount. Personnel must be continuously trained, given more participation in the production process, and are more empowered. The practice of flexible manufacturing system (FMS) is applied. Consequently, organizations operate “leaner and meaner” (i.e, lean production). One of the elements of JIT system is the use of “kanban’. Itis a Japanese term which means. ticket (.e., cards or markers). “A basic kanban system includes a withdrawal kanban that states the quantity that a succeeding process shall withdraw; a production kanban that states the output of the present process; and vendor kanban that tells a vendor what, how much, when and where to deliver. The use of tickets is not popular among western countries but the advantages of the kanban system are incorporated in the design of a computerized manufacturing system. ‘The cost accounting technique used in the JIT inventory system Is backflush costing. Inasmuch as the quality of production process is ensured and the manufacturing cycle time Is minimized, the cost of materials and labor are charged (i.e., backflushed) at the end of, the process when goods are alréady sold or completed. When errors are expected during the production process, direct materials and indirect materials are combined in an account *Raw-and-in-Process”. This account is adjusted to the cost of goods sold (if the trigger point is the point of sale) or to the finished goods inventory account (if the trigger point is the point of production). If the trigger point is the point of sale, the direct labor and overhead are charged directly to Cost of goods sold. If the trigger point is the point of production, the direct labor and overhead are charged directly to finished goods inventory account. There are no materials subsidiary records maintained and inventories are determined based on the physical count made at the end of the period, aad ith G camscanner15 INVENTORY MANAGEMENT CHAPTER 18 STRAIGHT PROBLEMS 1. Benefits of efficiency in inventory management. To reduce production start-up costs, Marlen Corporation may manufacture longer runs of the same track. Estimated savings from the increase in efficiency are P260,000 per year. However, inventory turnover will decrease from eight times'a year to six times a year. Costs of goods sold are P48 million on an annual basis. Required: If the required rate of return on investment in inventories is 15%, should the ‘company implement the new production plan? 2. Economic order quantity. Lito Corporation has been buying product A in lots of 1,200 units which represents a four month's supply. The cost per unit is 220. The order cost is P200 per order; and the annual inventory carrying cost per one unit is P25. Assume that the units will be required evenly throughout the yeer. Required: Calculate the following: 1. Economic order quantity. ‘2. Number of orders in a year. 3. Average inventory based on economic order quantity. 4. Total carrying cost, ordering costs, and relevant inventory costs at economic order quantity. 3. E0Qtabularanalysis, E0Q graphs. Mel Corporationbuysacertainpartofitsmanufacturing process for P20 part. Sixteen thousand parts a year are needed. It costs P3 a year to carry one of these parts in inventory. The cost of placing a purchase order for these parts is P15. Assume that the parts will be tequired evenly throughout the year. Resa Compute the economic order quantity. 2 Prepare a tabular analysis to compute the total relevant inventory costs assuming the following order sizes: 6400 units, 1,600 units, 400 units, 200 units, and 100 Units. The table should have the féllowing columns: order size, number of orders, cost per order, total ordering costs, average inventory, carrying cost per unit, total cairying costs, and total relevant inventory costs (where “total relevant inventory costs = total ordering costs and total carrying costs). 3. Graph the behavior of the ordering costs, carrying costs and total relevant inventory costs. Based on the graph, identify the economic order quantity. 4. Economic production quantity. Pabs Corporation needs 40,000 units of MaterialXC. ina year. The average carrying cost per unit of material is P5 and the set-up cost per production run is P40, The units are used evenly throughout the period. Required: Calculate the following: 1. Economic production run. 2. Number of production set-ups in a year. 3. Average inventory based on economic production quantity. 4. Total set-up cost, carrying cost and relevant inventory costs at economic production quantity. ‘Scanned with |CamScannerCHAI 5. F PTER 18 INVENTORY MANAGEMENT 916 Economic order quantity. Treat each of the cases below independently. Units are used evenly during the period.» Kiss Corporation buys baseballs with the following relevant data: Purchase price per unit P 20 Cost per purchase order P10 Annual baseballs requirement 36,000 units Desired return on investment 10% Rent, insurance, taxes, etc. P 0.40 Determine the economic order quantity. 2. Ruel V. Company manufactures bookcases. Set-up costs are P2.00. Mercury manufactures 4,000 bookcases evenly throughout the year. Using the economic ‘order quantity approach, the optimal production run would be 2,000 bookcases, Determine the cost of carrying one bookcase. 3 “Manila Company manufactures dolls. The cost of carrying one doll in inventory for one year is P0.60. Manila manufactures 6,000 dolls evenly throughout the year. (Using the economic order quantity approach, the optimal production run would be 200. What is the set-up cost per production run? 4. Acompany uses 10,000 units of a product per year at a unit cost of P1.00. The cost per order is P25 and carrying cost is 12 %% of average inventory. How many units must be placed each year? 5. Acompany incurred a cost of P200 per order for the trucking, delivery and relevant clerical cost, and annual carrying cost of 20% af average inventory. Monthly usage at cost amount to P3,000. What is the economic order to be placed each year? 6. The Magic Corporation has determined through an analysis of accounting data that 6. the manufacturing cost per order of a raw material is P30. The company expects to use P60,000 of this materials in the coming year. Its carrying charge is 10% of inventory. How many times should the raw material be ordered in the coming year? ‘Tranx Corporation uses 400 units per year of Material X, Constant production levels. ate maintained throughout the year. Material X costs P5 per unit. The cost of placing an orderis P8, and carrying costs are estimated at 20% of average inventory. Compute the economic:order quantity. Reorder point, lead time quantity, safety stock quantity. Treat each of the cases below independently. : 1. The following information is available for Butgong Company's Material AG-190: Annual usage 10,000 units Working days per year 250 days Normal lead time in working days 30 days Maximum lead time in working days 70 days ‘Scanned with |CamScanner917 INVENTORY MANAGEMENT CHAPTER 18 Required: Compute the following: 1. Lead time quantity. 2. Safety stock quantity. 3. Reorder point. 2. Free Style Corporation makes available the following information relative to its Material GR-111. ‘Annual demand 30,000 units Working days in a year 300 days Normal lead time 12 days Maximum lead time 19 days Maximum usage perworking day 125units. Economic order size 6000 units Required: Calculate the following: Lead time quantity. Safety stock quantity. Reorder point. ‘Average inventory. Shello Company sells 60,000 units of product Y annually. Sales are fairly uniform throughout the year. Normal lead time for the item is 10 days. Assume 300 working days during the year, what is the lead time usage? 4, The Bird Corporation, your client, wants to determine the reorder point for product C. Normal lead time for this product is 600 units, and a saféty stock of 300 units is required. What is the reorder point? 5. The Mouse Company uses about 10,00 units of material Z during a 250-day production year, Maximum and minimum usages are 55 and 25 units per days, Tespectively. Normal ead timeis 20 days from the date a purchases initiated. ‘Compute the minimum reorder point of material Z. ° yeeros Safety stock and reorder point. The followinginformation relates to Crown Corporation's _ material TEP: Annual usage in units 7,200 Working days per year 240 Normal lead time in working days 20 Maximum lead time in working days 45 Assuming that the units of material willbe required evenly throughout the year, determine the safety stock and order point. Economic order quantity. Volcano Company is a distributor of air filters to retail stores. Itbuysits filters from several manufacturers. Filters are ordered in lot sizes of 1,000 and each order costs P40 to place. Demand from retail stores is 20,000 filters per month and carrying cost is P0.10 a filter per month. ‘Scanned with |CamScannerCHAPTER 18 INVENTORY MANAGEMENT 918 Required: 1. What is the optimal order quantity with respect to so many lot sizes? 2. What would be the optimal order quantity if the carrying cost were PO.05 a filter per month? 3. What would be the optimal order quantity if ordering costs were P10? 9. Eeonomicorder quantity with constant quantity discount. Hello Corporation orders 50,000 units of products a year. Its average carrying cost per unit is P4 and its cost per order is P2.50. Determine the economic order quantity assuming a supplier is giving Hello a: 1. 5% cash discount on merchandise purchases. 2. 5% volume discount on merchandise purchases. 10. Economic order quantity, variable quantity discount. Yame Company buys 4,000 units of product Regs per year. It pays P10 per order and carries its inventory at P2 per unit per annum. Yame buys product Regs at P20 per unit. A supplier is offering Yame the following quantity discount: Order size (units) Quantity discount 4,000 10% 2,000 - 3; rh 1,000- 1 5 500- 4 200- 3 100- Z 1. nil Required: 1. Compute the total relevant inventory costs under each of the following orders sizes: 2,000 units; 1,000 units; 500 units; 250 units; and 125 units. Which order size gives the lowest inventory costs. 2. Whatis the effect of variable quantity discount in determining the economic order quantity. 11. Cost effects of deviation from economic order quantity. The Moonshine Corporation currently purchases its raw materials at economic order level. The materials costis P50 er unit and the company carries its average inventory at 10% per unit cost. It incurs cost per order at P30 and uses 67,500 raw materials annually. Its supplier has offered 2% discount on all purchases if the company buys on a quarterly basis. Required: 1. Compute the economic order quantity. 2. Determine the net savings if Moonshine Corporation accepts the Supplier's offer to buy on a quarterly basis. 12. Economic order quantity and cash discount. Sprit Company purchases 100,000 boxes of a product every 60 days. A company study estimated order costs for this inventory item is P250 per order and carrying costs of 80 cents per box. aad ith G camscanner919 INVENTORY MANAGEMENT CHAPTER 18 Required: 1. Estimate the optimal reorder point. _ 2. The supplier gives Sprit a trade discount of 5 centavos per box for purchases of 13. 20,000 box lots or more. Should this order volume be adopted by Sprit Company? Ordering and carrying costs, OQ, quantity discount. George Company buys 500 boxes of items X-100 every two months. Order costs are P380 per order, carrying costs are P1 per unit and vary directly with inventory investment. Currently, the company purchases the item for P5 each. Required: 1. Determine the total ordering and carrying costs under current policy. 2. Determine the economic order quantity and the related ordering and carrying costs. 3. .Whatis the optimal order size if the supplier offers a 5% discount for orders of 3,000 units? (cga-Canada) Optimum safety stock. The Starr Company distributes a wide range of electrical products. One of its best-selling items is a standard electric motor. The management of Starr Company uses the economic-order-quantity (E0Q) decision model to determine the optimum number of motors to order. Management now wants to determine how much safety stock to hold. Starr Company estimates annual demand (300 working days) to be 30,000 electric motors. Using the E0Q decision model, the company orders 3,000 motors at a time. The lead time for an order is five days. The annual carrying Costs of one motor in safety stock are P10. Management has also estimated that the stockout costs are P20 for each motor they are short. Starr Company has analyzed the demand during 200 past reorder points. The records indicate the following patterns: Demand during Number of time lead time quantity was demanded 440 6 460 2 480 “16 500 130 520 20 A 540 10 560 _6 200 Required: 1. Determine the level of safety stock for electric motors that Starr Company should ‘maintain in order to minimize expected stockout costs and carrying costs. When ‘computing carrying costs, assume that the safety stock is on hand at all times and that there is no overstocking caused by decreasesin expected demand. (Consider safety stock levels at 0, 20, 40, and 60 units.) What would be Starr Company's new reorder point? What factors should Starr Company have considered in estimating the stockout costs? (cma) en ‘Scanned with |CamScannerCHAPTER 18 INVENTORY MANAGEMENT 920 15. Economic order quantity. Compute the economic order quantity for each of the independent cases below. Round all answers to the nearest whole numbers. 1. Stevens, Inc, has an annual usage of 100 units of item M, having a purchase price of P55 per unit. The following data are applicable to Item M: Ordering cost P 5 per order , “Carrying cost percentage 15% 2. Lee equipment company estimates a need for 2,250 units of Anlox next yearat a cost of P3 per unit. The estimated carrying cost is 20%, and the cost to place an order is P12. 3. Tunnel Corporation has been buying product Ain lots of 1,200 units, which represents a four-month supply. The cost per unit is P100; the order cost is P200 per order; and the annual inventory carrying cost for one unit is P25. (aicpa) 16. Safety stock, reorder point. Cheng Cheng Company's usage of Material Ais 9,600 units during 240 working days per year. Normal lead time and maximum lead time are 20 working days and 30 working days, respectively. Assuming Material A will be required evenly throughout the year, what is the safety stock and order point? (icpa) > 17. Order point. Pilot Company has obtained the following costs and other data pertaining to one of its materials: Order quantity 3,500 units Normal use per day 500 units Maximum use per day 600 units Minimum use per day 100 units Lead time S days Required: Compute the following: 1.” Safety stock (maximum). 2. Order point. 3. Normal maximum inventory. 4. Absolute maximum inventory. (cga-Canada) 18. Order point. The James Company is setting up an inventory control system. For one type of material, the following data have beeri assembled: Order quantity 3,000 units Minimum use per day 80 units Normal use per day 120 units Maximum use per day 200 units Lead time ‘ 12 days Required: Compute the following: 1. Safety stock (maximum). 2. Order point. . 3. Normal maximum inventory. - 4, Absolute maximum inventory. (cga-Canada) ‘Scanned with |CamScanner921 INVENTORY MANAGEMENT CHAPTER 18 19, Safety stock. Sunny Company would like to determine the safety stock it needs to maintain for a product, to incur the lowest contribution of stockout cost and carrying cost. Each stockout costs P75; the carrying cost for each safety stock unit is P1; the product is ordered five times a year. The following probabilities of running out of stock during an order period are associated with various safety stock levels: Safety Probability Stock Level of Stockout 10 units 40% 20 20 40 8 80 4 Required: Determine the combined stockout and safety stock carrying cost associated with each level and the recommended level of safety stock. ‘(aigpa) 20. £0Q, safety stock. Sarap Company sells a number of products to many restaurants in the area. One product is a special meat cutter with a disposable blade. Blades are sold ina package of 12 at P20 per package. Ithas been determined that the demand for the replacement blades is at a constant rate of 2,000 packages per month. The packages cost the company P10 each from the manufacturer and require a three-day lead time from date of order to date of delivery. The ordering cost is P1:20 per order, and the carrying cost is 10% per year. The company uses the economic order quantity formula. Required: 1. Compute the economic order quantity 2. Compute the number of orders needed per year. 3. Compute the cost of ordering and carrying blades for the year. 4. Determine the number of days until the next order should be placed, assuming that there is no safety stock and that the present inventory level is 400 packages. (360 days = 1 year) 5. Discuss the difficulties that most firms have in attempting to apply the EOQ formula to their inventory problems. (icra) 21. Order point, inventory levels. Pow Company has developed the following figures to assist in controlling one of its inventory items: Minimum daily use 150 units Normal daily use 200 units Maximum daily use 230 units Working days per year 250 Lead time in working days 10 Safety stock 300 units Cost of placing an order P 80 Order quantity 4,000 units Required: Compute the following: 1. Order point. ‘ Normal maximum inventory. Absolute maximum inventory. Assuming demand is uniform and the EOQ formula is applicable, determine the cost of storing one unit for one year. (cga-Canada) een ‘Scanned with |CamScannerCHAPTER 18 INVENTORY MANAGEMENT 922 22. 23. Safety stock. For Product 6F, ordered five times per year, stockout cost per occurrence is P80 and safety stock carrying cost is 3 per unit. Available options are: Units of Probability of running safety stock out of safety stock 10 50% 20 40 30 30 40 20 50 10 55, i 3 Required: Compute the safety stock resulting in the lowest cost. (aicpa) E0Q, safety stock: Tomas Perez, general manager for TP Desk Company, is exasperated because its finished goods inventory of Style 103-Modern Desk twice during the previous month. This led to customer complaints and disrupted the normal flow of operations. “We ought to be able to plan better” declared Perez during a presentation of this findings tomanagement. “Our annual sales demand is 18,000 units for this model or an average of 75 desks per day based upon our 240-day work year. Unfortunately, the sales pattern is not this uniform. Our daily demand for that model varies considerably. If we do not have units on hand when a customer places an order, 35% of the time we lose the sale, 40% of the time we pay ar-extra charge of P24 per unit to expedite shipping when the unit becomes available, and 25% of the time the customer accepts a back order at no out-of-pocket cost to us. A lost sale reduces the contribution to profit by P60.” Perez displayed the following chart, showing the weighted average (sometimes called expected value) cost of a stockout on a given day” 75 desks per day x P60 x 35% P 1,575 75 desks per day x P24 x 40% 720 Back order (no out-of-pocket costs) x 25% 0 ‘Stockout cost P 2,295 “When we run-out of unit he continued, “we cannot convert the production line immediately, because we disrupt the production of our other products and cause cost increases. The setup process for this model on any stockout day inevitably results in the destruction of 12 finished desks, leading no salvageable materials. Once we get the line up, we can produce 200 units per day. | would prefer to have several planned runs of a predetermined, uniform quantity rather than the short unplanned runs we have often used to meet unfilled customer orders.” : The manager of the Cost Accounting Department suggested that they use an EOQ model todetermine optimum production runs and then establish a safety stock to guard against stockouts. The cost data for the Modern Desk that sells for P110 are taken from the accounting records as follows: Direct materials P 30.00 Direct labor (2 DLH @ P7.00) 14,00 Factory overhead: Variable (2 DLH @ P3.00) 6.00 Fixed (2 DLH @ P5.00) 10,00 Total manufacturing cost Bso.00 anned with |CamScanner923 INVENTORY MANAGEMENT CHAPTER 18 The Cost Accounting Department estimates thatthe company's carryingcostsare 19.2% of the incremental out-of-pocket manufacturing costs. This percentage can be broken down into a 10.8% variable rate and an 8.4% fixed rate. Requlred: TP Desk Company believes that it can solve part of its production scheduling problems by adapting the EOQ model to determine the optimum production run. a, Explain what costs the company will be attempting to minimize when it adapts the EOQ model to production runs. b. Using the EOQ model, calculate the optimum quantity that TP Desk Company should manufacture in each production run of Style 103-Modern Desk. ¢. Calculate the number of production runs of Modern Desk the TP Desk Company should schedule during the year based on the optimum quantity calculated in requirement 1b. 2, TP Desk Company should establisha safety stock levelto guard against stockouts. a. Explain the factors that affect the desired size of the safety stock for any inventory item. b. Calculate the minimum safety stock level that TP Desk Company could afford to maintain for Style 103-Modern Desk and not be worse off than it is unable to fill orders equal to an average day's demand. (icma) 24. Production batch size, E0Q, Clyde Peterson, general manager for Adam Furniture Company, is upset because the company exhausted its finished goods inventory of style 103-Modern Desk twice during the previous month. These stockouts lead to customer complaints and disrupted the normal flow of operations. “We should plan better’, declared Peterson. “[Link] sales demand 18,000 units for this model or an average of 75 desks per day based upon our 240-day work year. Unfortunately, the sales pattern is not uniform. Our daily demand on that model varies considerably. When we run out of units, we cannot convert immediately because we would disrupt the production of our the products and cause costs increases. The setup process for this model costs P60.’ Once we get the line up, we can produce +200 units per day, { would prefer to have several planned runs of a uniform quantity rather than short unplanned runs often required to meet unfilled customer orders.” ‘The manager of the Cost Accounting Department has suggested that an E0Q model be adopted to determine optimal production runs and then a safety stock established to guard against stockouts. The cost data for the Modern Desk, which sells for P110.00, is readily available from the accounting records. The manufacturing costs follow. Direct materials 30.00 Direct manufacturing labor (| direct manufacturing labor hour ~ DMLH x P14.00) 14.00 Variable manufacturing overhead (1 DMLH x P6.00) 6.00 Fixed manufacturing overhead (1 DMLH x Pr.) 10.00 Total manufacturing costs ps0.00 The Cost Accounting Department estimates that the companys carrying costs are the E0Q per year of the incremental cash manufacturing costs. anned with |CamScannerCHAPTER 18 INVENTORY MANAGEMENT 924 Required 1. Explain which costs the company would be attempting to balance if it adopted the E0Q model for its production runs, 2. Calculate Adam's optimal quantity for each production run of Style 103-Modem Desk. 3. Calculate the number of production runs of Modern Desks that Adam Furniture Company would schedule during the year on the basis of the optimal quantity calculated in requirement 2. (cma)925 INVENTORY MANAGEMENT CHAPTER 18 MULTIPLE CHOICE Basic concepts 1. Napier Company's budgeted sales and budgeted cost of sales for the coming year are P126 rillion and P72 million, respectively. Short-term interest rates are expected to average 10 %. If Napier can:increase inventofy turnover from its current level of nine times per year to a level of 12 times per year, its cost saving in the coming year are expected to be. a. 150,000 c. P350,000 b. P200,000 d. 600,000 (ema) 2. Blonde Company's budgeted sales and budgeted cost of sales for the coming year are 14.4 million and P9 million, respectively. Short-term interest fates are expected to average 15%. if the [Link] increase inventory turnover from its present level of nine times a year to a level times a year, its cost savings in the coming year would be a. 60,000 cc. P90,000 b. 67,500 d. P37,500 (rpcpa) 3. Inassessing the loan value of inventory, a banker will normally be concerned about tne portion of inventory that is work-n-process because a. WIP inventorys relatively easy to sell because it does notrepresent araw materials ora finished product. WIP inventory usually has the highest loan value of the different inventory types. WIP generally has the lowest marketability of the various types of inventories. WIP represents a lower investments by a corporation as opposed to other types of, inventories. (rpepa) aes 4, A&BCo!s financial plan for next year shows sales of P72 million and cost of sales of P45 million. It expects short-term interest rates to average 10% for the coming year. It aims to increase inventory turnover from the present level of 9 times to 12 times next year. If its plans and objectives would be carried out, how much is the cost savings for the coming year? a. P125,000 c. P375,000 b. P300,000 d. P500,000 (rpepa) 5. Order-filling costs, as opposed to order-getting costs, include all but which of the following items? a. Credit check of new customs. b. Packing and shipping of sales order. c.. Collection of payments for sales order. d. Mailing catalogs to current customer. (cma) aad ith G camscannerCHAPTER 18 INVENTORY MANAGEMENT 926 6. The control of order filling costs. a. Can be accomplished through the use of flexible budget standards. b._ Isrelated to pricing decisions, sales promotions, and customer reaction. c. Is not crucial because the costs are typically fixed and not subject to frequent changes. d. Is not crucial because the costs order-filling routine is entrenched and external influences are minimal. (re) 7. Which of the following will not affect the budgeting of order-filling costs. a. Market research and test. c. Policies and action of competitors. b. Location of distribution warehouses. d. Sales promotion policies. (re) 8. The carrying costs and associated with inventory management include Insurance cost, shipping costs, storage costs, and obsolescence. Storage costs, handling costs, interest on capital invested, and obsolescence. Purchasing cost, shipping costs, set up costs, and quantity discount lost. Obsolescence set up costs, interest on capital invested, and purchasing costs order cost. (ra) 9. . The order costs associated with inventory management include. a. Insurance cost, purchasing costs, shipping costs, and obsolescence. b. Obsolescence, set up costs, quantity discounts lost, and storage costs. : c. Quantity discounts lost, storage costs, handling costs, and interest on capital invested, d. Purchasing costs, shipping costs, setup costs, and quantity discounts lost (cma) eese 10. With regards to inventory management, an increase in the frequency of ordering will normally? a. Reduce the total cost b, Have no impact on ordering costs. c. Reduce the total carrying costs. 4. Have no impact of total carrying costs. (cia) 11. The production department of amanufacturing company has been plaguedwithexcessive number of defective units of standards machine parts that are purchased from vendors. ona regular basis. The most relevant quantitative management technique for designing a formal inspection system for incoming parts is: a. Economic order quantity models. c. Statistical quality control. b. Regression analysis. d. Standard cost variance analysis. (rpcpa) E0Q Mode! 12. Jeff Company sells 20,000 radios evenly throughout the year. The cost of carrying one Unit of inventory for one year is P8, and the purchase order cost per order is P32. What is the economic order quantity? a: 200 283 b. 400 d. 625 (rpcpa) canned with G camscanner927 INVENTORY MANAGEMENT CHAPTER 18 13. Red Company sells 10,000 RTW pants evenly throughout the year. The cost of carrying ‘one unit in inventory for one year is P6.00 and the purchase cost is P108.00 per order. What is the economic order quantity? a, 468 ce. 1,208 b. 600 d. none of these (rpepa) 14. The following data relate to inventories for a given year of Cloud Company: Economic order quantity 7,500 units Cost to place one purchase order P75 Total cost to place purchase orders for the year * P15,000 Cost to carry one unit for one year P6 The estimated annual usage in units would be a. 2,250,000 1,250,000 b. 2,000,000 d. 5,625,000 “(pepa) 15. State whether the following statements are true or false. Statement 1- The two main types of inventory cost relevantto inventory decision making are cartying casts and ordering costs. Statement 2 - The optimal ordering quantity in the EOQ model occurs at the point where the sum of the carrying costs and ordering costs are minimized. Statement? © Statement 2 a False True b. True - False c False False d. True True (rpcpa) 16. Ininventory management, theproblem of avoiding excessiveinvestmentininventoriesand at the same time avoiding inventory shortages can be solved by applying a quantitative technique known as a. Payback analysis. b. Probability analysis. cc. Economic order quantity model d. - Hightow point method. (rpepa) 17. The carrying cost pertaining to inventory include: a. _ Insurance costs, incoming freight costs and storage costs. b. Insurance costs, incoming freight costs and setup costs. cc. Setup costs and opportunity cost of capital invested in inventory. d. Storage costs and opportunity cost of capital invested in inventory. (rpcpa) 18. The order size determined by the economic order quantity formulaminimizesthe annual inventory cost which is comprised of ordering costs and a. Safety stock cost. ¢. Stockout cost. : b. Carrying cost. d. Noanswer. (rpepa) anned with |CamScannerCHAPTER 18 INVENTORY MANAGEMENT 928 19. You computed the economic order quantity of the main raw material of Moonlight Co,, at 10,000 units. However, the chief purchasing officer decided to order in quantities of 12,000 units. What is the probable effect of this decision on the companys annual purchase order cost compared with those amounts had the order been made at the economic order quantity? a. Lower purchase order cost and higher carrying cost. b. Lower purchase order cost and lower carrying cost. c. Higher purchase order cost and lower carrying cost. d. Higher purchase order cost and higher carrying cost. (spcpa) 20. In the Economic Order Quantity (E0Q) model, some of the underlying assumptions are: a. Unlimited production capacity, declining demand, decreasing ordering cost, decreasing carrying cost, and unlimited inventory capacity. b. Constant demand, constant ordering cost, constant carrying cost, unlimited production and inventory capacity. c. Limited production capacity, declining demand, constant ordering cost, constant carrying cost, and unlimited inventory capacity. d. Increasing demand, limited production capacity, increasing ordering cost, increasing carrying cost, and limited inventory capacity. (rpepa) 21: Missile Company has correctly computed its economic order quantity at 500 units. However, management feels it would rather order in quantities of 600 units. How should Missile’s total annual purchase-order costs and total annual carrying cost for an order quantity of 600 units comparetotherespective amounts for an order quantity of 500 units? Lower purchase-order cost and lower carrying cost. Higher purchase-order cost and higher carrying cost. Lower purchase-order cost and higher carrying cost. Higher purchase order cost and lower carrying cost. . (tpepa) aeoo 22.. Economic order quantity models and two-bin system are commonly used controls fora company's materials function. Those controls primarily relate to what part of the cycle? a. Materials requirements. c. Physical storage. b. | Raw Materials acceptance. d. Product distribution. (cia) 23. The selling price of the product is relatively high and the purchase cost of the product is relatively low. In this situation: a. Management must increase the price to cover the cost of carrying higher inventory. b. The E0Q model will indicate frequent larger orders. ¢. The E0Q of the product is affected by the selling price. d. The selling price has nothing to do with the EOQ of the product. (rpcpa) 24. A decrease in inventory cost will a. Increase the reorder point. b. Decrease the economic order quantity. cc. Have no effect on the economic order quantity. d. Decrease the holding cost percentage. (rpcpa) anned with |CamScanner929 INVENTORY MANAGEMENT CHAPTER 18 25. An increase in inventory holding costs will a. Haveno effect on the economic order quantity. b. Increase the economic order quantity c. Decrease the number of orders issued per year. d. Decrease the economic order quantity. (tpepa) 26. If one optimizes the inventory turnover ratio, which costs will not increase? a. Total reorder costs. c. Unit reorder costs. b. Stockout costs. d. Carrying costs. (rpcpa) 27. In computing the economic order quantity (EO), which of the following costs should be included? a. The shipping cost to deliver the products to the customer. b. Capital cost. ¢. Purchasing staff's salaries. d. Expected value analysis. (rpcpa) 28. Softdrinks Distributor which buys ina pre-sellbasisis discussing with theroute salesmen onthe proper cases tobe ordered and the frequency of call. Fromtheroute book and other records, the following are available: prior year's purchases, 50,000 cases; carrying cost per case of inventory, P1.20; distributor's discount, 1 case for every 10 cases bought, cost of placing an order, P3.00; weekly demand is approx. 952 cases. Safety stock required is 140 cases. No change in demand is expected this year. (Use a 365-day, 52 week year). Determine the economic order quantity (EOQ), and the reorder point assuming a two- day lead time, a. E0Qis 482 cases; reorder point is 500 cases. b. EOQis 500 cases; reorder point is 414 cases. ©. E0Qis 962 cases; reorder point is 275 cases. d. E0Qis 250 cases; reorder point is 280 cases. (rpcpa) 29. One of the products of Nature Health Products sells is a magnetic back support. The ordering costs related to this product is P12.50 per order. The cost of carrying one item of inventory for one year is P16.00. The business sells 40,000 of this type of product evenly throughout the year. How much is the total ordering costs per year and total carrying costs per year at the economic order quantity? Ordering costs Carrying costs a —_-P1,562.50 1,562.50 b. 1,562.50 2,560.00 c. _P2,000.00. - 2,000.00 d.- " P4000.00 4,000.00 (rpcpa) 30. Marlita works for a local ceramic company. She just completed her accountancy degree and learned the E0Q model in one of her subjects. She suggested toher employer to adopt. it. The company sells 20,000 pieces of specialty ceramic items each year. Traditionally they have produced these items four times a year, making 5,000 pieces at a time. They carry no safety stock as customers do not mind waiting for orders. The average piece of ceramic items cost P400 to make and costs the company P20 to carry in inventory for a year. The set up costs for each production run total P80. The company should anned with |CamScannerCHAPTER 18 aeoce INVENTORY MANAGEMENT 930 Adopt E0Q due to savings of P35,675. Continue the existing system due to P38,950 advantage. Adopt EOQ due to savings of P42,320. Continue the existing system due to P41,820 advantage. (rpcpa) 31. Rodentstock, Inc. currently places orders for a particular stockitem at quarterly intervals. Information concerning this items is a8 follows: Cost of placing an order Annual demand Purchasing price pr unit P10 20,000 units *P0.50 What annual cost saving would result if Rodenstock used the economic order quantity for order sizes instead of their current policy? a. P80 b. P90 32, The following information are given /d. p240 c. PISO (rpcpa) Optimal production run in units 2,000 Average inventory in units 7,000 Number of production runs ' 5 Cost per unit production P75 Desired annual return on inventory investment 18% Set-up cost per production run 5,000 Ifthe units will required evenly throughout the year, the total annual relevant costs using the economic-order-quantity approach is: a. P5000 ce. b. P75,000 a. 38,500 Ps0,000 (rpepa) The next two questions are based on the following information: Based on an EOQ analysis (assuming a constant demand), the optimal order quantity is 2,500. The company desires a safety stock of 500 units. A S-day lead time is needed for delivery. Annual inventory carrying costs equal 25% of the average inventory level. The company pays P4 per unit to buy the product, which it sells for P8. The company pays P150 to place a detailed order, and the monthly demand for the product is 4,000 units. 33, Annual inventory carrying costs equal a P 750 © P1,750 b. P1250 d.- P2,250 (cia) 34. Total inventory order per year equal a. P1,250 cc. P2880 b. P2400 d. 3,600 (cia) ‘Scanned with |CamScanner931 INVENTORY MANAGEMENT CHAPTER 18 35, The purpose of the economic order quantity model is to a. Minimize the safety stock. 'b. Minimize the sum of the order costs and the holding costs. c. Minimize the inventory quantities d. Minimize the sum of the demand costs and the backlog costs. (cia) 36. Theeconomic order quantity (E0Q) formula canbe adapted in order for afirmtodetermine the optimal mix between cash and marketable Securities. The EOQ model assumes all of the following except that a. The cost of a transaction is independent of the dollar amount of the transaction and interest rates are constant over the short run. b. Anopportunity cost is associated with holding cash, beginning with the first pesos. ¢. The total demand for cash is known with certainty. d_ Cash flow requirements are random (cma) 37. Which of the following is used in determining the economic order quantity (EQ)? a. Regression analysis. : ¢. Markov process. b. Calculus. d. Queuing Theory. (cia) 38, The economic order quantity (E0Q) formula assumes that a. Purchase costs per unit differ because of quantity discounts. b. Costs of placing an order vary with quantity order. c. Periodic demand for the good is known. d. Erratic usage rates are cushioned by safety stocks. (aicpa) 39. The following graph shows four cost curves: + An annual inventory carrying cost curve, + Anannual order cost curve. + Anannual inventory total cost curve. + Afixed curve with respect to order quantity. Cost Units Which of the curves is the annual inventory carrying cost curve? a. Curve. A c, Curve3. b. Curve 2. d. Curve 4, (cia) ‘Scanned with |CamScanner933 INVENTORY MANAGEMENT CHAPTER 18 46. The economic order quantity (EOQ) will rise following a. Adecrease in annual unit sales. b. ‘Amincrease in carrying costs. ¢. Anjincrease in the per-unit purchased price of inventory. d. Anincrease in the variable costs of placing and receiving an order, (cia) 47. One of the elements included in the economic order quantity (OQ) formula is a. Safety stock. c. Selling price of item. b. Yearly demand. d. Lead time for delivery. (cia) 48. Which one of the following items is not directly reflected in the basic economic order quantity (E0Q) model? a. Interest on invested capital. b. Public warehouse rental charges. c. Setup costs of manufacturing runs. d. Quantity discounts lost on inventory purchases. (ema) 49. Given the EOQ model below, the optimal order quantity is a Qi ce. Q3 b. a2 : dag (cia) 50. A ski manufacturing company dates invoices seasonally so that skis delivered in September will bear an invoice due date for the following February. As a result of using this method, the manufacturer's inventory carrying costs are (lower,higher, constant) and, the buyer is extended to a (shorter; longer) credit period than would otherwise be true. a. Lower, longer. ¢. Lower, shorter. b. ‘Higher, longer. d. Higher, shorter. (cla) 51. The economic order quantity is the size of the order that minimizes total inventory costs, including ordering and carrying costs. If the annual demand decreases by 36%, ‘the optimal order size will a. Decrease by 20%. c. Increase by 6%. b. ‘Increase by 20%. d. Decrease by 6%. (cla) Scanned wth G camscannerCHAPTER 18 INVENTORY MANAGEMENT 934 Reorder point 52. 53. 55. 56. 57. Thinking Co. sells 200 units of discs per week. Purchase order lead time is 3 weeks and the economic order quantity is 450 units. What is the reorder point? a. 425 units c 600 units . b. 1,750 units y d. 2,250 units (rpcpa) M&LCo. has the following information on inventory: Sales 20,000 units per year Order quantity 4,000 units * Safety stock 2,600 units Lead time 4 weeks What is the re-order point? (for calculation purposes, usé 50-week year) a, 42000 units cc. 2,600 units : b. 5,600 units d. 1,600 units (rpcpa) Discs Unlimited sells 200 discs per week. Purchase order lead timé averages three weeks. Based on most updated calculation, the economic order quantity is 450 units, The reorder point is a. 600 discs. c. 1,750 discs. b. 425discs. d. 2250 discs. (rpcpa) Huron Corporation purchases 60,000 headbands per year. The average purchase lead time is 20 working days, safety stock equals 7 days:normal usage, and the corporation works 240 days per year. Huron should reorder headbands when the quantity in inventory reaches a. §,000units. ce 1,750units. b- 6,750 units. d. 5,250 units (cma) China Sea Store sells 100,000 tea bags a year. Additional data are presented below: Selling price per bag P2.50 Purchase cost per bag : P1.50 Ordering cost P5.40 per order Carrying cost 20% of unit cost Number of days the company operates in a year 250 Average lead time on purchases 6 days What is the reorder point if the company will keep a safety stock of inventory? a. 2,400 bags. c. 6,400 bags. b. 5,400 bags. d. 8,800 bags. (rpcpa) For inventory management, ignoring safety stocks, which of the following is a valid computation of the reorder point? a... The economic order quantity. b. The economic order quantity times the anticipated demand during lead time. cc. The anticipated demand per day during lead time times lead time in days. d. The square root of the anticipated demand during the lead time. (aicpa) ‘Scanned with |CamScanner935 INVENTORY MANAGEMENT CHAPTER 18 58. The elapsed time between placing an order for inventory and receiving the order is. a. Lead time. c. Stockout time. b. Reorder time. d. Stocking time. (cma) 59. What are the three factors a manager should consider in controlling stockouts? a. Carrying costs, quality costs, and physical inventories. 4 b. Economic order quantity, annual demand, and quality costs. c. Time needed for delivery, rate of inventory usage, and safety stock. d. Economic order quantity, production bottlenecks, and safety stock. (cia) 60. For inventory management, ignoring safety stock, the valid computation of the reorder point is a. Economic order quantity. b. £0Q multiplied by the expected demand during lead time. c. Anticipated demand during lead time. 4 ‘Square root of the anticipated demand during lead time. (rpcpa), Safety stock 61. The cost of stock-out does not include a. Depreciation and obsolescence. c. Loss of sales. b. Loss of customer goodwill. d. Disruption of production schedules. (mpcpa) 62. When a specific level of stock is carried for an item in inventory, the average inventory level for that item . a. Isnot affected by the safety stock. b. Increase by the amount of the safety stock. c._ Increase by the one-half the amount of the safety stock. d. Decrease by the amount of the safety stock. (rpepa) 63. Fora 300-day work year Kulasa Corp. consumes 420,000 units of an inventory item. The usual lead-time for the inventory item is six (6) days; however, at times, the lead time has gone high as eight (8) days. Kulasa now desires to adjust its safety stock policy. The = likely effect on stockout costs and carrying costs, respectively, would be a. Increase and decrease. . . Increase and increase. b. Decrease and decrease. d. Decrease and increase. (tpepa) 64. Each stockout of Product AX sold by Axiom Inc. costs P87,500 per occurrence. The * earring cost per unit of inventory is P250 per year, and the company orders 1,500 units of product 24 times a year at a cost of P5,000 per order. The probability of stockout at various levels of safety stock is Units of safety stock Probability of stockout 0 50 100 30. 200 14 300 05 400 01 ‘Scanned with |CamScanner937 n. 74. INVENTORY MANAGEMENT CHAPTER 18 Units of Probability Safety Stock of a stockout 0 50 100 30 200 4 300 05 400 01 The optimal safety level for the company is a. Ounits. c.. 300 units. b. 100units. dd. [Link]. (ema) Handy operated a chain of hardware stores across Laguna. The controller wants to determine the optimum safety stock levels for an air purifier unit. The inventory manager ‘compiled the following data. + The annual carrying cost of inventory approximates 20% of the investment in inventory. + The inventory investment per unit averages P50. The stockout cost is estimated to be PS per unit. The company orders inventory on the average of 10 times per year. Total cost = carrying cost + expected stockout cost, The probabilities of a stockout per order cycle with varying levels of safety stock are as follows: Safety Stock Units Stockout Probability 0 0% 100 100 15% 0 200 12% The total cost of safety stock on an annual basis with a safety stock level of 100 units is a. P1750 | P 550 b. P1950 a. 2,000 (cma) ‘Amold Enterprises uses the EOQ model forinventory control. The company has anannual demand of P50,000 units for part number 191 and has computed an optimal lot size of 6,250 units, Per-unit carrying costs and stackout costs are P13 and P3, respectively. The following data have been gathered in an attemptto determine an appropriate safety stock level: Units Short Because of Number of Times Short Excess Demand during inthe Last 40 The Lead Time Period Reorder Cycle y 200 6 300 12 400 6 The annual cost of establishing a 200-unit safety stock is expected to be a. P2600 . c. P4260 b. P4,040 ? d. P5,200 . | ia) Scanned wth G camscannercl HAPTER 18 INVENTORY MANAGEMENT 940 86. The company uses a planning sys finished goods demanded and Meena mes aid boned davand (or aa thei components, and subassemblies at each of the pr cee a Themen eormponen e) prior stages of production. This system a. Economic order quantity. b. Materials requirements planning. c. Linear programming. d. Just-in-time purchasing. (cia) 87. Increased competition, technological innovation, anda shift from mi ie d : s standardized products to custorproduced products in many a nated theneed for productivity improvements and {flexibility of production systems. Inresponse to these demands, organizations have increased their reliance on ‘automation and the use of advanced technologies in their operations. ‘Which of the following is an example of the use of automation and advanced technologies? a. Flexible manufacturing ‘system (FMS) b. Just-in-time (JIT) system. Master budgeting system (MBS). : Economic order quantity (EQ). (cia) syed that economics of ‘scale gained through ducts are the best way to keep production 'e most appropriate response to whether 88, Traditionally, large manufacturers have belie Jarge production runs of lke, or similar, pro costs down and remain competitive. Select th this theory is stil valid. a... Yes, larger economics of scale continue te ‘accrue from ever larger production runs B. Yes, lower-per-unit costs for standard products ‘continue to guarantee a competitive advantage. cc. No; economics of scal d._ No, production flexi competitive. Je can no longer be gained from long production fans. ibility and diversity of products are needed to remain (cia) 9, ‘The benefits of a just-in-time system for 1a materials usually include. 2 Elimination of nonvalue-adding operations ithe [Link] in the number of supplier ‘thereby ensuring competitive bidding ©. Maximization of the standard delivery quantity, thereby lessening the Pa for each delivery. d. Decrease in the number perwork of deliveries required to maintain production. (2icpa) 90. Companies that adopt just-in-time purchasing system often experience 2. A reduction in the number of supplier. b, Fewer deliveries from suppliers. RS ae ¢. Agreater need for inspection of goods as the 9 ; d, Less needs for linkage with a vendor's computerized ‘order entry system. (cma) & i i -inctime philosophy. ditional manufacturer philosophy 19 just-in-time phil fe Ball inventory turnover and inventory ‘of this change on 91. Bell Co. changed froma ‘on Bell's balance sheet? What are the expected effects as a percentage of total assets reported anned with |CamScanner941 92. 93. 94, 95, INVENTORY MANAGEMENT CHAPTER 18 Inventory Inventory Turnover Percentage a, Decrease Decrease b. Decrease Increase c. Increase Decrease ; d. Increase Increase (cicpe) Which changes in costs are most conducive to switching from a traditional inventory ordering system to a just-time ordering system? Cost per Inventory Unit Purchase Order Carrying Cost a. Increasing Increasing b. Decreasing Increasing c. Decreasing Decreasing d. Increasing Decreasing (aicpa) In Belk Co’s just-in-time production system costs per setup were reduced from P28 to P2. In the process of reducing inventory levels, Belk found that there were fixed facility and administration costs that previously had not been included in the carrying cost calculation. The result was an increase from P8 to P32 per unit per year. What were the effects of these changes on Elk's economic lot size and relevant costs? LotSize Relevant Costs: a. Decrease Increase, b. Increase Decrease i c. Increase Increased. d. Decrease Decrease (aicpa) ‘A manufacturing company is attempting to implement a just-in-time (JIT) purchase policy system by négotiating with its primary suppliers to accept long-term purchase orders which result in more frequent deliveries of smaller quantities of raw materials. {f the JIT purchase policy is successful in reducing the total inventory costs of the manufacturing company, which of the following combinations of cost changes would be most likely to occur? : Cost Category Cost Category to increase to decrease a. Purchasing costs Stockout costs b. Purchasing costs Quality costs ©. Quality costs Ordering costs d. Stockout costs Carrying costs (cia) Key Co, iti 9 cones sane vom 8 traditional manufacturing operation with a job-order-costing Just inctime operation with a back flush costing system. What is (are) ‘Scanned with |CamScanner