STOCK CONTROL

Inventory refers to stock of raw material, work in progress or finished goods.

NEEDS FOR INVENTORY

1. Transaction motive i.e. to meet daily operational needs.

2. Economic reasons i.e. to save on inventory cost example bulky purchases may result in quantity
discount.
3. Seasonal factors – Seasonal items are stocked when available.
4. Precautionary motive i.e. to avoid running out of stocks by having safety stock.

OBJECTIVES OF INVETORY CONTROL

1. To avoid stock out – Understocking leads to stock out of materials leading to shortages of
materials or stocks, which makes the customers lose confidence hence the goodwill of the entity
is affected.
2. To avoid overstocking – overstocking ties up capital in the business hence leading to high
storage costs which affects the operations of the organization.
3. To minimize the ordering costs – It aims at reducing all the costs associated with making an
order to supply materials or stocks items.
4. Economy in purchasing – it aims in taking advantage of quantity discounts which minimizes the
costs of goods.
5. It minimizes wastage – Losses of material occur due to evaporation, fraud etc. therefore efforts
should be made to keep these losses at a minimum level.

REQUIREMENTS OF A GOOD MATERIALS / STOCK CONTROL SYSTEM

I. There should be proper coordination between various departments dealing with materials or
stocks.
II. There should be central purchasing department under the control of an efficient and competent
purchasing manager.
III. There should be proper classification and codification of stocks or materials items.
IV. Adequate records should be introduced to control materials and stock items during production
and the supply of the finished goods.
V. The storage of raw materials should be well coordinated subject to control measures.
VI. Various stock levels like minimum, maximum should be fixed for each stock / material items.
VII. The purchase of materials should be controlled through a budget.

STOCK LIMITS LEVELS

Re-order level - It is the point, which it is necessary to make a requisition for the supply of materials. It is
calculated as:

Re – order level = maximum consumption X maximum re – order period.

Minimum stock level – It is a level below which stock should not be allowed to fall. If stocks goes below
this point, there is likelihood of stock out.

Minimum stock level = Re-order level – (Normal/Average consumption x Normal Re-order period)

Maximum stock Level – It is the level above which stock should not be allowed to rise if stock goes
beyond this level; there is a likelihood of high management costs.

Maximum Stock level = Re – order level + Re-order quantity – (minimum consumption x minimum re-
order period)

Average Stock level = Minimum stock level + maximum stock level

INVETORY RELATED COSTS

1. ORDERING COST – This refers to the cost incurred in getting an item into the firm’s stores. These
costs are incurred each time an order is placed and include:
a) Cost of preparing a purchase requisition.
b) Cost of issuing the purchase order.
c) Cost of inspecting inventory items to be purchased.
d) Communication costs e.g. telephone, fax, e-mails.
e) Freight charges including insurance of goods in transit.
f) Clearing charges.
2. PURCHASE COST – This refers to the amount that is paid to the suppliers of the stock items.
3. HOLDING/CARRYING COST – These are costs incurred because the firm has decided to maintain
inventory items in the store. Holding cost includes:
a) Opportunity cost of capital used to purchase the stock items e.g. interest foregone.
b) Rent of storage space or the opportunity cost.
c) Protection costs such security systems costs, insurance premium etc.
4. STOCK OUT OR SHORTAGE COST - This is the cost associated with either a delay in meeting the
customers demand or inability to meet the demand. Stock out cost include:
a) Lost contribution.
b) Loss goodwill and loss of customers.
c) Cost of idle staff.
d) Back order cost. i.e. Cost of dealing with disappointed customer etc.
Total inventory ordering cost = purchase cost + Holding cost + ordering cost + stock out cost

ECONOMIC ORDER QUANTITY (EOQ)

The EOQ is the quantity which when ordered would lead to minimum inventory costs.

CHARACTERISTICS OF EOQ MODEL

1. It deals with a single stock item.

 2. It deals with a durable stock item.
3. Merchandizing firms use it.
BASIC ASSUMPTION OF EOQ MODEL
1) Annual demand is constant and known in advance with certainty.
2) Lead-time is constant and known in advance with certainty.
3) There are no stock outs
4) Purchase cost per unit remains constant i.e. there are no quantity discount.
5) Ordering cost per order remains constant irrespective of the size.
6) Holding cost per unit remains constant.
7) Replenishment of items is instantaneous.

DERIVATION OF EOQ MODEL

Total cost

COST
Holding
cost
Total cost
minimum cost

Ordering Cost

EOQ UNITS

Cost is minimized where: Holding cost = ordering cost

Holding cost = Average stock x holding cost per unit (Ch.)

= Q/2 x Ch.
Ordering cost = number of orders x cost per order (co)
Number of orders = Annual demand (D)
Quantity ordered (Q)
Ordering cost = D co
Q
 2𝐷𝐶𝑜
EOQ (Q) = √{ }
𝐶𝐻
WHERE:
D= Annual demand
Co= ordering cost per order
CH = Holding cost per unit
C = purchase cost per unit
Illustration
Demand for parts DP648 used by kings limited is constant at annual rate of 4000uits. The cost
per unit of the part is Sh. 200. The cost of placing an order is sh. 5000. Kings Ltd estimate that
the annual inventory carrying cost expressed as a percentage of cost per unit is 20%.
Required: Determine the best inventory policy for part DP648 assume a lead-time of 10days and
the company works 300days per annum.

Inventory policy variable

1. EOQ.
2. Number of orders.
3. Re-order level.
4. Frequency of orders.
5. Total inventory cost.
2𝐷𝐶𝑜
1. Q = √{ }
𝐶𝐻

2×4000×5000
√{ } = 1000units
20%×200

2. Number of orders = D/Q = 4000 = 4 orders

1000

3. Re-order level = daily demand x lead time 4000/300 x 10 days

=133unts
4. Frequency of ordering = number days in a year 300/4 = 75days
Number of orders
5. Total inventory costs = Purchase cost + ordering cost + Holding cost
D.C + D/QCO + Q/2CH
4000 X 200 + 4000 X 5000 + 1000/2X40
1000
= Ksh. 840,000
CPA JUNE 2009 Q3
Smart Option Ltd. has been selling a product branded “Exe” for the last five years. The demand for
product “Exe” for the past one year is as follows:

Month Demand in units

January 160,000
February 180,000
March 200,000
April 240,000
May 260.000
June 280,000
July 280,000
August 240,000
September 200,000
October 160,000
November 120,000
December 80,000

Additional information:
I. Minimum re-order period is 3months.
II. Average re-order period is 4 months.
III. Maximum re-order period is 5months
IV. Purchase cost per unit is sh. 60
V. Holding cost percentage is 20%
The company has been ordering 5000units per order
VI. Ordering cost is sh. 40 per order.
Required:
(a) Calculate the following:
i. Re-order level ( 2 marks )
ii. Minimum stock level. ( 2 marks )
iii. Maximum Stock level. ( 2 marks )
iv. Average stock. ( 2 marks)
v. Economic order quantity (EOQ) of product Exe ( 2 marks)
vi. Total cost at the economic order quantity ( 2 marks)
(b) Compute the cost savings if the company changes from buying 5,000 units per order to
buying the economic order quantity computed in (a) (v) above. ( 2 marks )
(c) Highlight four limitations of the economic order quantity model ( 4 marks)

SOLUTIONS:
(a)
i. Re- order level = 𝑚𝑎𝑥𝑖𝑚𝑢𝑚 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 ∗ 𝑚𝑎𝑥𝑖𝑚𝑢𝑚 𝑅𝑒 𝑂𝑟𝑑𝑒𝑟 𝑝𝑒𝑟𝑖𝑜𝑑
280,000 × 5 = 140,0000
ii. Minimum stock level= 𝑅𝑒 𝑜𝑟𝑑𝑒𝑟 𝑙𝑒𝑣𝑒𝑙 − (𝑁𝑜𝑟𝑚𝑎𝑙 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 ×
𝑁𝑜𝑟𝑚𝑎𝑙 𝑟𝑒 𝑜𝑟𝑑𝑒𝑟 𝑝𝑒𝑟𝑖𝑜𝑑)
1,400,000 − (200000 × 4) = 600,000
iii. Maximum stock level = 𝑅𝑒 𝑜𝑟𝑑𝑒𝑟 𝑙𝑒𝑣𝑒𝑙 + 𝑅𝑒 𝑜𝑟𝑑𝑒𝑟 𝑞𝑢𝑎𝑛𝑖𝑡𝑦 −
(𝑚𝑖𝑛𝑖𝑚𝑢𝑚 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 × 𝑚𝑖𝑛𝑖𝑚𝑢𝑚 𝑟𝑒 𝑜𝑟𝑑𝑒𝑟 𝑙𝑒𝑣𝑒𝑙 𝑝𝑒𝑟𝑖𝑜𝑑)
1400000 + 5000 − (80000 × 3) = 1165,000
𝑚𝑖𝑛𝑖𝑚𝑢𝑚 𝑠𝑡𝑜𝑐𝑘 𝑙𝑒𝑣𝑒𝑙+𝑚𝑎𝑥𝑖𝑚𝑢𝑚 𝑠𝑡𝑜𝑐𝑘 𝑙𝑒𝑣𝑒𝑙
iv. Average stock =
2
= 600,000+1165000 = 882,500
2

2𝐷𝐶𝑂
v. 𝐸𝑂𝑄 = √ 𝐶𝐻

2 × 2400000 × 40
√{ }
60 × 0.2

1920000000
√
12
= 4000
𝐷 𝑄
vi. TC = 𝐷. 𝐶 + 𝑄
𝐶𝑂 + 2
𝐶𝐻
4000 2400000
(2400000 × 60) + ( × 60 × 0.2) + ( × 40) = 144,048,000
2 4000
(b) EOQ = 5000
5000 2400000
(2400000 × 60) + ( × 60 × 0.2) + ( × 40) = 144,049,200
2 5000
COST SAVINGS = 144,049,200 − 144,048,000 = 1,200
(c) Limitation of EOQ –Give the assumptions of EOQ.

EOQ WITH TRADE DISCOUNT

Discounts are offered on large quantities ordered.

Types of quantity discount

1. Single discount offer
2. Multiple discount offer.

Single discount offer

PROCUDURES
1. Calculate the EOQ and total inventory cost without discount
2. Calculate the EOQ and total inventory cost with discount
3. Compare cost with and without discount
4. Make a decision

ILLUSTRATION
Samaki Ltd. has annual demand of 4000units per year. The cost per unit is sh.20; cost of
placing an order is sh. 500 and the company estimate that the annual inventory cost as a
percentage of unit cost is 20%. Lead-time is 3 days and one year has 300 working days.
 Assuming Samaki is offered 4% discount on orders of 1500units and above compute any
cost savings. Advice the company on whether to accept or reject the discount offer

Solution
Without discount offer
2𝐷𝐶𝑂
𝐸𝑂𝑄 = √
𝐶𝐻

2×4000×500
√{ } = 1000units
20%×20

𝐷 𝑄
Total cost = 𝐷. 𝐶 + 𝐶𝑂 + 𝐶𝐻
𝑄 2
4000 1000
(4000 × 20) + (1000 × 500) + ( 2 × 4) = 𝑠ℎ. 84,000

With discounts
C = 96% x 20 = 19.2
Ch = 20% x 19.2 = 3.84
Q = 1500 units
4000 1500
Total cost = (4000 × 19.2) + ( × 500) + ( × 3.84) = 𝑠ℎ. 81,013
1500 2
Annual cost savings = 84,000 – 81013 = Sh. 2987
Therefore Samaki Ltd should take up the discount offer.
MULTIPLE QUANITY DISCOUNT
Steps to follow:
1. Compute the EOQ.
2. Compute the total cost associated with the quantity evaluated incorporating the discount
3. Recommend the best order quantity with the least / minimum inventory cost.
N/B the EOQ in step 1 above may fall within the following categories.

category Treatment
1. Below the range - Evaluate the least quantity in the range
2. Within the range - Evaluate the EOQ
3. Above the range - Ignore the range

Illustration: A company buys 30,000 units in a year with ordering cost of sh. 2,500 per order and holding
cost at 20% of the cost of a unit. The supplier has provided the following schedule.
QUANTITY RANGE PRICE PER UNIT
1 - 3000 21
3001 - 5000 19
5001 - 7000 17
7001 - 9000 15.5
9001 - Above 13.5

Recommend the best inventory policy.

 QUANTITY PRICE EOQ CATEGORY TREATMENT
RANGE
2 × 30,000 × 2500
√{ }
20% 𝑂𝐹 𝐶

1- 3000 21 5976 above Ignore the range

3001-5000 19 6283 above Ignore the range
5001-7000 17 6642 within Evaluate 6642
7001-9000 15.5 6956 below Evaluate 7001
9001-above 13.5 7454 below Evaluate 9001

𝐷 𝑄
TC = 𝐷. 𝐶 + 𝐶𝑂 + 𝐶𝐻
𝑄 2
30000 5976
Total cost for 6642 = (30,000 × 17) + ( 5976 × 2500) + ( 2
× 4.2)= 532,583
30000 7001
Total cost for 7001= (30,000 × 15.5) + ( × 2500) + ( × 3.1)= 486,564
7001 2
30000 9001
Total cost for 9001= (30,000 × 13.5) + ( 9001 × 2500) + ( 2 × 2.7)= 425,484
The company should order 9001units for the least inventory cost.

ECONOMIC BATCH QUANTITY (EBQ)

This is a model for manufacturing firms, which produces components to be used in the production of
finished products. EBQ is the quantity to be produced per production run in-order to minimize the total
costs.

EBQ MODEL
D = Annual requirement /Demand
Q = EBQ
T = Length of production run in days or any other period.
B = Length of production break
P = Production rate units per day or any other day.
U = Usage rates in units per day or any other period.
Ch = Holding cost per unit.
Cs = Set up cost per set up
V = Variable production cost per unit.

Variable production cost = Annual requirements x cost per unit (D x V)

Set up cost = Number of set ups x cost/set up.
= Annual requirement x set up cost.
EBQ
= D x Cs
Q
Total cost = Variable production cost. + Set up costs + Holding costs.

2𝐷𝐶𝑠
EBQ= √ 𝑢
(1−𝑝)𝑐ℎ

Where;
 U = usage rates units per day or any other period.
P = production rate in units per day or any other day.
Cs= set up cost at set up.
Ch = holding cost per unit
D = Annual requirement/Demand
The Total cost at the EBQ is expressed as follows;
𝐷 𝑄 𝑈
TC = 𝐷𝑥𝑉 + 𝑄 𝑐𝑠 + 2 (1 − 𝑃 )𝐶ℎ
ILLUSTRATION
Marine company manufacturers part B2000 on a special machine to be used in a continuous
assembly. The following data is given for part B2000.
Production rate = 4000 pieces per day.
Assembly requirement = 1,200 pieces per day
Inventory holding cost = sh. 20 per piece per year
Variable cost of production = sh. 2000 per piece.
Set up cost = sh. 110,000 per set up.
Requisition lead time = 10 working days (one year has 250 working days)
Required: Determine the best production policy for the company and its associated total cost.

2𝐷𝐶𝑠
1. EBQ= √ 𝑢
(1−𝑝)𝑐ℎ
Cost per set up (Cs) = Sh.110, 000
Annual requirements (D) = Daily usage x working days in a year = 1200x250 = 300,000
P = 4000
U = 1200
2𝑥300,000𝑥110,000
EBQ= √ 1200 = 68,661units
(1−4000)20
2. Number of set ups = D = 300,000/68661 = 4
Q
3. Length of production run ( t ) = Q/p = 68661/4000 = 17 days
4. Length of break = Maximum stock (p-u)t = (4000-1200)17 =40days
Usage rate u 1200
𝐷 𝑄 𝑈
5. Total cost = 𝐷𝑥𝑉 + 𝑄 𝑐𝑠 + 2 (1 − 𝑃 )𝐶ℎ
300000 68661 1200
300,000𝑥2000 + 𝑥110000 + (1 − 4000)20 =
68661 2
600961249.2
6. Re-order level = Daily usage x lead time = 1200x10 = 12000units

QUALITATIVE MODELS OF STOCK CONTROL

It ensures efficient utilization of the stock/ materials. They include:

JUST IN TIME SYSTEM (JIT)

Toyota Motor Company developed this system in Japan. The aim is manufacture the required
items of high quality at the time they are required. It aims at perusing excellence at all stages of
production with a promise of continuous improvement.

ADVANTAGES/FEATURES
1. Emphasize on the perfect quality
2. Elimination of non-value added activities on the product
3. There is 100% on time delivery
4. It is a demand-pull manufacturing system i.e. items are manufactured at the request of the
customer.
5. It normally involve a short set up time i.e. the assembling period for the products is very
short.
6. There is no opening and closing stock for the items.
DISADVANTAGES
1. It is not applicable for the items that are perishable or are needed urgently.
2. It is normally affected by outdated technology.
3. Its affected by the machine breakdown since 90% of the work is done by machines,
which are likely to breakdown and affect operations.

1. ABC ANALYSIS (Pareto Analysis)

- It’s a system which groups items into three groups depending on their values as follows
 A items
- They are few items in number but they are of high values in the business compared to B
and C items.
- A company will always ensure that all these items are available all the time because their
contribution is high in terms of profits when they are sold. The control measurers put in
place for this items is strict.
 B item
- They are more than A items in number but of lower value than A items.
- The control measures put in place are not strict as for the A items.
- The company will always keep these items so a to support A items.
 C items
- They are many in number but of lower value compared to A & B
- The control measures are not strict because the profit realised from the product are very
low.

INVENTORY CONTROL
- They are system used to carryout stock taking activities.
 i. Periodic Inventory System/ Physical
- Stock taking is done at the end of the accounting period
- It involves the verification of the stock items at the end of the period to estimate the
closing balance of the inventory.
ii. Continuous/ Perpetual Inventory System
- It is a system of recording the stock balance after receipt/ issue in order to facilitate
regular checking to establish the closing stock of the items using methods like FIFO,
LIFO, and WEIGHTED average.

MATERISL RECEIPT AND ISSUES

- It involves the analysis of stock in order to determine the closing balance.
- It involves the following.
a) FIFO (First In First Out)
- Material purchased first should be issued out first.
- Therefore, the material in the store are the last material that were purchased.
- It normally involves the preparation of stores ledger in order to determine the value of the
closing balance.

NOV 2015 Q 3b
Store leger card
Date Receipts issues Balances
QTY CPU AMT QTY CPU AMT QTY AMT
ST
1 JULY 2000 100,000
3RD JULY 600 60 36000 2600 136000
5TH JULY 1600 50 80000 1000 56000
7TH JULY 1000 70 70000 2000 126000
9TH JULY 200 50 10000 2200 136000
12TH JULY 400 50 20000 1800 116000
15TH JULY 100 50 5000 1900 121000
TH
18 JULY 2400 80 192000 4300 313000
20TH JULY 600 60 36000
600 70 42000
1200 78000 3100 235000

21ST JULY 400 70 28000

100 50 5000
500 33000 2600 202000
25th JULY 100 45 4500 2700 206500
28TH JULY 20 50 1000 2680 205500
29TH JULY 80 50 4000
100 50 5000
420 80 33600
600 42600 2080 162900
ST
31 JULY 200 80 16000 1880 146900
 ADVANTAGES OF FIFO
1. It is based on realistic assumption that materials are issued in the order in which they were
received.
2. Materials are issued at the actual cost therefore; there is no unrealised profits/loss, which will
arise from the operation of this method.
3. It is easy to understand and simple to operate.
4. The valuation of the closing stock is at cost and it will reflect the actual cost that was incurred on
the materials.
DISADVANTAGES
1. Materials are issued to production at the previous cost and therefore the cost of production may
not reflect the current economic factors affecting the operations.
2. When prices are subject to frequent changes this method involves complicated adjustments in-
order to reflect the current

LIFO
It is based on the assumption that materials which were received last are first to be issued out.
The closing stock is valued at the price, which was last paid.
June 2008 Q 1b
Store leger card FIFO
Date Receipts issues Balances
March QTY CPU AMT QTY CPU AMT QTY AMT
1st 2500 90000
rd
3 350 36 12600 2150 77400
4th 500 36 18000 1650 59400
13th 1000 38 38000 2650 97400
th
14 75 36 2700 2725 100100
16th 75 36 2700
325 38 12350
400 15050 2325 85050

20th 1200 39 46800 3525 131850

22nd 50 39 1950 3475 129900
24th 900 39 35100 2575 94800

25th 1600 40 64000 4175 158800

26th 1600 40 64000

250 39 9750
 50 38 1900
1900 75650 2275 83150
th
27 175 39 6825 2450 89975
28th 500 38 19000 2950 108975

Sales: (350x46) + (500x45) + (400X46) + (900X43) + (1900X44) = 179,300

Purchases = 167,800
Return inwards = 75@46 =3450
175@43=7525
10975

Income statement
sales 179300
returns inwards (10975)
net sales 168325
less cost of sales
opening stock 90,000
purchases 167800
closing stock (108975) (148825)
gross profit 19500
less: expenses
operating expenses: 4500
shortage 1950 (6450)
net profit 13050

Advantages of LIFO
1. Material are issued to the production at latest price paid and therefore it takes into
consideration the current economic factors affecting the production.
2. It does not lead into unrealized profits/losses since materials are issued at the actual cost in
which they were acquired.
3. It is simple and easy to operate
Disadvantages LIFO
 1. It is not realistic, as it does not follow the physical flow of the materials.
2. The closing stock is valued at the old price and therefore it does not present the current
economic value of stock in the market.
3. It is cumbersome when prices are subject to frequent fluctuations.

WEIGHTED AVERAGE METHOD

It considers the quantity of the materials in the store when calculating the average price.
The issue price is computed using the total cost of material and divided by the number of units. The
issue prices remains stable it is much better than LIFO and FIFO because it uses the average price when
issuing out the stock

NOV 2015 Q 3b
Store leger card- Weighted average
Date Receipts issues Balances
JULY QTY CPU AMT QTY CPU AMT QTY AMT
1ST 2000 100,000
3RD 600 60 36000 2600 136000
5TH 1600 52.3 83680 1000 52320
7TH 1000 70 70000 2000 122320
TH
9 200 52.3 10460 2200 132780
12TH 400 60.4 24160 1800 108620
15TH 100 60.4 6040 1900 114660
TH
18 2400 80 192000 4300 306660
20TH 1200 71.3 85560 3100 221100

21ST 500 71.3 35650 2600 185450

25TH 100 45 4500 2700 189950

28TH 20 70.3 1406 2680 188544
29TH 600 70.3 42180 2080 146364

31ST 200 70.3 14060 1880 132304

HOW TO OBTAIN ISSUE PRICES

5TH = 136000/2600=52.3
12TH = 132780/2200=60.4

SIMPLE AVERAGE METHOD

Under this method, the average price is calculated by adding all the prices, which are in the store, and
dividing by the number of the prices. It takes into consideration the FIFO method when issuing stock in
the store.

NOV 2015 Q 3b
Store leger card- Simple average method
Date Receipts issues Balances
JULY QTY CPU AMT QTY CPU AMT QTY AMT
1ST 2000 100,000
3RD 600 60 36000 2600 136000
5TH 1600 55 88000 1000 48000
7TH 1000 70 70000 2000 118000
TH
9 200 55 11000 2200 129000
12TH 400 60 24000 1800 105000
15TH 100 60 6000 1900 111000
TH
18 2400 80 192000 4300 303000
20TH 1200 70 84000 3100 219000

21ST 500 75 37500 2600 181500

25TH 100 45 4500 2700 186000

28TH 20 62.5 1250 2680 184750
29TH 600 62.5 37500 2080 147250

31ST 200 62.5 12500 1880 134750

How to obtain the issue prices.

5th - 50+6 /2 = 55
12th = 60+50+70/3 = 60
20th = 60+