Managerial Accounting II

Semester: Winter 2025

Chapter 9: Budgeting
 Course Learning Outcomes1
(CLO)
CLO 1: Prepare a full set of budgeted statements,
including a cash budget.

CLO 3: Prepare flexible budgets for all types of

operations and identify variances from budgets

Note: 1- Per course outline

2
 Chapter Objectives

1. Explain why organizations budget and

describe the processes they use to create
budgets.
2. Prepare the supporting components of a master
budget and the budgeted financial statements.
3. Prepare a flexible budget and explain the need
for the flexible budget approach.
4. Discuss the optimal inventory level and order
size.

3
 The Basic Framework of
Budgeting
• A budget is a detailed quantitative plan for
acquiring and using financial and other resources
over a specified future time period.
• The act of preparing a budget is called budgeting.
• The use of budgets to control an organization’s
activity is known as budgetary control.
• The master budget summarizes a company’s plans,
setting specific targets for sales, production,
distribution, administrative, and financing activities.

4
 Why Organizations Create
Budgets
• Budgets serve as both a planning tool and a
control tool in organizations.
• Planning involves developing objectives and
preparing various budgets to achieve those
objectives.
• Control involves gathering feedback to assess
the extent to which the objectives developed
at the planning stage are being attained.
• An effective budgeting system provides for
both planning and control.
5
 Planning Process
As part of the planning process, budgets are
used to:
1. Encourage managers to think about and to
plan for the future.
2. Communicate management’s financial
goals throughout the organization.
3. Allocate resources to those parts of the
organization where they can be used most
effectively.
4. Coordinate the plans and activities of
managers in different departments.

6
 Control System
As part of a control system, budgets are
compared to actual results during the year to:

1. Improve the efficiency and effectiveness of

operations.
2. Evaluate and reward employees.

7
 Choosing a Budget Period
The annual operating budget
may be divided into quarterly
or monthly budgets.
Operating Budget

Q1 Q2 Q3 Q4
2025 2026 2027 2028

A continuous budget is a 12-month budget that

rolls forward one month (or quarter) as the
current month (or quarter) is completed.

8
 How Organizations Create
Budgets
• Companies usually create budgets by relying on
some combination of top-down budgeting
and participative budgeting.
• A participative budget involves managers from
across the organization in developing budget
estimates for their areas of responsibility.
• With a top-down approach, top-level managers
initiate the budgeting process by issuing overall
profit targets.
9
 How Organizations Create
Budgets
Many companies choose to use a participative
budgeting approach, involving lower-level
managers in developing the budget because it:
• Shows respect for their experience and opinions.
• Leverages their knowledge and experience to
provide more accurate estimates.
• Increases their motivation to achieve goals they
had input in setting.
• Empowers them to take ownership of the budget
and to be accountable for deviations from it.

10
 Budgetary Slack
• Budget estimates prepared by lower-level
managers cannot simply be accepted without
review by higher levels of management.
• If no review system is present, participative
budgets may contain excessive budgetary
slack.
• Slack is the difference between the revenues
and expenses a manager reasonably expects
to achieve, and the amounts included in the
budget.

11
 Benchmarking
• When creating budgets some companies use the
performance of competitors, “best-in-class”
companies, or other business units in the same
company.
• A best-in-class company is one known for
achieving exceptional levels of performance on
some aspect of their operations such as customer
service, distribution, marketing, and so on.
• The approach of comparing revenue, cost, or
process performance to other high-performing
companies, or to other successful business units
in the same company, is known as benchmarking.

12
 Behavioural Factors in
Budgeting
• Two important purposes of the budget are to
motivate people and coordinate their efforts.
• These purposes can be undermined if the
budget is used in an inflexible manner to
control people.
• This relates to the idea of responsibility
accounting, whereby managers are held
responsible for those items—and only those
items—that they can actually influence to a
significant extent.

13
 Behavioural Factors in
Budgeting
• Another key issue related to the motivational
aspect of budgets is the difficulty level of the
budget targets for revenues and expenses.
• If budgets are too difficult, employees will
eventually recognize that they are unattainable,
and motivation and morale will likely suffer.
• If the budgets are too easy, inefficiencies or
lack of effort will result.

14
The Master Budget: An Overview

Exhibit 9-1

15
 The Sales Budget Defined

• A sales budget is a detailed schedule

showing the expected sales for the budget
period. It is typically expressed in both
dollars and units of product.
• An accurate sales budget is the key to the
entire budget process.
• All of the other parts of the master budget
depend on the sales budget in some way.

16
 The Big Picture
A master budget for a manufacturing company is
designed to answer 10 key questions:
1. How much will we sell?
2. How much cash will we collect from customers?
3. How much raw material will we need to
purchase?
4. How much manufacturing cost (including direct
materials, direct labour, and manufacturing
overhead) will we incur?
5. How much cash will we pay to our suppliers and
our direct labourers, and how much will we pay
for manufacturing overhead?
17
 The Big Picture
6. What is the total cost that will be transferred
from finished goods inventory to cost of goods
sold?
7. How much selling and administrative expense
will we incur and how much cash will we pay
related to those expenses?
8. How much money will we borrow from or
repay to lenders, including interest?
9. How much operating income will we earn?
[Link] will our balance sheet look like at the
end of the budget period?

18
 Computational Examples
1. Sales Budget
2. Expected Cash Collections
3. Production Budget
4. Direct Materials Budget
5. Cash Disbursement for Materials
6. Direct Labour Budget
7. Manufacturing Overhead Budget
8. Ending Finished Goods Inventory Budget
9. Selling & Admin Expense Budget
[Link] Budget
[Link] Financial Statements (Income
Statement and Balance Sheet)
19
 Example 1: Sales Budget

• Royal Company is preparing budgets for the

quarter ending June 30.
• Budgeted sales for the next five months are:
April 20,000 units
May 50,000 units
June 30,000 units
July 25,000 units
August 15,000 units.
• The selling price is $10 per unit.

20
 Computational Examples
1. Sales Budget
2. Expected Cash Collections
3. Production Budget
4. Direct Materials Budget
5. Cash Disbursement for Materials
6. Direct Labour Budget
7. Manufacturing Overhead Budget
8. Ending Finished Goods Inventory Budget
9. Selling & Admin Expense Budget
[Link] Budget
[Link] Financial Statements (Income
Statement and Balance Sheet)
21
 Example 2: Expected Cash
Collections
• All sales are on account.
• Royal’s collection pattern is:
• 70% collected in the month of sale,
• 25% collected in the month following sale,
• 5% uncollectible.
• A March 31 accounts receivable balance
of $30,000 will be collected in full.

22
 Quick Check ✓

Complete the cash collection budget

for the quarter. Determine the total
amount of cash that is expected to be
collected for the quarter.

a. $700,000
b. $220,000
c. $190,000
d. $905,000
23
 Computational Examples
1. Sales Budget
2. Expected Cash Collections
3. Production Budget
4. Direct Materials Budget
5. Cash Disbursement for Materials
6. Direct Labour Budget
7. Manufacturing Overhead Budget
8. Ending Finished Goods Inventory Budget
9. Selling & Admin Expense Budget
[Link] Budget
[Link] Financial Statements (Income
Statement and Balance Sheet)
24
Example 3: Production Budget

Sales
Budget
and Production
Expected Budget
Cash
Collections

Production must be adequate to meet budgeted

sales and provide sufficient ending inventory.

25
Example 3: Production Budget

• Management at Royal Company wants

ending inventory to be equal to 20% of
the following month’s budgeted sales in
units.
• On March 31, 4,000 units were on hand.
• Estimated inventory at the end of the
quarter is 5000 units
• With this information, the production
budget can be prepared.
26
 Quick Check ✓

What is the required production for

May?

a. 56,000 units
b. 46,000 units
c. 62,000 units
d. 52,000 units

27
 Computational Examples
1. Sales Budget
2. Expected Cash Collections
3. Production Budget
4. Direct Materials Budget
5. Cash Disbursement for Materials
6. Direct Labour Budget
7. Manufacturing Overhead Budget
8. Ending Finished Goods Inventory Budget
9. Selling & Admin Expense Budget
[Link] Budget
[Link] Financial Statements (Income
Statement and Balance Sheet)
28
 Example 4: Direct Materials
Budget

Production Direct
Budget Materials
Budget

The direct materials budget determines the raw

materials that must be purchased to fulfill the production
budget and to provide adequate inventories.
29
 Example 4: Direct Materials
Budget
Use the following information to prepare
Royal Company’s direct materials budget:
• Five kilograms of material are required per
unit of product.
• Management wants materials on hand at the
end of each month equal to 10% of the
following month’s production.
• On March 31, 13,000 kilograms of material are
on hand. Material cost is $0.40 per kg.
• Expected ending inventory for the quarter
11,500 kilograms. 30
 Quick Check ✓

How much material should be purchased

in May?

a. 221,500 kilograms
b. 240,000 kilograms
c. 230,000 kilograms
d. 211,500 kilograms

31
 Computational Examples
1. Sales Budget
2. Expected Cash Collections
3. Production Budget
4. Direct Materials Budget
5. Cash Disbursement for Materials
6. Direct Labour Budget
7. Manufacturing Overhead Budget
8. Ending Finished Goods Inventory Budget
9. Selling & Admin Expense Budget
[Link] Budget
[Link] Financial Statements (Income
Statement and Balance Sheet)
32
Example 5: Cash Disbursement
for Materials
• Royal pays $0.40 per kilogram for its materials.
• One half of each month’s purchases is paid for
in the month of the purchase; the other half is
paid in the following month.
• The March 31 accounts payable balance is
$12,000.

With this information, the expected cash

disbursements can be computed.

33
 Quick Check ✓

What are the total cash disbursements for

the quarter?

a. $185,000
b. $ 68,000
c. $ 56,000
d. $201,400

34
 Computational Examples
1. Sales Budget
2. Expected Cash Collections
3. Production Budget
4. Direct Materials Budget
5. Cash Disbursement for Materials
6. Direct Labour Budget
7. Manufacturing Overhead Budget
8. Ending Finished Goods Inventory Budget
9. Selling & Admin Expense Budget
[Link] Budget
[Link] Financial Statements (Income
Statement and Balance Sheet)
35
 Example 6: Direct Labour
Budget

Direct Direct
Materials Labour
Budget Budget

The direct labour budget is a detailed plan showing

labour requirements over a specific time period.

36
 Example 6: Direct Labour
Budget
• At Royal, each unit produced requires .05 hours (3
minutes) of direct labour.
• The company has a “no layoff” policy, so all
employees will be paid for 40 hours of work each
week.
• In exchange for the “no layoff” policy, workers
agree to a wage rate of $25 per hour regardless of
the number of hours worked (no overtime pay).
• For the next three months, the direct labour
workforce will be paid for a minimum of 1,500
hours per month.
37
 Quick Check ✓
What would be the total direct labour cost
for the quarter if the company follows its
no lay-off policy, but pays $37.5 (time-
and-a-half) for every hour worked in
excess of 1,500 hours in a month?
a. $ 30,000
b. $198,750
c. $132,500
d. $142,500

38
 Computational Examples
1. Sales Budget
2. Expected Cash Collections
3. Production Budget
4. Direct Materials Budget
5. Cash Disbursement for Materials
6. Direct Labour Budget
7. Manufacturing Overhead Budget
8. Ending Finished Goods Inventory Budget
9. Selling & Admin Expense Budget
[Link] Budget
[Link] Financial Statements (Income
Statement and Balance Sheet)
39
Example 7: Manufacturing
Overhead Budget

Direct Manufacturing
Labour Overhead
Budget Budget

The manufacturing overhead budget provides a

schedule of all costs of production other
than direct materials and direct labour.
40
 Example 7: Manufacturing
Overhead Budget
• At Royal, manufacturing overhead is applied to
units produced on the basis of direct labour
hours.
• The variable manufacturing overhead rate is
$20 per direct labour hour.
• Fixed manufacturing overhead is $50,000 per
month and includes $20,000 of noncash costs
(primarily depreciation of plant assets).

41
 Computational Examples
1. Sales Budget
2. Expected Cash Collections
3. Production Budget
4. Direct Materials Budget
5. Cash Disbursement for Materials
6. Direct Labour Budget
7. Manufacturing Overhead Budget
8. Ending Finished Goods Inventory Budget
9. Selling & Admin Expense Budget
[Link] Budget
[Link] Financial Statements (Income
Statement and Balance Sheet)
42
 Example 8: Ending Finished
Goods Inventory Budget

Ending
Manufacturing Finished
Overhead Goods
Budget Inventory
Budget

After computing unit product costs, the carrying cost of

the unsold units is computed on the ending finished
goods inventory budget.
43
 Computational Examples
1. Sales Budget
2. Expected Cash Collections
3. Production Budget
4. Direct Materials Budget
5. Cash Disbursement for Materials
6. Direct Labour Budget
7. Manufacturing Overhead Budget
8. Ending Finished Goods Inventory Budget
9. Selling & Admin Expense Budget
[Link] Budget
[Link] Financial Statements (Income
Statement and Balance Sheet)
44
 Example 9: Selling and
Administrative Expense Budget

Ending Selling
Finished and
Goods Administrative
Inventory Expense
Budget Budget

The selling and administrative expense budget

includes the budgeted expenses for areas other than
manufacturing.
45
 Example 9: Selling and
Administrative Expense Budget
• At Royal, the selling and administrative expenses
budget is divided into variable and fixed
components.
• The variable selling and administrative expenses
are $0.50 per unit sold.
• Fixed selling and administrative expenses are
$70,000 per month.
• The fixed selling and administrative expenses
include $10,000 in costs – primarily depreciation –
that are not cash outflows of the current month.

46
 Quick Check ✓

What are the total cash disbursements for

selling and administrative expenses for the
quarter?

a. $180,000
b. $230,000
c. $110,000
d. $ 70,000

47
 Computational Examples
1. Sales Budget
2. Expected Cash Collections
3. Production Budget
4. Direct Materials Budget
5. Cash Disbursement for Materials
6. Direct Labour Budget
7. Manufacturing Overhead Budget
8. Ending Finished Goods Inventory Budget
9. Selling & Admin Expense Budget
[Link] Budget
[Link] Financial Statements (Income
Statement and Balance Sheet)
48
 Example 10: Cash Budget

Selling
and Cash
Administrative Budget
Expense
Budget

The cash budget pulls together much of the data

developed in the preceding steps and displays it in
four major sections: receipts, disbursements, cash
excess or deficiency, and financing.
49
 Cash Budget
The cash budget is divided into four sections:
1. Cash receipts listing all cash inflows excluding
borrowing;
2. Cash disbursements listing all payments
excluding repayments of principal and interest;
3. Cash excess or deficiency; and
4. The financing section listing all borrowings,
repayments and interest.

50
 Cash Budget
Royal:
• Maintains a 16% open line of credit for $75,000
• Maintains a minimum cash balance of $30,000
• Borrows on the first day of the month and repays
loans on the last day of the month
• Pays a cash dividend of $49,000 in April
• Purchases $109,200 of equipment in May and
purchases of $25,800 of equipment in June. Both
purchases were paid in cash.
• Has an April 1 cash balance of $62,500.
51
 Quick Check ✓

What is the excess or deficiency of cash

available over disbursements for June?

a. $ 85,000
b. $(10,000)
c. $ 75,000
d. $ 95,000

52
Example 11: Budgeted Financial
Statements

Budgeted
Cash Financial
Budget Statements

After the cash budget is completed, the budgeted

income statement and budgeted balance sheet can be
prepared for Royal.
53
 Computational Examples
1. Sales Budget
2. Expected Cash Collections
3. Production Budget
4. Direct Materials Budget
5. Cash Disbursement for Materials
6. Direct Labour Budget
7. Manufacturing Overhead Budget
8. Ending Finished Goods Inventory Budget
9. Selling & Admin Expense Budget
[Link] Budget
[Link] Financial Statements (Income
Statement and Balance Sheet)
54
 The Budgeted Income
Statement Sales Budget

Royal Company
Budgeted Income Statement
For the Three Months Ended June 30
Ending Finished
Sales (100,000 units @ $10) $ 1,000,000 Goods Inventory
Cost of goods sold (100,000 @ $5.74) 574,000
Gross margin 426,000
Selling and administrative expenses 260,000 Selling and
Operating income 166,000 Administrative
Interest expense 2,000 Expense Budget
Net income $ 164,000

Cash Budget

55
 The Budgeted Balance Sheet

• Royal reported the following account

balances prior to preparing its budgeted
financial statements:

• Land – $50,000
• Common shares – $200,000
• Retained earnings – $224,900
• Equipment – $232,000

56
 Royal Company
Budgeted Balance Sheet
25% of June
June 30 sales of
Current assets $300,000
Cash $ 43,000
Accounts receivable 75,000 11,500 kgs
Raw materials inventory 4,600 at $0.40/kg
Finished goods inventory 28,700
Total current assets 151,300 5,000 units
Property and equipment at $5.74/unit
Land 50,000
Equipment 367,000 Including
Total property and equipment 417,000
Total assets $ 568,300
purchases in
May & June
Accounts payable $ 28,400
Common shares 200,000 50% of June
Retained earnings 339,900 purchases
Total liabilities and equities $ 568,300 of $56,800
57
 Royal Company
Budgeted Balance Sheet
June 30
Current assets
Cash $ 43,000
Accounts receivable 75,000
Beginning Balance $ 224,900
Raw materials inventory Add: 4,600
net income 164,000
Finished goods inventory 28,700
Deduct: dividends (49,000)
Total current assets 151,300
Ending balance $ 339,900
Property and equipment
Land 50,000
Equipment 367,000
Total property and equipment 417,000
Total assets $ 568,300

Accounts payable $ 28,400

Common shares 200,000
Retained earnings 339,900
Total liabilities and equities $ 568,300
58
 Static Budgets
• The preceding budgets are static budgets.

• A static budget is prepared for only one planned

or budgeted level of activity.

• These budgets are suitable for planning, but they

can be inadequate for control if the actual level of
activity during the period differs significantly
from the budgeted level.

• Therefore, an alternative approach is needed to

restore the usefulness of budgets as a control
tool.
59
 Flexible Budgets

Flexible budgets:
• Account for changes in revenues and
expenses that are expected to occur due
to changes in actual activity levels.
• Provide estimates of what revenues and
expenses should be for any level of
activity within a specified range.
• Improve performance evaluation

60
Static Budgets and Performance
Reports

61
Static Budgets and Performance
Reports

62
Static Budgets and Performance
Reports

U = Unfavourable variance Unable to achieve the budget

F = Favourable variance that occurs when actual costs are less
than budgeted costs. 63
Static Budgets and Performance
Reports

Since cost variances are favourable, has the company done a

64
good job controlling costs?
Static Budgets and Performance
Reports
When cost variances are favourable, has the company
done a good job controlling costs?

This question can’t be answered using a static

budget. The relevant question should be…
“How much of the favourable cost variance is due to
lower activity, and how much is due to good cost
control?
To answer the question, the budget must flex to
the actual level of activity.

65
Preparing a Flexible Budget

Preparing a flexible budget requires an

understanding of cost behaviour:
• Total variable costs change in direct
proportion to changes in activity.
• Total fixed costs remain unchanged
within the relevant range.
With this information, a flexible budget
can be prepared.
66
 Preparing a Flexible Budget

Cost Total Flexible Budgets

Formula Fixed 8,000 10,000 12,000
per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs Variable costs are expressed as
Indirect labour $ 24.00
a constant amount per hour.
Indirect material 3.00
Power 0.50 $240,000 ÷ 10,000 hours is
Total variable cost $ 27.50
$24.00 per hour.
Fixed costs
Depreciation $ 12,000 Fixed costs are
Insurance 2,000 expressed as a
Total fixed cost
Total overhead costs
total amount.

67
 Preparing a Flexible Budget

Cost Total Flexible Budgets

Formula Fixed 8,000 10,000 12,000
per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs
Indirect labour $ 24.00 $192,000
Indirect material 3.00 24,000
Power 0.50 4,000
Total variable cost $ 27.50 $220,000
Fixed costs
Depreciation $24.00 per hour × 8,000 hours = $192,000
$ 12,000
Insurance 2,000
Total fixed cost
Total overhead costs

68
 Preparing a Flexible Budget

Cost Total Flexible Budgets

Formula Fixed 8,000 10,000 12,000
per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs
Indirect labour $ 24.00 $192,000
Indirect material 3.00 24,000
Power 0.50 4,000
Total variable cost $ 27.50 $220,000
Fixed costs
Depreciation $ 12,000 $ 12,000
Insurance 2,000 2,000
Total fixed cost $ 14,000
Total overhead costs $234,000

69
 Preparing a Flexible Budget

Cost Total Flexible Budgets

Formula Fixed 8,000 10,000 12,000
per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs
Indirect labour $ 24.00 $192,000 $240,000 $ 288,000
Indirect material 3.00 24,000 30,000 36,000
Power 0.50 4,000 5,000 6,000
Total variable cost $ 27.50 $220,000 $275,000 $ 330,000
Fixed costs
Depreciation $ 12,000 $ 12,000 $ 12,000 $ 12,000
Insurance 2,000 2,000 2,000 2,000
Total fixed cost $234,000 $289,000 $ 344,000
Total overhead costs

70
Flexible Budget Performance
Report
Cost Total
Formula Fixed Flexible Actual
per Hour Cost Budget Results Variances
Machine hours 8,000 8,000 0
Variable costs
Indirect labour $ 24.00 $192,000 $194,000 $ 2,000 U
Indirect material 3.00 24,000 25,500 1,500 U
Power 0.50 4,000 3,800 200 F
Total variable cost $ 27.50 $220,000 $223,300 $ 3,300 U
Fixed costs
Depreciation $ 12,000 $ 12,000 $ 12,000 $ 0
Insurance 2,000 2,000 2,050 50 U
Total fixed cost $ 14,000 $ 14,050 50 U
Total overhead costs $234,000 $237,350 $ 3,350 U

73
Static Budgets and Performance
Reports

Remember the question from earlier? How much

of the $51,650 favourable variance is due to lower
activity and how much is due to cost control?

74
Flexible Budget Performance
Report
Overhead Variance Analysis
Static Prepare a Actual
Overhead flexible Overhead
Budget at budget for at
10,000 Hours 8,000 hours 8,000 Hours
here.
$ 289,000 $ 237,350

The difference between original static budget

and actual overhead = $51,650 F.

75
Flexible Budget Performance
Report
Overhead Variance Analysis
Static Flexible Actual
Overhead Overhead Overhead
Budget at Budget at at
10,000 Hours 8,000 Hours 8,000 Hours
$ 289,000 $ 234,000 $ 237,350

Activity Cost control

This $55,000F variance is This $3,350U

due to lower activity. variance is due
to poor cost control.
76
 Appendix 9A
Inventory Decisions

77
 Inventory Decisions
• Inventory planning and control decisions are
an important aspect of the management of
many organizations.
• Inventory planning and control play an integral
role in preparing the master budget.
• The major issues that need to be addressed
are:
• How does the manger know what inventory
level is appropriate?
• Will the appropriate inventory level vary
from organization to organization?
78
Costs Associated with Inventory
• Inventory Ordering Costs: Costs
associated with the acquisition of inventory,
such as clerical costs and transportation
costs.
• Inventory Carrying Costs: Costs
associated with having inventory on hand,
such as storage space, handling costs,
property taxes, insurance, obsolescence
losses, and interest on capital invested in
inventory.
79
Costs Associated with Inventory

Costs of not carrying sufficient inventory to

meet customer demand:
• customer dissatisfaction
• lost sales
• forgone quantity discounts
• uneven production
• inefficient production run
• additional transportation charges

80
Computing the Economic Order
Quantity
• The economic order quantity (EOQ) is
the order size for materials that
minimizes the costs of ordering and
carrying inventory.
• There are two approaches:
1. The Tabular Approach
2. The Formula Approach

81
Just-in-Time and the Economic
Order Quantity

• The EOQ will decrease under either of

these circumstances:
1. The cost of placing an order
decreases.
2. The cost of carrying inventory
increases.

82
 Production Lot Size, Reorder
Point and Safety Stock
• Economic production lot size: The number of
units produced in a lot that minimizes setup
costs and the costs of carrying inventory.
• Setup costs: Labour and other costs involved in
getting facilities ready to produce a batch of a
particular item.
• Reorder point: The point in time when an order
must be placed to replenish depleted inventory.
This is determined by multiplying the lead time
by the average daily or weekly usage.
83
 Production Lot Size, Reorder
Point and Safety Stock
• Lead time: The interval between the time that
an order is placed and the time that the order is
received from the supplier or production is
completed.
• Safety stock: The difference between average
usage of materials and maximum usage of
materials that can reasonably be expected
during the lead time.

84
 Perishable Products

Inventory for services and for perishable products

poses an interesting problem:
• If too much is ordered the cost of the
inventory is similar to a carrying cost.
• If too little is ordered, there is a loss of
contribution margin due to a loss of sales.

85