COST ACCOUNTING SUMMARY Name: Sthefanie Chateryne Parera NIM : A31110272

QUANTITATIVE MODELS
(Planning of Materials) Inventories serve as a cushion between production and consumption of goods. They exist in various form: materials awaiting processing; partially completed products or components; and finished goods at the factory, in transit, at warehouse distribution points, and it retail outlets. 1. Planning Materials Requirements Materials planning deals with two fundamental factors: the quantity and the time to purchase. Determination of how much and when to buy involves two conflicting kinds of cost are illustrated in the following comparison: Estima Cost of Inadequate Carrying te Interest on investment in 10.00 Extra purchasing, handling, and working capital % transportation costs Property tax and insurance 1.25 % Higher prices due to small order quantities Warehousing or storage 1.80 % Frequent stockouts resulting in disruptions of production schedules, overtime, and extra setup time Handling 4.25 % Additional clerical costs due to keeping customer back-order records Deterioration and shrinkage of 2.60 % Inflation-oriented increases in stocks price when inventory purchases are deferred Obsolescence of stocks 5.20 % Lost sales and loss of customer goodwill Total 25.10 % 2. Economic Order Quantity The Economic Order Quantity (EOQ) is the amount of inventory ordered at one time that minimizes annual inventory cost. If a company buys Cost of Carrying Inventory

materials infrequently and in large quantities (the opposite of the just-in-time approach), the cost of carrying the inventory is high because of the sizable average investment in inventory. If purchases are made in small quantities, with frequent orders, correspondingly high ordering costs can result. Therefore, the optimum quantity to order at a given time is determined by balancing two factors: (1) the cost of possessing (carrying) materials and (2) the cost of acquiring (ordering) materials. The cost of carrying inventory are often expressed as percentages of the average inventory investment because the most common variable cost is interest or the cost of capital. In the case of warehousing or storage, for example, only those costs that vary with changes in the number of units ordered should be included. Ordering cost determine as the costs of not carrying enough inventory. Ordering costs include preparing a purchase requisition, purchase order, and receiving report; handling the incoming shipment; communicating with the vendor; and accounting for the shipment and payment. Differential calculus makes it possible to compute EOQ by formula by using information about the quantity required, unit price, inventory carrying cost percentage, and cost per order. One formula variation is as follows:

Where: RU = Annual Required Units CO = Cost per Order CU = Cost per Unit of Material CC = Carrying Cost percentage Given the terms EOQ, RU, CO, CU and CC as specified the formula is based on the following relationship:

= number of orders placed annually

= Annual Ordering Cost = Average number of units in inventory at any point in time = Annual carrying cost

Total annual cost of ordering = inventory, designated as AC

and

carrying

The last equation is then solved, using differential calculus to determine the minimum total annual cost of inventory. Some purchase prices are discounted if larger quantities are ordered. Larger shipments also can generate freight savings. These changes result in a lower unit cost and thus can alter the EOQ calculation. With quantity discounts, the cost of materials is not a constant because it is affected by the size of the discount. Therefore, the objective is to identify an order quantity that minimizes the sum of the ordering and carrying costs plus the cost of the materials. 3. The EOQ Formula and Production Runs The EOQ formula also can be used to compute the optimum size of a production run, in which case CO represents an estimate of the setup cost, and CU represents the variable manufacturing cost per unit. 4. Determining the Time to Order The EOQ formula addresses the quantity problem of inventory planning, but the question of when to order is equally important. The question is controlled by three factors: (1) time needed for delivery, (2) rate of inventory usage, and (3) safety stock. Determining the order point would be relatively simple if precise predictions were available for both rate of usage and lead time (the interval between the time an order is placed and the time the materials are on the factory floor ready for production). Forecasting materials usage requires the expenditure of time and money. In materials management, forecasts are an expense as well as an aid to balancing the cost to acquire and the cost to carry inventory. Because perfect forecasts are rarely possible, an inventory cushion or safety stock is often the least costly protection against a stockout. The optimum safety stock is that quantity that results in the smallest total cost of stockouts plus safety stock carrying cost. This carrying cost is calculated in the same way as for EOQ. The annual cost of stockouts depends on the frequency of their occurrence and the cost of each stockout. 5. Order Point Formula Order points are based on usage during the time necessary to requisition, order, and receive materials, plus an allowance for protection against stockout. The order point is reached when the available quantity is just equal to the foreseeable needs; that is , when the sum of inventory on hand and quantities due in equals the sum of lead time usage quantity and safety stock quantity.

I + QD = LTQ + SSQ
Where: I = Inventory balance on hand QD = Quantities due in (before depletion of I) from orders previously placed, materials transfers, and returns to stock LTQ = Lead Time Quantity, which equals normal lead time in months, weeks, or days, multiplied by a normal months, weeks or days use SSQ = Safety Stock Quantity If the weekly usage of a stock item is 175 units and the lead time is normally four weeks but possibly as long as nine weeks, then the order point is 1,575 units; 700 units usage during normal lead time (175 units x 4 weeks) plus 875 units of safety stock (175 units x 5 weeks). Assuming a beginning inventory of 2,800 units with no orders outstanding, the usage, order schedule, and maximum inventory levels are: Units in beginning 2,80 inventory .............................................................................. 0 Usage to order point (1,225 175 weekly usage = 7 1,22 weeks) ............................. 5 Order 1,5 point .......................................................................................... 75 ............... Usage during normal lead time (700 175 weekly usage = 4 700 weeks) ................ Maximum inventory or safety stock at date of delivery, assuming normal lead time and usage ........................................................................................ ........... 875 Order quantity units 2,09 received ............................................................................ 0 Maximum inventory, assuming normal lead time and 2,9 usage ............................ 65 6. Computer Simulation for Materials Requirements Planning Materials requirements planning (MRP) is a computer simulation for managing materials requirements based on each products bill of materials, inventory status, and process of manufacture. A master schedule of items to be produced and their due dates are entered into the computer, which then accesses the bill of materials, materials delivery lead times, and

quantities of inventory on hand and on order. The computer program calculates the needed quantity for each material and the amount and timing of demands on each work location.