Formula Method- easy to use and produces an exact figures.

EOQ= √2CN

Where:

EOQ= economic order quantity

C= cost of placing an order

N= number of units required annually

K= carrying cost per unit of inventory

To illustrate the application of the formula, let us assume the ff:

Number of units of materials required annually 10,000

Cost of placing an order P 10.00

Annual carrying cost per unit of inventory P 0.80

Using the EOQ formula

=√2(cost of order) (number of units required annually)

(Carrying cost per unit)

=√2(P 10) (10,000)

P 0.80

=√P 200,000

P 0.80

=√250,000

=500 units
Order Point must be established onece the Economic Order Quantity has been determined,
management must decide when to place the order.

Lead time is the period between the placement of the order and the receipt of the materials
ordered.

Inventory usage rate is the quantity of materials used in production over a period of time.

The order point should be where the inventory level reaches the number of units that would be
consumed during the lead time.

Illustrative problem 2

Assume that the expected daily usage of an item of material is 100 units and the anticipated
lead time is 4 days. The following calculation shows that the order point is 400 units.

Order point = 100 units (daily usage) x 4 days (lead time)

= 400 units

When the inventory level of materials is reduced to 400 units, an order should be placed for 500
units (the EOQ)

Safety Stock

Since it is almost impossible to estimate lead time and average usage rate with accuracy, many
companies prefer to carry a safety Stock (or additional inventory) as a cushion against possible
stockouts. In such a case, the order point is computed by adding the safety stock to the estimate
usage during the lead time. A safety stock calculation should arrive at a figure which properly
balances the risk of a stockout against the additional carrying costs incurred by the extra
inventory.

Business Papers Used to Support Material Transactions

1.Purchase Requisition- is a written request, usually sent to inform the purchasing department
of a need for materials or supplies. The purchase requisition is usually preprinted according to
the specifications of a particular company. Most forms usually include the requisition (serially
numbered) name of the department or individual making the request, quantity of items
requested, description of the item, unit price, order data, required delivery date, and authorized
signature.

2. Purchase Order- is a written request to a supplier for specified good at an agreed upon price.
The pruchase order is the supplier's authorization to deliver goods and submit a bill.
3. Receiving Report- When the goods that were ordered are delivered, the receiving
department will unpack and count them. It is interesting to note that the quantity ordered is
not shown on the copy of the purchase order sent to the receiving department.

4. Materials Requisition Slip- a written order to the storekeeper to deliver materials or supplies
to the place designated or to issue the materials to the person presenting a properly executed
requisition.

Methods of Costing Materials

The main objective is to produce accurate and meaningful figures for the goods manufactured
and sold which are to be used by management for control, analysis and for the determination of
the operating income.

The more common methods of costing materials issued and finished goods sold are :

1. FIFO

2. Average Cost

This methods are related to the flow of costs and not necessarily to the actual foow of materials
or finished goods. If only the materials were acquired at the same cost all year round, then
valuation of materials inventory, and, will not be a problem because the value can be computed
by sinply multiplying the units on hand and the unit cost. The same can be said for the finished
goods because if the units were produced at the dame cost all year round, the value at the end
of the period can be computed by multiplying the finished goods on hand by the cost to
produce each unit. The different methods are used because yhe materials are acquired at
different cost during the year. Average cost for perpetual inventory system refers to koving
average and for periodic inventory system-weighted average.

FIFO Method of Costing

The first-in, first-out method is based on the assumption that cost should be charged to
manufacturing cost or cost of goods sold in the order in which incurred. Inventories are stated in
terms of the most recent costs and expense is charged with the earliest cost incurred.