Inventory Part4

ACCA F2 - Management Accounting

Now we concentrate on some mathematics involved in managing inventory. The total cost of inventory is the sum of purchase cost, holding cost and ordering cost. Ordering costs and holding costs are minimum at EOQ (Economic Order Quantity) level. Total required quantity divided by EOQ gives number of orders. Total ordering cost is calculated by multiplying ordering cost per order with no of orders. Likewise, total holding cost is calculated using holding cost per unit multiplied by average inventory hold during the period. To go through mathematical calculation and explanation please check the article from ACCA. The link is provided below.

Transfer of inventory form one department of another within organisations does not include ordering cost. Interdivisional transfer is dealt with transfer pricing. The price agreed in transfer pricing may or may not be the open market price. All these issues will be discussed in later article related to transfer price.

Ratios are analytical tools used by accountants and managers to access the position of specific account and the performance of responsible managers. The relation between current ratio and quick ratio is used to see the affect of holding inventory in working capital. Inventory to working capital ratio shows firms capability to finance its inventory from its available cash. Inventory period is average number of days inventory is held (Inventory Period = 365*Average inventory/Annual cost of goods sold). Inventory turnover is ratio of cost of goods sold to average inventory. It also means times inventory is sold and replaced in a period. Further, for performance measurement inventory operations for organisation in same sector are identified, benchmarked and evaluated using quantifiable and non-quantifiable terms.

Inventory financing is a type of asset based lending, it is a short-term working capital loan secured by the inventory purchased. As the inventory is converted into sales, the loan is gradually paid-off and (when it is fully satisfied) new inventory is bought with a new loan, and the cycle starts all over again. Inventory-financing interest rates are usually higher than for accounts-receivable financing because in the latter-case goods have already been sold. Also called inventory loan.

Effect in inventory due to change in costing system: See on upcoming article on Marginal Costing.

IAS 2 - Inventory accounting  - inventory valuation : Check Summary on IAS 2

ACCA Article: Inventory

ACCA Article: Stock control.