ACCA MA Syllabus C. Cost Accounting Techniques - Costs of ordering and holding inventory - Notes ^{4 / 22}

A business holds inventory so that customer demands are met as soon as they arise.

Buffer (safety) inventory is the minimum inventory level required to prevent stock-outs from occurring.

Annual holding cost:

(Q/2 +buffer inventory) * Cost of holding 1 unit for 1 year (Ch)

Q is the quantity per order

Advantages of Holding Stock

• the need to meet customer demand

• taking advantage of bulk discounts

• reducing total annual re-ordering cost

Disadvantages of Holding Stock

• storage costs

• cost of capital tied up in stock

• deterioration, obsolescence, and theft

Stock-out costs

Stock-out costs occur when the business runs out of inventory and these include:

• Loss of sales

• Loss of customers

• Loss of reputation

• Reduced profits

An order cost is incurred every time an order is placed to purchase materials.

Therefore, an increase in the number of orders will cause a corresponding increase in ordering costs.

Annual order cost

D/Q * Cost to place 1 order (Co)

D is the annual demand
Q is the quantity per order