Home » Absorption and Variable Costing, and Inventory Management

# Absorption and Variable Costing, and Inventory Management

For a product-based industry, inventory management is one of the inevitable processes. Inventory management involves all the stages to be appropriately implemented from ordering, storing, processing, and delivery. Not being able to make the right amount of inventory available either of raw materials or finished products at the right time to the right place could be fatal for the business operations. Thus, an efficient inventory management tool and processes with benchmarks need to be implemented across the organization.

Industries should ensure that their products have been priced correctly and all costs have been considered with the desired profit margin over the products. For example, during the production of any product, substantial costs are incurred from procurement of inventories till the delivery of products to the final consumer, such as direct and indirect material costs, direct and indirect labor costs, fixed and variable overheads.

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Absorption and Variable Costing, and Inventory Management
Just from $9/Page Inventory management or material control process revolves around planning and managing the inventory from beginning to end. The inventory includes raw materials, consumables, work-in-progress inventory, and finished stocks. The big manufacturing organization often implements ERP tools to support inventory management. The following are the common techniques used widely for inventory control. Determination of various inventory levels Economic order quantity We will discuss inventory levels and EOQ in detail, and other methods are: ABC analysis Perpetual inventory system Just in time Material requirement planning Days sales of inventory Inventory Levels For ensuring the appropriate inventory, levels are fixed and always maintained, scientific methods for fixing levels are used. These levels may vary with certain factors affecting the requirement. The following levels are generally fixed: Re-order Level: The level at which a requisition for fresh supplies is initiated. \text{Re-order level}=\text{Minimum level}+ \text{Consumption during the period required till delivery;}Re-order level=Minimum level+Consumption during the period required till delivery; Example: Calculate the re-order level from the following information. Minimum level-2000 units, max level- 5000 units. Time required for delivery-5days. Daily consumption of material 100 units. Solution: Applying, above mentioned formula,\text{Re-order level} = 2000+(100\times5) =2500\;\text{units}Re-order level=2000+(100Ã—5)=2500units Maximum level: The maximum level of stock that can be held at any moment. It is that level beyond which we canâ€™t hold inventory due to constraints of working capital management and to avoid overstocking.\text{Maximum level}=\text{Re-order level quantity}- (\text{Minimum consumption} \times \text{Minimum re-order period})Maximum level=Re-order level quantityâˆ’(Minimum consumptionÃ—Minimum re-order period) Minimum Level: The level beyond which stock level should never fall. At least this amount shall always be present in the stock.\text{Minimum level}=\text{Re-order level} – (\text{Normal consumption}\times \text{Normal re-order period})Minimum level=Re-order levelâˆ’(Normal consumptionÃ—Normal re-order period) Average Level: It can be the average of minimum and maximum levels or\text{ Minimum level} + \text{Re-order quantity/2.} Minimum level+Re-order quantity/2. Danger Level: In an ideal situation, the stock level should not go beyond the minimum level, but if it reached below the minimum level, it is called the danger level. It triggers the urgency of material requisition.\text{ Danger level}= \text{Average consumption}\times \text{Maximum re-order period for emergency purchases} Danger level=Average consumptionÃ—Maximum re-order period for emergency purchases Economic Order Quantity (EOQ): It is the most favorable quantity to be purchased when placing every order. The fixed size of materials to be ordered ensures the overall lowest costs whenever we reach at re-order level. If a larger number of materials are ordered per batch, it increases the material handling costs significantly, reducing ordering costs. And if small quantities are ordered, it may increase ordering costs, and sometimes shortages may involve higher prices due to urgent requirements. EOQ is thus the optimum quantity at the time of re-order level. For EOQ, we consider the following three costs: ## Get Professional Assignment Help Cheaply Are you busy and do not have time to handle your assignment? 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