Firm Expects To Sell 50,000 Units Annually

Firm Expects To Sell 50000 Units Of Its Product Annually

A firm expects to sell 50,000 units of its product annually. It estimates that it costs $2,000 to place an order and that each unit costs $8.00 annually to carry in inventory. It takes 4 days to receive an order once it is placed. Assume that the store is open every day of the year.

a) How many units should the firm order at a time if it wants to minimize the sum of ordering and carrying costs?

To determine the optimal order quantity—also known as the Economic Order Quantity (EOQ)—we apply the EOQ model, which balances ordering costs and carrying costs to minimize total inventory costs. The EOQ formula is given by:

EOQ = √(2DS / H), where:

• D = annual demand (50,000 units)
• S = ordering cost ($2,000)
• H = holding cost per unit per year ($8)

Substituting the values:

EOQ = √(2 50,000 2,000 / 8) = √(200,000,000 / 8) = √25,000,000 = 5,000 units

Therefore, the firm should order approximately 5,000 units each time to minimize total costs.

b) How many orders will it place in a year?

Number of orders per year = Total annual demand / EOQ = 50,000 / 5,000 = 10 orders

c) How much will total ordering costs be for the year?

Total ordering costs = Number of orders Cost per order = 10 $2,000 = $20,000

d) What will its average inventory level (in units) be during the year?

Average inventory level = EOQ / 2 = 5,000 / 2 = 2,500 units

e) How much will total carrying costs be for the year?

Total carrying costs = Average inventory holding cost per unit = 2,500 $8 = $20,000

f) What is its reorder point?

Reorder point (ROP) is the level of inventory at which a new order should be placed. It considers lead time demand: ROP = Daily demand * Lead time days

Daily demand = Annual demand / Number of days open per year = 50,000 / 365 ≈ 137 units/day

Lead time = 4 days

Reorder point = 137 units/day * 4 days ≈ 548 units

g) What would you expect to happen to the reorder point if uncertainty is taken into consideration?

If uncertainty is considered—such as variability in demand or lead time—the reorder point would increase to serve as a safety stock buffer. Instead of 548 units, the reorder point would include additional units to mitigate stockouts, which depends on the variability and desired service level. Consequently, the reorder point might be adjusted upwards to ensure sufficient inventory during unpredictable demand or lead time delays.

Question 2: If a firm is considering implementing a JIT inventory system, list and describe the accounting issues that the firm should consider when making this decision.

Implementing a Just-In-Time (JIT) inventory system significantly alters the firm's inventory management and financial reporting. Several accounting issues must be carefully considered to ensure compliance, accurate financial statements, and effective cost management. These issues include inventory valuation, cost accounting, capital allocation, and internal controls.

Firstly, inventory valuation methods need reassessment. Traditional methods such as FIFO, LIFO, or weighted average may need adjustments to reflect the minimal inventory levels typical of JIT systems. Since JIT limits inventory on hand, the valuation of remaining inventory becomes less significant, and firms might favor methods that more accurately reflect current costs without overstating inventory values.

Secondly, cost accounting practices undergo transformation under JIT. The focus shifts from holding costs to process efficiencies, quality controls, and supplier performance. Accounting for procurement costs, waste reduction, and idle time becomes crucial, impacting both direct and indirect cost allocations.

Thirdly, JIT requires transparent and real-time cost tracking to monitor operational efficiency accurately. This necessitates advanced ERP systems or cost accounting software capable of assigning costs precisely, which may involve significant investment and process redesign.

Furthermore, capital allocation and budgeting strategies might need adjustment. JIT requires investment in supplier relationships, quality control, and flexible manufacturing processes, all of which should be reflected accurately in financial statements and budgets.

Internal controls also become critical. Since inventory levels are minimal, the risk of theft, misstatement, or errors increases. Therefore, firms must enhance internal control mechanisms to safeguard assets and ensure accurate reporting.

Additionally, tax implications must be considered. Reduced inventory levels may influence taxable income calculations and inventory-related deductions. Compliance with tax regulations regarding inventory valuation and write-offs becomes essential.

Finally, external reporting and disclosures may need to be revised to inform stakeholders about changes in inventory practices, risk management, and operational efficiencies. Transparency is vital to maintain investor confidence and comply with regulatory requirements.

In conclusion, while JIT offers benefits like reduced inventory costs and increased responsiveness, firms must carefully address the associated accounting issues, including valuation, costing, controls, and compliance, to effectively implement the system without compromising financial integrity.

References

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