Page 343 - Accounting Information Systems

314 PART II Transaction Cycles and Business Processes

warehouse. Also, a copy of the work order is sent to inventory control to update the FG inventory
records.
Work centers also fulfill an important role in recording labor time costs. This task is handled by work
center supervisors who, at the end of each workweek, send employee time cards and job tickets to the
payroll and cost accounting departments, respectively.

INVENTORY CONTROL. The inventory control function consists of three main activities. First, it
provides production planning and control with status reports on finished goods and raw materials inven-
tory. Second, the inventory control function is continually involved in updating the raw material inven-
tory records from materials requisitions, excess materials requisitions, and materials return tickets.
Finally, upon receipt of the work order from the last work center, inventory control records the completed
production by updating the finished goods inventory records.
An objective of inventory control is to minimize total inventory cost while ensuring that adequate
inventories exist to meet current demand. Inventory models used to achieve this objective help answer
two fundamental questions:
1. When should inventory be purchased?
2. How much inventory should be purchased?
A commonly used inventory model is the economic order quantity (EOQ) model. This model, how-
ever, is based on simplifying assumptions that may not reflect the economic reality. These assumptions are:
1. Demand for the product is constant and known with certainty.
2. The lead time—the time between placing an order for inventory and its arrival—is known and constant.
3. All inventories in the order arrive at the same time.
4. The total cost per year of placing orders is a variable that decreases as the quantities ordered increase.
Ordering costs include the cost of preparing documentation, contacting vendors, processing inven-
tory receipts, maintaining vendor accounts, and writing checks.
5. The total cost per year of holding inventories (carrying costs) is a variable that increases as the quan-
tities ordered increase. These costs include the opportunity cost of invested funds, storage costs,
property taxes, and insurance.
6. There are no quantity discounts. Therefore, the total purchase price of inventory for the year is constant.

The objective of the EOQ model is to reduce total inventory costs. The significant parameters in
this model are the carrying costs and the ordering costs. Figure 7-10 illustrates the relationship
between these costs and order quantity. As the quantity ordered increases, the number of ordering
events decreases, causing the total annual cost of ordering to decrease. As the quantity ordered
increases, however, average inventory on hand increases, causing the total annual inventory carrying
cost to increase. Because the total purchase price of inventory is constant (Assumption 6), we mini-
mize total inventory costs by minimizing the total carrying cost and total ordering costs. The com-
bined total cost curve is minimized at the intersection of the ordering-cost curve and the carrying-cost
curve. This is the EOQ.
The following equation is used to determine the EOQ:
r ffiffiffiffiffiffiffiffiffi
Q ¼ 2DS
H
where: Q ¼ economic order quantity
D ¼ annual demand in units
S ¼ the fixed cost of placing each order
H ¼ the holding or carrying cost per unit per year

To illustrate the use of this model, consider the following example:
A company has an annual demand of 2,000 units, a per-unit order cost of $12, and a carrying cost per
unit of 40 cents. Using these values, we calculate the EOQ as follows: