INVENTORY MANAGEMENT

ONE OF THE MOST

EMBARRASSING SITUATIONS
FOR A SUPPLY CHAIN
MANAGER IS TO RUN OUT OF
STOCK EVENTUALLY BRINGING
CERTAIN OPERATIONS TO A
HALT.
 SO WHAT?
HAVE MORE INVENTORY – NO
STOCKOUTS
BUT THEN WHAT ABOUT……
INVENTORY CARRYING COSTS !!!
 INTRODUCTION
• Inventory decisions are high-risk and high-
impact from the perspective of logistics
operations.
• Inventory assortment and subsequent
shipment in anticipation of future sales
determine a number of logistics activities.
• Without proper coordination, sales may be
lost and customer satisfaction may also
decline.
• Also critical to manufacturing.
• RM shortages can shut down the line or modify a
production schedule leading to added costs and FG
shortages.
• Overstock inventories can also increase costs and
reduce profitability through added warehousing,
working capital requirements, deterioration,
insurance, taxes, and obsolescence.
 NOTE IT……..

• Constitutes significant part of current assets

• On an average approximately 60% of current
assets in Public Limited Companies in India.
• A considerable amount of fund is required
• Effective and efficient management is
imperative to avoid unnecessary investment.
Basic Concept

Time
Input Purchase ----------> Input Utilized
Product value realized

Inventory
 Inventory

Inputs Outputs
Process
• Raw Materials • Finished Goods
• Purchased parts • Scrap and Waste
• Maintenance and
Repair Materials (in warehouses, or
“in transit”)
In Process
• Partially
Completed (often on the
Products and factory floor)
Subassemblies
 Inventory

Work in
process

Vendors Raw Work in Finished Customer

Materials process goods
Work in
process
Water Tank Analogy for Inventory

Inventory Level
Supply Rate

Inventory Level

Demand Rate
 MEANING
• A physical resource that a firm holds in stock with the
intent of selling it or transforming it into a valuable
state.
• Any stored resource used to satisfy a current or future
need (Raw Materials, Work-in-process, finished
goods, etc)
• Inventory is a list/record for goods and materials,
held available in stock by a business
 EFFECTS

• Represents as much as 50% of invested capitol at

some companies.
• Excessive inventory levels are costly.
• Insufficient inventory levels lead to stock outs.
• Storage costs are high.
 REASONS TO HOLD INVENTORY
FIVE REASONS:
• It enables the firm to achieve economies of scale
• It balances supply and demand
• It enables specialization in manufacturing
• It provides protection from uncertainties in demand
and order cycle
• It acts as a buffer between critical interfaces within
the channel of distribution
 Economies of scale
• Inventory is required to realize the economies of scale in
purchasing, transportation or manufacturing.
• Example: ordering large quantities of raw materials/
finished goods inventory allows the manufacturer to take
advantage of the per unit price reductions associated with
the volume purchases.
• Purchased materials have a lower transportation cost per
unit if ordered in large volumes  because less handling is
required.
 Balancing Supply and Demand for Seasonal Inventories
• Seasonal supply or demand may make it necessary for a firm to
hold inventory
• Example: Boxed Chocolate sales  increase during Mother’s Day
• Demand for a product may be relatively stable throughout the
year, but raw materials may be available only at certain times
during the year (e.g. producer of canned fruits and vegetables) 
this makes necessary to manufacture finished products in excess
of current demand and hold in inventory
Specialization
• Inventory makes it possible for each of the firm’s plants
to specialize in the products that it manufactures

• The finished product can be shipped to field warehouses

where they are mixed to fill customer order

• The specialization by facility is known as Focused

Factories
Protection from Uncertainties and Order Cycle

• Inventory is held to prevent a stock-out in the case

of variability in demand or variability in the
replenishment cycle

• example: price increase, supply shortage and to

maintain a source of supply
Inventory as a Buffer

• Inventory is held throughout the supply chain to act as a

buffer for the following critical interfaces:

1. Supplier – procurement (purchasing)

2. Procurement – production
3. Production – marketing
4. Marketing – distribution
5. Distribution – intermediary
6. Intermediary – consumer/user
REASONS TO NOT HOLD INVENTORY
• Carrying cost
– Financially calculable
• Takes up valuable factory space
– Especially for in-process inventory
• Inventory covers up “problems” …
– That are best exposed and solved
 DANGERS OF OVER INVESTMENT

• Unnecessary tie-up of firm’s fund and loss

of profit – involves opportunity cost
• Excessive carrying cost
• Risk of liquidity – difficult to convert to
cash
• Physical deterioration of inventories while
in storage due to mishandling and
improper storage facilities.
DANGERS OF UNDER INVESTMENT

• Production hold-ups – loss of labor hours

• Failure to meet delivery commitments
• Customers may shift to competitors
which will amount to a permanent loss to
the firm
• May affect the goodwill and image of the
firm
Inventory Hides Problems

Bad
Design
Lengthy Poor
Setups Quality
Machine
Inefficient Unreliable
Breakdown
Layout Supplier
 To Expose Problems:
Reduce Inventory Levels

Bad
Design
Lengthy Poor
Setups Quality
Machine
Inefficient Unreliable
Breakdown
Layout Supplier
Remove Sources of Problems and Repeat
the Process

Poor
Quality

Lengthy
Setups

Bad
Machine
Design Inefficient Unreliable
Breakdown
Layout Supplier
 The Logistics Flow
Finished
Raw Work-in- goods
materials process inventory
inventory inventory at plant
location
Finished goods
Supplier inventory at field
inventory location
Consumer Retail
inventory inventory
Reworking or
repackaging
of product

Waste and Waste

by disposal KEY: Forward logistics flow
product Reverse logistics flow

Reverse logistic  move product backward through the channel for a number of
reason
Example: a customer may return a product because it is damaged/ manufacturer may
need to recall a product because of defects
 TYPES
Cycle stock

• That results from replenishment of inventory

sold or used
• It is required in order to meet demand under
conditions of certainty; when the firm can
predict demand and replenishment times
(lead times)
• Example: if the rate of sales for a product is a
constant 20 units per day and the lead time is
always 10 days
no inventory beyond the cycle stock would
be required
Basic inventory Principles – cycle stock
A Order quantity of 400 units Order
Order
arrival
Inventory Order Order arrival
Average
400 place place
Cycle
inventory

200

0 Days10 20 30 40 50 60

B Order quantity of 200 units Order arrival:

Inventory Order Average

200 place Order Cycle
place inventory

100

0 Days10 20 30 40 50 60

C Order quantity of 600 units

Order arrival:
Inventory
Next order placed
600 Average
Order
place Cycle
inventory
300

0 Days 10 20 30 40 50 60
 In-transit Inventories
• Items that are en route from one location to another
• Considered part of cycle stock even though they are
not available for sale or shipment until after they
arrive at the destination
• In-transit inventory should be considered as inventory
at the place of arrival since the items are not available
for use, sale or subsequent reshipment

Safety or Buffer Stock

• Is held in excess of cycle stock because of uncertainty
in demand or lead time
• Average inventory at a stock-keeping location is
equal to half the order quantity plus the safety stock
Average inventory investment under conditions of uncertainty
a With variable demand

Inventory
200 Average
Cycle
inventory

100

8
Safety 10 40
10 20 30
Stock
Days
(50)

B With variable lead time

Inventory
200 Average
Cycle
inventory

100

12
Safety 10 40
20 30
Stock
Days
(40)

C With variable demand and lead time

Inventory
200 Average
Cycle
inventory

100

Safety 8 10 12 40
20 30
Stock
Days
(100)
Speculative Stock

• Is inventory held for reason other than satisfying current

demand.
• Example: materials may be purchased in volumes larger
than necessary in order to receive quantity discount,
because of a forecasted price increase or materials shortage
or to protect against the possibility of a strike.

Seasonal Stock

• Is a form of speculative stock that involves the

accumulation of inventory before a seasonal period begins
• Example: agricultural product, fashion industry and
seasonal items
Dead Stock

• Refers to items for which no demand has been

registered for some specified period of time
• Might be obsolete throughout a company or only at
one stock-keeping location
 Inventory Planning and Control
For maintaining the right balance between high and low
inventory to minimize cost
 INVENTORY SYSTEM
• A set of policies and controls that :
– monitors levels of inventory and
– determines what levels should be
maintained,
– when stock should be replenished, and
– how large orders should be
maintained.
 BENEFITS
• Ensure a continuous supply of raw materials
and supplies to facilitate uninterrupted
production.
• Maintain sufficient finished goods for smooth
sales operation and efficient customer service.
• It permits the procurement of raw materials in
economic lot sizes as well as processing of
these raw materials into finished goods in the
most economical quantities.
• It helps to reduce the material handling costs.
• It helps to utilize people and environment.
• Reduce dependencies of one another and
enable the organizations to schedule its
operations independently of another.
• It facilitates product display and service to
customers.
• It enables management to make cost and
consumption comparisons between operations
and periods.
• It keeps the obsolescence losses, inventory
carrying costs to the minimum.
• It provides a check against the loss of
materials.
INVENTORY MANAGEMENT
It involves the development and administration
of policies, systems and procedures which will
minimize total costs relative to inventory
decisions and related functions such as
customer service requirements, production
scheduling and purchasing.
INVENTORY MANAGEMENT
EFFECTIVENESS
• The key measure of effective inventory management
is the impact that inventory has on corporate
profitability

• Effective inventory management can improve

profitability by lowering costs or supporting
increased sale

• Better inventory management can increase the ability

to control and predict how inventory investment will
change in response to management policy
 Inventory Cost Structures

An optimum inventory level involves

the following main types of costs:
• Ordering costs
• Carrying (or holding) costs
• Stock out costs
• Capacity costs
• ORDERING COSTS
– Quotation or Tendering
– Requisitioning
– Order placing
– Transportation
– Receiving, inspecting and storing
– Quality control
– Clerical and staff

• CARRYING COSTS
– Warehousing or storage
– Handling
– Clerical and staff
– Insurance
– Interest
– Deterioration, shrinkage, evaporation and obsolescence
– Taxes
– Cost of capital
• STOCK-OUT COSTS:
– Loss of Sale
– Failure to meet delivery requirements
– Back ordering costs.

• CAPACITY COSTS:
– Overtime payments when capacity is too small
– Layoffs and idle time when capacity is too large.
 DECIDING ON THE INVENTORY
MODEL
• Assume an analyst applies an inventory
model that does not allow for spoilage to a
grocery chain’s ordering policy for lettuce
and formulates the strategy of ordering
lettuce in large amounts every 14 days. A
little thought will show that this is
obliviously foolish. This strategy implies
that lettuce will be spoiled. However it is
not a failure of inventory, it is a failure to
apply the correct model.
 Inventory Management
Systems/Models
• While managing inventory one must:

– Prioritize the items (ABC)

– Know how much to order (EOQ)
– Know when to order (ROP)
– Know to order (Continuous/Periodic)
– Know to track inventory (perpetual/physical)

(these are also known as Inventory Control Techiniques)

PRIORITIZATION TECHNIQUES

• Always better control (ABC) classification.

• High, medium and low (HML) classification.
• Vital essential and desirable (VED) classification.
• Scarce difficulty and easy to obtain (SDE)
• Fast moving, slow moving and non-moving (FSN)
• GOLF classification
• SOS classification
 ABC Analysis

• ABC Analysis – inventories are classified on

the basis of their consumption value.
• A – High value so, Low volume
• B – Medium Value so, larger inventory level.
• C – Low Value so, highest inventory level.

Also called Selective Control Inventory Method

(SIM)
 ABC Analysis
• Recognizes that some inventory items are
more important than others
• A group items are considered critical (often
about 70% of dollar value and 10% of items)
• B group items are important but not critical
(often about 20% of dollar value and 20% of
items)
• C group items are not as important (often
about 10% of dollar value and 70% of items)
 Silicon Chips Inc. Example

• Maker of super fast DRAM chips

• Has 10 inventory items
• Wants to classify them into A, B, and C groups
• Calculate dollar value of each item and rank items
Inventory Items for Silicon Chips
 THEREFORE…….
• A-items
– Track carefully (e.g. continuous review)
– Sophisticated forecasting to assure correct levels
• C-items
– Track less frequently (e.g. periodic review)
– Accept risks of too much or too little (depending on
the item)
 HML Classification
• On the basis of unit value of item
• For e.g. there is 1000 unit of Q @ Rs.10 and
10000 units of W @ Rs.5
• Aimed to control the purchase of raw materials

H – High, M – Medium, L - Low

 VED CLASSIFICATION
• Mainly for spare parts because their consumption
pattern is different from raw materials.
• Classification is done on the basis of criticality of
the item.
V – Vital, E – Essential, D - Desirable
• Therefore V items has to be stocked more and D
items has to be less stocked.
 FSN CLASSIFICATION
• According to the consumption pattern
• To combat obsolete items

F – Fast Moving, S – Slow Moving, N –

Non Moving
 SDF & GOLF CLASSIFICATION
• SDF:
• Based on source of procurement
S – Scarce, D – Difficult, E – Easy

• GOLF:
G – Government, O – Ordinary, L –
Local, F - Foreign
 SOS CLASSIFICATION
• Raw Materials especially for agriculture units

S – Seasonal, OS – Off Seasonal

ECONOMIC ORDER QUANTITY
(EOQ)
Determining How Much to Order

• One of the oldest and most well known

inventory control techniques
• Easy to use
• Based on a number of assumptions
 Economic Order Quantity (EOQ)
Model
• The best policy by minimizing the total of inventory
carrying costs and ordering costs

• The EOQ is a concept which determines the optimal

order quantity on the basis of ordering and carrying
costs

• When incremental ordering costs equal incremental

carrying costs, the most economic order quantity
exists
 THE BEST EOQ
EOQ recognizes the tug of war between acquisition
costs and inventory carrying costs:
when you order bigger quantities less frequently, your
aggregate acquisition costs are low but your
inventory costs are high due to higher inventory
levels.
Conversely, when you order smaller quantities more
often, your inventory costs are low but your
acquisition costs are higher because you are
expending more resources on ordering.
The EOQ is the order quantity that minimizes the sum
of these two costs.
 Economic Order Quantity (EOQ)
(Assumptions)
• Demand is known and constant
(AUU = annual usage in units)
• Ordering (setup) cost
(ACPO = acquisition costs per order)
• Unit cost is constant (no quantity discounts) (UC)
• Annual carrying costs on inventory value
(CCP = carrying cost percentage)
• No stock outs.
• Receipts of inventory is instantaneous.
• Material is ordered or produced in a lot or batch.
 FORMULA

2 x ACPO x AUU
EOQ = UC x CCP

Where,
ACPO – Acquisition Costs Per Order
AUU – Annual Usage in Units
UC – Unit Cost
CCP – Carrying Cost Percentage
 EOQ (Example#1)
• AUU = 4800 units
• ACPU = Rs.40
• UC = Rs.100
• CCP = 25%

WHAT IS THE EOQ?

 EOQ (Example#1)
• AUU = 4800 units
• ACPU = Rs.40
• UC = Rs.100
• CCP = 25%

EOQ = √ 2x40x4800
100 x 25%

= 124 UNITS
 DO IT YOURSELF…….
• It costs you $150 in overhead per order
• You use 5000 units a year
• Your finance department tells you that
annual carrying costs are equal to 20% of
the value of goods in stock.
• You pay $200 per unit
• You should order…………….?
 DO IT YOURSELF…….
• It costs you $150 in overhead per order
• You use 5000 units a year
• Your finance department tells you that
annual carrying costs are equal to 20% of
the value of goods in stock.
• You pay $200 per unit
• You should order…………….?
194 units at a time
 EOQ Inventory Order Cycle
Demand
Order qty, Q
rate
Inventory
Level

ave = Q/2

Reorder point, R

0 Lead Lead Time

time time
As Q increases, average Order Order Order Order
inventory level increases, but
number of orders placed Placed Received Placed Received
decreases
 REORDER POINT
Determining When to Order
• After Q* is determined, the second
decision is when to order
• Orders must usually be placed before
inventory reaches 0 due to order lead time
• Lead time is the time from placing the
order until it is received
• The reorder point (ROP) depends on the
lead time (L)
 FORMULA (ROP)
ROP = SSQ + (QUD X ALT) (if safety stock is
included)

Where,
ROP = Reorder Point
SSQ = Safety Stock Quantity
QUD = Quantity used daily
ALT = Average Lead Time (in days)
 ROP(Example#1)

• Minimum Daily requirement – 800 units

• Time required to receive emergency supplies –
4 days
• Average daily requirement – 700 units
• Time required for refresh supplies – 30 days
• Calculate ordering point or re-order level.
 ROP(Example#1)
• Minimum Daily requirement – 800 units
• Time required to receive emergency supplies – 4 days
• Average daily requirement – 700 units
• Time required for refresh supplies – 30 days
• Calculate ordering point or re-order level.
Calculation:
ROP = 800 x 30
= 24000 units
 ROP(Example#2)
• Two types of materials are used.
• Minimum usage – 20 units per week each
• Maximum usage – 40 units per week each
• Normal usage – 60 units per week each
• Lead time;
– Material A - 3 to 5 weeks
– Material B - 2 to 4 weeks
• Calculate re-order point for both materials.
 ROP(Example#2)
• Two types of materials are used.
• Minimum usage – 20 units per week each
• Maximum usage – 40 units per week each
• Normal usage – 60 units per week each
• Lead time;
– Material A - 3 to 5 weeks
– Material B - 2 to 4 weeks
• Calculate re-order point for both materials.
Calculation:
A: 60 x 5 = 300 units
B: 60 x 4 = 240 units
 ‘Q’ SYSTEM vs ‘P’ SYSTEM

IT IS EMPLOYED BY THE ORGANIZATION

WITHIN THE BASIC FRAMEWORK OF MODELS
–
FIXED ORDER QUANTITY SYSTEM or
Q SYSTEM
FIXED ORDER PERIOD SYSTEM or
P SYSTEM
 DISTINCTION
Points of Diff Q system P System

Quantity of order Constant-the same Quantity of order varies

quantity order each time each time order is
placed.

Size of Inventory Less than P System Larger than Q System

Time to maintain Higher Less time

Record keeping Continuous Only at the review

period

Period of order Any time when stock Only after

levels reaches to predetermined period.
reorder point
INVENTORY TRACKING METHODS

• PERPETUAL INVENTORY SYSTEM

• PHYSICAL INVENTORY SYSTEM
 Perpetual Inventory System
perpetual
inventory system
An inventory A perpetual inventory system tracks the
system that tracks
the number of number of items in inventory on a constant
items in inventory basis. With this system, a business keeps
on a constant basis. track of sales as they occur.
In a manual system, employees gather paper
records of sales and enter that information
into the inventory system. Computer-based
systems are faster and more accurate.
Physical Inventory System
In a physical inventory system , stock is
visually inspected or actually counted to
determine the quantity on hand. A company
uses this system alongside perpetual
inventory systems to:
• Determine the correct value of its ending
inventory
• Identify stock shortages
• Plan future purchases

There are numerous methods for inventory

control.
cycle counts
A small portion of
Physical Inventory System
the inventory is
physically counted
each day by stock
keeping units so
that the entire The most popular method of inventory
inventory is
accounted for on a management is the physical inventory. These are
regular basis. usually wall-to-wall store inventories that
stock keeping require the business to close temporarily to
unit (SKU) conduct the inventory.
A unit or a group
of related items in Cycle counts allow a business to physically
a unit control count only a small portion of the inventory every
inventory system;
the smallest unit day to track the entire inventory. The inventory
used in inventory is counted by a stock keeping unit (SKU) ,
control. which is a unit or a group of related items.
 Physical Inventory System

Visual control is used mainly by smaller businesses. It uses

stock cards noting the necessary number of each displayed item.
The difference between the number on the card and the actual
number of items on hand is the amount that needs to be
reordered.
This system is somewhat inaccurate because it does not account
for misplaced merchandise.
 Cycle Counting of Inventory
Cycle counting uses inventory classifications developed
by ABC analysis.
That is:
• Class A items are counted frequently, perhaps once a
month.
• Class B items are counted less frequently, perhaps
once a quarter.
• Class C items are counted perhaps once every six
months.
Using Both Systems
Most businesses find it most effective to use both systems
because they complement each other. The perpetual system
gives an up-to-date inventory record throughout the year.
The physical system gives an accurate count that can be
compared to the perpetual records to identify errors or
problems.
Using Both Systems
When the physical count shows less merchandise than is
supposed to be in inventory, a stock shortage or shrinkage
has occurred. Possible reasons are:
• Employee and customer theft
• Receiving errors
• Incorrect counting
• Selling errors
 Stock Control

Stock control involves monitoring stock levels and

investments in stock so that a business is run efficiently.
It includes:
• Dollar versus unit control methods
• Inventory turnover calculations
 Using Both Systems

dollar
control Dollar control represents the planning
and monitoring of the total inventory
The planning
and monitoring investment that a business makes during
of the total a stated period of time. It helps a
inventory business determine the cost of goods sold
investment that and the amount of gross profit or loss
a business during a given period of time.
makes during a
stated period of
time.
Using Both Systems

unit control
Unit control measures the quantities of
The quantities merchandise that a business handles
of
during a stated period of time. It allows
merchandise
that a business purchasing personnel to see what brands,
handles sizes, colors, and price ranges are
during a stated popular.
period of
time.
 Using Both Systems

inventory Inventory turnover is the number of times the

turnover average inventory has been sold and replaced in a
The number of given period of time. It is the most effective way
times the average to measure how well inventory is being managed.
inventory has
been sold and The higher the inventory turnover rate, the more
replaced in a times the goods were sold and replaced. Stores
given period of
that keep records of the retail value of stock
time.
compute their inventory turnover rates as follows:
_______Net sales (in retail dollars)________
Average inventory on hand (in retail dollars)
Using Both Systems
When only cost information about inventory is available,
inventory turnover can be calculated with this formula:

_______Cost of goods sold________

Average inventory on hand (at cost)
Using Both Systems

When a store wants to look at the number of items carried in

relation to the number of items sold, it calculates its stock
turnover rates in units with this formula:
_______Number of SKUs sold________
Average SKUs on hand
 INVENTORY COST FLOWS

Beginning Net Cost

Inventory of Purchases

Merchandise
Available
for Sale

Ending Cost of
Inventory Goods Sold
 IMPORTANCE OF INVENTORY
VALUATION
• Costing method has important effect on net income
and asset valuation.

Beginning + Inv. = Goods Available for Sale

Inv. Purchase
Costing method
Needs to be allocated
Weighted Average
LIFO
FIFO Ending Inv. Cost of Goods Sold
 BASIC ASSUMPTIONS
• FIFO (first-in, first-out): Units sold are
assumed to be first units purchased (ending
inventory = costs of the last purchases)
• LIFO (last-in, first-out): Units sold are
assumed to be last units purchased (ending
inventory = cost of the first units purchased)
• Average (periodic): Unit cost = (cost of
beginning inventory + cost of purchases)
divided by the total units involved; thus,
ending inventory = unit cost x units on hand!
 AS A RESULT……..
• FIFO: Ending inventory is costed using nearest-to-
year-end replacement costs.
– Old (lower) costs were matched to sales, which produces a
“higher” reported gross profit.

• LIFO: Ending inventory is costed using nearest-to-

year-start (oldest) costs.
– New (higher) costs were matched to sales, which produces
a “lower” reported gross profit.

(Opposite results are reported during deflationary times)

 Comparative Results During Inflation
(1)
In a period of rising prices, LIFO has the smallest
ending inventory and FIFO the largest.

(2)
In a period of rising prices, LIFO has the largest cost
of goods sold and FIFO the smallest.

(3)
In a period of rising prices, FIFO has the largest gross
profit and LIFO has the smallest.
 Average Cost

When
When aa unit
unit is
is sold,
sold, the
the
average
average costcost ofof each
each
unit
unit in
in inventory
inventory is is
assigned
assigned to to cost
cost ofof
goods
goods sold.sold.
Cost of Units
Goods ÷ available on
Available for the date of
Sale sale
 Inventory Costing Method

Use of Inventory Methods in Practice

 Example # 1
• Facts:
a. Retailer started the year with a beginning
inventory of one refrigerator that cost $300.
b. The retailer purchases another identical
refrigerator for a cost of $340 during the year.
c. At the end of the year, the retailer sells one of the
refrigerators for $500.
2. The total cost of goods available for sale equals
beginning inventory plus purchases ($640 in this
example).
 Example # 1 (Cont’d)
– The first-in, first-out (FIFO) method of inventory
costing method assumes that the first unit
purchased is the first unit sold. Therefore, cost of
goods sold in this example is $300.

– The last-in, first-out (LIFO) method of inventory

costing method assumes that the last unit
purchased is the first unit sold. Therefore, cost of
goods sold in this example is $340.
 Example # 1 (Cont’d)

FIFO LIFO Average

Sales Revenue $ 500 $ 500 $ 500
COGS $ 300 $ 340 $ 320
Operating Profit $ 200 $ 160 $ 180
Ending Value $ 340 $ 300 $ 320
 Example 2
• Facts: C & Co. had beginning inventory of 14,000 units
purchased at $6 per unit, for a total opening cost of $84,000.
• ANNUAL INVENTORY ACTIVITY FOLLOWS:

Purchases Units Unit Cost Total Cost

January 10 10,000 $7.00 $ 70,000
June 15 15,000 $8.00 $120,000
December 1 8,000 $8.50 $ 68,000
Total 33,000 $258,000
Example 2 – Contd.
Sales Units Sales Price Total Sales
February 15 7,000 $15.00 $105,000
May 1 5,000 $16.00 $ 80,000
October 1 11,000 $17.00 $187,000
December 15 15,000 $18.00 $270,000
Total 38,000 $642,000

Calculate ending inventory, cost of goods

sold and gross profit under three periodic
methods: LIFO, FIFO and Average.
Example 2 – Contd.

Cost of Good Available for Sale?

• Solution:
– 47,000 units were available during the period
(14,000 beginning inventory + 33,000
purchased)
– 38,000 units were sold
– 9,000 units were in ending inventory
• Cost of goods available for sale = $84,000
of beginning inventory + purchases of
$ 258,000 = $ 342,000.
Example 2 – Contd.

LIFO Assumption
• Ending Inventory = $54,000
The cost of the first 9,000 units purchased:
9,000 beginning inventory × $6
• Cost of Goods Sold = $288,000
Details: (8,000 × $8.50) + ($15,000 × $8) +
(10,000 × $7) + (5,000 × $6)

• Check: $54,000 + $288,000 = $342,000, the

cost of goods available for sale
Example 2 – Contd.
FIFO Assumption
• Ending Inventory = $76,000
The cost of the last 9,000 units purchased:
(8,000 × $8.50) + (1,000 × $8)
• Cost of Goods Sold = $266,000
Details: (14,000 × $6) + (10,000 × $7) +
(14,000 × $8)

• Check: $76,000 + $266,000 = $342,000, the

cost of goods available for sale
Example 2 – Contd.
Periodic Averaging
• Average Cost = $7.2766
$342,000 cost of goods available for sale
47,000 units available for sale
• Ending Inventory = $65,489
9,000 units × $7.2766
• Cost of Goods Sold = $276,511
38,000 units × $7.2766

• Check: $65,489 + $276,511 = $342,000, the

cost of goods available for sale
Example 2 – Contd.
Comparative Results During Inflation
LIFO FIFO Average
Balance Sheet
Ending Inventory (1) 54,000 76,000 65,489
Income Statement
Sales 642,000 642,000 642,000
CGS (2) 288,000 266,000 276,511
Gross Profit (3) $354,000 $376,000 $365,489