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    Risk in the Production Cycle.

    Topic: Design the internal controls for inventory and production.

    Study Level: Master in Accounting.

    © BrainMass Inc. brainmass.com December 24, 2021, 9:45 pm ad1c9bdddf

    SOLUTION This solution is FREE courtesy of BrainMass!


    Inventory plays a very important role in the production process as well as in the ability of a company in meeting the volume of demand. Along the production process, goods-in-process inventories are needed while finished goods inventories would finally fill the volume of consumers' demand.
    The level of inventory that a company maintains at a given point in time has cost implications. Maintaining a certain volume of inventory requires investment commitment. hence, a possibility of incurring cost of capital.
    A considerably high inventory level ( higher than expected demand) would mean additional cost on the part of the company that may be caused by carrying cost, possible obsolescence and deterioration costs as well as opportunity cost. On the other hand, an inventory level that is too low would be risky on the part of the company because of a possibility that consumers' demand will not be filled. This may result to loss of customers in favour of competitors.
    Because of the costs involved and the possibility of customer loss that would result to weakening of the company's competitive position, an effective inventory control management is necessary.

    The following inventory control management techniques may be applied:
    1. Economic Order Quantity ( EOQ)

    This is an inventory management technique that allows the company to minimize both the ordering and carrying costs. The EOQ is the quantity of inventory that must be ordered every time an order is placed that would minimize the ordering and carrying costs.

    Ordering cost is the cost that the company incurs every time an order is placed while the carrying cost is the cost incurred as the company carries a unit of inventory. The method further requires that an estimate be done on annual inventory requirement.

    The formula is: EOQ = SQRT of (2SO)/C

    Where: EOQ is economic order quantity
    S is the annual inventory requirement
    O is cost per order transaction
    C is carrying cost per unit.

    2. Continuous review ( Q) system
    This is also called Reorder Point System (ROP) which continuously keeps track of the inventory level every time a certain unit is used up or withdrawn. This is done continuously until such time that a pre-determined reorder point is reached which signals that it is time to place an order.

    The reorder points vary depending on whether demand and lead times are certain or uncertain. When these variables are certain, the reorder point estimates do not give allowance to a safety stock because amount of inventory needed between orders are known. Hence, the reorder point is equal to the demand during lead time.

    On the other hand, if the demand and lead times are uncertain, a safety stock level is considered in the computation of reorder point. Hence the reorder point would be the demand during lead time plus an allowance for safety stock.

    3. Periodic review ( P) System

    This system is almost the same as the continuous review system. The only difference is that the review is done periodically rather than continuously (Krajewski and Ritzman, 1996). The new order is always placed at the end of the review while the time between orders is fixed and the demand between reviews varies.

    Using the system, the lot size (Q) may vary between reviews because of changes in demand.

    4. Production 'Run Model

    For this model, the carrying costs of the production are based on the average inventory which is one half the maximum inventory levels. The maximum inventory level is computed as follows:
    Maximum inventory level = total produced during the production run - total used during the production run (Render, 2003).

    = (daily production rate) (number of days of production)
    - (daily demand)(number of days of production)
    = (pt) - (dt)


    Krajewski, Lee J. And Ritzman, Larry P. (1996). Operations Management: Strategy and Analysis.
    Addison - Wesley Publishing Company.
    Render, Barry et al. (2003). Quantitative Analysis for Management. Pearson Education
    (Asia) Pte. Ltd.

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