Lection 4 Calculating Inventory Carrying Costs 1 Capital

Lection 4 “Calculating Inventory Carrying Costs” 1) Capital costs 2) 2) Inventory service costs 3) 3) Storage space costs 4) 4) Inventory risk costs

Calculating Inventory Carrying Costs Inventory carrying costs should include only those costs that vary with the quantity of inventory and that can be categorized into the following groups: 1) Capital costs 2) 2) Inventory service costs 3) 3) Storage space costs 4) 4) Inventory risk costs

1) Capital costs 2) Direct costing is a method of cost accounting based on separating costs into fixed and variable components. 3) Under direct costing, the fixed costs of production are excluded from inventory values. 4) Therefore, inventory values more closely reflect the out-of-pocket cost of their replacement.

With absorption costing (full costing), the traditional approach used by most manufacturers, fixed manufacturing overhead is included in the inventory value

First-in, first-out (FIFO). Stock acquired earliest it assumed to be sold first, leaving stock acquired more recently in inventory. Last-in, first – out (LIFO). Sales are made from the most recently acquired stock, leaving items acquired in the earliest time period in inventory.

Average cost. This method could be a moving average in which each new purchase is averaged with the remaining inventory to obtain a new average price, or a weighted average in which the total cost of the operating inventory plus all purchases is divided by the total number of units.

2) Inventory Service Costs are comprised of ad valorem (personal property) taxes and fire ant theft insurance paid as a result of holding the inventory. Taxes vary depending on the state in which inventories are held. Tax rates can range from zero in states where inventories are exempt to as much as 20 percent of the assessed value. In general, taxes vary directly with inventory levels.

Insurance rates are not strictly proportional to inventory levels because insurance is usually purchased to cover a certain value of product for a specified time period. Nevertheless, an insurance policy will be revised periodically based on expected inventory level changes.

3) Storage Space Costs relate to four general types of facilities: 1) plant warehouses, 2) public warehouses, 3) rented or leased (contract) warehouses, and 4) company-owned (private) warehouses.

Plant warehouse costs are primarily fixed. If any costs are variable, they are usually variable with the amount of product that moves through the facility, throughput, and not with the quantity of inventory stored.

Public warehouse costs are usually based on the amount of product moved into and out of the warehouse (handling charges) and the amount of inventory held in storage (storage charges). In most cases, handling charges are assessed when the products are moved into the warehouse and storage charges are assessed on a periodic basis (e. g. monthly).

Rented or leased warehouse space is normally contracted for a specified period of time. The amount of space rented is based on the maximum storage requirements during the period covered by the contract. Thus, warehouse rental charges do not fluctuate from day to day with changes in the inventory level, although rental rates can vary from month to month or year to year when a new contract is negotiated.

The costs associated with company-owned or private warehouses are primarily fixed, although some may vary with throughput. All operating costs that can be eliminated by closing a company-owned warehouse or yhe net savings resulting from a change to public warehouses should be included in warehousing costs, not inventory carrying costs.

4) Inventory risk costs vary from company to company, but typically include charges for 1) obsolescence, 2) damage, 3) shrinkage, and 4) relocation of inventory.

Obsolescence cost is the cost of each unit must be disposed of at a loss because it can no longer be sold at a regular price. In essence, it is the cost of holding products in inventory beyond their useful life.

Damage costs. Damage attributed to a public warehouse operation is usually charged to the warehouse operator if it is above a specified maximum amount. Damage is often identified as the net amount after claims.

Shrinkage costs may be more closely related to company security measures than inventory levels, even though definitely will vary with the number of warehouse locations. Thus, management may find it more appropriate to assign some or all of these costs to the warehouse locations than to the amount of inventory.

Relocation costs are incurred when inventory is transshipped from one warehouse location to another to avoid obsolescence. For example, products that are selling well in the Midwest may not be selling on the West Coast. By shipping the products to the location where they will sell, the company avoids the obsolescence costs but incurs additional transportation costs. Transshipment to avoid obsolescence or markdowns are the result of having too much inventory, and the cost should be included in inventory carrying costs.