Cost Accounting

Management must make decisions about the control of stock levels with a view to minimizing the cost of the company while achieving more efficiency in the availability of material to fulfill planned usage requirements. Consideration should be given to the following control levels:

1. Minimum stock level
2. Maximum stock level
3. Re-order level
4. Re order quantity (Note the re-order quantity is not necessary the EOQ)

1. Minimum stock level

This is the level below which stock should not fall. It is essentially a base (buffer) stock level. If stock falls below this point, there is a danger of stockout.

Minimum stock level = Reorder level – (Normal consumption x normal reorder period)

2. Maximum stock level

This is the upper limit above which stock should not be allowed to rise. Each material to be kept in store must have a maximum level and stock should not be allowed to go beyond this level

Maximum stock level = Re-order level +re-order Quantity - (Minimum consumption x minimum re-order period)

3. Re-order level

Is a point that lies between minimum and maximum stock levels at which purchase orders must be placed to ensure that goods ordered are received before the minimum stock level is reached? It is the level of stocks at which replenishment must be made to avoid a stock-out.

Re-order level = maximum consumption X maximum re-order period

4. Re-Order quantity

This is the quantity of stock ordered once the re-order point is reached. The quantity is such as to minimize stock costs taking into consideration the cost of holding stocks and making an order. This is also regarded as the Economic Order Quantity (EOQ).

Economic Order Quantity (EOQ):

It constitutes the quantity purchased of either stocks or raw materials that is considered most optimum. This is the quantity that minimizes both holding costs and ordering costs, As the quantity of purchase increases there is a reduction in ordering costs, but an increase in holding costs

The EOQ model assumes:

• Annual demand is known
• Hold costs are constant and known
• Ordering costs are known and constant
• The same quantity is ordered every time an order is made since demand as assumed not to fluctuate significantly.