Question

Scenario: Davis Skaros has recently been promoted to production manager. He has just started to receive various managerial reports, including the production cost report you prepared. It showed his department had 2,000 equivalent units in ending inventory. His department has had a history of not keeping enough inventory on hand to meet demand. He has come to you, very angry, and wants to know why you credited him with only 2,000 units when he knows he had at least twice that many on hand.

Prepare a maximum 700-word informal memo and explain to Mr. Skaros why his production cost report showed only 2,000 equivalent units in ending inventory. Using a professional tone, explain to him clearly why your report is accurate.

Answer 1

To: Production Manager, David Skaros

From: Accounting Department

Date

Subject: Ending Inventory related query

Mr.Skaros, this is to explain to you the reasons for not maintaining enough inventory to meet demands

Obsolete Inventory:

Overstocking on products runs the risk of the product becoming obsolete. This is true especially in technology sectors such as smartphones and televisions, but no industry is exempt. Even the latest kid's game craze might inspire you to place a large order. If the buzz dissipates quickly and kids aren't looking for the game, you'll be left holding a lot of inventory you can't move.

Storage Capacity and Fees:

Storage capacity and the related storage fees are a concern for companies holding more inventory than is needed. It takes space and resources to hold inventory. Companies lose profit by paying labor for maintaining the storage space, organizing the stock and transporting the stock from one place to another. Companies that rent storage space lose additional profit by paying rental fees to store unused stock.

Storage Costs:

The more stuff you have, the more space you need. Commercial space is leased per square foot. Consider the costs to store excess inventory compared to the savings on wholesale orders. It also costs to do more inventory control and audits, potentially requiring additional manpower to work the warehouse.

Perishable Products:

Overstocking perishable items often results in the items sitting in storage past the recommended “use by” date. For example, food businesses cannot sell out-of-date products because of the risk to the health and safety of customers. In these cases, overstocking results in items that must be thrown out, meaning they are a total loss.

Discounts:

A business owner who overstocks often finds himself in the position of needing to sell the inventory at deeply discounted prices in order to clear up space for new inventory. By selling the discounted stock the business suffers low margins and profits.

Potential Insurance Costs and Loss:

Insurance costs go up with larger storage areas and larger inventory values. This factor needs to be considered and compared to wholesale savings. If there is a fire, theft or another natural disaster, not only will the business be recuperating, it will need to pay higher premiums as insurance rates go up.

Tying Up Capital:

When you have excess inventory, you pay for the order, the storage, and insurance. You can't get around this. For businesses that are working with small margins and on tight monthly budgets, this can hamper business development decisions because they don't have cash on hand.

Business owners might examine the disadvantages pertinent to the business and then decide whether carrying excess inventory makes sense. It is up to each business owner to review the financial health of his company. Inventory is one key factor in that.