Question

Companies can use the Economic Order Quantity (EOQ) method to maintain the existing inventory conditions within the company, especially to reduce the existing fixed costs that can arise from the purchase of goods using expedition services. For example, buying goods with Full Container Load (FCL) and Less Container Load (LCL), the LCL fixed cost will be greater because the goods purchased are small but the tariff for sending goods from the supplier to the factory requires no small cost, especially with shipping goods from abroad that will add costs until the terminology is formed in the practice of cost accounting is referred to as 'landing cost'. In maintaining the freshness of UHT milk, companies need to use good quality paper and can withstand water and even the freshness of dairy products is maintained even if stored at room temperature. We often see this when we go to retail stores, right? As an accountant from the UHT Dairy Products Company, you have the task of conducting a survey of the raw materials for packaging – paper from Korea that must be sent to Indonesia. Management also questioned which costs could arise and whether the company should continue to import paper when paper was needed or the need for maintaining paper stock at the factory. If companies must import paper when needed, what should be considered and what costs will occur, and vice versa? Analyze and use info graphics of the decisions that must be taken by the company along with the impacts, advantage, and disadvantage, also which methods that can be used? EOQ or Just in Time (JIT)?

Answer 1

Economic Order Quantity (EOQ):

EOQ is the inventory ordering quantity that the company should keep such that they achieve a minimum of total costs associated with the inventory. EOQ minimizes costs like ordering costs, carrying costs, out of stock costs, etc. EOQ works best in such cases where the inventory demand, ordering cost and carrying costs remain the same over a specified time.

Just-in-time inventory system (JIT):

JIT is an inventory management methodology that aims to minimize various times in the system of production and with suppliers and customers. The idea behind JIT is to align the supplies form the raw-material suppliers with the defined schedules of production. The JIT strategy used by industries to reduce time waste and to improve productivity by procuring the JIT system, there is an expectation form the supplier that they should predict demand from their customers.

By analyzing the given facts, it's observed that UHT, milk processing, should provide their customers with their daily dairy requirements. If they adopt the EOQ system, their production process will not be impacted by the nonavailability of raw material. Since the packing material is imported, the landing cost forms a significant part. To keep these costs to a minimum, the company should have an appropriate level of vigilance on the level of inventory where they should order the material rather than ordering the material as and when they need it.

If the company wishes to consider the JIT approach, the procuring process of raw material depends on the production schedule. But the production schedule may not be constant since there is a significant level of uncertainty regarding customer order flows which may lead to increases landing costs for the company. This situation may also lead to the non-availability of the product to the customers at times.

Therefore, the EOQ system is the preferred alternative for the organization than that of the JIT system.

Advantages of opting EOQ system of inventory management:

· There will not a disruption caused by the out-of-stock situation

· The storage and carrying costs can be reduced to a minimum.

· Since the landing cost is high, there will benefit the company by ordering only the planned quantity of raw material.

· The re-stocking process can be implemented with much ease and can save a considerable amount of costs in the form of ordering, carrying, and out-of-stock costs.

Disadvantages of opting for the EOQ system of inventory management:

· There are numerous assumptions required to operate the EOQ system all of which may not be valid on a daily basis.

· The EOQ system assumes that the demand from customers is constant which may be the case applicable universally.

· Continuous demand forecasting is another most difficult exercise in times of constant customer preference change and the availability of many alternatives.

· Monitoring the reorder quantities on a regular basis, which is crucial in the EOQ system, is a time-consuming process that leads to a significant increase in human resource costs.

Even after comparing the advantages and disadvantages above stated, it is still beneficial for the company to adopt the EOQ system of inventory management.