Inventories usually are an important asset for both manufacturing and merchandising firms. A proper balance of inventory quantities is desirable from several standpoints. Maintaining such a balance is dependent upon a number of factors including ordering at the proper time and in the correct lot size. Serious penalties may attend both overstocking and stockout situations.

Required:

a. In connection with inventory ordering and control, certain terms are basic. Explain the meaning of each of the following:

1. Economic order quantity.

2. Reorder point.

3. Lead time.

4. Safety stock.

b. 1. What are the costs of carrying inventories? Explain.

2. How does overstocking add to the cost of carrying inventories?

c. 1. What are the consequences of maintaining minimal or inadequate inventory levels?

2. What are the difficulties of measuring precisely the costs associated with understocking?

d. Discuss the propriety of including carrying costs (of normal inventory, overstocking and understocking) in the inventory cost:

1. For external reporting.

2. For internal decision making.