What are the costs associated with Inventories in Accounting?

Inventories are items that are held for resale by an organization. Most organization are in dilemma as to whether make fewer orders with huge amount of stock or order more frequently with less amount of stocks in each order. Ordering costs and handling costs analysis are likely to answer these questions of dilemma. In accounting, Stocks are reported as Current Asset in the Statement of Financial Position. There are various costs that an organization is likely to suffer as a result of ordering and holding such stocks/inventories.

There are two major costs associated with inventories which are as follows;

1. Holding costs

These icludes;

a. Warehousing costs - Inventories occupies space and the organization need to rent if the store has been rented but also depreciation, Insurance and repairs and maintenance if the store/premises is owned by an organization.

b. Handling costs - Warehouse keepers need to be paid monthly salaries/wages but also moving the stocks within the store may necessitate incurring some costs to an organization.

c. Cost of capital / opportunity cost - Investing in stocks means more funds have been tied in stocks rather than investing somewhere else that could enable earning a return.

d. Insurance - Stocks held by an organization need to be insured against various incidents such as insurance against fire, theft, flood etc. These are costs that are to be borne by an organization. 

e. Deterioration and Obsolescence - External factors such as heat and dust on inventories held by an organization may result into deterioration in terms of quality of stocks hence. Technological advancements may also cause inventory obsolescence.

f. Pilferage - It is obvious that when holding inventories in stores, a certain percentage of inventories may be lost due to theft.




2. Ordering cost

a. Ordering cost - Purchasing staffs need to be paid salaries/wages, telephone bills need to be paid and also stationery costs need to be paid. all these are costs that need to be accounted in relation to inventories.

b. Delivery costs - Checking and inspecting the quality of inventories/materials involves staffs who need to be paid their salaries/wages.



However it should be noted that holding fewer inventories may reduce holding costs but still may increase ordering costs due to the fact that organization will need to make more orders frequently. On the other hand, if organization wants to make fewer orders in order to reduce ordering costs, it is likely to incur more holding costs due to the fact that it will be required to order a huge amount of inventory. This case is so called inverse relationship.