Chapter III, Problem 1RQ

Define and give examples of inventory ordering, holding, and shortage costs.

To determine

Explain the meaning of the inventory ordering, holding and shortage costs and give examples.

Explanation of Solution

Merchandise Inventory: Merchandise is the stock of goods bought by a wholesaler, or a retailer, or a trader, to be sold within a year. Merchandise Inventory is a current asset account which includes all the costs incurred to acquire merchandise, and process it further for sale.

Explain the meaning of the inventory ordering, holding and shortage costs and give examples as follows

Ordering costs: The cost of preparing, placing and receiving a purchase order is called as ordering costs. Examples: Clerical costs of preparing purchase orders, time spent to find the suppliers and transportation costs.

Holding costs: Holding cost is a manufacturing cost that is incurred while the inventory is kept on hand for some period of time.  Examples: Warehouse expense, security cost, insurance expense, deterioration and theft costs.

Shortage costs: Shortage cost is a manufacturing cost that is incurred when the organization does not have material or finished goods on hand for the production process. Examples: Costs caused by disrupted production, lost sales, and loss on quantity discounts on purchases.