Question

While calculating the Economic Order Quantity, it is necessary that a company should know how much the 'Inventory Carrying Cost' is and what does it include. From the following, identify the item which is not included in 'Inventory Carrying Cost':

• A. Interest
• B. Paperwork for placing order
• C. Space cost
• D. Insurance

Hint:

$$\text{\textbf{Carrying Costs} (Holding)} = \text{Storage, Insurance, Interest, Obsolescence}$$ $$\text{\textbf{Ordering Costs} (Transaction)} = \text{Paperwork, Postage, Shipping, Receiving Inspection}$$ Carrying costs increase as inventory volumes grow, whereas ordering costs decrease as order sizes grow because fewer total orders are placed.

Answer 1

The Correct Option is B

Step 1: Understanding Inventory Costs:
In inventory management, total inventory costs are divided into two main categories: Ordering Costs and Carrying (Holding) Costs. These costs react in opposite directions as order sizes change, and are balanced to find the optimal order volume.

Step 2: Differentiating Between Carrying and Ordering Costs:

• Carrying (Holding) Costs ($C_h$): The expenses incurred to store, preserve, and insure inventory over a period. This includes:
  • Storage Space Costs (C): Rent, utilities, and maintenance for warehouses.
  • Opportunity Cost of Capital (A): Interest expenses on funds tied up in inventory.
  • Inventory Risk Costs (D): Insurance policies, obsolescence, shrinkage, and physical degradation.
• Ordering Costs ($C_o$): The transaction expenses incurred each time a new order is placed with a supplier. This includes:
  • Paperwork & Clerical Costs (B): Preparing purchase orders, auditing bills, processing invoices.
  • Logistics Costs: Transport, inspection, and handling fees.

Step 3: Selecting the Correct Option:
Because “Paperwork for placing order” (B) is an transaction-based expense tied to the frequency of purchases, it is classified as an ordering cost rather than a carrying cost. Thus, (B) is the correct option.