Inventory uncertainty : a study of its nature and causes and a simulation of its behavior

Accounting uncertainty arises from many sources—measurement error, philosophical uncertainty, uncertainties due to lack of knowledge about future events, and the uncertainty introduced by allocations necessary to produce periodic statements. This last source of uncertainty, applied to inventories, expresses itself in the need for a cost flow decision. The fact that cost flow assumptions are the basis for allocating inventory costs, indicates a deep belief that allocations are (whether they should be or not) based on physical flows. For a particular inventory item, it is not possible to know which flow occurred, hence, an assumption. However, probabilities of flows can be determined; and based on these probabilities, an Uncertainty Inventory Method is developed which takes into account all possible cost flows and which produces a mean and standard deviation of inventory costs. That standard deviation is a measure of inventory cost uncertainty. The behavior of this uncertainty was investigated through simulation using a particular set of cost/demand data. It was concluded that I) uncertainty due to allocations in original cost recording increases inventory cost uncertainty, 2) the uncertainty for this data was totally immaterial, and 3) it should be possible to estimate inventory cost uncertainty from individual item costs, cost variabilities and demands.