On the pitfalls of end-of-period cost accounting in periodic review inventory models

This paper investigates the pitfalls of accounting for inventory and backorder costs at the end of the period in periodic review inventory models when costs are in actuality incurred continuously in time. Using a simple model, we show that (i) the end-of-period scheme results in higher than optimal order-up-to levels and inventory cost if the cost and demand parameters are unchanged, both deviations tending to be rather large, and (ii) it is possible to replicate both the optimal base stock level and its cost by selecting the values of the cost or demand parameters judiciously. While this often requires extreme values for the cost parameters and no simple cost parameter adjustment scheme is likely to be robust, we find a simple adjustment to the demand parameters which serves as a good approximation and is quite robust. We therefore conclude that end-of-period cost accounting without parameter adjustments is in general inappropriate when costs are incurred continuously, but there are ways to make it work well.