Economic Order Quantity

Information:
Mantener Corporation does warranty work for a major
producer of DVD players.
The following values apply for a part used in the repair of the
DVD players (the
part is purchased from external suppliers):

Annual demand 25,000 units

Order Quantity 500 units
per
Ordering cost 40 order
per
Carrying cost 2 unit

Required
For Mantener, calculate the ordering cost, the carrying
1 cost and the
total cost associated with an order size of 500 units
Calculate the EOQ and its associated ordering cost,
2 carrying cost and
total cost. Compare and comment on the EOQ relative to
the current
order quantity.
What if Mantener enters into an exclusive supplier
3 agreeement with one
supplier who will supply all of the demands with smaller
more frequent orders?
Under this arrangement, the ordering cost is reduced to
$0.40 per order.
Calculate the new EOQ and comment on the
implications.

Solution
1 Annual Demand 25,000
Divided by Order Quantity 500
Number of orders 50
Multiply by Ordering cost per order 40
Total Ordering cost 2,000

Order Quantity 500

Divided by 2 2
Average inventory 250
Multiply by carrying cost per unit 2
Total carrying cost 500

Total Ordering cost 2,000

Plus Total Carrying cost 500
Total cost 2,500

EOQ 1,000

Annual Demand 25,000

Divided by Order Quantity 1,000
Number of orders 25
Multiply by Ordering cost per order 40
Total Ordering cost 1,000

Order Quantity 1,000

Divided by 2 2
Average inventory 500
Multiply by carrying cost per unit 2
Total carrying cost 1,000

Total Ordering cost 1,000

Plus Total Carrying cost 1,000
Total cost 2,000

Relative to the current order quantity is larger, with fewer

orders
placed; however, the total cost is $500 less. Notice that
Carrying cost
is equal to the Ordering cost for EOQ:

EOQ 100

Annual Demand 25,000

Divided by Order Quantity 100
Number of orders 250
Multiply by Ordering cost per order 0.4
Total Ordering cost 100

Order Quantity 100

Divided by 2 2
Average inventory 50
Multiply by carrying cost per unit 2
Total carrying cost 100

Total Ordering cost 100

Plus Total Carrying cost 100
Total cost 200

Information
Mantener Corporation has an EOQ of 1,000 units. The
company uses 100 units
per day, and an order to replenish the part requires a
lead time of four days.

Required:
1 Calculate the reorder point
What if the average usage per day of the part is 100
2 units but a daily
maximum usage of 120 units is possible? What is
the reorder point
when this demand uncertainty exists?

Solution
1 Rate of usage 100
Multiply by lead time 4
Reorder point 400

With uncertainty, safety stock is needed. Safety

2 stock is computed as follows:
Maximum usage 120
Average usage 100
Difference 20
Lead time 4
Safety stock 80

Average rate of usage 100

 Lead time 4
400
Safety stock 80
Reorder point 480

BACKFLUSH COSTING

The following three methods illustrate backflush costing.

The three methods differ in the number of trigger points at which
journal
entries are made in the accounting system.

Method 1
1. Purchase of raw
Trigger points materials
2. Completion of finished
goods.
3. Sale of finished goods

1. Raw and In Process

Inventory account (RIP) account
2. Finished goods account

Main features 1. Three Trigger points

2. Use of combined raw
materials and in process
account
Method 2
1. Purchase of raw materials
-
2. Sale of finished goods

1. Raw and In Process (RIP) account

1. Two trigger points

2. Use of combined raw materials and in process account
3. No finished goods account

Method 3
-
 1. Completion of finished goods.
2. Sale of finished goods

1. Finished goods account

In all three methods, there are no journal entries in the

accounting system for work in process (stage 2).
These three methods are usually used where the amounts for
work in process are small.

Transactions
A Trams purchased P170,000 of raw materials on account.

B All materials purchased were requisitioned for production

C Trams incurred direct labor costs of P80,000

D Actual factory overhead costs amounted to P122,000

E Trams applied conversion costs total P202,000 (including

direct labor cost of P80,000

F All telephones were completed and sold.

TRADITIONAL COSTING
JOURNAL ENTRIES
ACCOUNT TITLES DR CR
Materials Inventory 170,000
Accounts payable 170,000

Work in process inventory 170,000

Materials inventory 170,000

Work in process inventory 80,000

Accrued payroll 80,000

Factory overhead control 122,000

 Various accounts 122,000

Work in process inventory 122,000

Factory overhead control 122,000

Finished goods inventory 372,000

Work in process inventory 372,000

Cost of goods sold 372,000

Finished goods inventory 372,000

JIT COSTING
JOURNAL ENTRIES
ACCOUNT TITLES DR CR
Raw and In process 170,000
Accounts payable 170,000

No entry

Conversion cost 80,000

Accrued payroll 80,000

Conversion cost 122,000

Various accounts 122,000

No entry

Cost of goods sold 292,000

Raw and in process 170,000
Conversion cost 122,000
The following data will be used to illustrate the three methods:

Material purchase on credit for the period ₱195,000

Conversion costs for the period 120,000

Number of units manufactured 10,000 units

Number of finished units sold 9,900 units

The cost per unit is P31 (P19 materials P12 conversion costs).
There are no
opening stocks and for simplicity it is assumed that there are no
variances.

Using the backflush costing the journal entries under three methods.

METHOD 1: THREE TRIGGER POINTS

Transactions Journal entries

a Purchases of raw materials Raw and in process 195,000
Accounts payable 195,000

b Incur conversion costs Conversion costs 120,000

Various accounts 120,000

c Completion of finished goods Finished goods inventory 310,000

Raw and in process 190,000
Conversion costs 120,000

d Cost of goods sold Cost of goods sold 306,900

Finished goods inventory 306,900

METHOD 2: TWO TRIGGER POINTS

Transactions Journal entries

195,00
a Purchases of raw materials Raw and in process 0

Accounts payable 195,000

 120,00
b Incur conversion costs Conversion costs 0

Various accounts 120,000

c Completion of finished goods No entry

306,90
d Cost of goods sold Cost of goods sold 0

Raw and in process 188,100

Conversion costs 118,800

Cost of goods sold 1,200

Coversion costs 1,200

METHOD 2: TWO TRIGGER POINTS

Transactions Journal entries

a Purchases of raw materials

b Incur conversion costs Conversion costs 120,000

 120,00
Various accounts 0

c Completion of finished goods Finished goods 310,000

190,00
Accounts payable 0
120,00
Conversion costs 0

d Cost of goods sold Cost of goods sold 306,900

306,90
Finished goods 0

Assume that Wilkins Company uses JIT costing for

the production of goods
during the month of January.
The following transactions summarize the major
steps in Wilkin's production
during the month of January.

Raw materials received from suppliers

1 amounted to P4,000.
Direct labor costs of P10,400 and overhead
2 costs of P7,800 were
incurred and applied, respectively, during the
month of January.
The cost of work in process at January 31,
3 2011 was P3,600. This
cost was determined through the production
report and is composed
of the following elements:
Direct materials 1,500
Direct labor 1,200
Overhead 900

In addition, assume that finished goods inventory at

January 31, 2011 was P6,500
consisting of :
Direct materials 1,500
 Direct labor 2,850
Overhead 2,150
JIT COSTING
JOURNAL ENTRIES

ACCOUNT TITLES DR CR

Raw and in process 4,000

Accounts payable 4,000

Cost of goods sold 18,200

Accrued payroll 10,400

Factory overhead control 7,800

Finished goods 2,500

Raw and in process 2,500

Cost of goods sold 1,000

Finished goods 1,000

Raw and in process 2,100

Finished goods 5,000

Cost of goods sold 7,100

Materials received 4,000

Less Materials in RIP (1,500)
Amount to be backflush (Units completed) 2,500

Material cost of units completed 2,500

Less Material in FG, end (1,500)
Amount to be backflushed (CGS) 1,000

For Raw and in-process

Labor cost 1,200
Overhead 900
Total to be adjusted 2,100

For finished goods

Labor cost 2,850
Overhead 2,150
Total to be adjusted 5,000