Semester II
Cost & Management Accounting I
Material Cost
Note 7
By
Mithun Das
Assistant Professor
Department of Commerce
Bagnan College
Some important problems and their solution:
1. A manufacturer purchases 800 units of a certain component p.a. @ Rs.30 per unit from outside supplier. The annual
usage is 800 units, order placing and receiving cost is Rs.100 per order and cost of holding one unit of the
component for one year is Rs.4. Calculate the Economic Order Quantity by tabular method. Also calculate the
number of orders to be placed per year.
Solution:
The following table is prepared to compute the Economic Order Quantity:
Annual Cost of No. Units Average Inventory Ordering Total annual cost
consumption material of per inventory carrying cost (@ cost per (cost of materials +
(units) @ ₹ 30 orders order (units per ₹ 4 per unit on order (@ ₹ ordering cost +
order / 2) average 100 per inventory carrying cost
inventory) order)
800 24000 1 800 400 1600 100 25700
800 24000 2 400 200 800 200 25000
800 24000 3 267 133 532 300 24832
800 24000 4 200 100 400 400 24800
800 24000 5 160 80 320 500 24820
800 24000 6 133 67 268 600 24868
800 24000 7 114 57 228 700 24928
From the above table it is found total annual cost is lowest (₹ 24800) at order number 4 when number of units per
order is 200. So EOQ in this case is 200 units.
2. After inviting tenders, two quotations are received as follows. Supplier A: Rs.2.20 per unit Supplier B: Rs.2.10 per
unit plus Rs.2000 fixed charges irrespective of the units ordered. Calculate the order quantity for which the purchase
price per unit will be the same. Considering all factors regarding production requirements and availability of
finance, the purchase officer wants to place an order for 15, 000 units. Which supplier should he select?
What would be your answer if the purchase officer wants to place an order for 25, 000 units?
Solution:
The difference between the prices quoted by the supplier is Rs.0.10 per unit as regards to the variable costs while
the difference between the fixed costs is Rs.2000. The variable cost of Rs 0.10 per unit charged by supplier A is
higher than supplier B, but the fixed expenses of Rs 2000 is charged by supplier B which is not charged by supplier
A.
The quantity of purchase where the purchase price per unit will be the same can be calculated with the help of the
following formula:
Desired purchase quantity = Difference in the fixed cost/Difference in the variable cost = Rs.2000 / Rs.0.10 = 20,
000 units.
Thus, the purchase cost will be the same if the number of units ordered is 20, 000. If more than 20, 000 units are
ordered, supplier B should be selected while for orders of less than 20, 000 units, supplier A should be selected.
For order of 15, 000 units, supplier A should be selected. This can be proved as shown below:
Particulars Supplier A Supplier B
Cost of materials (15000 x 2.20) = 33000 (15000 x 2.10) = 31500
Add: Fixed Cost Nil 2000
Total Cost 33000 33500
For order of 25, 000 units, supplier B should be selected. This can be proved as shown below:
Particulars Supplier A Supplier B
Cost of materials (25000 x 2.20) = 55000 (25000 x 2.10) = 52500
Add: Fixed Cost Nil 2000
Total Cost 55000 54500
3. From the following particulars in respect of a material, compute the Economic Ordering Quantity by preparing a
table.
Ordering Quantities Price Per Kg. [Rs.]
Less than 250 6.00
250 and less than 800 5.90
800 and less than 2000 5.80
2000 and less than 4000 5.70
4000 and above 5.60
The annual demand for the material is 4000 kg. Stock holding costs are 20% of the material cost per annum. The
ordering and receiving costs are Rs.10 per order.
Solution:
The following table is prepared to compute the Economic Order Quantity:
Value of Inventory Total annual cost
Ordering
Average average carrying cost (cost of materials +
Unit Total cost Units cost per
Units of No. of inventory inventory (@ 20% per ordering cost +
Cost of of per order (@
purchase orders (units per (Average unit on inventory carrying
material materials order ₹ 10 per
order / 2) Inventory x average cost
order)
unit cost) inventory)
200 6.00 24000 20 200 100 600 120 200 24320
250 5.90 23600 16 250 125 738 148 160 23908
400 5.90 23600 10 400 200 1180 236 200 24036
800 5.80 23200 5 800 400 2320 464 50 23714
1000 5.80 23200 4 1000 500 2900 580 40 23820
2000 5.70 22800 2 2000 1000 5700 1140 20 23960
4000 5.60 22400 1 4000 2000 11200 2240 10 24650
From the above table it is found total annual cost is lowest (₹ 23714) when number of units per order is 800. So
EOQ in this case is 800 units.
4. A purchase manager places order for his organization, each time a lot of 500 kgs of raw material. From the following
information, find out the amount of profit or loss of the organization for the said order:
Annual consumption- 1000 units, cost per kg of raw material- Rs 100, ordering cost per order- Rs 400, inventory
carrying cost- 20%.
Solution:
EOQ of the above requirement:
√2AO/C A=annual consumption, O= ordering cost per order, C= inventory carrying cost per unit
p.a.
= √ (2 x 1000 x 400)/(100 x 20%) = 200 units
Calculation of total cost under two different situations:
Value of Inventory Total annual
average carrying Ordering cost
Average (cost of
Unit Cost Total cost Units inventory cost (@ cost per
Units of No. of inventory materials +
of of per (Average 20% per order (@
purchase orders (units per ordering cost +
material materials order Inventory unit on ₹ 400 per
order / 2) inventory
x unit average order)
cost) inventory) carrying cost
200 100 100000 5 200 100 10000 2000 2000 104000
500 100 100000 2 500 250 25000 5000 800 105800
From the above table it is clear that at existing situation i.e. at purchase level of 500 units, total cost is Rs 105800
but if EOQ is followed, total cost would have been Rs 104000. So, the company is suffering a loss of Rs (105800
-104000) = Rs 1800 for the said order.
5. S ltd. Furnishes the following information:
Consumption- 300 units per quarter, cost per unit – Rs 40, ordering cost per order – Rs 600, obsolescence 15% and
insurance on inventory -25%.
Compute EOQ, number of orders per year and time between consecutive orders.
A supplier offers a discount of 2% on a purchase of 600 units. Should it be accepted?
Solution:
EOQ of the above requirement:
√2AO/C A=annual consumption, O= ordering cost per order, C= inventory carrying cost per unit
p.a.
= √ (2 x 300 x 4 x 600)/(40 x (15% + 25%) = √1440000 / 16 = √90000 = 300 units
Number of orders p.p. = Annual Consumption / EOQ
= (300 x 4)/ 300 = 4 orders
Time between consecutive orders = 12 months/ 4 orders = 3 months.
Calculation of total cost under two different situations:
Value of Inventory Total annual cost
Ordering
Average average carrying cost (cost of materials
Unit Total cost Units cost per
Units of No. of inventory inventory (@ 40% per + ordering cost +
Cost of of per order (@ ₹
purchase orders (units per (Average unit on inventory carrying
material materials order 400 per
order / 2) Inventory x average cost
order)
unit cost) inventory)
300 40 48000 4 300 150 6000 2400 1600 52000
600 39.2 47040 2 600 300 11760 4704 800 52544
From the above calculation it is clear if the offer is accepted, then total cost will go up from Rs 52000 to Rs 52544
i.e., there will be an increase of Rs 544. So, the offer should not be accepted.