2.

ABC Analysis
From the following information classify the inventory items into A, B and C categories -

Material K-1 K-2 K-3 K-4 K-5 K-6 K-7

Maximum Stock - units 2,030 1,250 400 5,200 200 3,500 1,000

Minimum Stock - units 470 930 120 2,320 160 1,740 680

Average Cost per unit (₹) 12 90.10 150 5 50 2.5 16

Solution: ABC Analysis

Material Avg % in Quantity Price pu (₹) Inventory Value = % in Value Category

Stock Quantity × Rate
Quantity

K-1 1,250 12.50% 12.00 15,000 7.50% B

K-2 1,090 10.90% 90.10 (approx) 98,210 49.11% A

K-3 260 2.60% 150.00 39,000 19.50% A

K-4 3,760 37.60% 5.00 18,800 9.40% B

K-5 180 1.80% 50.00 9,000 4.50% C

K-6 2,620 26.20% 2.50 6,550 3.28% C

K-7 840 8.40% 16.00 13,440 6.72% B

Total 10,000 100.00% 2,00,000 100.00%

Note: Average Stock = ½ of (Maximum Stock + Minimum Stock)

2. EOQ Computation & Discount Analysis

3. EOQ Computation using Carrying Costs N 08

The annual carrying cost of Material ‘X’ is ₹ 3.60 per unit and its Total Carrying Cost is ₹
9,000 per annum. What would be the Economic Order Quantity for Material ‘X’, if there is
no Safety Stock of Material ‘X’?
Solution: Average Inventory × Carrying Cost per unit per annum = ₹ 9,000
/2 of EOQ × ₹ 3.60 = ₹ 9,000. On solving, EOQ = 5,000 units.
1

4. EOQ using Wilson’s Formula M 07, RTP

The average annual consumption of a material is 18,250 units at a price of ₹ 36.50 per unit.
The storage cost is 20% on an average inventory and the cost of placing an order is ₹ 50.
How much quantity is to be purchased at a time?
Solution: A = Annual Requirement of Raw Materials = 18,250 units (given)
2AB
EOQ=√ C
, where B = Buying Cost per order = ₹ 50 per order(given)

C=Carrying Cost per unit per annum = ₹ 36.50 × 20% = ₹ 7.30 p.u. p.a.

On substitution, EOQ = 500 units, (i.e. quantity to be purchased at a time)

5. EOQ and related basic computations RTP, N 96
About 50 items are required every day for a machine. A fixed cost of ₹ 50 per order is
incurred for placing an order. The inventory carrying cost per item amounts to Re.0.02 per
day. The lead period is 32 days. Compute - (1) EOQ (2) Re-order Level (3) Number of orders
per year (4) Time lag between two purchases and (5) Associated Cost.

Solution: A = Annual Requirement of Raw Materials = 52,000 × 12 mths × 2 units

RM = 12,48,000 units.

2AB B = Buying Cost per order = ₹ 350 per order (given)

1. EOQ = √ , where
C
C = Carrying Cost per unit per annum = ₹ 15 × 12% = ₹ 1.80 p.u. p.a.

On substitution, EOQ = 22,030 units.

2. Cost Comparison of EOQ with purchase policy of 52,000 units:

Particulars EOQ Minimum Lot Size = 52,000 units

(a) Quantity Ordered every time 22,030 units 52,000 units

(Q)
A 12,48,000 12,48,000
(b) Number of Orders p.a. = Q 22,030
= 56.65 orders 52,000
= 24 orders

(c) Buying Costs p.a. at ₹ 350 56.65 × ₹ 350 = ₹ 19,828 24 × ₹ 350 = ₹ 8,400

(d) Average Inventory = ½ of (a) ½ × 22,030 = 11,015 units ½ × 52,000 = 26,000 units

(e) Carrying Costs p.a. at ₹ 1.80 11,015 × ₹ 1.80 = ₹ 26,000 × ₹ 1.80 = ₹ 46,800
19,827

(f) Associated Costs p.a. = (c) + ₹ 39,655 ₹ 55,200

(e)

Hence, Additional Cost by ordering 52,000 units every time = ₹ 55,200 - ₹ 39,655 = ₹ 15,545.
3. Minimum Carrying Cost to be incurred by the Company (relating to EOQ) = ₹ 19,827 p.a.
6. EOQ, Effect of Wrong Price on Associated Cost N 09
(i) Compute EOQ and the Total Variable Cost for the following:
 Annual Demand = 5,000 units
 Unit Price = ₹ 20.00
 Order Cost = ₹ 16.00
 Storage Rate = 2% per annum
 Interest Rate = 12% per annum
 Obsolescence Rate = 6% per annum.

(ii) Determine the Total Variable Cost that would result for the items if an incorrect price of
₹ 12.80 is used.
Solution: Note: 1. Total Variable Cost related to EOQ = Associated Cost p.a. = Buying Cost p.a.
+ Carrying Cost p.a.
2. % (Carrying Cost = 2% (Storage) + 12 Interest) + 6% (Obsolescence) = 20% p.a.

Particulars With Correct Price With Incorrect

Price

1. A = Annual Requirement of 5,000 5,000

RM units units

2. B = Buying Cost per order ₹ 16 ₹ 16

3. C = Carrying Cost p.u. p.a. 20% of ₹ 20 = ₹ 4.00 20% of ₹ 12.80 = ₹ 2.56

(Note 2)

2AB 2×5000×16 2×5000×16

4. EOQ = √ √ =200 units √ = 250 units
2 4 2.56

A 5,000 units 5,000 units

[Link] of Orders (i.e. Deliveries) p.a. = Q = 25 orders = 20
200 units 250 units
orders

6. Buying Costs p.a. = (2) × (5) 25 × ₹ 16 = ₹ 400 20 × ₹ 16 = ₹ 320

7. Average Inventory = ½ of (4) ½ × 200 = 100 units ½ × 250 = 125 units

8. Carrying Costs p.a. = (3) × (7) 100 × ₹ 4 = ₹ 400 125 × ₹ 2.56 = ₹

320

9. Total Variable (i.e. Associated) Costs p.a. ₹ 800 ₹ 640

(6+8)
7. EOQ and related basic computations N 99
The Complete Gardener is deciding on the EOQ for two brands of lawn fertilizers - Super
Grow and Nature’s Own. The following information is collected -

Particulars Super Grow Fertiliser Nature’s Own Fertiliser

Annual Demand 2,000 Bags 1,280 Bags

Relevant Ordering Cost per Purchase ₹ 1,200 ₹ 1,400

Order

Annual Relevant Carrying Cost per bag ₹ 480 ₹ 560

1. Compute EOQ for Super Grow and Nature’s Own,

2. For the EOQ, what is the sum of the total annual relevant Ordering Costs and total annual
relevant Carrying Costs for Super Grow and Nature’s Own?
3. For the EOQ, compute the number of deliveries per year for Super Grow and Nature’s
Own.
Solution:

Particulars Super Grow Fertilizer Nature's Own Fertilizer

1. A = Annual 2,000 Bags 1,280 Bags

Requirement of RM

2. B = Buying Cost per ₹ 1,200 ₹ 1,400

order

3. C = Carrying Cost per ₹ 480 ₹ 560

bag per annum

2AB 2 × 2,000 bags ×₹ 1,200 2×1,280bags× ₹ 1,400

4. EOQ = √ C
√ = 100 bags √ =80 bags
₹ 480 ₹ 560

2,000 bags 1,280 bags

[Link] of Orders p.a. 100 bags
= 20 orders 80 bags
= 16 orders
A
=Q

6. Buying Costs p.a. = 20 × ₹ 1,200 = ₹ 24,000 16 × ₹ 1,400 = ₹ 22,400

(2) × (5)

7. Average Inventory = ½ ½ × 100 = 50 bags ½ × 80 = 40 bags

of (4)

8. Carrying Costs p.a. = 50 × ₹ 480 = ₹ 24,000 40 × ₹ 560 = ₹ 22,400

(3) × (7)
9. Relevant Associated ₹ 48,000 ₹ 44,800
Costs p.a. (6+8)

8. EOQ and Effect of different ordering quantity - Savings due to EOQ M 99,
M 06
PQR Limited produces a product which has a monthly demand of 52,000 units. The product
requires a Component X which is purchased at ₹ 15 per unit. For every finished product, 2
units of Component X are required. The Ordering Cost is ₹ 350 per order and the Carrying
Cost is 12% p.a. You are required to -
• Calculate the Economic Order Quantity for Component X.
• If the minimum lot size to be supplied is 52,000 units, what is the extra cost, the Company
has to incur?
• What is the minimum carrying cost, the Company has to incur?
Solution:

A = Annual Requirement of Raw Materials = 52,000 ×

12 mths × 2 units RM = 12, 48,000 units.

1. EOQ= √
2AB
, B = Buying Cost per order = ₹ 350 per order (given)
C
Where C=Carrying Cost per unit per annum = ₹ 15 × 12% = ₹
1.80 p.u. p.a.
On substitution, EOQ = 22,030 units.

2. Cost Comparison of EOQ with purchase policy of 52,000 units:

Particulars EOQ Minimum Lot Size = 52,000

units

(a) Quantity Ordered every 22,030 52,000

time (Q) units units
A 12,48,000 12,48,000
(b) Number of Orders p.a. = Q = 56.65 orders = 24 orders
22,030 52,000

(c) Buying Costs p.a. at ₹ 350 56.65 × ₹ 350 = ₹ 19,828 24 × ₹ 350 = ₹

8,400

(d) Average Inventory = ½ of ½ × 22,030 = 11,015 units ½ × 52,000 = 26,000 units

(a)

(e) Carrying Costs p.a. at ₹ 11,015 × ₹ 1.80 = ₹ 19,827 26,000 × ₹ 1.80 = ₹ 46,800
1.80

(f) Associated Costs p.a. = (c) ₹ 39,655 ₹ 55,200

+ (e)

Hence, Additional Cost by ordering 52,000 units every time = ₹ 55,200 - ₹ 39,655 = ₹ 15,545.
3. Minimum Carrying Cost to be incurred by the Company (relating to EOQ) = ₹ 19,827 p.a.

9. EOQ and Total Cost N 19 (New)

Surekha Limited produces 4000 Litres of Paints on a quarterly basis. Each Litre requires 2
kg of Raw Material. The cost of placing one order for Raw Material is ₹ 40 and the
Purchasing Price of Raw Material is ₹ 50 per kg. The Storage Cost and Interest Cost is 2%
and 6% per annum respectively. The lead time for procurement of Raw Material is 15 days.
Calculate Economic Order Quantity and Total Annual Inventory Cost in respect of the
above raw material.
Solution:

2AB A = Annual Requirement of Raw Materials = 4,000 litres × 2 kg × 4

1. EOQ = √ C
, where quarters = 32,000 kg.
B = Buying Cost per order = ₹ 40 per order
C = Carrying Cost per unit per annum = ₹ 50 × (2+6) 8% = ₹ 4
On substitution, EOQ = 800 kg

1. EOQ = / where

2. Associated Cost = Buying Cost per annum + Carrying Cost per annum
p.a.

= (No. of Orders x Cost per Order) + (Avg. Inventory x Carrying Cost p.u.
p.a.)

= (32,000 kg × ₹ 40) + (800 kg × ₹ 4 p.u]

800 kg 2

= ₹ 1,600 + ₹ 1,600 = ₹ 3,200

Note: Inventory Carrying Cost per annum Also, Purchase Cost p.a. = 32,000 kg × ₹ 50 = ₹
= ₹ 1,600. 16,00,000.

Total Cost p.a. (=Purchase Cost + Associated Cost) = (₹ 16,00,000 + ₹ 3,200) = ₹ 16,03,200.

Annual Consumption 12,000 Units (360 Inventory Carrying Cost 24%

Days)

Cost per unit ₹1 Normal Lead Time 15 days

Ordering Cost ₹ 12 per order Safety Stock 30 days consumption

10. EOQ and Inventory Level Planning M 05

Vetrivel Enterprise manufactures a special product “Kulisa”. The following particulars are
collected for the year.
Required: (1) Compute Re-order Quantity, and Re-order Level, (2) What should be the
inventory level (ideally) immediately before the material order is received?

Solution: A = Annual Requirement of Raw Materials = 12,000 units (given)

2AB B = Buying Cost per order = ₹ 12 per order (given)

1. EOQ = √ C
, where
C = Carrying Cost per unit per annum = ₹ 1 × 24% = ₹ 0.24 p.u. p.a.

On substitution, EOQ = ROQ = 1,095 units, (approximately)

30 15
2. Re-Order Level = Safety Stock + Lead Time Consumption = (12,000 × 360
) + (12,000 × 360) =
1,500 units
3. Since Lead Time = 15 days, atleast 15 days' material consumption requirements should be
held in Stores, before an order is placed for the next consignment of materials. So, the ideal stock
15
level at the time of receipt =12,000 × 360 = 500 units.

Alternatively, Ideal Stock Level can be taken as Safety Stock, i.e. 30 days consumption = (12,000
30
× 360) = 1,000 units.
11. EOQ and Effect of different ordering quantity - Savings due to EOQ RTP
Shakti Co. buys in lots of 500 boxes, which is a 3 months’ supply. The Cost per box is ₹
125 and the Ordering Cost is ₹.250 per order. The Inventory Carrying Cost is estimated at
20% of the unit value per annum.
• What is the total annual cost of the existing inventory policy?
• How much money could be saved by employing the EOQ?

Solution: A = Annual Requirement of Raw Materials = 500 × 12/3 months = 2,000

boxes.

2AB B = Buying Cost per order = ₹ 250 per order (given)

1. EOQ = √ , where
C
C = Carrying Cost per unit per annum = ₹ 125 × 20% = ₹ 25 p.u. p.a.

On substitution, EOQ = 200 boxes.

2. Cost Comparison of EOQ with 3 months consumption Purchase Policy (i.e. Quarterly
Purchase)

Particulars EOQ Quarterly Purchase

(a) Quantity Ordered every time 200 units (Given) 500 units
(Q)
A 2,000 (Quarterly) = 4 orders
(b) Number of Orders p.a. = Q 200
= 10 orders

(c) Buying Costs p.a. at ₹.250 10 × ₹ 250 = ₹ 2,500 4 × ₹ 250 = ₹ 1,000

1
(d) Average Inventory = ½ of (a) Zz x 200 = 100 units ½ × 500 = 250 units
(e) Carrying Costs p.a. at ₹.25 100 × ₹ 25 = ₹ 2,500 250 × ₹ 25 = ₹ 6,250

(f) Associated Costs p.a. = (c) + ₹ 5,000 ₹ 7,250

(e)

Hence, Cost saved by ordering at EOQ lots every time = ₹ 7,250 - ₹ 5,000 = ₹ 2,250 p.a.
12. EOQ using Wilson’s Formula and Evaluation of Discount Offers N 08, N 07
A Publishing House purchases 72,000 rims of a special type paper per annum at cost ₹ 90
per rim. Ordering Cost per order is ₹ 500 and the Carrying Cost is 5% per year of the
inventory cost. Normal lead time is 20 days and the Safety Stock is Nil. Assume 300
working days in a year. Required:
• Calculate the Economic Order Quantity (EOQ)
• Calculate the Reorder Inventory Level.
• If a 1% quantity discount is offered by the Supplier for purchases in lots of 18,000 rims
or more, should the Publishing House accept the proposal?

Solution: A = Annual Requirement of Raw Materials = 72,000 rims (given)

2AB B = Buying Cost per order = ₹ 500 per order (given)

1. EOQ = √ , where
C
C = carrying Cost per unit per annum = ₹ 90 × 5% = ₹ 4.50 p.u. p.a.

On substitution, EOQ = 4,000 rims.

20
2. Re-Order Level = Safety Stock + Lead Time Consumption = Nil + (72,000 × ) = 4,800 rims
300

Particulars EOQ 2% Discount

(d) Average Inventory = ½ of (a) 4,000 kg 12,000 kg

(e) Carrying Costs p.a. ₹ 12,000 (12,000 kg × ₹ 3 Less 2%) = ₹

35,280

(f) Purchase Cost p.a. = (A × ₹ 19,20,000 (96,000 kg × ₹ 20 Less 2%) = ₹

Price) 18,81,600

(g) Total Costs p.a. = (c) + (e) + (f) ₹ 19,44,000 ₹ 19,20,880

Conclusion: Discount Offer may be accepted due to savings in cost.

13. EOQ using Wilson’s Formula and Evaluation of Discount Offers RTP
The annual demand for an item of stock is 45 units. The item costs ₹ 200 per unit to
purchase. Holding Costs are 15% of the unit costs per annum and the Ordering Costs are
₹ 300 per order. The Supplier offers a 2% discount for orders in excess of 60 units, and a
discount of 5% for orders in excess of 90 units. What is the economic lot size?
Solution:
 A = Annual Requirement of Raw Materials = 45 units.
2AB B = Buying Cost per order = ₹ 300 per order (given)
1. EOQ= √ ,
C C=Carrying Cost per unit per annum = ₹ 200 × 15% = ₹
Where 30 p.u. p.a.
On substitution, EOQ =30 units.

.
2. Cost Comparison of EOQ with 2% and 5% Discount Offers

Particulars EOQ 2% Discount 5% Discount

(a) Quantity Ordered every 30 units (Assumed) 60 units (Assumed) 90 units

time (Q)

(b) Number of Orders 45 45 45

30
= 1.5 orders 60
= 0.75 orders 90
= 0.5 orders
A
p.a. =
Q

(c) Buying Costs p.a. at ₹ 300 1.5 × ₹ 300 = ₹ 450 0.75 × ₹ 300 = ₹ 225 0.5 × ₹ 300 = ₹
150.00

(d) Average Inventory = ½ of ½ × 30 = 15 units ½ × 60 = 30 units ½ × 90 = 45 units

(a)

(e) Carrying Costs p.a. [Note: 15 units×(15%× ₹ 30 units×[15% of (₹ 45 units×[15% of (₹

CC pu pa is based on 200) = ₹ 450 200 less 2%)] = ₹ 882 200 less 5%)] = ₹
Purchase Price] 1,282.50

(f) Purchase Costs p.a. 45 units× ₹ 200 = ₹ 45 units× (₹ 200 less 45 units× (₹ 200 less
9,000 2%) = ₹ 8,820 5%) = ₹ 8,550

(g) Total Costs p.a.= (c + e + ₹ ₹ 9,927.00 ₹

f) 9,900.00 9,982.50

Conclusion: It is economical to continue buying in EOQ lots of 30 units per order, due to lower
Total Costs.
14 EOQ using Wilson’s Formula and Evaluation of Discount Offers RTP
A Company uses a purchased component in an assembly. It follows a policy of Economic
Order Quantity for procurement of the component. The Purchase Price of the component
is ₹ 800 each and the cost of carrying one unit is 15% per annum. The cost of placing an
order is ₹ 150. The Company has estimated the total cost of carrying and order placement
at ₹ 36,000. The Supplier has offered a discount of 3% on the Purchase Price if the entire
requirement of the component is covered in two purchase orders in a year.
1. Find the Economic Order Quantity.
2. Calculate the Total Cost of Component Procurement and Storage, if the Discount Offer
is accepted. Compare this cost with the Total Cost of the EOQ.
3. What further discount if any, should be negotiated for minimizing the cost? Assume that
the inventory carrying cost does not vary according to discount policy.
Solution: 1. Computation of EOQ
It is given in the question that at EOQ, Total Cost of Carrying and Order Placement, i.e. Associated
Cost p.a. = ₹ 36,000. Hence, Buying Cost p.a. = Carrying Cost p.a. = ½ of Associated Cost
p.a. = ½ of ₹ 36,000 = ₹ 18,000.

Equating Carrying Cost p.a. we have - Equating Buying Cost p.a. we have -

Carrying Cost p.a. = (Avg. Inv. × Carrying Cost Buying Cost p.a. = (No. of Orders × Cost per
p.u. p.a.) Order)
Q
18,000 = × (15% of ₹ 800). So, 18,000 = A A
Q
2 18,000 = Q × ₹ 150. 18,000 = 300 × 150
2
×120

On solving, Q = 300 units. Hence, EOQ = 300 On solving, A = 36,000 units.

units. Note: The Company follows EOQ
policy. Hence Q = EOQ.

2. Discount Analysis

Particulars EOQ 3% Discount

(a) Quantity Ordered every time (Q) 300 units 36,000 = 18,000
2 orders units
A 36,000 (Given) = 2 orders
(b) Number of Orders p.a. = Q 2
= 120 orders

(c) Buying Costs p.a. at ₹ 150 120 × ₹ 150 = ₹ 2 × ₹ 150 = ₹ 300

18,000

(d) Average Inventory = ½ of (a) ½ × 300 = 150 units ½ × 18,000 = 9,000 units

(e) Carrying Costs p.a. at ₹ 120 (given that 150 × ₹ 120 = ₹ 9,000 × ₹ 120 = ₹ 10,80,000
Carrying Cost does not vary as per 18,000
Discount Policy.)

(f) Purchase Costs p.a. [Note: The 36,000 units× ₹ 800 = 36,000 units× (₹ 800 less
Question requires Total Costs. Hence, ₹ 2,88,00,000 3%) = ₹ 2,79,36,000
Discount Approach is not applied here.]

(g) Total Costs p.a.= (c + e + f) ₹ 2,88,36,000 ₹ 2,90,16,300

Conclusion: 3% Discount Offer is not worthwhile, due to additional costs of ₹ 2,90,16,300 - ₹

2,88,36,000 = ₹ 1,80,300, when compared with EOQ.
3. Computation of Additional Discount required
₹ 1,80,300
Additional Discount to be negotiated to justify 2 purchase orders p.a. = 36,000units
= ₹ 5 p.u.
Approximately.
₹5
Hence, Additional Discount Percentage required = = 0.626% of Purchase Price.
₹ 800

15. EOQ using Wilson’s Formula and Evaluation of Discount Offers N12
KL Limited produces Product ‘M’ which has a quarterly demand of 8,000 units. The product
requires 3 kgs quantity of Material ‘X’ for every finished unit of product. The other
information are follows -
Cost of Material ‘X’ - ₹ 20 per kg, Cost of placing an order - ₹ 1,000 per order, Carrying Cost
-15% p.a. of Average Inventory. You are required:
• Calculate the Economic Order Quantity for Material ‘X’.
• Should the Company accept an offer of 2% discount by the Supplier, if he wants to supply
the Annual Requirement of Material ‘X’ in 4 equal Quarterly Instalments?
Solution
A = Annual Requirement of Raw Materials = 8,000
units × 3 kg × 4 quarters = 96,000 kg.
EOQ=√
2AB
,where B = Buying Cost per order = ₹ 1,000 per order
C C= Carrying Cost per unit per annum = ₹ 20 × 15%
=₹3
On substitution, EOQ = 8,000 kg
Computation of EOQ with 2% Discount Purchase Policy
Particulars EOQ 2%Discount

(a) Quantity Ordered (Q) 8,000 96,000

4 orders
= 24,000 kg
every time kg
A 96,000 (given quarterly) = 4 orders
(b)Number of Orders p.a. = Q 8,000
= 12 orders

(c) Buying Costs per at ₹ 1,000 12 × ₹ 1,000 = ₹ 4 × ₹ 1,000 = ₹ 4,000

per order 12,000

(d) Average Inventory = ½ of (a) 4,000 12,000 kg

kg

(e) Carrying Costs ₹ (12,000 kg × ₹ 3 Less 2%) = ₹ 35,280

p.a. 12,000

(0 Purchase Cost p.a. = (A × ₹ 19,20,000 (96,000 kg × ₹ 20 Less 2%) = ₹

Price) 18,81,600

(g) Total Costs p.a. = (c) + (e) ₹ 19,44,000 ₹ 19,20,880

+ (f)

Conclusion: Discount Offer may be accepted due to savings in cost.

16. EOQ and Discount Analysis M 18 (New)
An Entity manufactures a special product which requires a component “SKY BLUE”, with
the following particulars -

Annual demand of “SKY BLUE” 12000 units

Cost of placing an order ₹ 1,800

Cost per unit of “SKY BLUE” ₹ 640

Carrying Cost per annum 18.75%

The Company has been offered a quantity discount of 5% on the purchases of “SKY BLUE”
provided the order size is 3,000 components at a time. You are required to -
1. Compute the Economic Order Quantity.
2. Advise whether the Quantity Discount Offer can be accepted.
Solution:

2AB A = Annual Requirement of Raw Materials = 12,000 units (given)

1. EOQ = √ C
, where
B = Buying Cost per order = ₹ 1,800 per order (given)

C = Carrying Cost per unit per annum = ₹ 640 × 18.75% = ₹ 120 p.u. p.a.

On substitution, EOQ = 600 units.

2. Cost Comparison of EOQ with purchase policy of 3,000 units:

Particulars EOQ Lot Size = 3,000 units

(a) Quantity Ordered every time (Q) 600 units 3,000 units
A 12,000 12,000
(b) Number of Orders p.a. = Q = 20 orders = 4 orders
600 3,000

(c) Buying Costs p.a. at ₹ 1,800 20 × ₹ 1,800 = ₹ 36,000 4 × ₹ 1,800 = ₹ 7,200

(d) Average Inventory = ½ of (a) ½ × 600 = 300 units ½ × 3,000 = 1,500 units

(e) Purchase Price p.u. ₹ 640 ₹ 640 less 5% discount = ₹

608

(f) Carrying Cost p.u. at 18.75% of (e) ₹ 640 × 18.75% = ₹ 120 ₹ 608 × 18.75% = ₹ 114

(g) Carrying Costs p.a. = (d × f) 300 × ₹ 120 = ₹ 36,000 1,500 × ₹ 114 = ₹ 1,71,000

(h) Associated Costs p.a. = (c) + (g) ₹ 72,000 ₹ 1,78,200

(i) Purchase Price p.a. (e x 12,000 units) 12,000 × ₹ 640 = ₹ 12,000 × ₹ 608 = ₹
 76,80,000 72,96,000

(j) Total Cost p.a. (h + i) ₹ 77,52,000 ₹ 74,74,200

Conclusion: Discount Offer may be accepted due to Cost Savings = 77,52,000 - 74,74,200 = ₹
2,77,800. The Company may also consider other relevant factors like - (a) permanence of
Discount Offer, (b) invisible costs due to higher stockholding, etc.
Note: Instead of adding the Purchase Price p.a. (in Line (i) above), the Discount Received p.a.
can be considered as a reduction from Associated Cost, to arrive at Net Cost p.a. for decision
making.
17. EOQ and Discount Analysis M 18
ASJ Manufacturer produces a product which requires a component costing ₹ 1,000 per
unit. Other information related to the Component are as under:

Usage of Component 1,500 units per month

Ordering Cost ₹ 75 per order

Storage Cost Rate 2% per annum

Obsolescence Rate 1% per annum

Maximum Usage 400 units per week

Lead Time 6-8 weeks

The Firm has been offered a quantity discount of 5% by the Supplier on the purchase of
component, if the order size is 6,000 units at a time. Compute - (a) EOQ, (b) Re-Order Level,
and (c) advise whether the Discount Offer be accepted by the Firm.
Solution:

2AB A = Annual Requirement of Raw Materials = 1,500 × 12 = 18,000 units

1. EOQ = √ C
, where (given)

B = Buying Cost per order = ₹ 75 per order (given)

C = Carrying Cost per unit per annum = ₹ 1,000 × (2+1) i.e. 3% = ₹ 30

p.u. p.a.

On substitution, EOQ = 300 units.

2. Re-Order Level = Maximum Usage × Maximum Lead Time = 400 units × 8 weeks = 3,200
units
3. Cost Comparison of EOQ with Purchase Policy of 6,000 units:

Particulars EOQ Lot Size = 6,000 units

(a) Quantity Ordered every time 300 units 6,000 units

(Q)
A 18,000 18,000
(b) Number of Orders p.a. = Q 300
= 60 orders 6,000
= 3 orders

(c) Buying Costs p.a. at ₹ 75 60 × ₹ 75 = ₹ 4,500 3 × ₹ 75 = ₹ 225

(d) Average Inventory = ½ of (a) ½ × 300 = 150 units ½ × 6,000 = 3,000 units

(e) Purchase Price p.u. ₹ 1,000 ₹ 1,000 less 5% discount = ₹

950

(f) Carrying Cost p.u. at 3% of (e) ₹ 1,000 × 3% = ₹ 30 ₹ 950 × 3% = ₹ 28.5

(g) Carrying Costs p.a. = (d x f) 150 × ₹ 30 = ₹ 4,500 3,000 × ₹ 28.5 = ₹ 85,500

(h) Associated Costs p.a. = (c) + ₹ 9,000 ₹ 85,725

(g)

(i) Purchase Price p.a. (e × 18,000 × ₹ 1,000 = ₹ 18,000 × ₹ 950 = ₹

18,000 units) 1,80,00,000 1,71,00,000

(j) Total Cost p.a. (h + i) ₹ 1,80,09,000 ₹ 1,71,85,725

Conclusion: Discount Offer may be accepted due to savings in cost.

Note: Instead of adding the Purchase Price p.a. (in Line (i) above), the Discount Received p.a.
can be considered as a reduction from Associated Cost, to arrive at Net Cost p.a. for decision
making.
18. EOQ and Stock Levels RTP
The Stock Control Policy of a company is that each stock is ordered twice a year. The
quantum of each order being one-half of the year’s forecast demand.
The Materials Manager, however wishes to introduce a policy in which for each item of
stock, Re-Order Levels and EOQ is calculated. For one of the items X, the following
information is available

Forecast Annual Demand 3,600 units

Cost per unit ₹ 100

Cost of placing an order ₹ 40

Stock holding cost 20% of Average Stock Value

Lead Time 1 month

It is estimated by the Materials Manager that for item X, a Buffer Stock of additional 100
Units should be provided to cover fluctuations in demand.
If the new policy is adopted, calculate for Stock Item X -
1. Re-Order Level that should be set by the Material Manager.
2. Anticipated reduction in the value of the average stock investment.
3. Anticipated reduction in the Total Inventory Costs in the first and subsequent years.
Solution:

2AB A = Annual Requirement of Raw Materials = 3,600 units (given)

1. EOQ = √ C
, where
B = Buying Cost per order = ₹ 40 per order (given)

C = Carrying Cost per unit per annum = ₹ 100 × 20% = ₹ 20 p.u. p.a.

On substitution, EOQ = 120 units.

1
2. Re-Order Level = Safety Stock + Lead Time Consumption (1 month) =100 units + (3,600x )
12
= 400 units
3. EOQ vs Half-Yearly Purchase Policy

Particulars EOQ Existing Policy (half-yearly)

(a) Quantity Ordered every 120 units 3,600

2
= 1,800 units
time

(b) Number of Orders p.a. 3,600 (Half-yearly) = 2 orders

= 30 orders
120

(c) Buying Costs p.a. at ₹ 40 30 × ₹ 40 = ₹ 1,200 2 × ₹ 40 = ₹ 80

(d) Average Inventory Safety Stock + V⅛ EOQ = ½ × 1,800 = 900 units

100+60=160 units

(e) Value of Avg Inventory = (d ₹ 16,000 ₹ 90,000

× ₹ 100)

(f) Carrying Costs p.a. at 20% ₹ 3,200 ₹ 18,000

of (e)

(g) Associated Costs p.a. = (c ₹ 4,400 ₹ 18,080

+ f)

• Anticipated reduction in the value of the Average Stock Investment = ₹ 90,000 - ₹ 16,000 = ₹
74,000.
• Anticipated Reduction in total inventory-related costs = ₹ 18,080 - ₹ 4,400 = ₹ 13,680
However, in the first year, Safety Stock of 100 units is to be purchased at a cost of ₹ 10,000 (100
units × ₹ 100). So, while the saving would be of ₹ 13,680, the cost reduction in the system would
be only ₹ 3,680. In subsequent years, however, the cost reduction will be ₹ 13,680.
Note: Alternative assumptions exist in treatment of Safety Stock and calculation of Reduction in
Associated Costs.

19. EOQ and Timing of an Order M 08

ZED Company supplies Plastic Crockery to Fast Food Restaurants in a metropolitan city.
One of its products is a Special Bowl, disposable after initial use, for serving soups to its
customers. These Bowls are sold in packs of 10 pieces at a price of ₹ 50 per pack.
The demand for Plastic Bowl has been forecasted at a fairly steady rate of 40,000 packs
every year. The Company purchases the Bowl direct from a Manufacturer at ₹ 40 per pack,
within a three days lead time. The ordering and related cost is ₹ 8 per order. The Storage
Cost is 10% per annum of average inventory investment. You are required to -
1. Calculate Economic Order Quantity.
2. Calculate the number of orders needed every year.
3. Calculate the Total Cost of Ordering and Storage of Bowls for the year.
4. Determine when should the next order to be placed. (Assume that the Company does
not maintain a Safety Stock and that the present inventory level is 333 packs with a year
of 360 working days.)

Solution: A = Annual Requirement of Raw Materials = 40,000 packs.

2AB B = Buying Cost per order = ₹ 8 per order(given)

1. EOQ = √ , where
C
C = Carrying Cost per unit per annum = ₹ 40 × 10% = ₹ 4 p.u. p.a.

On substitution, EOQ = 400 packs.

Annual Requirement (A) 40,000
2. Number of Orders p.a. = = = 100 orders per annum.
Quantity Ordered (Q) 400

3. Associated Cost p.a. = Buying Cost per annum + Carrying Cost per annum
= (No. of Orders × Cost per Order) + (Avg. Inventory × Carrying Cost p.u. p.a.)
400
= [100 × ₹ 8] + [ 2
× ₹ 4 p.u] = ₹ 800 + ₹ 800 = ₹ 1,600
4. Timing of next purchase order:
• Annual Requirement = 40,000 units over 360 days, (given).
360
• Hence, Present Stock of 333 packets will be sufficient for 40,000 × 333 = 3 days only.

• Since Lead-Time is 3 days and Present Stock Quantity can meet only the Lead Time
Consumption (since there is no Buffer Stock), the next order should be placed immediately.
Note: If Lead Time were 2 days, the order can be placed even on the following day. However, if
Lead Time were 4 days, emergency purchases should be made.
20. Material Cost - EOQ, Multiple Materials and Markets RTP
Aditya Agro Ltd (AAL) produces edible oils of different varieties. The monthly demand
pattern for the Finished Products are -
Mustard Oil: 45,000 Litres, Soybean Oil: 15,000 Litre, Olive Oil: 3,000 Litre
To produce 1 litre of Mustard Oil, Soybean Oil and Olive Oil, 5 kg of Mustards, 6 kg of
Soybeans and 4.5 kg of Olives are required respectively. There is no Opening and Closing
Stock of Materials. AAL can purchase the Materials either from the Farmers directly or from
the Wholesale Market. Following is the material-wise summary related with the purchase
of Materials:

Particulars Mustards Soya beans Olive

Source of Purchase Wholesale Farmers Wholesale Farmers Wholesale Farmers

Minimum Quantity to be Any 13,50,000 Any 2,70,000 Any 1,62,000 Kg

purchased quantity kg. quantity Kg quantity

Purchase Price per kg (₹) 15.30 12.50 11.00 9.00 36.00 30.80

Transportation Cost per 6,000 15,000 9,000 12,000 3,000 11,000

purchase (₹)

Sorting & Piling Cost per - 1,200 - 800 1,800 -

purchase (₹)

Loading Cost per 50 kg. (₹) 10.00 5.00 10.00 3.00 10.00 25.00

Unloading Cost per 50 kg. 2.00 2.00 2.00 2.00 2.00 2.00
(₹)

The Company is paying 12.5% p.a. as Interest to its Bank for Cash Credit facility and ₹ 100
per 100 kg, as Rent to the Warehouse.
1. Calculate the Purchase Cost of each Material - (a) from Wholesale Market, and (b) from
the Farmers.
2. Calculate Economic Order Quantity of each Material under the both options.
3. Recommend the Best Purchase Option for the Material ‘Olive’.
Solution: 1. Computation of Purchase Cost per Kg. of Materials (all amounts in ₹ Per Kg)

Particulars Mustards Soybeans Olives

Market Wholesale Farmers Wholesale Farmers Wholesale Farmers

Purchase Price 15.30 12.50 11.00 9.00 36.00 30.80

Add: Loading ₹ 10÷ 50 Kg ₹ 5÷ 50 Kg ₹ 10÷ 50 Kg ₹ 3÷ 50 ₹ 10÷ 50 ₹ 25÷ 50 Kg

= Kg =0.20
=0.20 = 0.10 Kg= 0.06 = 0.50
0.20

Add: Unloading ₹ 2÷ 50 Kg = ₹ 2÷ 50 Kg ₹ 2÷ 50 Kg = ₹ 2÷ 50 Kg ₹ 2÷ 50 Kg ₹ 2÷ 50 Kg =
= 0.04
0.04 = 0.04 0.04 = 0.04 0.04

Total Cost 15.54 12.64 11.24 9.10 36.24 31.34

 2. Computation of EOQ

Particulars Mustards Soybeans Olives

Annual Requirement (45,000 Ltr. × 5 Kg × 12 (15,000 Ltr. × 6 Kg × 12 (3,000 Ltr. × 4.5 Kg ×

(A) Months) = 27,00,000 Kg Months) = 10,80,000 Kg 12 Months) =
1,62,000 Kg

Market Wholesale Farmers Wholesale Farmers Wholesale Farmers

Buying Cost per Order

(B)

(a) Transportation 6,000 15,000 9,000 12,000 . 3,000 11,000

(b) Sorting and Piling - 1,200 - 800 1,800 -

Cost

Total 6,000 16,200 9,000 12,800 4,800 11,000

Carrying Cost per Kg p

a. (C)

(a) Interest at 12.5% on 1.9425 1.5800 1.4050 1.1375 4.5300 3.9175

Purchase Cost as per
WN 1

(b) Warehouse Rent at 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000

₹ 1 / Kg

Total 2.9425 2.5800 2.4050 2.1375 5.5300 4.9175

2 AB 1,04,933.53 1,84,138.47 89,906.40 1,13,730.98 16,769.90 26,921.34

EOQ = √ C
(in kgs)

3. Best Purchase Option for Olives

Particulars Wholesale Farmers

(a) Annual Requirement (A) (Kg.) 1,62,000 1,62,000

(b) Quantity purchased every 16,769.90 1,62,000

time (Q)

(c) No. of Orders p a. (A ÷ Q) 9.66 or 10 1

(d) Average Inventory (Q ÷ 2) 8,384.95 Kg 81,000 Kg

(e) Buying Cost p.a. (9.66 Orders × ₹ 4,800) = ₹ (1 Order × 11,000) = ₹ 11,000
 46,369

(f) Carrying Cost p.a. (8,384.95 Kg × ₹ 5.5300) = ₹ (81,000 Kg × 4.9175) = ₹

46,369 3,98,318

(g) Purchase Cost p.a. (1,62,000 Kg × ₹ 36.24) = ₹ (1,62,000 Kg × ₹ 31.34) = ₹

58,70,880 50,77,080

(h) Total Cost (e) + (f) + (g) ₹ 59,63,618 ₹ 54,86,398

Conclusion: Purchasing Olives directly from the Farmers is better due to lower Costs.
21. EOQ with Quantity Discount - Tabular Analysis with Purchase Price Approach M 09
X Ltd is reviewing its stock policy, and has the following alternatives available for the
evaluation of stock:

I Purchase stock twice in a month 400 units

II Purchase monthly 800 units

III Purchase every three months 2,400 units

IV Purchase every six months 4,800 units

V Purchase annually 9,600 units

It is ascertained that the Purchase Price per unit is ₹ 40 for deliveries upto 2,000 units. A
5% discount is offered by the Supplier on the whole order where deliveries are 2,001 to
4,000 units and 10% reduction on total order for deliveries in excess of 4,000 units. Each
purchase order incurs administration costs of ₹ 250. Interest on capital and other storage
costs are ₹ 12.50 per unit of average stock quantity held. Calculate the optimum order size.
Solution: Computation of EOQ under Trial and Error Method (Purchase Price Approach)

Lot Buying Cost p.a. = Carrying Cost per Associated Purchase Cost per Total Cost
Size No. of Orders × Cost annum = Avg Inv. × Cost p.a. annum for 9,600 per annum
per order CC p.u. p.a. units

(1) 9,600 units Col.(1) (4) = (5) = 9,600 units × (6) =

(2) = Col. (1)
× ₹ 250 (3) = ×₹
2 Purchase Price p.u.
12.50pu (2) + (3) (4) + (5)

400 24 × 250 = 6,000 200 × 12.50 = 2,500 8,500 9,600 × 40= 3,92,500
3,84,000

800 12 × 250 = 3,000 400 × 12.50 = 5,000 8,000 9,600 × 40= 3,92,000
3,84,000

2,400 4 × 250 = 1,000 1200 × 12.50 = 16,000 9,600 × 38= 3,80,800

15,000 3,64,800

4,800 2 × 250 = 500 2400 × 12.50 = 30,500 9,600 × 36= 3,76,100

 30,000 3,45,600

9,600 1 × 250 = 250 4800 × 12.50 = 60,250 9,600 × 36= 4,05,850

60,000 3,45,600

Note: Purchase Price for 2,001 to 4,000 units = ₹ 40 - 5% = ₹ 38, for Qtty > 4,000 units = ₹ 40 -
10% = ₹ 36.
Conclusion: From the above table, the Optimum Order Size (i.e. EOQ) is 4,800 units (i.e.
purchase every six months), since the Total Cost is the least at that level.
22. EOQ with Quantity Discount - Tabular Analysis with Purchase Price Approach N 90, N
10, M 94
ABC Ltd has received an offer of quantity discount on its order of materials as under -

Price per ₹ 4,800 ₹ 4,680 ₹ 4,560 ₹ 4,440 ₹ 4,320

tonne

Tonnes Less than 50 and less than 100 and less than 200 and less than 300 &
Number 50 100 200 300 above

The annual requirement for the material is 500 tonnes. The Ordering Cost per order is ₹
6,250 and the Stockholding Cost is estimated at 25% of the Material Cost per annum.
(1) Compute the most economical purchase level.
(2)Compute EOQ if there are no purchase discounts and the price per tonne is ₹ 5,250.
Solution: Purchase Price Approach is given here. Student may adopt either Purchase Price or
Discount Approach in exams.
1. Computation of EOQ under Trial and Error Method (Purchase Price Approach)

Lot Buying Cost p.a. = Carrying Cost per Associated Purchase Cost per Total Cost
No. of Orders × Cost annum = Avg Inv. × CC Cost p.a. annum for 500 tons per annum
Size
per order p.u. p.a.

(1) 500 tons Col. (1) (4) (5) = 500 tons × (6) =
(2) = Col. (1)
×₹ (3) = 2
× Purc
=(2)+(3) (Purchase Price)
6,250 Price × 25% (4) + (5)

10 50x 6,250 = 3,12,500 5 × 1,200 = 6,000 3,18,500 500 × 4,800= 27,18,500

24,00,000

50 10x 6,250 = 62,500 25 × 1,170 = 29,250 91,750 500 × 4,680= 24,31,750

23,40,000

100 5 × 6,250 = 31,250 50 × 1,140 = 57,000 88,250 500 × 4,560= 23,78,250

22,80,000

200 5/2 × 6,250 = 15,625 100x 1,110 = 1,11,000 1,26,625 500 × 4,440= 23,46,625
22,20,000
300 5/3 × 6,250 = 10,417 150x 1,080 = 1,62,000 1,72,417 500 × 4,320= 23,32,417
21,60,000

Conclusion: From the table, the most economical purchase quantity (i.e. EOQ) is 300 tonnes,
relating to Least Total Costs.
2. Computation of EOQ under Wilson's Model

A = Annual Requirement of Raw Materials = 500 tonnes.

2AB B = Buying Cost per order = ₹ 6,250 per order (given)

EOQ = √ C
, where
C = Carrying Cost p.u. p.a. = ₹ 5,250 (Pure. Price) × 25% = ₹ 1,312.50 per
tonne p.a.

On substitution, EOQ = 69.01 tonnes.

23. EOQ without Material Price - Savings I Discount Approach

Veerabahu Ltd uses 50 containers of acid per annum at their plant. It has been calculated
that a Purchase Order costs ₹ 10 to process and that the cost of stockholding is ₹ 1 per
container p.a. Suppliers of acid offer quantity discounts as under -

Number of Containers 1-9 10-49 50-99 100 & above

Discount per unit (₹ ps) NIL 0.50 1.00 1.60

Compute EOQ in the above situation - (a) with discount, and (b) without discount.
Solution: Generally for EOQ decision-making, Relevant Cost = Buying Cost p.a. + Carrying Cost
p.a. + Purchase Cost p.a. However, the Purchase Price is not given in this question. Hence,
Relevant Cost = Buying Costs + Carrying Costs Less Discounts Received (from basic price). The
computations are as under-

Lot Buying Cost p.a. = Carrying Cost per Associated Discount Received Net Cost per
No. of Orders × Cost annum = Avg Inv. × Cost p.a. per annum for 50 annum
Size
per order CC p.u. p.a. units

(1) 50 units Col. (1) (4)=(2+3) (5) = 50 uts × Disc. (6) = (4-5)
(2) =
Col.(1)
× 10 (3) = ×₹1
2

1 50 × 10 = 500 1/2 × 1= 0.50 500.50 50 x Nil = Nil 500.50

10 5 × 10 = 50 5 × 1= 5.00 55.00 50 × 0.50 = 25.00 30.00

50 1 × 10 = 10 25 × 1 = 25.00 35.00 50 × 1.00 = 50.00 (15.00)

100 1/2 × 10 = 5 50 × 1 = 50.00 55.00 50 × 1.60 = 80.00 (25.00)

Since Least Relevant Cost = ₹ (25) (negative cost indicates maximum gain), EOQ = 100 units.
Remarks: EOQ = 100 units means that two years' requirement (50 containers per annum) are to
be purchased in bulk and stored, in order to avail the quantity discount applicable for such bulk
purchase.
2. Computation of EOQ under Wilson's Model (i.e. without Discount)

A = Annual Requirement of Raw Materials = 50 containers.

2AB B = Buying Cost per order = ₹ 10 per order (given)

EOQ = √ C
, where
C = Carrying Cost per unit per annum = ₹ 1 per container p.a.

On substitution, EOQ = 31.62 = 32 containers (approximately).

24. EOQ with Quantity Discount - Tabular Analysis with Discount Approach M 02
The quarterly production of a Company's product which has a steady market is 20,000
units. Each unit of a product requires 0.5 kg of Raw Material. The cost of placing one order
for Raw Material is ₹ 100 and the Inventory Carrying Cost is ₹ 2 per annum. The lead time
for procurement of Raw Material is 36 days and a Safety Stock of 1,000 kg of Raw Material
is maintained by the Company. The Company has been able to negotiate the following
discount structure with the Supplier-

2. Re-Order Level = Max. Usage × Max. Lead Time = 1,250 units × 3 weeks 3,750 units

3. Minimum Level = ROL - (Average Usage × Average Lead Time) = 3,750 - (1,000 1,750 units
× 2) (Note)

4. Maximum Level = ROL + ROQ - (Min. Usage × Min. Lead Time)

= 3,750 + 2,236 - (750 × 1) [Note: EOQ = ROQ] 5,236 units

Note: Avg Usage = ½ of (Max + Min) = ½ of (1,250 + 750) = 1,000 units per week.

Avg Lead Time = ½ of (Max + Min) = ½ of (3 + 1) = 2 weeks.

25. EOQ with Quantity Discount - Non-Financial Considerations - Per Ton Approach N 04
SAP Ltd requires 25,000 tons of a raw material annually. It costs ₹ 10,000/- per order and
carrying costs are ₹ 50 per ton per annum (including interest of ₹ 28). It has received the
following quotations from local suppliers for the next year’s supply.

Lot Size Upto 4,999 tons 5,000-9,999 tons 10,000-24,999 25,000 & above
tons

Unit Rate ₹ 100 ₹ 98 ₹ 95 ₹ 90

1. Advise the Company regarding the most optimum order quantity.

2. A German Supplier has offered a price of ₹ 75 per ton for 25,000 tons in a single
shipment. For this shipment, Special Packing Expenses charged to the Company would
be ₹ 1 Lakh. Advise whether this offer can be accepted in preference to (1) above.
3. Would your advice to (2) differ, if the Packing Expenses were ₹ 1, 50,000? What will be
the maximum Packing Expenses that can be borne by the SAP Ltd?

Solution: 1. Computation of EOQ for Local Supplies

• A = Annual Requirement of Raw Materials = 25,000 tons. Note:

Interest should be included as a
• B = Buying Cost per order = ₹ 10,000 per order
relevant carrying cost for decision-
• C = Carrying Cost per unit per annum = ₹ 50. making.

Lot Buying Cost p.a. = No. of Carrying Cost Associated Associated Purchase Total
Orders × Cost per order p.a. = Avg Inv. × Cost p.a. Cost per Price per Cost
Size
CC p.u. p.a. ton ton per ton
25,000 tons Col.(1) Col.(4)
(1) (2) =
Col.(1)
×₹10,000 (3) = × ₹ 50 (4)=(2)+(3) (5)= (6) = (7) =
2 25,000 Given (5)+(6)

2,500 10x10,000= 1,00,000 1,250 × 50 = 1,62,500 ₹ 6.50 ₹ 100.00 ₹

62,500 106.50

5,000 5 × 10,000= 50,000 2,500 × 50 = 1,75,000 ₹ 7.00 ₹ 98.00 ₹

1,25,000 105.00

10,000 2.5x10,000= 25,000 5,000 × 50 = 2,75,000 ₹ 11.00 ₹ 95.00 ₹

2,50,000 106.00

25,000 1 × 10,000= 10,000 12,500× 50 = 6,35,000 ₹ 25.40 ₹ 90.00 ₹

6,25,000 115.40

Since Least Relevant Cost is ₹ 105.00 per unit, the EOQ for local supplies = 5,000 tons.
[Note: Associated Costs have been averaged on per ton basis, to which Purchase Price per
ton has been added.]
Alternative Presentation (Discount Approach)

Lot Buying Cost p.a. = No. of Carrying Cost Associated Associated Discount Net Cost
Orders × Cost per order p.a. = Avg Inv. × Cost p.a. Cost per per ton per ton
Size
CC p.u. p.a. ton

(1) 25,000 tons Col.(1) Col.(4)

(2)= Col.(1)
×₹10,000 (3) = 2
× ₹ (4)=(2)+(3) (5)= (6) = (7) = (5-
25,000 100 - 6)
50
Price

2,500 10x10,000= 1,00,000 1,250 × 50 = 1,62,500 ₹ 6.50 Nil ₹ 6.50

62,500

5,000 5 × 10,000= 50,000 2,500 × 50 = 1,75,000 ₹ 7.00 ₹ 2.00 ₹ 5.00

1,25,000
10,000 2.5x10,000= 25,000 5,000 × 50 = 2,75,000 ₹ 11.00 ₹ 5.00 ₹ 6.00
2,50,000

25,000 1 × 10,000= 10,000 12,500× 50 = 6,35,000 ₹ 25.40 ₹ 10.00 ₹ 15.40

6,25,000

Since Least Relevant Cost is ₹ 5.00 per unit, the EOQ for local supplies = 5,000 tons.
[Note: Associated Costs have been averaged on per ton basis, from which Discount per ton
has been deducted.]
2. Evaluation of German Supplier's Offer

Particulars EOQ German Supplier's

Offer

(a) Quantity Ordered every time 5,000 25,000 tons

(Q) tons

(b) Number of Orders p.a. = A 25,000 tons

= 5 orders Single Shipment = 1
Q 5,000 tons
order

(c) Buying Costs p.a. at ₹ 5 × ₹ 10,000 = ₹ 1 × ₹ 10,000 = ₹

10,000 50,000 10,000
1
(d) Average Inventory = ½ of (a) /2 × 5,000 = 2,500 ½ × 25,000 = 12,500
tons tons

(e) Carrying Costs p.a. at ₹ 50 2,500 × ₹ 50 = ₹ 12,500 × ₹ 50 = ₹

1,25,000 6,25,000

(f) Associated Costs p.a. = (c) ₹ ₹ 6,35,000

+ (e) 1,75,000

(g) Average Associated Cost ₹ 1,75,000 ₹ 6,35,000

25,000 tons
= ₹ 7.00 25,000 tons
= ₹ 25.40
per ton

(h) Packing Charges Nil ₹ 1,00,000

25,000 tons
= ₹ 4.00
per ton

(i) Purchase Price per (for Local Supplies) = ₹ 98.00 ₹ 75.00

ton

G) Total Cost per ton (g + h + i) ₹ 105.00 ₹

104.40

Conclusion: The German Supplier's Offer may be accepted due to lower costs. However, the
savings is only ₹ 0.60 per ton or ₹ 15,000 p.a. (25,000 tons × 0.60). Hence, non-financial
considerations should also be taken into account in decision-making. Some of these non-financial
considerations (i.e. non-cost factors) to be considered are -
(a) Stability of Prices of German Supplier, (b) Possibility of adverse changes in Foreign Exchange
rates, (c) Possible increase in Packing Expenses, (d) Lead time and associated risks involved in
transit, (e) Possibility of further negotiations with Local Suppliers, and (f) Need to maintain
continuing business relationship with Supplie₹
3. Effect of ₹ 1,50,000 Packing Expenses:
• If Packing Charges were ₹ 1,50,000 instead of ₹ 1,00,000, the German Offer should be rejected
since cost of German offer is higher by ₹ 35,000 p.a.
• Maximum Packing Charges payable = ₹ 1,00,000 + ₹ 15,000 [savings as per (2) above] = ₹
1,15,000.
3. Computation of Stock Levels
26. Stock Levels RTP
P Ltd uses 3 types of materials A, B and C for production of Product X. The relevant
monthly data for consumption of materials are given below. Calculate for each material -
(i) ROL, (ii) Minimum Level, (iii) Maximum Level, and (iv) Average Level.

Particulars A B C

Normal Usage 200 units 150 units 180 units

Minimum Usage 100 units 100 units 90 units

Maximum Usage 300 units 250 units 270 units

Re-Order Quantity 750 units 900 units 720 units

Re-Order Period 2 to 3 months 3 to 4 months 2 to 3 months

Solution:

Stock Formula Material A Material B Material C

Level

Re-Order = Maximum Usage × 300 × 3 = 2!50 × 4 = 1,000 270 × 3 =

Maximum Lead Time 900 units units 810 units
Level

Minimum = ROL - (Average Usage × 900 - (200 × 2.5) = 1,000-(150 × 3.5) 810-(180 × 2.5) =
Average Lead Time) 400 units = 475 units 360 units
Level

Maximum = ROL + ROQ - (Minimum 900 + 750 - (lOO× 1,000+ 900-(100× 810 + 720 - (90 ×
Usage × Minimum Lead 2) = 1,450 units 3) = 1,6«00 units 2) = 1,350 units
Level
Time)

Average = Max. Level + Min. Level 1,450 + 400 1,600 + 475 1,350 + 360
Level 2 2 2 2

= 925 units = 1,038 units = 855 units

Note: (a) Average Lead Time = ½ of (Max + Min) = ½ of (3 + 2) = 2.5 months (for Material A).
[Similarly for B & C also.]
(b) Average Stock Level can also be computed as Minimum Level + ½ ROQ.

27. Stock Levels - Reverse Working N 14

Following details relate to a manufacturing Firm: Find-(a) Maximum Consumption per day,
(b) Minimum Consumption per day.

Re-order Level 1,60,000 Average Lead Time 6 days

units

Economic Order Quantity 90,000 units Difference between Minimum Lead

Time and Maximum Lead Time
Minimum Stock Level 1,00,000 4 days
units

Maximum Stock Level 1,90,000

units

Solution: Let Maximum Lead time = X, Minimum Lead time = Y. So, X - Y = 4

X+Y
Average Lead Time = 2
= 6, So, X + Y = 12
On addition (to cancel Y), 2X = 16, So, X = 8, Y = 8 - 4 = 4
Hence, Maximum Lead Time = 8 days, Minimum Lead Time = 4 days
Reorder Level = Maximum Usage × Maximum Lead Time
1, 60,000 units = Maximum Usage × 8 days So, Maximum Usage = 20,000 units per day.
Maximum Level = ROL + EOQ (ROQ assumed as EOQ) - (Minimum Usage × Minimum Lead
Time)
1, 90,000 = 1, 60,000 + 90,000 - (Minimum Usage × 4 days) So, Minimum Usage = 15,000 units
per day
28. Stock Levels M 95
In a Company, weekly minimum and maximum consumption of Material A are 25 and 75
units respectively. The Re-Order Quantity as fixed by the Company is 300 units. The
Material is received within 4 to 6 weeks from issue of supply order. Calculate Minimum
Level and Maximum Level of Material A.
Solution:

Stock Level Formula Answer

Re-Order = Maximum Usage × Maximum Lead Time 75 × 6 = 450 units

Level

Minimum = ROL - (Average Usage × Average Lead Time) 450 - (50 × 5) = 200 units
Level
Maximum = ROL + ROQ - (Minimum Usage × Minimum 450 + 300 - (25× 4) = 650
Level Lead Time) units

Note: (a) Average Lead Time = ½ of (Max + Min) = ½ of (6 + 4) = 5 weeks.

(b) Average Usage Rate = ½ of (Max + Min) = ½ of (75 + 25) = 50 units per week.
29. Stock Levels Computation RTP, N 87, N 89
A Company uses three Raw Materials A, B and C for a particular product for which the
following data apply -

Raw Usage per Re - Price Delivery Period Re- Minimum

order Order

Material Unit of Quantity Per kg Minimum Average Maximum Level Level

product

A 10 Kgs 10,000 ₹ 0.10 1 2 3 8,000

Kgs Kgs

B 4 Kgs 5,000 ₹ 0.30 3 4 5 4,750

Kgs Kgs*

C 6 Kgs 10,000 ₹ 0.15 2 3 4 2,000

Kgs Kgs

Weekly uction varies 75 to 225 units, averaging 200 units of the said product. Compute
prod from the following quantities -

(a) Minimum Stock of A, (b) Maximum Stock of B, (c) Re-Order Level C, and (d) Average
Stock Level of A.
Solution:

1. Minimum = ROL - (Average Usage × Average Lead Time) = 8,000 - (200 × 10 4,000
Level of A × 2) kgs

2. Maximum = ROL + ROQ - (Min. Usage × Min. Lead Time) = 4,750 + 5,000 - 7,650
Level of B (175×4×3) kgs

3. Re-Order = Max. Usage × Max. Lead Time = (225 × 6× 4) 5,400

Level of C kgs

(or) = Minimum Level + (Average Usage × Average Lead Time) = 2,000 + 5,600
alternatively (200 × 6 × 3) kgs

4. Average = Minimum Stock Level +½ Re-Order Quantity = 4,000 (WN 1) +½ of 9,000

Stock of A 10,000 kgs

(or) Maximum Stock+Minimum Stock 16,250 + 4,000 10,125

= 2
= 2
(See Note)
alternatively Kgs
Note: Maximum Stock of A = ROL + ROQ - (Min. Usage × Min. Lead Time) = 8,000 + 10,000 -
(175 × 10 × 1) = 16,250
30. Re-order Level M 10
Re-Order Quantity of Material ‘X’ is 5,000 kg. Maximum Level 8,000 kg, Minimum Usage 50
kg. per hour, Minimum Re-Order Period 4 days, Daily Working Hours in the factory is 8
hou₹ You are required to calculate the Re-Order Level of Material ‘X’.
Solution:
Note: Maximum Level = ROL + ROQ - (Min. Usage × Min. Lead Time)
On substitution, we have 8,000 kg = ROL + 5,000 - (8 hours × 50 kg × 4 days). On solving, ROL
= 4,600 kg.
31. Stock Levels RTP
If Material usage per day is 140 units, Lead Time is 6 days and Safety Stock is 8 days,
compute ROL.
Solution: Re-Order Level = Safety Stock + Lead Time Consumption
= (8 × 140) + (6 × 140) = 1120 + 840 = 1,960 units.
32. EOQ and Stock Levels N 09
ML Manufacturing Ltd requires 1, units of Material ‘EX’ on an average for a week which is
purchased at a price of ₹ 30 per unit. The Ordering Cost is ₹ 150 per purchase order and
Inventory Carrying Cost per unit amounts to ₹ 0.06 per week. The Re- Order Period is 1 to
3 weeks and the weekly usage of Material ‘EX’ varies from 750 to 1,250 units.
Solution:

A = Annual Requirement of RM = 1,000 units × 52 weeks =

52,000 units p.a.

B = Buying Cost per order = ₹ 150 per order (given)

2AB
1. EOQ= √ C
, where
C = Carrying Cost per unit per annum = Re.0.06 × 52 weeks
= ₹ 3.12 p.u. p.a.

On substitution, EOQ = 2,236 units.

2. Re-Order Level = Max. Usage × Max. Lead Time = 1,250 units × 3 weeks 3,750 units

= ROL - (Average Usage × Average Lead Time) = 3,750 - (1,000 1,750 units
3. Minimum Level
× 2) (Note)

4. Maximum = ROL + ROQ - (Min. Usage × Min. Lead Time)

Level

= 3,750 + 2,236 - (750 × 1) [Note: EOQ = ROQ] 5,236 units

 ½
of (Max + Min) = ½ of (1,250 + 750) = 1,000 units per week.
Note: Avg Usage
= Avg Lead Time =
½ of (Max + Min) = ½ of (3 + 1) = 2 weeks.

33. EOQ and Stock Levels N 13

Primex Limited produces Product ‘P’. It uses annually 60,000 units of a Material ‘Rex’
costing ₹ 10 per unit. Other relevant information are:

Cost of Placing an Order ₹ 800 per Order

Carrying Cost 15% per Annum of Average Inventory

Re-order Period 10 days

Safety Stock 600 Units

The Company operates 300 days in a year. Calculate:

(i) Economic Order Quantity of Material ‘Rex’. (ii) Maximum Stock Level
(iii) Re-Order Level (iv) Average Stock Level
Solution:

A = Annual Requirement of Raw Materials = 60,000 units.

2AB B = Buying Cost per order = ₹ 800 per order (given)

1. EOQ = √ C
, where
C = Carrying Cost per unit per annum = ₹ 10 × 15% = ₹ 1.50 p.u. p.a.

On substitution, EOQ = 8,000 units.

2. Re-Order Level = Safety Stock + Lead Time Consumption

10 = 2,600 units.
= 600 + (60,000 × 300) = 600 + 2,000

3. Minimum Level = Safety Stock (given) = 600 units.

4. Maximum Level = ROL + ROQ - (Min. Usage × Min. Lead Time) =

= 2,600 + 8,000 - (Lead Time Consumption = 8,600 units.

assumed 2,000)

5. Average Level = Min Level + ½ ROQ = 600 + ½ of (8,000) = 4,600 units.

34. EOQ and Stock Levels M 96, M 98, M 00, N 02, N 06, RTP
PQR Ltd manufactures a special product, which requires ‘ZED’. Following particulars were
collected for the year -
(i) Monthly demand of Zed 7,500 units (v) Carrying Cost % p.a. 10%

(ii) Cost of placing an order ₹ 500 (vi) Normal Usage 500 units per week

(iii) Re-Order Period 5 to 8 weeks (vii) Minimum Usage 250 units per week

(iv) Cost per unit ₹ 60 (viii) Maximum Usage 750 units per week

Compute - (i) ROQ, (ii) ROL, (iii) Minimum Stock Level, (iv) Maximum Stock Level and (v)
Average Stock Level.
Solution:

2AB A = Annual Requirement of Raw Materials = 7,500 units × 12 months

1. EOQ = √ C
, where = 90,000 units.

B = Buying Cost per Order = ₹ 500 per Order.

C = Carrying Cost per unit per annum = ₹ 60 × 10% = ₹ 6 p.u. p.a.

On substitution, EOQ = 3,873 units. (Note: EOQ = ROQ)

2. Re-Order Level = Max. Usage × Max. Lead Time = 750 × 8 6,000

units

3. Minimum Level = ROL - (Average Usage × Average Lead Time) = 6,000 - 2,750
(500 × 6.5) units

4. Maximum Level = ROL + ROQ - (Min. Usage × Min. Lead Time) = 6,000 + 8,623
3,873 - (250 × 5) units

5. Average Level [Link] + [Link] 8,623 + 2,750 5,687

= =
2 2 units

35. EOQ and Stock Levels N 18 (New)

SJ Private Ltd manufactures 20,000 units of a product per month. The cost of placing an
order ₹ 1,500. The Purchase Price of the Raw Material is ₹ 100 per kg. The Re-Order Period
is 5 to 7 weeks. The Consumption of Raw Materials varies from 200 kg to 300 kg per week,
the average consumption being 250 kg. The Carrying Cost of Inventory is 9.75% per
annum.
Compute - (a) ROQ, (b) ROL, (c) Maximum Stock Level, (d) Minimum Stock Level, and
(e)Average Stock Level.
Solution:

A = Annual Requirement of Raw Materials = 250 kgs RM × 52

weeks = 13,000 kg.
 2AB B = Buying Cost per Order = ₹ 1,500 per Order.
1. EOQ = √ C
, where
C = Carrying Cost per unit per annum = ₹ 100 × 9.75% = ₹ 9.75
p.u. p.a.

On substitution, EOQ = 2,000 kg. (Note: EOQ = ROQ)

2. Re-Order Level = Max. Usage × Max. Lead Time = 300 × 7 2,100 kg

3. Maximum Level = ROL + ROQ - (Min. Usage × Min. Lead Time) = 2,100 + 3,100 kg
2,000 - (200 × 5)

4. Minimum Level = ROL - (Average Usage × Average Lead Time) = 2,100 - 600 kg
(250 × 6)

5. Average Level [Link]+ [Link] 3,100 + 600 1,850 kg

= 2
= 2

36. EOQ, ROL, Cost Savings, etc. N 20 (New)

An Automobile Company purchases 27,000 Spare Parts for its annual requirements. The
Cost per Order is ₹ 240 and the Annual Carrying Cost of Average Inventory is 12.5% Each
Spare Part costs ₹ 50. At present, the order size is 3,000 Spare Parts. Assume that number
of days in a year = 360 days. Find out:
• How much the Company’s Cost would be saved by opting EOQ Model?
• The Re-Order Point under EOQ Model if lead time is 12 days.
• How frequently should orders for procurement be placed under EOQ Model?

Solution: A = Annual Requirement of Raw Materials = 27,000 units (given)

2AB B = Buying Cost per order = ₹ 240 per order (given)

1. EOQ = √ C
, where
C = Carrying Cost per unit per annum = ₹ 50 × 12.5% = ₹ 6.25 p.u.
p.a.

On substitution, EOQ = 1,440 units.

12
2. Re-Order Level = Safety Stock + Lead Time Consumption = Nil + (27,000 × 360) = 900 units
3. Cost Comparison of EOQ with purchase policy of 3,000 units:

Particulars EOQ Lot Size = 3,000 units

(a) Quantity Ordered every time (Q) 1,440 units 3,000 units
A 27,000 27,000
(b) Number of Orders p.a. = 1,440
= 18.75 orders 3,000
= 9 orders
Q
(c) Buying Costs p.a. at ₹ 240 18.75 × ₹ 240 = ₹ 4,500 9 × ₹ 240 = ₹ 2,160

(d) Average Inventory = ½ of (a) ½ × 1,440 = 720 units ½ × 3,000 = 1,500 units

(e) Carrying Costs p.a. = (d × ₹ 6.25) 720 × ₹ 6.25 = ₹ 4,500 1,500 × ₹ 6.25 = ₹ 9,375

(f) Associated Costs p.a. = (c) + (e) ₹ 9,000 ₹ 11,535

Observation: Cost Saving by using EOQ Model = ₹ 11,535 - ₹ 9,000 = ₹ 2,535.

360 days p.a.
4. Frequency of Orders under EOQ Model = 18.75 orders p.a.
= 19.2, i.e. once in 20 days

37. EOQ and Stock Levels, related computations M 19

ACE Ltd produces a product EMM using a material ‘REX’. To produce one unit of EMM,
0.80 kg of ‘REX’ is required. As per the Sales Forecast conducted by the Company, it will
able to sell 45,600 units of Product EMM in the coming year. There is an Opening Stock of
3,150 units of Product EMM and the Company desires to maintain Closing Stock equal to
one month’s forecasted sale. Following is the information regarding material ‘REX’:

Purchase Price per kg ₹ 25 Average Lead Time 8 days

Cost of placing order ₹ 240 per order Difference between Minimum and 6 days
Maximum Lead Time

Storage Cost 2% per annum Maximum Usage 150 kg

Interest Rate 10% per annum Minimum Usage 90 kg

Opening Stock of Material ‘REX’ is 2,100 kg and Closing Stock will be 10% more than
Opening Stock.
Required:
1. Compute the EOQ and Total Cost as per EOQ.
2. Compute the Re-Order Level and Maximum Level.
3. If the Company places an order of 7,500 kg of REX at a time, it gets 2% discount. Should
the offer be accepted?
Solution:

Particulars Computation Result

1. Budgeted Production Qtty = Budgeted Sales + Closing Stock of FG (- 46,250 units

) Opening Stock of FG
= 45,600

2. Raw Material Usage Qtty 46,250 units of FG x 0.8 kg of Material 37,000 kg

3. Raw Material Purchase Qtty = Budgeted Usage + Closing Stock of RM 37,210 kg

(-) Opening Stock of RM
 = 37,000 kg + (2,100 kg × 110%) (-) 2,100
kg

2AB A = Annual Requirement of Raw Materials 2,440 kg

4. EOQ = √ C
, where = 37,210 kg (as above)
B = Buying Cost per order = ₹ 240 per
order (given)
C = Carrying Cost per kg per annum = ₹
25 × 12% = ₹ 3 per kg p.a.
Note: Carrying Cost = Storage + Interest =
2% + 10% = 12%
On substitution, EOQ = ROQ = 2,440 kg

5. Total Cost of EOQ = Material Purchase Cost + Buying Cost ₹ 9,37,570

p.a. + Carrying Cost p.a.
37,210kg
= (37,210kg × ₹25) + ( 2,440kg × ₹240) +
2,440kg
( × ₹3) = 9,30,250 + 3,660 + 3,660
2

6. Lead Time Let Maximum Lead Time = "x" and Max =11 days
Minimum Lead Time = "y".
Min = 5 days
Avg Lead Time = 8. So, x + y = (2 × 8) =
16. Also, x - y = 6 (given)
Solving these equations, we have "x" =11
and "y" = 5

7. Re-Order Level = Maximum Usage × Maximum Lead Time 1,650 kg

= 150 Kg × 11 days

8. Maximum Level = ROL+ROQ-(Min. UsagexMin. Lead 3,640 kg

Time) = 1650 + 2440 (-) [90 × 5]

9. Total Cost of Order Size of = Material Purchase Cost + Buying Cost ₹ 9,23,861
p.a. + Carrying Cost p.a.
7,500 kg
37,210kg
= (37,210kg × ₹25 × 98%) + ( 7,500kg ×
7,500kg
₹240) + ( 2
× ₹2.94)

= 9,11,645 + 1,191 + 11,025

Since this cost is lower than EOQ level, the
offer may be acceptable.

38. Material Cost - Stock Levels, EOQ - Reverse Working

Aditya Ltd produces a product ‘Exe’ using a Raw Material Dee. To produce one unit of Exe,
2 kg of Dee is required. As per the sales forecast conducted by the Company, it will able
to sell 10,000 units of Exe in the coming year. The following is the information regarding
the Raw Material Dee:
(i) The Re-Order Quantity is 200 kg less than the Economic Order Quantity (EOQ).
(ii) Maximum Consumption per day is 20 kg more than the Average Consumption per day.
(iii) There is an Opening Stock of 1,000 kg.
(iv) Time required to get the Raw Materials from the Suppliers is 4 to 8 days.
(v) The Purchase Price is ₹125 per kg.
There is an Opening Stock of 900 units of the Finished Product Exe. The Rate of Interest
charged by Bank on Cash Credit Facility is 13.76%. To place an order, the Company has to
incur ₹ 720 on Paper and Documentation Work.
From the above and taking 364 days for a year, find out the following in relation to Raw
Material Dee - (a) Re-Order Quantity, (b) Maximum Stock Level, (c) Minimum Stock Level,
and (d) Impact on the Company’s Profitability by not ordering the EOQ.
Solution:
1. Computation of Annual Consumption & Annual Demand for Raw Material 'Dee'

Particulars Result

Sales Forecast of Product 'Exe' 10,000 units

Less: Opening Stock of ‘Exe’ 900 units

Hence, Exe' to be produced 9,100 units

Raw Material required to produce 9,100 units of 'Exe' (9,100 units × 2 18,200 kg.
kg)

Less: Opening Stock of 'Dee' 1,000 kg.

Annual Demand for Raw Material 'Dee' 17,200 kg.

2. Computation of Economic Order Quantity (EOQ) & ROQ:

2× Annual demand of 'Dee' × Ordering Cost 2×17,200Kg×720 2×17,200Kg×720
(a) √ =√ =√ = 𝟏, 𝟐𝟎𝟎𝐊𝐠
Carrying Cost Per unit Per annum 125×13.76% 17.2

(b) ROQ = EOQ - 200 = 1,000 Kg

3. Computation of Max & Min Usage Rates
Annual Usage 18,200 Kg
(a) Average Consumption per day = = = 50 Kg.
364 days 364

(b) So, Maximum Consumption per day = 50 Kg + 20 Kg = 70 Kg

Max + Min
(c) Hence, Minimum Consumption per day = 30 Kg (using the formula 2
= Avg).
4. Computation of Stock Levels
(a) Re-Order Level (ROL) = (Maximum Usage per day × Maximum Lead Time) = 70 Kg × 8 days=
560 Kg.
(b) Maximum Stock level = ROL + ROQ - (Min. Usage × Min. Lead Time)
= 560 kg + 1,000 kg - (30 kg × 4 days) = 1,440 kg.
(c) Minimum Stock Level = ROL - (Average Usage × Average Lead Time)
= 560 kg - (50 kg × 6 days) = 260 kg.
Note: Average Lead Time = ½ of (4+8) = 6 days.
5. Impact of not ordering the EOQ

If ROQ Purchased If EOQ Purchased

(a) Quantity Purchased every time (Q) 1,000 kg 1,200 kg

(b) No. of Orders p.a. = (A ÷ Q) 17,200 kg 17,200 kg

1,000 kg
= 17.2 Orders 1,200 kg
= 14.33 Orders

(c) Buying Cost p.a = (b) × ₹ 720 17.2 orders × ₹ 720 = ₹ 14.33 orders × ₹ 720 = ₹
12,384 10,320

(d) Average Inventory = Q 1,000 kg

= 500 kg
1,200 kg
= 600 kg
2 2 2

(θ) Carrying Cost p.a. = (d) × ₹ 17.20 500 kg × ₹ 17.2 =₹ 8,600 600 kg × ₹ 17.2 = ₹ 10,320

(0 Associated Cost p.a. [(c) + (e)] ₹ 20,984 ₹ 20,640

Extra Cost incurred due to not ordering EOQ =₹ 20,984 - ₹ 20,640 = ₹ 344
Issues are to be priced on the basis of Weighted Average Method. The Stock Verifier of the
Company reported a shortage of 80 kgs on 31 st May and 60 kgs on 30th June. The shortage is
treated as inflating the price of remaining material on account of shortage. You are required to
prepare a Stores Ledger Account.
Solution: Stores Ledger under WAC Method

Date Trans Receipts Issues Balance

Quantity Rate Value Quantity Rate Value Quantity Rate Value

Apr 1 Bal b/d 1,500 4.80 7,200

Apr 4 Issue 1,100 4.80 5,280 400 4.80 1,920

Apr 10 Receipt 1,600 5.00 8,000 2,000 4.96 9,920

Apr 20 Receipt 2,400 4.90 11,760 4,400 4.93 21,680

Apr 24 Issue 1,600 4.93 7,888 2,800 4.93 13,792

May 5 Receipt 1,000 5.10 5,100 3,800 4.97 18,892

May 10 Issue 1,500 4.97 7,455 2,300 4.97 11,437

May 17 Receipt 1,100 5.20 5,720 3,400 5.05 17,157

May 25 Receipt 800 5.25 4,200 4,200 5.09 21,357

May 26 Issue 1,700 5.09 8,653 2,500 5.08 12,704

May 31 Shortage 80 - - 2,420 5.25 12,704

Jun 11 Receipt 900 5.40 4,860 3,320 5.29 17,564

Jun 15 Issue 1,500 5.29 7,935 1,820 5.29 9,629

Jun 21 Issue 1,200 5.29 6,348 620 5.29 3,281

Jun 24 Receipt 1,400 5.50 7,700 2,020 5.44 10,981

Jun 30 Shortage 60 - - 1,960 5.60 10,981

Note:
(400 kg X 4.80) + (1,600 kg X 5.00)
• Closing Stock on 10th Apr is valued as = ₹ 4.96 per kg. Other days'
2,000 kg
Closing Stock balance is valued on the same principles.
• Practical Hint: Value Column is written first, e.g. on 10 th April, Balance = 1,920 + 8,000 = 9,920.
Then, Quantity Column is written 400 + 1,600 = 2,000 kg. Thereafter, Rate Column is computed
9,920
as 2,000 kg = ₹ 4.96 per kg.

• Since Shortage is treated as inflating the price of remaining material on account of shortage, it
is not assigned any value / cost. The balance materials will be automatically valued at an inflated
rate.
49. Stores Ledger - Weighted Average Cost Method RTP
Aditya Ltd is engaged in heavy engineering works on the basis of job order received form
industrial customers. The Company has received a job order of making Turbine from a
Power Generating Company. Below are some details of Stores Receipts and Issues of
Copper Wire, used in the manufacturing of Turbine:

Feb.1 Opening Stock of 1,200 Kgs @ ₹475 per kg.

Feb.5 Issued 975 kgs to Mechanical Division vide Material Requisition No. Mec
09/13

Feb.6 Received 3,500 kgs. @ ₹ 460 per kg vide Purchase Order No. 159/13

Feb.7 Issued 2,400 kgs. to Electrical Division vide Material Requisition No. Ele
012/13

Feb.9 Returned to Stores 475 kgs. by Electrical Division against Material

Requisition No. Ele 012/13.
Feb.15 Received 1,800 kgs. @ ₹480 per kg vide Purchase Order No. 161/13

Feb.17 Returned to Supplier 140 kgs. out of quantity received vide Purchase Order
No. 161/13.

Feb.20 Issued 1,900 kgs. to Electrical Division vide Material Requisition No. Ele
165/13

On 28th February, it was found that 180 kgs of wire was fraudulently misappropriated by
the Stores Assistant and never recovered by the Company. From the above information,
you are required to prepare the Stock Ledger account using ‘Weighted Average’ method
of valuing the issues.
Solution:
Stores Ledger (Weighted Average Method) (Rates and Values in ₹)

Date Trans Receipts Issues Balance

Feb Qty Rate Value Qty Rate Value Qty Rate Value

1 Balance b/d – – – – – – 1,200 475.00 5,70,000

5 Issue Mec 09/13 – – – 975 475.00 4,63,125 225 475.00 1,06,875

6 Receipt PO 3,500 460.00 16,10,000 – – – 3,725 460.91 17,16,875

159/13

7 Issue Ele 12/13 – – – 2,400 460.91 11,06,175 1,325 460.91 6,10,700

9 Returns Ele 475 460.91 2,18,932 – – – 1,800 460.91 8,29,632

012/13

15 Receipt PO 1,800 480.00 8,64,000 – – – 3,600 470.45 16,93,632

161/13

17 Pure Ret PO – – – 140 480.00 67,200 3,460 470.06 16,26,432

161/13

20 Issue Ele 165/13 – – – 1,900 470.06 8,93,133 1,560 470.06 7,33,299

28 Shortage – – – 180 470.06 84,622 1,380 470.06 6,48,688

Journal

Note:
• Purchase Returns on 17 th is taken at the same rate at which the Material Consignment was
received, i.e. ₹ 480.00. Alternatively, it may be taken at the relevant current WAC Rate ₹ 470.45,
and the difference may be debited to the Supplier A/c, by way of Credit Adjustment to Overhead
A/c.
• 180 kgs Theft is an Abnormal Loss, and hence, transferred to Costing Profit & Loss A/c.
50. Stores Ledger - WAC and LIFO Methods M 19 (New)
The following are the details of Receipt and Issue of Material ‘CXE’ in a Manufacturing
Company during the month of April:

Date Particulars Quantity (kg) Rate per kg

April 4 Purchase 3,000 ₹ 16

April 8 Issue 1,000

April 15 Purchase 1,500 ₹ 18

April 20 Issue 1,200

April 25 Return to Supplier out of purchase 300

made on April 15

April 26 Issue 1,000

April 28 Purchase 500 ₹ 17

Opening Stock as on 1st April is 1,000 kg @ ₹ 15 per kg.

On 30th April, it was found that 50 kg of Material ‘CXE’ was fraudently misappropriated by
the Store Assistant and never recovered by the Company. You are required to -
1. Prepare a Store Ledger Account under each of the following method of pricing the issue
- (a) Weighted Average Method, (b) LIFO.
2. What would be the Value of Material Consumed and Value of Closing Stock as on 30 th
April as per these two methods?
Solution: [Link] Stores Ledger under Weighted Average Cost Method (Rates and Values
in ₹)

Date Trans Receipts Issues Balance

Qty Rate Value Qty Rate Value Qty Rate Value

Apr 1 Balance b/d 1,000 15.00 15,000

4 Purchase 3,000 16 48,000 4,000 15.75 63,000

8 Issue 1000 15.75 15,750 3,000 15.75 47,250

15 Purchase 1,500 18 27,000 4,500 16.50 74,250

20 Issue 1200 16.50 19,800 3,300 16.50 54,450

25 Purchase 300 18.00 5,400 3,000 16.35 49,050

Return
26 Issue 1000 16.35 16,350 2,000 16.35 32,700

28 Purchase 500 17 8,500 2,500 16.48 41,200

30 Shortage 50 16.48 824 2,450 16.48 40,376

Total 5,000 83,000 3,550 58,124

Note:
• Under WAC Method, Purchase Returns on 25 th is taken at the same rate at which the Material
Consignment was received, i.e. ₹ 18. Alternatively, it may be taken at the relevant current WAC
Rate ₹ 16.50, and the difference may be debited to the Supplier A/c, by way of Credit Adjustment
to Overhead A/c.
• Hint for WAC: Value Column is written first, e.g. on 4 th April, Balance = 15,000 + 48,000 =
63,000. Then, Quantity Column is written 1,000 + 3,000 = 4,000 kg. Thereafter, Rate Column is
63,000
computed as = ₹ 15.75 per kg.
4,000 kg

2. Priced Stores Ledger under LIFO Method (Rates and Values in ₹)

Date Particulars Receipts Issues Balance

Quantity Rate Value Quantity Rate Value Quantity Rate Value

Apr 1 [Link] 1,000 15 15,000

4 Purchase 3,000 16 48,000 1,000 15 15,000

3,000 16 48,000

8 Issue 1,000 16 16,000 1,000 15 15,000

2,000 16 32,000

15 Purchase 1,500 18 27,000 1,000 15 15,000

2,000 16 32,000

1,500 18 27,000

20 Issue 1,200 18 21,600 1,000 15 15,000

2,000 16 32,000

300 18 5,400

25 Pure. Return 300 18 5,400 1,000 15 15,000

2,000 16 32,000
26 Issue 1,000 16 16,000 1,000 15 15,000

1,000 16 16,000

28 Purchase 500 17 8,500 1,000 15 15,000

1,000 16 16,000

500 17 8,500

30 Shortage 50 17 850 1,000 15 15,000

1,000 16 16,000

450 17 7,650

Total 5,000 83,000 3,550 59,850 2,450 38,650

Summary:
• Under both methods, 50 kgs Misappropriation is an Abnormal Loss, and, should be transferred
to Costing P & L A/c.
• Value of Consumption and Closing Stock is summarised below -

Method WAC LIFO

Value of Materials Consumed 58,124-5,400-824 59,850 - 5,400 - 850

= Total Issues - [Link] - Shortage = ₹ 51,900 = ₹ 53,600

Value of Closing Stock ₹ 40,376 ₹ 38,650

51. Profit under different methods of Inventory Valuation N 19

M/s XYZ Traders is Distributor of an Electronic Calculator. A periodic inventory of
Electronic Calculators on hand is taken when books are closed at the end of each quarter.
The following summary is available for the quarter ended on 30th September:

Sales ₹ 1,46,20,000

Opening Stock 25,000 Calculators @ ₹ 200 per Calculator

Administrative Expenses ₹ 3,75,000

Purchases (including Freight Inward):

- 1st July 50,000 Calculators @ ₹ 191 per Calculator

- 30th September 25,000 Calculators @ ₹ 210 per Calculator

Closing Stock - 30th September 32,000 Calculators

Compute the following by WAM (Weighted Average Method), FIFO Method and LIFO
Method.
(1) Value of Inventory on 30th September, (2) Profit or Loss for the quarter ended 30 th
September.
Solution: 1. Computation of Total Value of Goods Available for Sale

Date Quantity (units) Rate including Cost(₹)

Freight (₹)

Opening Stock 25,000 200 50,00,000

Purchase on 1st July 50,000 191 95,50,000

Purchase on 30th Sept 25,000 210 52,50,000

Total 1,00,000 1,98,00,000

₹ 1,98,00,00 0
So, Cost under WAM (Weighted Average Method) = 1,00,000 units
= ₹ 198 per unit.

2. Profit Statement under different Methods of Inventory Valuation

Particulars WAM FIFO LIFO

1(a) Sales 1,46,20,000 1,46,20,000 1,46,20,000

1(b) Closing Stock 32,000 × 198 = 63,36,000 (7,000 × 191)+(25,000 (7,000 × 200)+(25,000
× 210) = 65,87,000 × 210)
= 66,50,000

Sub-Total (1) 2,09,56,000 2,12,07,000 2,12,70,000

2(a) Opening Stock 50,00,000 50,00,000 50,00,000

2(b) Purchases (95,50+52,50) = 1,48,00,000 1,48,00,000

1,48,00,000

Sub-Total (2) 1,98,00,000 1,98,00,000 1,98,00,000

3. Gross Profit (1 - 11,56,000 14,07,000 14,70,000

2)

4. Administrative 3,75,000 3,75,000 3,75,000

Exps

5. Net Profit (3 - 4) 7,81,000 10,32,000 10,95,000

Notes: Explanation for Closing Stock Valuation

1. WAM: Closing Stock will be valued at the WAM Rate as computed in WN 1 above.
2. FIFO: Closing Stock will be valued at the latest Purchase Rates under FIFO. This is because
the earliest / first available rates will be considered for the purpose of pricing material issues /
consumption. Hence, Closing Stock of 32,000 units will be valued as under -
Stock in Hand, Out of Purchases on 30 th Sept (25,000 units at ₹ 210) (fully available on hand)
+ Stock in Hand, Out of Purchases on 1st July (7,000 units at ₹ 191) (balance available on hand)=
₹ 65,87,000
3. LIFO: Closing Stock will be valued at the Earliest Purchase Rates under LIFO. Since
Purchases on 30th Sept (i.e. last date of the period) cannot be available for sale during the period,
the Closing Stock of 32,000 units will comprise 25,000 units purchased on the last date + 7,000
units out of previously held stock. Hence, Closing Stock of 32,000 units will be valued as under -
Stock in Hand, Out of Purchases on 30 th Sept (25,000 units at ₹ 210) (fully available on hand)
+ Stock in Hand, Out of Opening Stock on 1st July (7,000 units at ₹ 200) (balance available on
hand)= ₹ 66,50,000
52. Stock Levels, ROQ, Stores Ledger, Inventory T/o Ratio RTP
Digicool Items manufactures a special product using Item X and applies Weighted Average
Cost Method for Inventory Valuation. Following are the data for a period.

Date Particulars Units Rate p.u. (₹)

15 December Purchase Order- 008 10,000 9.93

30 December Purchase Order- 009 10,000 9.78

01 January Opening Stock 3,500 9.81

05 January Goods Received Note (GRN)-008 (against the 10,000 –

Purchase Order- 008)

05 January Material Returned Note (MRN)-003 (against the 500 –

Purchase Order- 008)

06 January Material Requisition-011 3,000 –

07 January Purchase Order-010 10,000 9.75

10 January Material Requisition-012 4,500 –

12 January Goods Received Note (GRN)-009 (against the 10,000 –

Purchase Order- 009)

12 January Material Returned Note (MRN)-004 (against the 400 –

Purchase Order- 009)

15 January Material Requisition-013 2,200 –

24 January Material Requisition-014 1,500 –

25 January Goods Received Note (GRN)-010 (against the 10,000 –

 Purchase Order- 010)

26 January Material Requisition-015 4,200 –

31 January Material Requisition-014 3,200 –

From the above -
1. Compute - (a) Re-Order Level, (b) Maximum Stock Level, (c) Minimum Stock
Level.
2. Prepare Stores Ledger for January and determine the value of stock as on 31 st
January.
3. Compute Value of Item X used during the month of January.
4. Compute Inventory Turnover Ratio.
Solution: 1. Lead Time and Usage Rate
Note: Lead Time is ascertained by comparing Date of Purchase Requisition and Date of GRN. Usage
Rate is ascertained from Material
Requisition. ____________________________ __________________________
_____________________________________
Particulars Maximum Minimum Average
21+14
Lead Time (15 Dec to 05 Jan)= 21 days (30 Dec to 12 Jan)=14 days + = 17.5 days
2

4,500+1,500
Usage Rate (10 Jan MRN 012) 4,500 units (24 Jan MRN 014) 1,500 units = 3,000 units
2

2. Stock Levels
a. Re-Order Level = Max. Usage x Max. Lead Time = 4,500 units x 21 days 94,500 units
b. Maximum Level = ROL + ROQ - (Min. Usage x Min. Lead Time)
= 94,500 + 10,000 - (1,500 x 14)
83,500 units
Note: It is seen that Q= 10,000 in all Purchase Requisitions. So, ROQ=
10,000.
= ROL - (Average Usage x Average Lead Time) = 94,500 - (3,000
c. Minimum Level ×17.5) 42,000 units
[Link] Ledger under WAC Method and related Computations
Date Trans Receipts Issues Balance
Jan Quantity Rate Value Quantity Rate Value Quantity Rate Value
1 Bal b/d 3,500 9.810 34,335
5 GRN-008 10,000 9.930 99,300
5 Matl Return 500 9.930 4,965 13,000 9.898 1,28,670
6 MRN-011 3,000 9.898 29,694 10,000 9.898 98,976
10 MRN-012 4,500 9.898 44,541 5,500 9.897 54,435
12 GRN-009 10,000 9.780 97,800
12 Matl Return 400 9.780 3,912 15,100 9.823 1,48,323
15 MRN-013 2,200 9.823 21,611 12,900 9.823 1,26,712
24 MRN-014 1,500 9.823 14,734 11,400 9.823 1,11,978
25 GRN-010 10,000 9.750 97,500 21,400 9.789 2,09,478
28 MRN-015 4,000 9.789 39,156 17,400 9.789 1,70,322
30 MRN-016 3,200 9.789 31,325 14,200 9.789 1,38,997
Related Computations:
• Practical Hint: Value Column is written first, e.g. on 5th, Balance 34,335 + 99,300 - 4,965 = 1,28,670. =
Then, Qtty Column is written 3,500 + 10,000 - 500 = 13,000. Thereafter, Rate Column is computed as
 1,28,670
= ₹ 9.898 p.u.
13,000
Value of Closing Stock = 14,200 kg valued in total at ₹ 1,38,997.
Value of Material Consumed = MRN Total = 29,694 + 44,541 + 21,611 + 14,734 + 39,156 + 31,325 =₹ 1,81,061
34,335+1,38,997
Value of Average Inventory = Vi of (Opg + Clg) = = ₹ 86,666
2
Cost of Material Consumed 1,81,061
Inventory Turnover Ratio = = =2.09 times
Average Stock Value 86,666

53. Journal Entries on Material Shortages / Differences M 91, RTP

The following summary is extracted after physical verification of stores. Pass Journal
Entries where necessary* to record the adjustments in the Cost Ledger and state how you
would adjust the accounts, where necessary, in the Subsidiary Stores Ledger.

Material Physical Stores Avg Remarks f Reasons

Ledger Cost
Code Count
balance p.u.

A 200 205 units ₹ 2.00 Normal Shrinkage resulting from storage & material
units issue.

B 60 units 60 units ₹ 3.00 Material is now obsolete. Total quantity has since
been sold for ₹ 100.

C 500 550 units Re.1.00 Shortage is due to theft.

units

D 550 400 units ₹ 2.00 A receipt of 100 units was not recorded in the Stores
units Ledger and its Control Account. The balance is due
to errors in issuing from stores.

E 100 120 units - 20 units returned to Supplier was not recorded.

units Original Invoice Cost was ₹ 3 per unit and the
Current Standard Cost was ₹ 2.50 per unit.

F 600 640 units ₹ 3.00 Discrepancy is due to carelessness in Stocktaking.

units

Solution: Note: Refer Chapter 5 on Cost A/cing Systems for understanding the Journal Entries
given here.

Item Journal Entry in Control Accounts Entry in Subsidiary Stores Ledger

A Stores Adjustment A/c Dr. 10 Normal Shrinkage will be shown as an issue

of 5 units at ₹ 2 per unit.
To Stores Ledger Control A/c 10 (Being
Normal Loss of 5 units at ₹ 2 per unit). Where Issue Price is already inflated to cover
normal shrinkage, only quantity column
Note: Stores Adjustment A/c balance will
(and not rate) should be updated / filled up.
thereafter be transferred to Production OH
Control A/c.
B Material Abnormal Loss A/c Dr. 180 60 units at ₹ 3 will be shown as an issue in
the relevant Stores Ledger column.
To Stores Ledger Control A/c 180 (Being
Obsolete materials transferred to Abn Loss).
General Ledger Adjustment A/c Dr. 100
To Material Abnormal Loss A/c 100 (Being
sale value of obsolete materials).
Note: Balance in Material Abnormal Loss
A/c will be transferred to Costing P & L
Account.

C Material Abnormal Loss A/c Dr. 50 50 units at ₹ 1 will be shown as an issue in

the relevant Stores Ledger column.
To Stores Ledger Control A/c 50 (Being loss
by theft, i.e. 50 units at ₹l)
Note: Balance in Material Abnormal Loss
A/c will be transferred to Costing P & L
Account.

D Stores Ledger Control A/c Dr. 200 100 units at ₹ 2 should be recorded on the
Receipts Column of Stores Ledger.
To General Ledger Adjt A/c 200 (Being
omission of entry 100 units at ₹ 2 recorded) Issues Column should be rectified / reduced
Stores Ledger Control A/c Dr. 100 by 50 units at ₹ 2 and the correct Closing
Stock should be updated. (Note: Receipt
To WIP Ledger Control A/c 100 (Being
Column should not be updated for correction
errors in material issues, now rectified)
of errors in issue)

E General Ledger Adjustment A/c Dr. 60. To 20 units at ₹ 2.50 (Current Standard Cost)
Stores Ledger Control 50 To Material should be shown as an issue in the Stores
Purchase Price Variance 10 (Being 20 units Ledger, and the correct Closing Stock should
returned to Supplier, now recorded, the be updated.
difference between Invoice Price and
(Note: Refer Chapter 11 Standard Costing for
Standard Cost adjusted against Purchase
Journal Entries in respect of Variance
Price Variance A/c)
Analysis.)

F No entry necessary in Cost Ledger. No entry in Subsidiary Stores Ledger.

However, Stock Sheets should be adjusted to
reflect the correct balance.

7. Stock-Out and Probability Analysis

54. Optimum Inventory, Stock-Out Costs
The following information on stock-outs is supplied by a Company -

Stock Out 800 units 600 units 400 units 200 units Nil units
(units)
 Number of 2 3 5 10 30
times

The Selling Price per unit is ₹ 200. Inventory Carrying Costs are ₹ 19 per unit, while Stock-
Out Costs are ₹ 50 per unit. From the given information, answer the following questions -
1. If the Company wishes to never miss a sale, what should be its Safety Stock? What are
the total costs associated with this level of Safety Stock?
2. What are the total costs associated with Safety Stocks of 600,400 and 200 units?
3. What is the optimum Safety Stock Level?
Solution:
1. Probability of Stock-Out is first determined as under -

Stock Out (units) 800 units 600 units 400 units 200 units Nil units Total

Number of times 2 3 5 10 30 50

Probability (% of total) 0.04 0.06 0.10 0.20 0.60 LOO

2. Relevant Costs of Stock-Out and Inventory Holding are calculated as under -

Safety Demand Stockout in Probability Relevant Expected Relevant Total

Realizations units of stock Stock-out cost Stock-out Carrying
Stock Relevant
resulting in out (5) = (3) × ₹ cost (6) = Cost
(3) = (2) -
level Stockouts 50 (4)X(5) (7)=(1)× ₹ Costs
(1)
19
(units) (8)=(6+7)

(1) (2) (3) (4) (5) (6) (7) (8)

I 800 800 0 0.00 Nil Nil 15,200 15,200

II 600 800 200 0.04 10,000 400 11,400 11,800

III 400 800 400 0.04 20,000 800

600 200 0.06 10,000 600

1,400 7,600 9,000

IV 200 800 600 0.04 30,000 1,200

600 400 0.06 20,000 1,200

400 200 0.10 10,000 1,000

3,400 3,800 7,200

V Nil 800 800 0.04 40,000 1,600

 600 600 0.06 30,000 1,800

400 400 0.10 20,000 2,000

200 200 0.20 10,000 2,000

7,400 Nil 7,400

Note: In Situation I, if the Safety Stock is 800 units, any level of demand (i.e. Nil, 200, 400, 600
or 800 units) can be fully met. Hence, there are no stock-out costs at all.
In Situation II, if the Safety Stock is 600 units, the Firm will face stock-out only when Demand >
600 units (i.e. only when Demand = 800 units). Similar calculations are made for other Situations
also.
3. Answers:
(a) If the Firm wishes to never miss a sale, its Safety Stock should be 800 units, Associated Costs
= ₹ 15,200.
(b) Associated Costs of Safety Stocks of 600, 400 and 200 units are ₹ 11,800, ₹ 9,000 & ₹ 7,200
as above.
(c) Optimum Safety Stock Level = Least Associated Cost as above = 200 units.
55. EOQ, ROL, Stock Out Costs, and Probability Analysis M 04, RTP
IPL Limited uses a small casting in one of its finished products. The castings are
purchased from a foundry. IPL Limited purchases 54,000 castings per year at a cost of ₹
800 per casting.
The castings are used evenly throughout the year in the production process on a 360 day
per year basis. The Company estimates that it costs ₹ 9,000 to place a single purchase
order and about ₹ 300 to carry one casting in inventory for a year. The high carrying costs
result from the need to keep the castings in carefully controlled temperature and humidity
conditions, and from the high cost of insurance.
Delivery from the foundry generally takes 6 days, but it can take as much as 10 days. The
days of delivery time and percentage of their occurrence are shown in the following table
-

Delivery Time (days) 6 7 8 9 10

Percentage of occurrence 75 10 5 5 5

1. Compute the Economic Order Quantity.

2. Assume that the Company is willing to take a 15% risk of being out of stock. What would
be the Safety Stock and the Re-Order Point?
3. Assume that the Company is willing to take a 5% risk of being out of stock. What would
be the Safety Stock and the Re-Order Point?
4. Assume 5% stock-out risk. What would be the total cost of ordering and carrying
inventory for one year?
5. Refer to the original data. Assume that using process re-engineering the Company
reduces its cost of placing a purchase order to only ₹ 600. In addition, the Company
estimates that when the waste and inefficiency caused by inventories are considered, the
true cost of carrying a unit in stock is ₹ 720 per year, (a) Compute new EOQ, and (b) How
frequently would the Company be placing an order, as compared to the old purchasing
policy?

Solution:

A = Annual Requirement of Raw Materials = 54,000 castings.

1. EOQ = 2AB
√ , where B = Buying Cost per order = ₹ 9,000 per order.
C
C = Carrying Cost p.u. p.a. = ₹ 300 per unit per annum.
On substitution, EOQ = 1,800 castings.

2. Effect of 15% Stock-out Risk:

(a) Average Consumption 54,000 Castings = 150

per day = 360 days castings.
Maximum Lead Time + Minimum Lead time 10 + 6 = 8 days.
(b) Average Lead Time = =
2 2

(c) For 15% stock-out risk, relevant delivery time = 7 days.

(Cumulative % of occurrence upto 7 days is 75 + 10 = 85%. Hence, risk of stock-
out is 15%)

(d) Hence, Re-Order Point = 7 days consumption = 7 × 150 = 1,050

castings.

3. Effect of 5% Stock-out Risk:

(a) For 5% stock-out risk, relevant delivery time = 9 days.

(Cumulative % of occurrence upto 9 days is 75+10+5+5 = 95%. Hence, risk of
stock-out is 5%)

(b) Hence, Re-Order Point = 9 days consumption = 9 × 150 = 1,350

castings.

4. Associated Costs at 5% Stock Out Risk:

(a) Ordering Costs per annum =

54,000
orders × ₹ 9,000 per order = ₹ 2,70,000
1,800

(b) Carrying Costs per annum = 1,350 units ROL (since ROL will always be = ₹ 4,05,000
held) × ₹ 300 p.u. p.a.

(c) Hence, Total Costs per annum = ₹ 2,70,000 + ₹ 4,05,000 = ₹ 6,75,000

 A = Annual Requirement of Raw Materials = 54,000 castings.

2AB B = Buying Cost per order = ₹ 9,000 per order.

1. EOQ = √ C
, where
C = Carrying Cost p.u. p.a. = ₹ 300 per unit per annum.
On substitution, EOQ = 1,800 castings.
360
The Company should be placing an order every alternative day ( ), i.e. once in two days
180
360
under the new system, whereas it was making an order once in 12 days earlier. ( 30
)
56 ROL, Stock Out Costs, and Probability Analysis RTP
ABC Ltd distributes a wide range of Water Purifier Systems. One of its best selling items
is a Standard Water Purifier. The Management of ABC Ltd uses the EOQ decision model to
determine optimal number of Standard Water Purifies to order. Management now wants to
determine how much safety stock to hold.
ABC Ltd estimates the annual demand (360 working days) to be 36,000 Standard Water
Purifie₹ Using the EOQ decision model, the Company orders 3,600 Standard Water
Purifiers at a time. The lead-time for an order is 6 days. The annual carrying cost of one
Standard Water Purifier is ₹ 450. Management has also estimated that the additional stock-
out costs would be ₹ 900 for shortage of each Standard Water Purifier.
ABC Ltd has analyzed the demand during 200 past re-order periods. The records indicate
the following patterns-

Demand during lead time 540 560 580 600 620 640 660 Total

Number of times quantity was 6 12 16 130 20 10 6 200

demanded

• Determine the level of safety stock for Standard Water Purifier that ABC Ltd should
maintain in order to minimize expected stock-out costs and carrying costs. When
computing carrying costs, assume that the safety stock is on hand at all times and that
there is no over-stocking caused by decrease in expected demand (consider Safety Stock
Levels of 0, 20,40 and 60 units).
• What would be ABC's new Re-Order Point?
• What factors ABC Ltd should have considered in estimating stock-out costs?
Solution: 1. Determination of Safety Stock to minimize expected Stock-Out Costs &
Carrying Costs

(a) Average daily Annual demand 3600 100 units per

usage = = = day
360 days p. a. 360

(b) Re-Order Point = Average Daily Usage × Lead time = 100 units per day × 600 units
6 days =
(c) Possible Safety = Possible Demand order Point
Stock Less Re

2. Probability of demand during lead time is as under -

Demand during lead time 540 560 580 600 620 640 660 Total

No. of times quantity was 6 12 16 130 20 10 6 200

demanded

Probability (% of Total) 0.03 0.06 0.08 0.65 0.10 0.05 0.03 1.00

3. Cost Analysis: Relevant Costs under different Safety Stock situations are as under -

Safety Demand Stockout Prob- Relevant No. of Expected Relevant Total

Stock Realizations in units ability Stock-out orders Stock-out carrying
Relevant
(3) = (2) - cost
level resulting in of cost per cost(7) =
ROL Costs
stock (8) = (1) ×
(units) Stockouts (5)=(3)×₹900 year (4)×(5)×(6)
of 600 -
out 4.50 (9)=(7)+(8)
(1)

(1) (2) (3) (4) (5) (6) (7) (8) (9)

I0 620 20 0.10 18,000 10 18,000

640 40 0.05 36,000 10 18,000

660 60 0.03 54,000 10 16,200

52,200 0 52,200

II 20 640 20 0.05 18,000 10 9,000

660 40 0.03 36,000 10 10,800

19,800 9,000 28,800

III 40 660 20 0.03 18,000 10 5,400 18,000 23,400

IV 60 Nil Nil 0 27,000 27,000

4. Decision: Safety Stock of 40 units would minimize ABC Ltd's total expected stock-out and
carrying cost.
(a) New Re-order Point = ROL + Safety Stock = 600 units + 40 units = 640 units.
(b) Factors to consider in estimating stock-out cost -
• Expediting an order from Supplier (additional Ordering Cost plus any associated Transportation
Cost).
• Loss of sales due to stock-out (Opportunity Cost in terms of contribution lost on the sales not
made due to stockout, plus any contribution lost on future sales due to that customer, that will be
caused by the stock-out.)
8. Miscellaneous Illustrations
57. Supplier Choice RTP
After inviting tenders, two quotations are received as follows -
• Supplier Arun-₹ 4.80 per unit,
• Supplier Bala - ₹ 4.40 per unit plus ₹ 12,000 Fixed Charges to be added irrespective of
quantity ordered, f
Additional Information: Present Stock - 35,000 units, Average Monthly Consumption -
10,000 units,
Maximum Level - 80,000 units, Minimum Stock - 30,000 units.
Advise with arguments, with which Supplier, the order should be placed and what quantity
should be ordered?
Solution:
1. Since the order is to be placed at the present stock level, Re-order Level = Present Stock =
35,000 units.
2. Minimum Level = Re-Order Level Less (Average Usage × Average Lead Time).
On substitution, 30,000 = 35,000 - (10,000 × Avg Lead Time). So, Lead Time = ½ month or 15
days.
3. Maximum Level = ROL + ROQ - (Minimum Usage × Lead Time) (approx, formula)
Substituting, we have, 80,000 = 35,000 + ROQ - (10,000 × ½). Hence, ROQ (i.e. EOQ) = 50,000
units.
4. Cost Comparison for the quantity ordered:
• Supplier Arun: ₹ 4.80 × 50,000 units = ₹ 2, 40,000
• Supplier Bala: (₹ 4.40 × 50,000 units) + 12,000 = ₹ 2, 32,000
Hence, Supplier Bala should be preferred for the order quantity of 50,000 units.
Alternative Analysis: Since purchase costs consist of fixed and variable elements, the Cost
Indifference Point (i.e. where both alternatives Arun and Bala have equal costs) is computed first
- [Also see Chapter 12 Marginal Costing]
Change in Fixed Cost Rs .12,000
Indifference Point = Change in Variable Cost p.u = ₹ 0.40
= 30,000 units

Interpretation of Indifference Point:

Quantity Below 30,000 units At 30,000 units Above 30,000 units

Least Cost Option Option with Both Options (Arun / Option with lower
Bala) have equal cost Variable Cost p.u. (Bala)
Lower Fixed Cost (Arun)

Annual Requirement of Material = 10,000 units p.m. × 12 months = 1, 20,000 units. Since the
annual purchase quantity is above 30,000 units, Supplier Bala (with the lower Variable Cost p.u.)
should be chosen.
58. Effect of JIT Purchasing
Kumar Enteprises has decided to adopt JIT policy for materials. The following effects of
JIT policy are identified -
• To implement JIT, the Company has to modify its production and material receipt facilities
at a Capital Cost of ₹ 6, 00,000. The new facilities will require a cash operating cost ₹ 48,000
per annum.
• Raw Material Stockholding will be reduced from ₹ 28, 00,000 to ₹ 8, 00,000.
• The Company can earn 15% on its long-term investments.
• The Company can avoid rental expenditure on storage facilities amounting to ₹ 30,000
per annum. Property Taxes and insurance amounting to ₹ 12,000 will be saved due to JIT
programme.
• Presently there are 7 workers in the Stores Department at a Salary of ₹ 3,000 each per
month. After implementing JIT Scheme, only 2 workers will be required in this Department.
Of the balance 5 workers, 3 will be transferred to other departments, while 2 workers’
employment will be terminated.
• Due to receipt of smaller lots of Raw Materials, there will be some disruption of
production. The Costs of Stock-Out is estimated at ₹ 66,000 per annum.
Determine the financial impact of the JIT policy. Is it advisable for the Company to
implement JIT system?
Solution: Cost-Benefit Analysis of JIT policy

Costs ₹ Benefits ₹

Interest on Capital for modifying 90,000 Interest on Investment on released 3,00,000

production facilities (₹ 6, 00,000 × funds (₹ 28,00,000 - ₹ 8,00,000) ×
15%) 15%

Operating Costs of new production 48,000 Savings in Salary of 2 workers 72,000

facilities terminated (₹ 3,000 × 12 months × 2)

Stock-Out Costs (given) 66,000 Savings in Rental Expenditure 30,000

Net Benefit due to JIT policy 2,10,000 Savings in Property Tax & Insurance 12,000

Total 4,14,000 Total 4,14,000

Conclusion: The JIT policy may be implemented, as there is a Net Benefit of ₹ 2, 10,000 per
annum.
59. Material Mix to retain profit M 91, M 07
Raw Materials ‘AXE’ costing ₹ 150 per kg. and ‘BXE’ costing ₹ 90 per kg are mixed in equal
proportions for making product ‘A’. The loss of material in processing works out to 25%
of the product. The Production Expenses are allocated at 40% of Direct Material Cost The
end product is priced with a margin of 20% over the total cost.
Material ‘BXE’ is not easily available and substitute Raw Material ‘CXE’ has been found for
‘BXE’ costing ₹ 75 per kg. It is required to keep the proportion of this substitute material
in the mixture as low as possible and at the same time maintain the selling price of the end
product at existing level and ensure the same quantum of profit as at present. You are
required to compute the ratio of the mix of the Raw Materials ‘AXE’ and ‘CXE’.
Solution:
1. Percentage of Loss = 25% of output (given)
Hence, Raw Material input for every 1 kg of output = 1 kg Output + 25% Loss = 1 + 0.25 = 1.25
kg.
2. Consumption of Raw Materials AXE and BXE = 50% each = 0.625 kg each of AXE and BXE.
3. Present Cost and Selling Price of 1 kg of Product (using AXE and BXE):

Material AXE Cost = 0.625 kg × ₹ 150 = ₹ 93.75

Material BXE Cost = 0.625 kg × ₹ 90 = ₹ 56.25

Total Material Cost = ₹ 150.00

Add: Production Expenses at 40% = ₹ 60.00

Total Production Costs = ₹ 210.00

Add: 20% Profit Margin on Cost = ₹ 42.00

Selling Price = ₹ 252.00

To retain the present Selling Price, Material Cost per kg of output should be maintained at ₹ 150
(as above).
4. Let the quantity of Raw Material AXE be "a" Kg. hence the quantity of new Raw Material CXE
= (1.25 - a) kg. Total Raw Material Cost = [a x 150] + [(1.25 - a) × 75] = [150a + 93.75 -75a] = 75a
+ 93.75.
This cost should be equal to ₹ 150. So, we have 75a + 93.75 = 150 (or) 75a = 56.25 and so a =
0.75 Hence, quantity of AXE should be 0.75 kg whereas quantity of CXE should be (1.25 - a) =
0.50 Kg. The required ratio of material AXE ad CXE is 0.75: 0.50, i.e. 3:2 or 60% and 40%
respectively.
60. True or False Questions
State whether the following statements are correct. Give reasons.
1. Safety Stock increases as Demand increases.
2. In ABC Analysis, high Cost items fall in Category A, and the Least Cost items are likely to fall
in Category C.
3. To protect against Stock outs, a large batch size is a must.
4. EOQ is based on a balancing between Inventory Carrying Cost and Shortage Costs.
5. Lead Time is the time interval elapsing between the placement of a replenishment order and
the receipt of last installment of goods against the order.
Solution:
 T/F Reason

1 False • Safety Stock is held for meeting the unpredictable fluctuation in the Demand and
Supply.
• Safety Stock varies with the fluctuations in Demand, and not with the level of
Demand.

2 False • Classification into A, B and C is based on Quantity and Value of Inventory on Hand,
and is not based on Cost / Price of Materials.

3 True • If the Batch Size is large, the number of Orders in a year will be lower.
• Hence, Stock moves to the lowest point (Re-Order Level) fewer times a year.
• Hence, the danger of Stock out will be comparatively less.
• Thus, to protect against Stock Out, a large Batch Size is desirable.

4 False EOQ seeks to maintain optimum balance between Ordering Cost and Carrying Cost
of Inventory. It does not consider the Shortage Costs.

5 False Lead Time is the time gap between the placement of a Replenishment Order, and the
receipt of first installment of goods against that Order.

61. ABC Analysis M 21 (New)

MM Ltd has provided the following information about the items in its inventory.

Item Code Number Units Unit Cost (₹)

101 25 50

102 300 01

103 50 80

104 75 08

105 225 02

106 75 12

MM Ltd has adopted the policy of classifying the items constituting 15% or above of Total
Inventory Cost as ‘A’ Category, items constituting 6% or less of Total Inventory Cost as C
Category and the remaining items as ‘B’ Category.
You are required to:
1. Rank the items on the basis of % of Total Inventory Cost.
2. Classify the items into A, B, and C categories as per ABC Analysis of Inventory Control Adopted
by MM Ltd.
Solution: Similar to Page 2.30, Q.1,2
 Item Units Cost pu (₹) Total Cost % in Cost Rank Category
(₹)

101 25 50 1,250 16.67% 2 A

102 300 1 300 4.00% 6 C

103 50 80 4,000 53.33% 1 A

104 75 8 600 8.00% 4 B

105 225 2 450 6.00% 5 C

106 75 12 900 12.00% 3 B

Total 750 7,500 100.00%

Note: Rank is based on Descending Order of Inventory Cost. ABC Category is as per Company
Policy specified in the Qn.
62. EOQ - Reverse Working N 21 (Old)
ARS Limited produces the component from a single raw material in economic lots (EOQ) of 2,800
units at a cost of ₹ 8 per unit. Average Annual Demand of the component is 28,000 units. The
annual holding and carrying cost is ₹ 0.25 per unit and minimum stock level is set at 450 units.
You are required to calculate -
1. Ordering Cost per Order, [Link] Stock Level, [Link] of Orders,
4. If the Company plans to reduce the number of orders calculated in (3) above by 2, by this
change, to what extent will the EOQ and the Ordering Cost per order be increased?

Solution: A = Annual Requirement of Raw Materials = 28,000 units (given)

2AB B = Buying Cost per order = ₹ ? per order (to be computed)

1. EOQ = √ , where
C
C = Carrying Cost per unit per annum = ₹ 0.25 p.u. p.a.

2×28,000×𝐵
Given EOQ = 2,800 units = √ 0.25
On solving, B = ₹ 35 per Order.

2. Average Stock Level = Min Level + ½ ROQ = 450 + ½ of (2,800) = 1,850 units.
Annual Requirement (A) 28,000
3. Number of Orders p.a. = = = 10 orders per annum.
Quantity Ordered (Q) 2,800

4. Buying Cost per annum at EOQ Level = (No. of Orders x Cost per Order) = 10 x ? 35 = ₹ 350
• Assuming the same amount of ₹ 350 is to be maintained, with 10 less 2 = 8 orders, the revised
₹ 350
Ordering Cost per Order will be = ₹ 43.75 per Order. So, Ordering Cost per Order
8 orders
increases by 43.75 - 35 = ₹ 8.75/Order.
 2AB 2 × 28,000 × 43.75
• Revised EOQ = √ C
=√ 0.25
= 3,130 units. So, EOQ increases by 3,130 - 2,800 =
330 units.
63. Inventory Turnover Ratio N 21 (New)
XYZ Ltd uses two types of Raw Materials - ‘Material A’ and Material B’ in the production process
and has provided the following data for the year ended on 31 st March:

Particulars Material A (₹) Material B (₹)

Opening Stock as on 1st April 30,000 32,000

Purchase during the year 90,000 51,000

Closing Stock as on 31st March 20,000 14,000

1. You are required to calculate - (a) Inventory Turnover Ratio of ‘Material A’ and ‘Material B’, and
(b) Number of Days for which the Average Inventory is held for both Materials ‘A’ and ‘B’. (Assume
360 days in a year.)
2. Based on above calculations, give your comments.
Solution: Similar to Page 2.51, Q.4O M 18 (New) Exam Qn and Page 2.71, Q.27

Particulars Material A Material B

1. Cost of Raw Material Consumption 30,000 + 90,000 - 20,000 32,000 + 51,000 - 14,000

= Opg Stock + Purchases - [Link] = ₹ 1,00,000 = ₹ 69,000

[Link] + [Link] 30,000 + 20,000 32,000+14,000
2. Average RM Stock = = ₹ 25,000 =₹ 23,000
2 2 2

3. Material Turnover Ratio = (1) ÷ (2) 4 times 3 times

4. Number of days Average Stock held = 90 days 120 days

360 ÷ (3)

5. Comments on Nature of Raw Material Comparatively fast moving Comparatively Slow.

6. Reasons for above Comments Low Turnover Ratio, and High Turnover Ratio, and
High Stockholding period Low Stockholding period