Material Cost

Inventory Control Levels:
Re-order Level (ROL): It is the level at which fresh order needs to be
ROI. = Max. Consumption × Max. Re-order Period
Or
Min. Stock Level – (Avg. Consumption × Average Re-order period!
Safety Stock – Avg. lead time consumption
Re-order period is also known as Lead Time 

Re-order Quantity/Economic Order Quantity (ROQ/EOQ): It is the size of the order for which total ordering and total carrying costs are minimum.
EOQ = 2× Annual Requirement (A)× Cost per order (O) Carrying cost per unit p.a.(C) −−−−−−−−−−−−−−−−−−−−−−−−−−−−√

Minimum Stock Level:
It is the minimum quantit) which must he retained in stock.
= ROL – (Avg. Consumption × Average Re-order Period)

Maximum Stock Level:
It is the maximum limit up to which stock can be stored at any time.
= ROL + RQQ – (Min. Consumption × Min. Re-order Period)

Average Inventory Level:
It is the quantity of material that is normally held in stock over a period.
= Minimum Stock Level + 1/2 Re-order Quantity
OR
 Maximum Stock Level + Minimum Stock Level 2

Danger Level:
The level where normal issue of materials is stopped and only emergency materials are issued.
= Avg. Consumption × Lead time for emergency purchase
Some time minimum consumption is also used.

Classification of items in ABC Analysis:

• A Category: Quantity less than 10% but value more than 70%
• B Category: Quantity less than 20% but value ahout 20%
• C Category: Quantity about 70% but value less than 10%

Inventory Turnover Ratio:
It is used for measuring inventory performance. High inventory turnover – Indicates that material is a fast moving one.
Low turncn cr ratio – Indicates over-investment and locking up of working capital in inventories.
Cost of Materials Consumed
Inventor Turnover Ratio =  Cost of Materials Consumed  Cost of Average Stock 
Average Stock = 1/2 (opening stock + closing stock)
Average No. of days of Inventory holding = =365 Days or 12 Months  Inventory turnover Ratio 

Theory Questions

Question 1.
State the objectives of system of material control. [ICAIModule]
Answer:
(i) Minimising interruption in production process: Material Control system ensures that no activity, particularly production, suffers from interruption for want of materials and stores. This requires constant availability of every item needed in the production process.

(ii) Optimisation of Material Cost: The overall material costs includes price, ordering costs and holding costs. Since all the materials and stores are acquired at the lowest possible price considering the required quality and other relevant factors like reliability in respect of delivery, etc., holding cost too needs to be minimized.

(iii) Reduction in Wastages: It aims at avoidance of unnecessary losses and wastages that may arise from deterioration in quality due to defective or long storage or from obsolescence.

(iv) Adequate Information: The system of material control maintains proper records to ensure that reliable information is available for all items of materials and stores. This not only helps in detecting losses and pilferages but also facilitates proper production planning.

(v) Completion of order in time: Proper material management is very nec-essary for fulfilling orders of the firm. This adds to the goodwill of the firm.

Question 2.
What is Bill of Material? Describe the uses of Bill of Material in following ‘ departments:
(i) Purchases Department
(ii) Production Department
(iii) Stores Department ‘
(iv) Cost/Accounting Department [CA Inter-Dec, 2021, 5 Marks]
Answer:
It is a detailed list specifying the standard quantities and qualities of materials and components required for producing a product or carrying out of any job.

Uses of Bill of Material

Marketing (Purchase) Dept.	Production Dept.	Stores Dept.	Cost /Accounting Dept.
Materials are procured (purchased) on the basis of specifications mentioned in it.	Production is planned according to the nature, volume of the materials required to be used. Accordingly, material requisition lists are prepared.	It is used as . a reference document while issuing materials to the requisitioning department.	It is used to estimate cost and profit. Any purchase, issue and usage are compared/verified against this document.

Question 3.
Distinguish between Bill of Material and Material Requisition note. [CA Inter May 2012, 4 MarksJ
Answer:
Differences between Bill of Material and Material Requisition Note

Bill of Material	Material Requisition Note
It is the document prepared by the engineering or planning department.	It is prepared by the production or other consuming department.
It is a complete schedule of component parts and raw materials required for a particular job or work order.	It is a document asking Storekeeper to issue materials to the consuming department.
It often serves the purpose of a material requisition as it shows the complete schedule of materials required for a particular job ie. it can replace material requisition.	It cannot replace a bill of materials.
It can be used for the purpose of quotations.	It is useful in arriving at historical cost only.
It helps in keeping a quantitative control on -materials drawn through the material requisition.	It shows the material actually drawn from stores.

Question 4.
Write the treatment of items associated with the purchase of material:
(i) Cash discount
(ii) Subsidy/ Grant/ Incentives
(iii) GST
(iv) Commission brokerage paid [CA Inter May 2016, 4 Marks]
Answer:

• Cash discount: Cash discount is not deducted from the purchase price. It is treated as interest and finance charges. It is to be ignored.
• Subsidy/Grant/Incentive: Any subsidy/grant/incentive received from the Government or from other sources deducted from the cost of purchase.
• GST: It is excluded from the cost of purchase if credit for the same is available. Unless mentioned specifically it should not form part of cost of purchase.
• Commission or brokerage paid: Commission or brokerage paid is added with the cost of purchase.

Question 5.
State how the following items are treated in arriving at the value of cost of material purchased:
(i) Detention Charges/Fines
(ii) Demurrage
(iii) Cost of Returnable containers
(iv) Central Goods and Service Tax (CGST)
(v) Shortage due to abnormal reasons. /CAtnterJan, 2021,5Marks]
Answer:
Treatment of items in arriving at the value of cost of material Purchased

Items	Treatment
1. Detention charges/Fine	Detention charges/fines imposed for non-compliance of rule or law by any statutory authority. It is an abnormal cost and not included with cost of Purchase
2. Demurrage	Demurrage is a penalty imposed by the transporter for delay in uploading or offloading of materials. It is an abnormal cost and not included with cost of purchase.
3. Cost of returnable containers	If the containers are returned and their- costs arc ref unded, then cost of containers should not be considered in the cost of purchase. If the amount of refund on returning the container is less than the amount paid, then, only the short fall is added with the cost of purchase.
4. Central Goods and Service Tax (CGST)	Central Goods and Service Tax (CGST) is paid on manufacture and supply of goods and Collected from the buyer. It is excluded from the cost of purchase if the input credit is available for the same. Unless mentioned specifically CGST is not added with the cost of purchase.
5. Shortage due to abnormal reasons	Shortage arises due to abnormal reasons such as material mishandling, pilferage, or due to any avoidable reasons are not absorbed by the good units. Losses due to abnormal reasons are debited to costing profit and loss account.

Question 6.
State how the following items are treated in arriving at the value of cost of material purchased:
(i) Trade discount
(ii) Insurance charges
(iii) Freight inwards
(iv) Cost of non-returnable containers
(v) Shortage due to normal reasons flCAIModule/
Answer:

Items	Treatment
1. Trade discount	Trade discount is deducted from the purchase price if it is not shown as deduction in the invoice.
2. Insurance charges	Insurance charges are paid for protecting goods during transit. It is added with the cost of purchase.
3. Freight inwards	It is added with the cost of purchase as it is directly attributable to procurement of material.
4. Cost of non-returnable containers	The cost of non-returnable containers is added with the cost of purchase of materials.
5. Shortage due to normal reasons	Good units absorb the cost of shortage due to normal reasons. Losses due to breaking of bulk, evaporation, or due to any unavoidable conditions etc. are the reasons of normal loss.

Question 7.
Distinguish clearly between Bin Cards and Stores Ledgers. [CA Inter Nov 2017, Nov 2004, May 2003, May 2002, May 2000, 4 Marks]
Answer:

Bin cards	Stores Ledger
Bin Cards is maintained by the store keeper in the store.	Store ledger is maintained in cost accounting department.
It contains only quantitative details of material received, issued and returned to stores.	It contains information both in quantity and value.
Entries are made when transaction takes place.	It is always posted after the transaction.
Each transaction is individually posted.	Transactions may be summarized and then posted.
Inter-department transfers do not appear in Bin Card.	Material transfers from one job to another job are recorded for costing purposes.

Question 8.
Define Inventory control and given its objectives. List down the basis to be adopted for inventory control. [CA Inter Nov, 2019, 5 Marks]
Answer:
The Chartered Institute of Management Accounts (CIMA) defines Inventory Control as “The function of ensuring that sufficient goods are retained in stock to meet all requirements without carrying unnecessarily large stocks”.
The objective of inventory control is to make a balance between sufficient stock and over-stock.

The stock maintained should be sufficient to meet the production requirements so that uninterrupted production flow can be maintained. Insufficient stock not only pause the production but also cause a loss of revenue and goodwill.

On the other hand, Inventory requires some funds for purchase, storage, maintenance of material with a risk of obsolescence, pilferage etc. A trade-off between stock-out and over-stocking is required. The management may employ various methods of inventory a balance.

Management may adopt the following basis for Inventory Control:

• By Setting Quantitative Levels
• On the basis of Relative Classification
• Using Ratio Analysis
• Physical control

Question 9.
Explain ‘Just In Time1 (JIT) approach of inventory management. [CA Inter May 2018, 5 Marksj
Answer:
JIT is a system of inventory management with an approach to have a zero inventories in stores. According to this approach material should only be purchased when it is actually required for production.
JIT is based on two principles

• Produce goods only when it is required and .
• The products should be delivered to customers at the time only when they want.

It is also known as ‘Demand pull’ or ‘Pull through’ system of production. In this system, production process actually starts after the order for the products are received. Based on the demand, production process starts and the requirement for raw materials is sent to the purchase department for purchase. The steps followed in this system are as follows:

Question 10.
Discuss ABC Analysis as a system of Inventory Control. [CA Inter May 2000, Nov. 2004, Nov. 2005, May 2008, Nov, 2011, May 2017, 4 Marks]
Answer:
It is an important technique of inventory control on selective basis whereby the measure of control over an item of inventory varies with its usage value. It exercises discriminatory control over different items of stores grouped on the basis of the investment involved.

Usually the items of material are grouped into three categories viz A, B and C according to their use value during a period:

• ‘A’ Category of items consists of only a small percentage ie., about 10% of the total items of material handled by the stores but require heavy investment i.e., about 70% of inventory value, because of their high prices and heavy requirement.
• ‘B’ Category of items comprises of about 20% of the total items of material handled by stores. The percentage of investment required is about 20% of the total investment in inventories.
• ‘C’ category of items does not require much investment. It may be about 10% of total inventory value but they are nearly 70% of the total items handled by stores.

Question 11.
What are the advantages of ABC analysis. [ICAIModule]
Answer:

• Continuity in production: It ensures that, without there being any danger of interruption of production for want of materials or stores, minimum investment will be made in inventories.
• Lower cost: The cost of placing orders, receiving goods and maintaining stocks is minimised specially if the system is coupled with the determination of proper economic order quantities.
• Less attention required: Management time is saved since attention need to be paid only to some of the items rather than all the items.
• Systematic working: With the introduction of the ABC system, much of the work connected with purchases can be systematized on a routine basis, to be handled by subordinate staff.

ECPGURGAON.COM

Question 12.
How is slow-moving and non-moving item of stores detected and what steps are necessary to reduce such stocks? (CA Inter Nov. 2001, 4 Marks]
Answer:
Slow moving and non-moving items of stores can be detected in the following ways:

• By preparing & scanning periodic reports showing the status of different items of stores.
• By calculating the stock holding of various items in terms of numbers of days/months of consumption as a percentage.
• By computing ratios periodically, relating to the issues of average stock held
• By implementing the use of a well designed information system.

Steps to reduce stock of slow moving and non-moving items of stores:

• Proper procedures and guidelines should be laid down for the disposal of non-moving items, before they further deteriorates in value.
• Diversity in production to use up such materials.
• Use these materials as substitute in place of other materials.

Question 13.
Write a short note on VED analysis of Inventory Control. (CA Inter July 2021, 5 Marks]
Answer:
Vital, Essential and Desirable (VED): Under this system of inventory analysis, inventories are classified on the basis of its criticality for the production function and final product. This classification is done for spare parts which are used for production.

• Vital: Items are classihed as vital when its unavailability can interrupt the production process and cause a production loss. Items under this category are strictly controlled by setting re-order level.
• Essential: Items under this category are essential but not vital. The unavailability can cause sub-standardization and loss of efficiency in production process. Items under this category are reviewed periodically and get the second priority.
• Desirable: Items under this category are optional in nature, unavailability does not cause any production or efficiency loss.

Question 14.
Describe perpetual inventory records and continuous stock verification. [CA Inter May 2001, 3 Marks]
Answer:
Perpetual Inventory Records:
Perpetual inventory represents a system of records maintained by the stores department. It comprises of:

• Bin Cards, and
• Stores Ledger.

The success of perpetual inventory depends upon the following:
(a) The Stores Ledger showing quantities and amount of each item.
(b) Stock Control cards (or Bin Cards).
(c) Reconciling the quantity balances shown by stores ledger and bin cards.
(d) Checking the physical balances of a number of items every day systematically and by rotation.
(e) Explaining promptly the causes of discrepancies, if any, between physical balances and the book figures.
(f) Making corrective entries wherever required and
(g) Removing the causes of the discrepancies.

Continuous Stock Verification:
The checking of physical inventory is an essential feature of every sound system of material control. The system of continuous stock-taking consists of physical verification of items of inventory. The stock verification may be done by internal audit department but are independent of the store and pro-duction staff. Stock verification is done at appropriate interval of time without prior notice. The element of surprise is essential for effective control of the system.

Question 15.
Discuss the advantages of perpetual inventory records and continuous stock verification, [CA Inter Nov, 2006, 4 Marks]
Answer:
Advantages of Perpetual Inventory Records:

• Physical stocks can be counted and book balances can be adjusted as and when desired without waiting for the entire stock-taking to be done.
• Quick compilation of Profit and Loss Account for interim period due to prompt availability of stock figures.
• Discrepancies are easily located and thus corrective action can be promptly taken.
• It reveals the existence of surplus, dormant, obsolete and slow-moving materials, so that remedial measures may be taken in time.
• Fixation of the various stock levels and checking of actual balances in hand with these levels assist the store keeper in maintaining stocks within limits and in initiating purchase requisitions for correct quantity at the appropriate time.

Advantages of Continuous Stock Taking:

• Closure of normal functioning is not necessary.
• Stock discrepancies are likely to be brought to the notice and corrected much earlier than under the annual stock-taking system.
• The system generally has a sobering influence on the stores staff because of the element of surprise present therein.
• The movement of stores items can be watched more closely by the stores auditor so that chances of obsolescence buying are reduced.
• Final Accounts can be ready quickly. Interim accounts are possible quite conveniently.

Question 16.
“Perpetual inventory system comprises Bin Card and Stores Ledger, but the efficacy of the system depends on continuous stock-taking.” Comment. [CA Inter May 2013, 4 MarksJ
Answer:
Perpetual Inventory system represents a system of records maintained by the stores department.

Records comprise of

• Bin Cards and
• Stores Ledger.

Bin Card maintains a quantitative record of receipts, issues and closing balances of each item of stores. Like a bin card, the Stores Ledger is maintained to record all receipt and issue transactions in respect of materials. It is filled up with the help of goods received note and material requisitions. But a perpetual inventory system’s efficacy depends on the system of continuous stock taking.

Continuous stock taking means the physical checking of the records ie. Bin cards and store ledger with actual physical stock. Perpetual inventory is essentially necessary for material control. It incidentally helps continuous stock taking.

The main advantages of continuous stock taking are as follows:

1. Closure of normal functioning is not necessary.
2. Stock discrepancies are likely to be brought to the notice and corrected much earlier than under the annual stock-taking system.
3. The system generally has a sobering influence on the stores staff because of the element of surprise present therein.
4. The movement of stores items can be watched more closely by the stores auditor so that chances of obsolescence buying are reduced.
5. Final Accounts can be ready quickly. Interim accounts are possible quite conveniently.

Question 17.
Explain FIFO and UFO method of stores issue. [CA Inter May 2018> 2.5 Marks]
Answer:
First-in First-out (FIFO) method: It is a method of pricing the issues of mate-rials, in the order in which they are purchased. In other words, the materials are issued in the order in which they arrive in the store or the items longest in stock are issued first. Thus each issue of material only recovers the purchase price which does not reflect the current market price.

It is suitable in times of falling price since the material cost charged to pro-duction will be high while the replacement cost of materials will be low. But, in case of rising prices, if this method is adopted, the charge to production will be high while the replacement cost of material will be low.
Consequently, it would be difficult to purchase the same volume of materials (as in the current period) in future without having additional capital resources.

Last-in-First-out (LIFO) method: It is a method of pricing the issues of materials on the basis of assumption that the items of the last batch (lot) purchased are the first to be issued. Therefore, under this method, the prices of the last batch (lot) are used for pricing the issues, until it is exhausted. Where the quantity of issue is more than the quantity of the latest lot, then earlier lot and its price will also be taken into consideration.
During inflationary period or period of rising prices, the use of LIFO would help to ensure that the cost of production determined on the above basis is approximately the current one.

Question 18.
Explain, why the Last in First out (LIFO) has an edge over First in First out (FIFO) or any other method of pricing material issues. [CA inter Nov, 2907, 3 Marks]
Answer:
LIFO has following advantages:
(a) The cost of the material issued will be reflecting the current market price.
(b) The use of the method during the period of rising prices does not reflect undue high profit in the income statement.
(c) In the case of falling price, profit tend to rise due to lower material cost, yet the finished goods appear to be more competitive and are at market price.
(d) During the period of inflation, LIFO will tend to show the correct profit.

Question 19.
Explain the meaning of waste, spoilage, defectives and scrap and give the accounting treatment for each one.
[CA Infer Nov, 2019, Nov. 2015, May 2009, Nov. 2008, May 2007, May 2005, Nov. 2003, May 2003, May 2000, 8 Marks]
Answer:
Waste: It is the portion of raw material which is lost during storage or production and discarded. The waste may or may not have any value.

Accounting Treatment:

• Normal Wastage: Cost of normal waste is absorbed by good production units.
• Abnormal Wastage: The cost of abnormal loss is transferred to Costing Profit and loss account.
• Spoilage: Spoilage is the term used for materials which are badly damaged in manufacturing operations, and they cannot be rectified economically and hence taken out of the process to be disposed of without further processing.

Accounting Treatment:
Normal Spoilage: Normal spoilage (ie., which is inherent in the operation) costs are included in costs, either by charging it to the production order or to the production overhead so that it is spread over all the products. Any value realised from spoilage is credited to production order or production overhead account, as the case may be.

Abnormal Spoilage: Abnormal Spoilage (ie., arising out of causes not inherent in the manufacturing process) costs are charged to Costing Profit and Loss Account. When spoiled work is the result of rigid specification, the cost of spoiled work is absorbed by good production while the cost of disposal is charged to production overhead.

Defectives: Defectives are those units or portions of production which do not meet the quality standards due to sub-standard materials, bad-supervision, bad-planning, poor workmanship, inadequate-equipment and careless inspection.

Accounting Treatment:

• Normal Defects: An amount equal to the cost less realisable value on sale of defectives is charged to material cost of good production.
• Abnormal Defects: Material Cost of abnormal defectives are not included in material cost but treated as loss after giving credit to the realisable value of such defectives and is transferred to costing profit and loss account.
• Scrap: Scraps are the materials which are discarded and disposed of without further treatment. Generally, scrap has either no value or insignificant value. Sometimes, it may be reintroduced into the process as raw material.

Accounting Treatment:

• Normal Scrap: The cost of scrap is borne by good units and income arises on account of realisable value is deducted from the cost. ‘
• Abnormal Scrap: The scrap account should be charged with full cost and the credit is given to the job or process concerned. The profit or loss in the scrap account due to realization will be transferred to the Costing Profit and Loss Account.

Question 20.
Explain obsolescence and circumstances under which materials become obsolete, state the steps to be taken for its treatment. [CA Inter Nov, 2018, 5 Marks]
Answer:
Obsolescence is the loss in the intrinsic value of an asset due to its supersession. In other words, it refers to the loss in the value of an asset due to technological advancements.

Materials may become obsolete under any of the following circumstances:

• when it is a spare part or component of a machinery used in manufacture and that machinery become obsolete,
• where it is used in the manufacture of a product which has now become obsolete
• where the material itself is replaced by another material due to either improved quality or fall in price.

Treatment:
In all three cases, the value of the obsolete material held in a stock is a total loss and immediate steps should be taken to dispose it off at the best available price. The loss arising out of obsolete materials is an abnormal loss and it does not form part of the cost of manufacture.

Question 21.
Differentiate between ‘scrap’ and ‘defectives’ and how they are treated in cost accounting. [CA Inter Nov. 2015, Nov. 2008, 4 Marks]
Answer:
Difference between Scrap and Defectives

Scrap	Defectives
It is the loss, connected with the output	It is the loss connected with the output as well as input.
Scraps are not intended but cannot be elim­inated due to nature of material or process itself.	Defectives also are not intended but can be eliminated through proper control system.
Generally scraps are not used or rectified.	Defectives can be used after rectifi­cation.
Scraps have insignificant recoverable value.	Defectives are sold at a lower value from that of the good one.

Practical Questions

Question 1.
The following information relating to a type of Raw material is available:

Annual demand	2,000 units
Unit price	₹ 20
Ordering cost per order	₹ 20
Storage cost	2% p.a.
Interest rate	8% p.a.
Lead time	Half- month

Calculate economic order quantity and total annual inventory coat of the raw material. [CA Inter Nov. 2019, Nov. 2009, 5 Marks]
Answer:
Annual demand (A) = 2,000 units
Ordering Cost (O) = ₹ 20
Carrying cost per unit per annum (c × i) = [Storage cost + Interest cost]
= [(₹ 20 × 296) + (₹ 20 × 8%)]
= ₹ 2

EOQ = 2AOc×i−−−−√
= 2×2,000×₹20₹2−−−−−−−−√
= 80,0002−−−−−√ = 200 units

Total Annual Inventory cost

Purchase cost (₹ 2,000 units × ₹ 20)	₹ 40,000
Total Ordering cost (2,000200 × ₹ 20)	₹ 200
Total Carrying cost (2002 × ₹ 20 × 10%)	₹ 200
	₹ 40,400

Question 2.
(i) Compute EOQ and the total 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 cost that would result for the items if a new price of ₹ 12.80 is used.
Answer:
(i) Annual Demand (A) = 5,000 units
Ordering Cost (O) = ₹ 16
Carrying cost per unit p.a. (c × i)
= [Storage cost (2%) + Int. cost (1296) + Obsolescence cost (696)] – 20%
= ₹ 20 × 20% = ₹ 4 per unit p.a.
E.O.Q = 2AOc×i−−−−√=2×5,000×₹16₹4−−−−−−−−√=40,000−−−−−−√ = 200 units

Total Annual Inventory cost:

Purchase cost (5,000 units × ₹ 20.00)	₹ 1,00,000
Ordering cost (5,000200 × ₹ 16)	₹ 400
Carrying cost [2002 × ₹ 4]	₹ 400
Total cost	₹ 1,00,800

(ii) If the new price of ₹ 12.80 is used:
C = 2096 of ₹ 12.80 = ₹ 2.56 per unit p.a.
EOQ = 2×5,000×₹16₹2.56−−−−−−−−√ = 250 units

Total Annual Inventory cost:

Purchase cost (5,000 units × ₹ 12.80)	₹ 64,000
Ordering cost (5,000250 × ₹ 16)	₹ 320
Carrying cost [2502 × ₹ 2.56]	₹ 320
Total cost	₹ 64,640

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Question 3.
The demand for a certain product is random. It has been estimated that the monthly demand of the product has a normal distribution with a mean of 390 units. The unit price of product is ₹ 25. Ordering cost is ₹ 40 per order and inventory carrying cost is estimated to be 35 per cent per year.
Required; Calculate Economic Order Quantity (EOQ). [CA Inter Nov. 2907,2 Marks]
Answer:
Calculation of Economic Order Quantity (EOQ)
Monthly demand = 390 units, Annual demand (A) = 390 × 12 = 4,680 units
Ordering cost (O) = ₹ 40 per order
Cost per unit = ₹ 25.
Inventory carrying cost of one unit (CC) = ₹ 25 × 3596 = ₹ 8.75
EOQ = 2×A×OCC−−−−−−√=2×4,680×408.75−−−−−−−−√ = 206.85 or 207 units.

Question 4.
M/s. X Private Limited is manufacturing a special product which requires a component “SKY BLUE”. The following particulars are available for the year ended 31st March, 2021:

Annual demand of “SKY BLUE”	12.000 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:
(i) Compute the Economic Order Quantity.
(ii) Advise whether the quantity discount offer can be accepted.
[CA Inter May 2018, 5 Marks]
Answer:
Annual demand (A) = 12,000 units
Ordering Cost (O) = ₹ 1,800
Carrying cost per unit per annum (c × i) = ₹ 640 × 18.7596 = ₹ 120
(i) Calculation of Economic Order Quantity:
EOQ = 2AOc×i−−−−√=2×12,000×₹1,800₹120−−−−−−−−−−−√ = 600 units

(it) Evaluation of Profitability of Different Options of Order Quantity

	When EOQ is ordered	When discount of 5% is accepted and order size is 3,000 units
Size of the order	600 units	3,000 units
No. of orders	20(12,000 ÷ 600)	4(12,000 ÷ 3,000)
Total Purchase Cost	₹ 76,80,000(12,000 kgs × ₹ 640)	₹ 72,96,000(12,000 kgs × ₹ 608)
Total ordering cost	₹ 36,000(₹ 1,800 × 20 orders)	₹ 7,200(X 1,800 X 4 orders)
Total carrying cost	₹ 36,000(600 units × ½ x ₹ 640 × 18.75%)	₹ 1,71,000(3,000 units × ½  x ₹ 608 × 18.7596)
Total Cost	₹ 77,52,000	₹ 74,74,200

Note: Here, it is assumed that the carrying cost varies due to discount in the purchase price. Alternatively, it may be assumed that the carrying cost per unit is fixed and does not vary due to discount in purchase price. In such case the Total carrying cost, for order size is 3000 units, shall be ₹ 1,80,000 (3,000 units × ½ × ₹ 640 × 18.75%)

Advice: The total cost is lower if Company accept an offer of 5% discount by the supplier. The company is advised not to accept the EOQ.

Question 5.
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.
Required;
(i) Calculate the economic order quantity for component X.
(ii) If the minimum lot size to be supplied is 52,000 units, what is the extra cost, the company has to incur?
(iii) What is the minimum carrying cost, the Company has to incur? [CA Inter May 2006, 8 Marks]
Answer:
Annual demand (A) = 52,000 units × 2 × 12 = 12,48,000 units
Ordering Cost (O) = ₹ 350
Carrying cost per unit per annum (c × i) = ₹ 15 × 12% = ₹ 1.80
(i) EOQ = 2AOc×i−−−−√
= 2×12,48,000×350₹1.80−−−−−−−−−−−√
= 22,030 units

(ii) Extra cost incurred by the company:

	Minimum lot size	EOQ
Size of the order	52,000 units	22,030 units
Total ordering cost	₹ 8,400 (52,000×2×1252,000         × 350)	₹19,827.50 (52,000×2×1222,030 × 350)
Total carrying cost	₹ 46,800 (52,000 units × ½ × ₹ 15 X 12%)	₹ 19,827.50 (22,030 units × ½ × ₹ 15 × 12%) 1296))
Total Cost	₹ 55,200	₹ 39,655

Extra cost incurred = ₹ 55,200 – ₹ 39,655= ₹ 15,545

(iii) Minimum carrying cost, the company has to incur:
= EOQ2 × c × i = 22,0302 × ₹ 15 × 12% = ₹ 19,827.50

Question 6.
A company manufactures a product from a raw material, which is purchased at ₹ 60 per kg. The company incurs a handling cost of ₹ 360 plus freight of ₹ 390 per order. The incremental carrying cost of inventory of raw material is ₹ 0.50 per kg. per month. In addition, the cost of working capital finance on the investment in inventory of raw material is ₹ 9 per kg. per annum. The annual production of the product is 1,00,000 units and 2.5 units are obtained from one kg. of few material.
Required:
(i) Calculate the economic order quantity of raw material
(ii) Advise, how frequently should orders for procurement be placed
(iii) If the company proposes to rationalise placement of orders on quarterly basis, what percentage or discount in the price of raw material should be negotiated?
Assume 360 days in a year. [CA Inter May 2014, Nov. 2001, 8 Marks]
Answer:
Annual requirement of raw material in kg. (A) = 1,00,000/2.5 units per kg = 40,000 kg
Ordering Cost (Handling & freight cost) (O) = ₹ 360 + ₹ 390 = ₹ 750
Carrying cost per unit per annum (c × i) = Inventory carrying cost+ working capital cost
= (₹ 0.5 × 12 months) + ₹ 9
= ₹ 15 per kg

(i) EOQ = 2AOc×i−−−−√
= 2×40,000×₹750₹15−−−−−−−−−−√ = 2,000 kg

(ii) Frequency of orders for procurement:
No. of order per annum =  Annual requirement EOQ
= 40,000 kg⋅2,000 = 20 orders
Frequency of placing order (in days) = 360 days 20 times  = 18 days

(iii) Percentage of discount in the price of raw materials to be negotiated:

	Quarter order	EOQ
Size of the order	10,000 kg.	2,000 kg.
No. of orders	4	20
Total ordering cost	₹ 3,000 (₹ 750 × 4 orders)	₹ 15,000 (₹ 750 × 20 orders)
Total carrying cost	₹ 75,000 (10,000 kg × ½  × ₹ 15)	₹ 15,000 (2,000 kg × ½  × ₹ 15)
Total Cost	₹ 78,000	₹ 30,000

Increase in total cost if quarterly orders are placed = ₹ 78,000 – ₹ 30,000 = ₹ 48,000
Reduction expected in purchase price of raw material (per kg) =  Increase in total cost  Annual requirement 
= ₹48,00040,000 kg = 1.20 per kg
Discount in the price of raw material to be = ₹1.20₹60 = 2% negotiated

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Question 7.
The annual carrying cost of material ‘X’ is ₹ 3.6 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’? [CA Inter Nov. 2008, 2 Marks]
Answer:
Total Carrying Cost at EOQ level = EOQ2 × Carrying cost per unit
₹ 9,000 = EOQ2 × ₹ 3.60
EOQ = (₹ 9,000 × 2) ÷ ₹ 3.60 = 5,000 units

Question 8.
HBL Limited produces product ‘M’ which has a quarterly demand of 20,0 units. Each product requires 3 kg. and 4 kg. of material X and Y respectively. Material X is supplied by a local supplier and can be procured at factory stores at any time, hence, no need to keep inventory for material X. The material Y is not locally available, it requires to be purchased from other states in a specially designed truck container with a capacity of 10 tons.
The cost and other information related with the materials are as follows:

	Material X	Material Y
Purchase price per kg. (excluding GST)	₹ 140	₹ 640
Rate of GST	18%	18%
Freight per trip (fixed, irrespective of quantity)	–	₹ 28,000
Loss of materials in transit	–	2%
Loss in process on purchased quantity	4%	5%

Other information:

• The company has to pay 15% p,a. to bank for cash credit facility.
• Input credit is available on GST paid on materials.

Required:
(i) Calculate cost per kg. of material X and Y
(ii) Calculate the Economic Order quantity for both the materials [CA Inter Nov. 2019, RTPJ
Answer:
Annual demand for product M – 20,000 units × 4 = 80,000 units
Calculation of Annual purchase quantity

	Material X	Material Y
Quantity required for per unit of product M	3 kg.	4 kg.
Net quantity for materials required	2,40,000 kg.	3,20,000 kg.
Add: Loss in transit	–	6,882 kg.
Add: Loss in process	10,000 kg.	17,204 kg.
Purchase quantity	2,50,000 kg.	3,44,086 kg.

Note: ITC on GST paid is available and therefore, it will not be included in cost of material.

(i) Calculation of cost per kg. of Material X and Y:

	Material X	Material Y
Purchase quantity	2,50,000 kg.	3,44,085 kg.
Rate per kg.	₹ 140	₹ 640
Purchase price	₹ 3,50,00,000	₹ 22,02,14,400
Add: Freight	0	₹ 9,80,000
Total cost	₹ 3,50,00,000	₹ 22,11,94,400
Net Quantity	2,40,000 kg.	3,20,000 kg
Cost per kg.	₹ 145.83	₹ 691.23

No. of trucks = 3,44,085 kg.10 tons ×1,000 = 34.40 trucks or 35 trucks.
Therefore, total freight = 35 trucks × ₹ 28,000 = ₹ 9,80,000

(ii) Calculation of Economic Order Quantity (EOQ) for Material X and Y:

	Material X	Material Y
Annual Requirement	2,50,000 kg	3,44,085 kg.
Ordering cost	0	₹ 28,000
Cost per unit	₹ 145.83	₹ 691.23
Carrying cost	15%	15%
Carrying cost per unit p.a.	₹ 21.88	₹ 103.68

EQQ = 2× Annual Requirement × Order cost  Carrying cost per unit p.a −−−−−−−−−−−−−−−−−−−−−−√
For Material X
As the ordering cost is ‘O’, EOQ cannot be defined.
For Material Y
EOQ = 2×3,44,085×₹28,000₹103.68−−−−−−−−−−−−√ = 13,633 units

Question 9.
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 is as follows:

Cost of material ‘X’	₹ 20 per kg
Cost of placing an order	₹ 1,000 per order
Carrying cost	15% per annum of average inventory

Required:
(a) Calculate the Economic Order Quantity for material ‘X’.
(b) 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? [CA Inter Nov. 2012, 5 Marks]
Answer:
Annual Demand of material ‘X’ (A):
= 8,000 units per quarter × 4 quarters in a year × 3 kg. for every finished product
= 96,000 kgs.
Ordering Cost (O) = ₹ 1,000
Carrying cost per unit per annum (c X i) = ₹ 20 × 1596 = ₹ 3

(i) Calculation of EOQ for material ‘X’:
EOQ = 2AOc×i−−−−√=2×96,000×₹1,000₹3−−−−−−−−−−−√. = 8,000 kgs.

(ii) Evaluation of Cost under different options of ‘order quantity’.

	When EOQ is ordered	When discount of 2% is accepted and supply is made in 4 equal instalments
Size of the order	8,000 Kgs.	24,000 (96,000 ÷ 4)
No. of orders	12 (96,000 ÷ 8,000)	4 (96,000 ÷ 24,000)
Total Purchase Cost	₹ 19,20,000 (96, 000 kgs × ₹ 20)	₹ 18,81,600 (96, 000 kgs × ₹ 19.6)
Total ordering cost	₹ 12,000 (₹ 1,000 × 12 orders)	₹ 4,000 (₹ 1,000 × 4 orders)
Total carrying cost	₹ 12,000 (8,000 units × ½  × ₹ 20 × 15%)	₹ 35,280 (24,000 units × ½ × ₹ 19.6 × 15%)
Total Cost	₹ 19,44,000	₹ 19,20,880

Note: Here, it is assumed that the carrying cost varies due to discount in the purchase price. Alternatively, it may be assumed that the carrying cost per unit is fixed and does not vary due to discount in purchase price. In such case the Total carrying cost, for order size is 24,000 units, shall be ₹ 36,000 (24,000 units × ½ × ₹ 20 × 15%)

Advice: The total Cost is lower if Company accept an offer of 2% discount by the supplier, when supply of the annual requirement of material ‘X’ is made in 4 equal instalments.

Question 10.
SK Enterprise manufactures a special product “ZE”. The following particulars were collected for the year 2021:

Annual consumption	12,000 units (360 days)
Cost per unit	₹ 1
Ordering cost	₹ 12 per order
Inventory carrying cost	24%
Normal lead time	15 days
Safety stock	30 days consumption

Required:
(i) Re-order quantity
(ii) Re-order level
(iii) What should be the inventory materia] order is received?
Answer:
Annual demand (A) = 12,000 units
Ordering Cost (O) = ₹ 12
Carrying cost per unit per annum (c × i) = ₹ 1 × 24% = ₹ 0.24

(i) ROQ or EOQ = 2AOc×i−−−−√
= 2×12,000×₹12₹0.24−−−−−−−−−√ = 1,095.4 units or 1,100 units
= Safety stock + Normal lead time consumption
=1,000 + 500 = 1,500 units

(ii) ROL = Safety stock + Normal lead time consumption
= (12,000360 × 30) + (12,000360 × 15)
= 1,000 + 500 = 1,500 units

(ii) Inventory level required immediately before the material ordered is received i.e. safety stock
Safety Stock = [12,000360 × 30) = 1,000 units

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Question 11.
ABC Limited has received an offer of quantity discounts on its order of materials as under:

Price per tonne (₹)	Tonnes
4,800	Less than 50
4,680	50 and less than 100
4,560	100 and less than 200
4,440	200 and less than 300
4,320	300 and above

The annual requirement for the material is 500 Tonnes. The ordering cost per order is ? 6,250 and the stock holding is estimated at 25% of the material cost per annum.
Required:
(1) Compute the most economical purchase level.
(2) Compute EQQ if there are no quantity discounts and the price per tonne is ₹ 5,250. [CA Inter Nov. 2010, Nov. 2004, 5 Marks]
Answer:
(i) Calculation of most economical purchase level:
A = Annual requirement = 500 tonnes.

Since the total cost of 500 tonnes including ordering and carrying cost is minimum (? 23,32,437.50) when the order size is 300 tonnes. Therefore, the most economical purchase level is 300 Tonnes.

(ii) Calculation of EOQ, where no discount is available:
EOQ = 2AOc×i−−−−√=2×500×₹6,250₹5,250×0.25−−−−−−−−−√ = 69 tonnes

Question 12.
ZED Company supplies plastic crockery to fast food restaurants in met-ropolitan city. One of its products is a special bowl, disposable after initial use, for serving soups to its customers. Bowls are sold in pack 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 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.
Required:
(i) Calculate Economic Order Quantity.
(ii) Calculate number of orders needed every year.
(iii) Calculate the total cost of ordering and storage bowls for the year.
(iv) Determine when should the next order to be placed. Assuming that the company does maintain a safety stock and that the present inventory level is 333 packs with a year of 360 working days. [CA Inter May 2008, 8 Marks]
Answer:
Annual demand (A) = 40,000 packs
Ordering Cost (O) = ₹ 8
Carrying cost per unit per annum (c × i) = ₹ 40 × 10% = ₹ 4

(i) Economic Order Quantity:
EOQ = 2×40,000 packs ×₹8₹4−−−−−−−−−−−−√ = 400 packs

(ii) Number of orders per year =  Annual requirement  EOQ =40,000400 = 100 order

(iii) Ordering and storage costs:

Ordering costs (100 orders × ₹ 8)	₹ 800
Storage cost [(400 = 2) × ₹ 40 × 10%]	₹ 800
Total Cost	₹ 1,600

(iv) Timing of next order
(a) Day’s requirement served by each order.
Number of days requirement =  No. of working days  No. of order in a year 
= 360100 = 3.6 days supply
This implies that each order of 400 packs supplies for requirements of 3.6 days only.

(b) Days requirement covered by inventory
=  Units in inventory  Units required per day 
= 333 units 40,000 units 360 days  = 3 days requirement

(c) Time interval for placing next order
= Inventory left for day’s requirement – Lead time of delivery = 3 days – 3 days = 0 days
This means that the next order for the replenishment of supplies has to be placed immediately.

Question 13.
A company manufactures 5,000 units of a product per month. The cost of placing an order is ₹ 100. The purchase price of the raw material is ₹ 10 per kg. The Re-order period is 4-8 weeks. The consumption of Raw materials varies from 100 kgs. to 450 kg per week, the average consumption being 275 kg. The carrying cost of inventory is 20% per annum.
You are required to calculate:
1. Re-order quantity
2. Re-order level
3. Maximum level
4. Minimum level .
5. Average stock level. [CA Inter Nov. 2006, Nov. 2002, 10 Marks]
Answer:
Annual consumption of raw material (A) [275 kg. × 52 weeks] = 14,300 kg.
Cost of placing an order (O) = ₹ 100
Carrying cost per kg. Per annum (c × i) = ₹ 10 × 20% = ₹2
(i) Re-order Quantity (ROQ):
ROQ or EOQ = 2AOc×i−−−−√=2×14,300×₹100₹2−−−−−−−−−−√ = 1,196 kgs. (approx)

(ii) Re-order Level (ROL) = Maximum usage × Maximum re-order period
= 300 kg × 7 weeks = 2,100 kg.

(iii) Maximum Level = ROL + ROQ – (Minimum usage × Minimum re-order period)
= 2,100 kg. + 2,000 kg. – (200 kg. × 5 weeks)
= 3,100 kg.

(iv) Minimum Level = ROL – (Normal usage × Normal re-order period)
= 2,100 kg. – (250 kg. × 6 weeks)
= 600 kg.

(v) Average Stock Level = (Minimum level + Maximum level) = 2
= (600 kg. + 3,100 kg.) ÷ 2
= 1,850 kg.

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Question 14.
M/s. SJ Private Limited manufactures 20,000 units of a product per month. The cost of placing an order is ₹ 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.

You are required to calculate:
(i) Re-order quantity
(ii) Re-order level
(iii) Maximum level
(iv) Minimum level
(v) Average stock level [CA Inter Nov. 2018, 5 Marks]
Answer:
Annual consumption of raw material (A) [250 kg. × 52 weeks] = 13,000 kg.
Cost of placing an order (O) = ₹ 1,500
Carrying cost per kg. per annum (c × i) = ₹ 100 × 9.75% = ₹ 9.75

(i) Re-order Quantity (ROQ):
(ii) Re-order Level (ROL) = Maximum usage × Maximum re-order period
= 300 kg × 7 weeks = 2,100 kg.

(iii) Maximum Level = ROL + ROQ – (Minimum usage × Minimum re-order period)
= 2,100 kg. + 2,000 kg. – (200 kg. × 5 weeks)
= 3,100 kg.

(iv) Minimum Level = ROL – (Normal usage × Normal re-order period)
= 2,100 kg. – (250 kg. × 6 weeks)
= 600 kg.

(v) Average Stock Level = (Minimum level + Maximum level) = 2
= (600 kg. + 3,100 kg.) ÷ 2
= 1,850 kg.

Question 15.
Supreme Limited is a manufacturer of energy-saving bulbs. To manufacture the finished product one unit of component ‘LED’ is required. Annual requirement of component ‘LED’ is 72,000 units, the cost being ₹ 300 per unit. Other relevant details for the year 2020-2021 are:
Cost of placing an order ₹ 2,250
Carrying cost of inventory 12% per annum

Lead time:

Maximum	20 days
Minimum	8 days
Average	14 days
Emergency purchase	5 days

Consumption:

Maximum	400 units per day
Minimum	200 units per day
Average	300 units per day

You are required to calculate:
(i) Re-order quantity
(ii) Re-ordering level
(iii) Minimum stock level
(iv) Maximum stock level
(v) Danger level [CA Inter Nov. 2016, 5 Marks]
Answer:
Annual demand (A) = 72,000 units
Ordering Cost (0) = ₹ 2,250
Carrying cost per unit per annum (c × i) = ₹ 300 × 1296 = ₹ 36
(i) Re-order Quantity (ROQ):

(ii) Re-order Level (ROL) = Maximum usage × Maximum re-order period
= 400 units × 20 days
= 8,000 units

(in) Minimum Level = ROL – (Average usage × Average re-order period)
= 8,000 units – (300 units × 14 days)
= 3,800 units

(iv) Maximum Level = ROL + ROQ – (Minimum usage × Minimum re-order period)
= 8,000 units + 3,000 units – (200 units × 8 days)
= 9,400 units

(v) Danger Level = Average usage × Emergency delivery time
= 300 units × 5 days
= 1,500 units

Question 16.
POR Tubes Ltd. are the manufacturer of picture tubes for T.V. The following are the details of their operations during 2021-22:

Ordering cost	₹ 100 per order
Inventory carrying cost	20% p.a.
Cost of tubes	₹ 500 per tube
Normal usage	100 tubes per week
Minimum usage	50 tubes per week
Maximum usage	200 tubes per week
Lead time to supply	6-8 weeks

Required:
(i) Economic order quantity. If the supplier is willing to supply quarterly 1,500 units at a discount of 5%, is it worth accepting?
(ii) Re-order level
(iii) Maximum level of stock
(iv) Minimum level of stock. [CA Inter May 2000, 4 Marks]
Answer:
Annual demand (A) = 100 tubes × 52 = 5,200 tubes
Ordering Cost (O) = ₹ 100
Carrying cost per unit per annum (c × i) = ₹ 500 × 20% = ₹ 100
(i) Calculation of EOQ for material ‘X’:
EOQ = 2AOc×i−−−−√=2×5,200×₹100₹100−−−−−−−−−√ = 102 tubes (approx)

Evaluation of Cost under different options of ‘order quantity’

	When EOQ is ordered	When discount of 5% is accepted and quarterly order size is 1,500 units
Size of the order	102	1,500
No. of orders	50.98 (5,200 102)	3.47 (5,200 ÷ 1,500)
Total Purchase Cost	₹ 26,00,000 (5,200 × ₹ 500)	₹ 24,70,000 (5,200 × ₹ 475)
Total Ordering Cost	₹ 5,098 (50.98 orders × ₹ 100)	₹ 347 (3.47 orders × ₹ 100)
Total Carrying Cost	₹ 5,100 (102/2 × ₹ 500 × 20%)	₹ 71,250 (1,500/2 × ₹ 475 × 20%)
Total cost	₹ 26,10,198	₹ 25,41,597

Since, Total inventory cost is lower, if the re-order quantity is fixed at 1,500 units, so the discount offer should be accepted :

(ii) Re-order Level (ROL) = Maximum usage × Maximum re-order period ‘
= 200 tubes × 8 weeks
= 1,600 tubes

(iii) Maximum Level = ROL + ROQ – (Minimum usage × Minimum re-order period)
= 1,600 + 102 – (50 tubes × 6 weeks)
= 1,402 tubes

(iv) Minimum Level = ROL – (Average usage × Average re-order period)
= 1,600 – (100 tubes × 7 weeks)
= 900 tubes

Question 17.
A Lid. produces a product ‘X’ using a raw material ‘D’. To produce one unit of X, 4 kg. of D is required. As per the sales forecast conducted by the company, it will be able to sale 20,006 units of X in the coming year.
The following are the information related to the raw material D:
(i) The Re-order quantity is 400 kg. less than the Economic Order Quantity (EOQ).
(ii) Maximum consumption per day is 40 kg. more than the average consumption per day.
(iii) There is an opening stock of 2,000 kg.
(iv) Time required to get the raw materials from the suppliers is 4 to 8 days.
(v) The purchase price is ₹ 250 per kg.
There is an opening stock of 1,800 units of the finished product X.
The carrying cost of inventory is 14% p.a.
To place an order company has to incur ₹ 1,340 on paper and documentation work from the above information FIND OUT the followings in relation to raw material D:
(a) Re-order Quantity
(b) Maximum Stock level
(c) Minimum Stock level
(d) Calculate the impact on the profitability of the company by not ordering the EOQ
[Take 300 days for a year] [CA Inter RTP May, 2021]
Answer:
Working Notes:
(i) Computation of Annual consumption & Annual Demand for raw material ‘D’:

Sales forecast of the product ‘X’	20,000 units
Less: Opening stock of ‘X’	1,800 units
Fresh units of ‘X’ to be produced	18,200 units
Raw material required to produce 18,200 units of ‘X’( 18,200 units × 4 kg.)	72,800 kg.
Less: Opening Stock of ‘D’	2,000 kg.
Annual demand for raw material ‘D’	70,800 kg.

Annual demand of raw material ‘D’ (A) = 70,800 kg.
Ordering Cost (0) = ₹ 1,340
Carrying cost per unit per annum (c × i) = ₹ 250 × 14% = ₹ 35

(ii) Computation of Economic Order Quantity (EOQ):
EOQ = 2× Annual demand of D′× Ordering cost  Carrying cost per unit per annum −−−−−−−−−−−−−−−−−−−−−−−−√
= 2×70,800 kg.×₹1,340₹35−−−−−−−−−−−−−√
= 2,328 kg.

(iii) Re-Order level:
= (Maximum consumption per day × Maximum lead time)
= {(Annual Consumption of ‘D’/300 days + 40 kg.) × 8 days}
= {(70,800 kg./300 days + 40 kg.) × 8 days]
= 2,208 kg.

(iv) Minimum consumption per day of raw material ‘D’:
Average Consumption per day = 236 Kg.
Hence, Maximum Consumption per day = 236 kg. + 40 kg. = 276 kg.
So, Minimum consumption per day will be
Average Consumption = Min. consumption + Max. consumption/2
Or, 236 kg. = Min. consumption + 276 kg./2
Or, Min. consumption = 472 kg – 276 kg. = 196 kg.

(a) Re-order Quantity :
EOQ – 400 kg. = 2,328 kg. – 400 kg.
= 1,928 kg.

(b) Maximum Stock level:
= Re-order level + Re-order Quantity – (Min. consumption per day × Min. lead time)
= 2,208 kg. + 1,928 kg. – (196 kg. × 4 days)
= 4,136 kg. – 784 kg.
= 3,352 kg

(c) Minimum Stock level:
= Re-order level – (Average consumption per day × Average lead time)
= 2,208 kg. – (236 kg. × 6 days)
= 792 kg.

(d) Impact on the profitability of the company by not ordering the EOQ

	When purchasing the ROQ	When purchasing the EOQ
Order quantity	1,928 kg.	2,328 kg.
No. of orders in a year	70,800 kg/1,928 kg = 36.72 orders	70,800 kg/2,328 kg = 30.41 orders
Ordering Cost	36.72 orders × ₹ 1,340 = ₹ 49,204.8	30.41 orders × ₹ 1,340 = ₹ 40,749.4
Average Inven­tory            –	1,928 kg/2 = 964 kg.	2,328 kg/2 = 1,164 kg.
Carrying Cost	964 kg × ₹ 35 = f 33,740	1,164 kg. × ₹ 35 = ₹ 40,740
Total Cost	₹ 82,944.8	₹ 81,489.4

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Question 18.
Following details are related to a manufacturing concern:

Re-order Level	1,60,000 units
Economic Order Quantity	90,000 units
Minimum Stock Level	1,00,000 units
Maximum Stock Level	1,90,000 units
Average Lead Time	6 days

Difference between minimum lead time and Maximum lead time 4 days
Calculate:
(i) Maximum consumption per day
(ii) Minimum consumption per day [CA Inter Nov. 2014, 5 Marks]
Answer:
Difference between Minimum lead time and Maximum lead time = 4 days
Max. lead time – Min. lead time = 4 days
Or, Max. lead time = Min. lead time + 4 days ………….(i)
Average’ lead time is given as 6 days i.e.
 Max. lead time + Min. lead time 2 = 6 days ………..(ii)
Putting the value of (i) and (ii)
 Max. lead time +4 days + Min. lead time 2 = 6 days
Or, Min. lead time + 4 days + Min. lead time =12 days
Or, 2 Min. lead time = 8 days
Or, Minimum lead time = 4 days
Therefore, Maximum lead time = 4 days + 4 days = 8 days

(i) Maximum consumption per day:
Re-order level (ROL) = Max. Re-order period × Maximum Consumption per day
1,60,000 units = 8 days × Maximum Consumption per day
Or, Maximum Consumption per day = 1,60,0008 days  = 20,000 units

(ii) Minimum Consumption per day:
Maximum Stock Level = ROL + ROQ – (Min. lead time × Min. Consumption per day)
Or, 1,90,000 units = 1,60,000 units + 90,000 units – (4 days × Min. Consumption per day)
Or, 4 days × Min. Consumption per day = 2,50,000 units – 1,90,000 units
Or, Minimum Consumption per day = 1,60,0004 days  = 15,000 units

Question 19.
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:
(i) How much the company’s cost would be saved by opting EOQ model?
(ii) The Re-order point under EOQ model if lead time is 12 days.
(iii) How frequently should orders for procurement be placed under EOQ model? [CA Inter Nov. 2020, 8 Marks]
Answer:
Annual demand (A) = 27,000 spare parts
Ordering Cost (O) = ₹ 240
Carrying cost per unit per annum (c × i) = ₹ 50 × 12.5% = ₹ 6.25
EOQ = 2×27,000×₹240₹6.25−−−−−−−−−−√ = 1,440 spare parts

(i) Calculation of saving by opting EOQ:

	Existing Order policy	EOQ Model
No. of orders	9 (27.000 4- 3,000)	18.75 or 19 (27,000 ÷ 1,440)
Ordering Cost (₹)	2,160 (9 × ₹ 240)	4,500 [(27,000 ÷ 1,440) × 240]
Carrying cost (₹)	₹ 9,375 (3,000 units × ½ × ₹ 50 × 12.5%)	₹ 4,500 (1,440 units × ½  × ₹ 50 × 12.5%)
Total cost (₹)	11,535	9,000

Savings of Cost by opting EOQ Model = ₹ 11,535 – ₹ 9,000 = ₹ 2,535

(ii) Re-order point under EOQ:
ROL = Maximum consumption × Maximum lead time
Consumption per day = 27,000 ÷ 360 days = 75 units
ROL = 75 units × 12 days = 900 units

(iii) Frequency of Orders (in days) = 360 days ÷ No. of orders per year
= 360 days ÷ 19 = 18.95 or 19 days

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Question 20.
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 hours. You are required to calculate the re-order level of material ‘X’. [CA Inter May 2010, 2 Marks]
Answer:
Maximum Level = Re-order level ÷ Re-order Quantity – (Min. usage × Min. Re-order Period)
Re-order Level = Maximum Level – [Re-order Quantity – (Min. usage × Min. Re-order Period)
= 8,000 kg. – [5,000 kg. – (400 kg* × 4 days)]
= 8,000 kg. – 3,400 kg. = 4,600 kg.
Hence, Re-order level is 4,600 kg.
Minimum usage per day = 50 kg. × 8 hours = 400 kg.

Question 21.
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.
You are required to calculate:
(i) Economic Order Quantity for material ‘Rex’.
(ii) Re-order Level
(iii) Maximum Stock Level
(iv) Average Stock Level [CA Inter Nov. 2013, 5 Marks]
Answer:
Annual demand (A) = 60,000
Ordering Cost (O) = ₹ 800
Carrying cost per unit per annum (c × i) = ₹ 10 × 15% = ₹ 1.50

(ii) Re-order Level = Safety Stock + [Normal daily Usage × Reorder period]
= 600 units + [(60,000 units × 300 days) × 10 days]
= 2,600 units

(iii) Maximum stock level = E.O.Q (Re-order Quantity) + Safety Stock
= 8,000 units + 600 units
= 8,600 units

(iv) Average stock level = (Minimum level* + Maximum level) × 2
= (600 units + 8,600 units) × 2
= 4,600 units
‘Minimum Level = Safety stock level = 600 units

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Question 22.

The quarterly production of a company’s product which has a steady market is 20,000 units. Each unit of a product requires 0.3 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 materials is maintained by the company. The company has been able to negotiate the following discount structure with the raw material supplier:

Order quantity (kg)	Discount (₹)
Up to 6,000	NIL
6,1 – 8,000	400
8.1 – 16,000	2,000
16.1 – 30,000	3,200
30.1 – 45,000	4,000

You are required to:
(i) Calculate the re-order point taking 30 days in a month.
(ii) Prepare a statement showing the total cost of procurement and storage of rawr material after considering the discount of the company elects to place one, two, four or six orders in the year.
(iii) State the number of orders which the company should place to minimize the costs after taking EOQ also into consideration. [CA Inter May 2002, 8 Marks]
Answer:
Annual production of the product (₹ 20,000 units per quarter × 4 quarters) = 80,000 units
Annual requirement of the raw material (A) (80,000 units × 0.5 kg. per unit) = 40,000 kgs.
Ordering Cost (O) = ₹ 100
Carrying cost per unit per annum (c × i) = ₹ 2
EOQ = 2×40,000×₹100₹2−−−−−−−−−−√ = 2,000 kgs.

Total Cost at EOQ level:

ORDERING COST ( [40,000 DIVIDED BY 2000]* 100)        2000

CARRYING COST  [ (2000 DIVIDED BY 2) * 2 ]                      2000

                                                                                                         4000

(i) Re-order level or point = Safety stock + Lead time consumption
= 1,000 kg + [(40,000 ÷ 360 days) × 36 days]
= 1,000 kg + 4,000 kg
= 5,000 kg.

(ii) Statement showing the total cost of procurement and storage of raw materials:

(iii) Number of orders which the company should place to minimize the costs after taking EOQ also into consideration is 20 orders each of size 2,000 kg. The total cost of procurement and storage in this case comes to ₹ 4,000, which is minimum.

Question 23.
IPL Ltd uses a small casting in one of its finished products. The casting is purchased from a foundry. IPL Ltd 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-days-per-year basis. The company estimates that it costs ₹ 9000 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 tabulation:

(i) Compute the Economic Order Quantity (EOQ).
(ii) Assume the company is willing to assume a 15% risk of being out of stock. What would be the safety stock? The re-order point?
(iii) Assume the company is willing to assume a 5% risk of being out of stock. What would be the safety stock? The re-order point?
(iv) Assume 5% stock-out risk. What would be the total cost of ordering and carrying inventory for one year?
(v) Refer to the original data. Assume that using process re-engineering the company reduc & its cost of placing a purchase order to only ? 600. In addition, 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 the new EOQ
(b) How frequently would the company be placing an order, as compared to the old purchasing policy? [CA Inter May 2004, 9 Marks]
Answer:
(i) Computation of Economic Order Quantity (EOQ)
A = Annual Usage = 54,000 castings
O = Ordering cost per order = ₹ 9,000
C = Carrying cost per unit = ₹ 300
EOQ = 2AOC−−−−√
= 2×54,000×₹9,000₹300−−−−−−−−−−−√
= 1,800 castings.

(ii) Safety Stock (Assuming a 15% risk of being out of stock)
Safety stock for one day = 54,000/360 days = 150 castings. .
Re-order point = Minimum stock level + (Average lead time × average usage)
=150 + (6 × 150)
= 1,050 casting.

(iii) Safety stock (Assuming a 5% risk of being out of stock)
Safety stock for 3 days = 150 × 3 days = 450 castings.
Re-order Point = 450 castings + 900 casting = 1, 350 castings

(iv) Total cost of ordering = (54,000/1,800) × ₹ 9,000
= ₹ 2,70,000
Total cost of carrying = (450 + 1,800/2) × ₹ 300
= ₹ 4,05,00

(v) Computation of new EOQ
Total number of orders to be placed in a year will be 180 (54,000/300).
Each order is to be placed after 2 days (as year = 360 days).
Under old purchasing policy each order is placed after 12 days.

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Question 24.
Imbrios India Ltd. is recently incorporated start-up company back in the year 2019. It is engaged in creating Embedded products and Internet of Things (IoT) solutions for the Industrial market. It is focused on innovation, design, research and development of products and services. One of its embedded products is LogMax, a system on module (SoM) Carrier board for industrial use. It is a small, flexible and embedded computer designed as per industry specifications. In the beginning of the month of September 2021, company entered into a job agreement of providing 4800 Log Max to NIT, Mandi. Following details w.r.t. issues, receipts, returns of Store Department handling Micro-controller, a component used in the designated assembling process have been extracted for the month of September, 2021:

Sep. 1	Opening stock of 6,000 units @ ₹ 285 per unit
Sep. 8	Issued 4875 units to mechanical division vide material requisition no. Mech 009/20
Sep. 9	Received 17,500 units @ ₹ 276 per unit vide purchase order no. 159/2020
Sep. 10	Issued 12.000 units to technical division vide material requisition no. Tech 012/20
Sep. 12	Returned to stores 2375 units by technical division against material requisition no. Tech 012/20.
Sep. 15	Received 9,000 units @ ₹ 288 per units vide purchase order no. 160/ 2020
Sep. 17	Returned to supplier 700 units out of quantity received vide purchase order no.160/2020.
Sep, 20	Issued 9,500 units to technical division vide material requisition no. Tech 165/20

On 25th September, 2021, the stock manager of the company expressed his need to leave for his hometown due to certain contingency and immediately left the job same day. Later, he also switched his phone off.
As the company has the tendency of stock-taking every end Of the month to check and report for the loss due to rusting of the components, the new stock manager, on 30th September, 2021, found that 900 units of Micro-controllers were missing which was apparently misappropriated by the former stock manager. He, further, reported loss of 300 units due to rusting of the components.
From the above information you are required to prepare the Stock Ledger account using ‘Weighted Average’ method of valuing the issues. [ICAI Module]
Answer:
Store Ledger of Imbrios India Ltd. (Weighted Average Method)

* Abnormal loss of 900 units is to be transferred to Costing Profit &Loss A/c,
** Normal loss of 300 units is to be absorbed by good units.

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Question 25.
M/s XYZ Traders is a distributor of an electronic calculator. A periodic inventory of electronic calculator on hand is taken when books are closed at the end of each quarter. The following summary of information is available for the quarter ended on 30th September, 2021:
Sales ₹ 1,46,20,000
Opening Stock 25,000 calculator @ ₹ 200 per calculator
Administrative Expenses ₹ 3,75,000

Purchases (including freight inward):

• July 1, 2021 50,000 calculator @ ₹ 191 per calculator
• September 30, 2021 25,000 calculator@ ₹ 210percalculator

Closing stock- September 30, 2021 32,000 calculator
You are required to compute the following by WAM (Weighted Average Method), FIFO method and LIFO method.
(i) Value of Inventory on 30th September, 2021.
(ii) Profit or loss for the quarter ended on 30th September, 2021. [CA Inter Nov. 2019, 8 Marks]
Answer:
(i) Computation of Value of Inventory as on 30th September 2021:

Weighted average rate = ₹50,00,000+₹95,50,000+₹52,50,00025,000+50,000+25,000 = ₹ 198

(ii) Computation of Profit or Loss for the Quarter ended on 30th September 2021

	WAM (₹)	FIFO (₹)	LIFO (₹)
Sales Less: Consumption	1.46.20.000 1.34.64.000	1.46.20.000 1.32.13.000	1.46.20.000 1.34.63.000
Less: Administrative Exp.	3,75,000	3,75,000	3,75,000
Profit or Loss	7,81,000	10,32,000	7,82,000

Note: It is assumed that the issue/consumption pattern was even throughout the quarter.

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Question 26.

Arnav Electronics manufactures electronic home appliances. It follows weighted average Cost method for inventory valuation. Following are the data of component X:

*GRN- Goods Received Note; **MRN- Material Returned Note
Based on the above data, you are required to calculate:
(i) Re-order level
(ii) Maximum stock level
(iii) Minimum stock level
(iv) Prepare Store Ledger for the period January, 2021 and determine the value of stock as on 31-01-2021.
(v) Value of components used during the month of January, 2021.
(vi) Inventory turnover ratio. [CA Inter May 2020, RTP]
Answer:
Workings:
Consumption is calculated on the basis of material requisitions:
Maximum component usage = 4,500 units (Material requisition on 10-01-2021) Minimum component usage = 1,500 units (Material requisition on 24-01-2021) Lead time is calculated from purchase order date to material received date Maximum lead time = 21 days (15-12-2020 to 05-01-2021)
Minimum lead time = 14 days (30-12-2020 to 13-01-2021)
Calculations:
(i) Re-order level
= Maximum usage × Maximum lead time
= 4,500 units × 21 days
= 94,500 units

(ii) Maximum stock level
= Re-order level + Re-order Quantity – (Min. Usage × Min. lead time)
= 94,500 units + 10,000 units – (1,500 units × 14 days)
= 1,04,500 units – 21,000 units
= 83,500 units

(iii) Minimum stock level
= Re-order level – (Avg. consumption × Avg. lead time)
= 94,500 units – (3,000 units × 17.5 days)
= 94,500 units – 52,500 units
= 42,000 units

(iv) Store Ledger for the month of January 2020:

Value of stock as on 31-01-2021 (‘000) = ₹ 1,39,001

(v) Value of components used during the month of January, 2021:
Sum of material requisitions 011 to 016 (‘000)
= ₹ 29,694 + ₹ 44,541 + ₹ 21,611 + ₹ 14,734 + ₹ 39,156 + ₹ 31,325
= ₹ 1,81,061

(vi) Inventory Turnover Ratio
= Value of materials used/Average stock value
= ₹ 1,81,061/₹ (1,39,001 + 34,335)/2
= ₹ 1,81,061/₹ 86,668
= 2.09