Cost Associated with Material

Purchase Ordering
• Purchase price • Documents
• All cost incurred in them to present • Delivery
location and condition

Holding Stock-out (NOT HAVING INVENTORY)

• Rent • Opportunity cost
• Damaged • Goodwill
• Theft
• Obsolete (out of date)
• Expired (not usable)

We should keep these costs as low as possible

There is one technique that will make these cost lower

Especially the cost of Ordering and Holding
How much to order at a time?
Ordering Quantity

Economic Ordering Quantity (EOQ) (or compare)

The cost of holding and ordering are inversely related the decrease in one causes increase in another
For example the less you order the more orders you have to make (to decrease holding cost ordering
cost will increase)

The more units you order the less orders you have to make (to Decrease cost of ordering cost of holding
will increase)
The confusion is how many units to order exactly

Inversely Related : The increase of one cause the decrease in another

increase of cold causes decrease in ice-cream sold
Directly Related: The increase in one causes increase in another
Increase in heat cause increase in ice-cream sold

CH CO

Accounting fo Material Page 1

 Given in exam

CO= Cost per order= $80/order

D= Annual demand = 2500
CH= Cost of holding/unit/year= $15/unit/year

((2*80*2500)/15))= 163 meaning that we should order 163 units

every time

2500/163=15.3374 orders

Accounting fo Material Page 2

 Co=$10
Ch= $.10*12=$1.2/unit/year
D=5400unit

((2*10*5400)/1.2))=300

Total Cost of Holding TCH 200

Total cost of holding ( TCH)
Average inventory *CH
Average Inventory
Average inventory= OQ/2 200/2=100 units
100*$1.2=$120
300/2=150

150*$1.2=$180 TCH Total cost of holding (TCO)

Orders
Total Cost of Order TCO 5400/200=27 orders

Orders * CO 27*$10=$270.

Orders = D/OQ
$120+$270=$390
5400/300=18 orders
360
18*$10=$180 TCO
TCH 360/2*$1.2=$216
TCO 5400/360*$10=$150

Total cost 216+150=366

180+180=360

Accounting fo Material Page 3

 (B)

((2*32*1800)/4.5))=160

Assume there was no bulk discount

160 300

TCH 160/2*$4.5=$360 TCH 300/2*$4.5=$675

TCO 1800/160*$32=$360.00 TCO 1800/300*$32=$192
Purchase 1800*$25=$45000 Purchase 1800*$25=$45000.00
Total $360+$360+$45000=$45720 Total $675+192+$45000=$45867

Now let's consider discount

160
TCH 160/2*$4.5=$360 TCH 300/2*$4.5*98%=$661.5
TCO 1800/160*$32=$360.00 TCO 1800/300*$32=$192
Purchase 1800*$25=$45000 Purchase 1800*$25*98%=$44100
Total $360+$360+$45000=$45720 Total 661.5+192+44100=44953.5

45720-44953.5=766.5 less with bulk discount

We should always go with the EOQ but if there is change in purchases price or any
other cost because of quantity then we have to compare which gives us the lowest
cost

Accounting fo Material Page 4

 When to order?
Reorder Level
The point in inventory level where the order is placed ( To avoid Stock out)

Why does stock out happen?

Main Reasons
1 Demand is more than expected.
2 Delivery of goods arrived late.

Reorder Level = Maximum Demand X Maximum Lead Time

(12+18)/2=15

95*18=1,710 ( C )
When inventory decreases to this level we should place an order

If inventory at any point is more than 2860 then it is not

good management

How much is too much inventory?

Maximum Inventory

This is the high level that inventory should not cross

Why inventory would be too much?

Reason

1 Demand was minimum

2 Order arrived earliest

Reorder level-(Min demand* Min Time)+OQ

1710 -(50 *12) +1750=2860

Accounting fo Material Page 5

 How much is too little?

Minimum Level

This is the low level that inventory shouldn't decrease from.

If It does find contingencies( Alternative).

Reorder Level -(Average use x Average time)

1710 -(75 * 15)=585

How much to order : Ordering Quantity 1750

When to order: Reorder Level 1710
How much is too much : Maximum Level 2860
How much is too little : Minimum Level 585

2860

1710

585

Accounting fo Material Page 6

 (A)

Physical Inventory= Free inventory+ Customer orders - Supplier orders

physical

Free Inventory= Inventory available for sales

Physical Inventory - Customer orders + Suppliers orders = Free Inventory

1750 -16250 + 27500 = 13000

Physical Inventory: Inventory physically available in warehouse

Free inventory+ Customer orders - Supplier orders = Physical Inventory

13000 +16250 -27500 = 1750 (A )

On Customer orders: Inventory that we have sold but not yet taken by customers

Physical Inventory + Supplier Orders - Free inventory = Customer orders

1750 +27500 -13000 = 16250

On Supplier Order: Inventory bought but not yet arrived (on the way )

Customer orders - Physical Inventory +Free inventory =Supplier Orders

16250 -1750 +13000 = 27500

Accounting fo Material Page 7

 Safety/Buffer Stock: Inventory kept in separate location for emergencies not used regularly

(D)

( D)

15*10%=1.5

((2*20*12500)/1.5))=577 ( A)

When CO reduce= OQ reduce= Avg inventory reduce= Ch reduce

(D)

(10+15)/2=12.5

(C )

Reorder Level
Max use * Max time 14000
520*15=7,800
7800
Maximum Level
Reorder Level-(Min Use*Min Time) + OQ 2800
7800-(180*10)+8000=14000

Minimum Level
Reorder Level-(Avg Use*Avg Time)
7800-(400*12.5)=2800

Accounting fo Material Page 8

 500+(2000/2)=1500 average inventory
1500*$2=$3000 ( C)

.10*12=1.2

((2*10*5400)/1.2)=300 (D )

Buffer stock+(OQ/2)= Average Inventory

Reverse the formula

Average Inventory *CH

?+(6000/2)=3400
3400-3000=400 (A)
To prove
400+(6000/2)=3400
In question 6.12

?+(2000/2)=1500 average inventory

1500-1000=500

Accounting fo Material Page 9

 ((2*100*1225)/8)=175 (A )

Re-order Level = 130*26=3,380

(20+26)/2=23 Max level

Reorder Level-(Min use* min time) +OQ
3380 -(60 *20 )+4000=6180 ( B )

Min Level
3380-(23*100)=1080

1250000/.00125=31623 ( C )
(2*125*5000)/.0025*(1-5000/10000))

( C)

Accounting fo Material Page 10

 R=4000
D=2000
Co=50
Ch=.001

((2*50*2000)/.001*(1-2000/4000)) 200000/.0005 =20000

R=4000 20000/4000=5
D=2000
Co=$50
Ch=$.001
1) 4000-2000=2000
2) 2000+4000-2000=4000
3) 4000+4000-2000=6000
4) 6000+4000-2000=8000
5) 8000+4000-2000=10000
6) 10000-2000=8000
7) 8000-2000=6000
8) 6000-2000=4000
9) 4000-2000=2000
10) 2000-2000=0
11) 4000-2000=2000
12) 2000+4000-2000=4000
13) 4000+4000-2000=6000
14) 6000+4000-2000=8000
15) 8000+4000-2000=10000
16) 10000-2000=8000
17) 8000-2000=6000
18) 6000-2000=4000
19) 4000-2000=2000
20) 2000-2000=0

Accounting fo Material Page 11

Documents

Material Requisition Note : To request materials (mostly from store)

Material Transfer Note : To evidence transfer of material

Purchase Requisition Note : To request purchase of material (mostly to purchasing/procurement department )

Request for Quotation (RFQ) : Asking suppliers to send their quotations

Quotation: A price list

Estimate: An estimate of total cost

Purchase Order : To request sales (to supplier)

for customer

Sales Order: To request sales (from customer)

for supplier

Goods Delivery Note (GDN): A confirmation that goods have been delivered

Goods Received Note (GRN): A confirmation that goods have been Received

Invoice/Bill: Shows how much payment has to be made for a transactions (for credit sales)

Sales Receipt: shows that payment for a sale has been received ( for cash sales)

Remittance Advice: States reasons for payments

Credit Note/(memo): It shows that receivables has been credited (decrease) Dr Sales Cr TR

Debit Note/(memo): It shows that payables has been debited (decrease) DR TP Cr Purchases

Accounting fo Material Page 12

 Choose
between
them

Accounting fo Material Page 13

Accounting fo Material Page 14
Find reorder level
Minimum level
Maximum level

Accounting fo Material Page 15