TABANI’S SCHOOL OF ACCOUNTANCY

COST AND MANAGEMENT ACCOUNTING

INVENTORY MANAGEMENT

MATERIAL
• Costs of ordering stocks include the following:

✓ Preparation of purchase order.

✓ Costs of receiving goods.
✓ Documentation processing costs.
✓ Transport costs
✓ Intermittent costs of chasing order, rejecting faulty goods.
✓ Additional costs of frequent or small quantity orders.
✓ Where goods are manufactured internally, the set up and tooling costs associated with
each production run.

• Costs of carrying stocks include the following:

✓ Storage costs (rent, lighting, heating, refrigeration, air-conditioning etc.)

✓ Stores staffing, equipment maintenance and running costs.
✓ Handling costs.
✓ Audit, stock taking or perpetual inventory costs.
✓ Required rate of return on investment in current assets.
✓ Obsolescence and deterioration costs.
✓ Insurance and security costs.
✓ Costs of money tied up in inventory.
✓ Pilferage and damage costs.

• Stock-out costs: There are the costs associated with running out of stock. The avoidance of
these cots is the basic reason why stocks are held in the first instance. These costs include the
following:

✓ Lost contribution through the lost sale caused by the stock-out.

✓ Loss of future sales because customers go elsewhere.
✓ Loss of customer goodwill.
✓ Cost of production stoppages caused by stock-outs of WIP or raw material.
✓ Labour frustration over stoppages.
✓ Extra costs associated with urgent, often small quantity, replenishment purchases.

Inventory levels: The following levels of inventory are fixed for efficient management of inventory:

➢ Re-order level: Re-order level is the level of stock availability when a new order should be
raised. The stores department will initiate the purchase of material when the stock of material
reaches at this point. This level is fixed between the minimum and maximum stock levels and
he following formulae are useful for this purpose:

Re-order level = Maximum Usage × Maximum lead time.

➢ Minimum stock level: Minimum stock level is he lower limit below which the stock of any
stock item should not normally be allowed to fall. Their level is also called safety stock or
buffer stock level. The main object of establishing this level is to protect against stock-out of a
particular stock item and in fixation of which average rate of consumption and the time
required for replenishment i.e., lead time are given prime consideration.

Minimum stock level = level Re-order – (Average or Normal usage × Average OR Normal lead
time)

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TABANI’S SCHOOL OF ACCOUNTANCY
COST AND MANAGEMENT ACCOUNTING

➢ Maximum Stock level: Maximum stock level represents the upper limit beyond which the
quantity of any item is not normally allowed to rise to ensure that unnecessary working capital
is not blocked in stock items. Maximum stock level will be fixed sum. It represents the total of
safety stock level and economic order quantity. Maximum stock level can be expressed in the
formula given below:

Maximum level = Re-order level + Economic order quantity - (Minimum usage × Minimum
lead time)
Q.1. Karachi Limited is a large retailer of sports goods. The company buys footballs from a supplier
in Sialkot. Karachi Limited uses its own truck to pick the footballs from Sialkot. The truck
capacity is 2,000 footballs per trip and the company has been getting a full load of footballs at
each trip, making 12 trips each year.

Recently the suppliers revised its prices and offered quantity discount as under:

Quantity Unit price (Rs.)

2,000 400
3,000 390
4,000 380
6,000 370
8,000 360

Other related data is given below:

• All the purchases are required to be made in lots of 1,000 footballs.
• The cost of making one trip is Rs.15,000. The company has the option to hire a third
party for transportation which would charge Rs.9 per football.
• The cost of placing an order is Rs.2,000.
• The carrying cost of the one football for one year is Rs.80.
Required:
(i) Work out the most economical option.
(ii) Compute the annual savings in case the company revises its policy in accordance with the
computation in (i) above. (10)

Q.2. Hexa (Private) Limited is engaged in the supply of a specialized tool use in the automobile
industry. Presently, the company is incurring high cost on ordering and storage of inventory.
The purchase department has tried different order levels but has not been able to satisfy the
management. The Financial Officer has asked you to evaluate the current situation. He has
provided you the following information:

(i) The annual usage of inventory is approximately 8,000 cartons. The supplier does not
accept orders of less than 800 cartons. The cost of each carton is Rs.2,186.
(ii) The average cost of placing an order is estimated at Rs.14,000 and presently two orders
are placed in each quarter.
(iii) The sales are made on a regular basis and on average, half of the quantity ordered is
held in inventory. The cost of storage is considered to be 16% of the value of
inventory.
Required:
a) Determine the following
- Economic order quantity (EOQ)
- Number of orders to be placed, based on EOQ.
b) Compute the ordering costs and storage costs in the existing situation. How much cost can
be saved if quantity ordered is equal to EOQ as determined in (a) above
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TABANI’S SCHOOL OF ACCOUNTANCY
COST AND MANAGEMENT ACCOUNTING

Q.3. Omega Limited is a manufacturer producing various items. One of its main products has a
constant monthly demand of 20,000 units. The production of this product requires two kg of
chemical A. the cost of the chemical is Rs.5/- per kg. the supplier of the chemical takes six days
to deliver the same from the date of the order. The ordering cost is Rs.12 per order and the
holding cost is 10% per annum.

Required:
(a) Calculate the following:
(i) The economic order quantity,
(ii) The number of orders required per year
(iii) The total cost of ordering and holding the chemical A for the year.
(b) Assuming that there is no safety stock and that the present stock level is 4,000 kg, when
should the next order be placed?
(c) Assuming that a safety stock of 4,000 kg of chemical is maintained, what will the holding
cost per year?
(d) Discuss the problems which most firms would have in attempting to apply the EOQ
formula.

Q.4. CTC Juice Limited purchases 25,000 liters of material each year from a single supplier. At the
moment the company obtains the material in batches of 800 liters. The materials cost is Rs.16
per liter, the cost of ordering a new batch form supplier is Rs.32 and the cost of holding one
litre in stock is Rs.4/- per annum plus an interest cost equal to 15% of the purchase price of the
material.

Required: Suggested the Economic Ordering Quantity and the annual saving if this order
quantity is replaced with the current order size.

Q.5. National Fibre Company manufacturing Fibre glass used in the communication industry. The
company is currently revising the production process. The chemical is purchased in 10 pounds
containers for Rs.100 each. The firm uses 4,800 containers per year. The controller estimates
that it costs the company Rs.150/- to place an order of chemical ‘X’. The annual cost of storing
chemical ‘X’ is Rs.4/- per container.

Required:
(a) Determine the economic order quantity using the formula.
(b) Prepare a table showing the total annual cost of ordering and storing chemical ‘X’ for each
of the following quantities.
400,600 & 800 containers
(c) How many orders will be placed per year.

Q.6. The ABC Company’s annual requirement for 1990 of ‘V’ Belt is estimated at 50,000 units. The
per unit cost is Rs.16. The estimated carrying cost is 25% of average inventory investment and
the cost to place an order is Rs.10.

Required:
(i) To calculate the most economical order quantity.
(ii) Number of orders to the placed per year.
(iii) The frequency in days that orders should be placed on 365 days a year.

Q.7. Hamid Construction Company has been buying a given item in Lots of 1,200 units which is
sufficient for six months need. Cost per order is Rs.100 per unit cost is Rs.12 and carrying cost
is 25%.

Required:
Savings by buying in Economic order quantities.
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TABANI’S SCHOOL OF ACCOUNTANCY
COST AND MANAGEMENT ACCOUNTING

Q.8. Chocó-king Limited (CL) produces and markets various brands of chocolates having annual
demand of 80,000 kg. The following information is available in respect of coco powder which
is the main component of the chocolate and represents 90% of the total ingredients.
(i) Cost per kg is Rs. 600.
(ii) Process losses are 4% of the input.
(iii) Purchase and storage costs are as follows:
▪ Annual variable cost of the procurement office is Rs. 6 million. The total number
of orders (of all products) is estimated at 120.
▪ Storage and handling cost is Rs. 20 per kg per month.
▪ Other carrying cost is estimated at Rs. 5 per kg per month.
(iv) CL maintains a buffer stock of 2,000 kg.
Required:
(a) Calculate economic order quantity. (07)
(b) A vendor has offered to CL a quantity discount of 2% on all orders of minimum of 7,500
kg. Advise CL, whether the offer of the vendor may be accepted. (06)
Q.9. Eastern Limited purchases product Shine for resale. The annual demand is 10,000 units which
is spread evenly over the year. The cost per unit is Rs.160. Ordering costs are Rs.800 per order.
The suppliers of Shine are now offering quantity discounts for large orders as follows.
Ordered Quantity Unit price
Rs.
Upto 999 units 160.00
1000 to 1999 units 158.40
2000 or more units 156.80
The purchasing manager feels that full advantage should be taken of discounts and purchases
should be made at Rs.156.80 per unit, using orders for 2000 units or more.
Holding costs for Shine are calculated at Rs.64 per unit per year, and this figure will not be
altered by any change in the purchase price per unit.
Required: Advise Eastern Limited about the best choice available to them.
Q.10. Hockey Pakistan Limited (HPL) is engaged in the manufacturing of a single product ‘H-2’
which requires a chemical ‘AT’. Presently, HPL follows a policy of placing bulk order of
60,000 kg of AT. However, HPL’s management is presently considering to adopt economic
order quantity model (EOQ) for determining the size of purchase order of AT.
Following information is available in this regard:
(i) Average annual production of H-2 is 45,600 units. Production is evenly distributed
throughout the year.
(ii) Each unit of H-2 requires 10 kg of AT. Cost of AT is Rs. 200 per kg. 5% of the
quantity purchased is lost during storage.
(iii) Annual cost of procurement department is Rs. 2,688,000. 65% of the cost is variable.
(iv) AT is stored in a third party warehouse at a cost of Rs. 6.25 per kg per month.
(v) HPL’s cost of financing is 8% per annum.
Required:
(a) Calculate economic order quantity. (06)
(b) Supplier of AT has offered a discount of 5% quantity per order is increased to 120,000
kg. Advise whether HPL should accept the offer. (06)
(c) Discuss any three practical limitations of using the EOQ model. (03)
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TABANI’S SCHOOL OF ACCOUNTANCY
COST AND MANAGEMENT ACCOUNTING

Q.11. Khan Limited (KL) imports and sells a product ‘AA’. KL is faced with a situation where lead
time is mostly predictable i.e. 1 month but lead time usage varies quite significantly. Data
collected for past three years shows that probability for lead time usage is as follows:

No. of units demanded Probability of demand

during lead time during lead time (%)
1,000 30
660 50
450 20

Other relevant information is as follows:

(i) Annual demand is 8,640 units.

(ii) Contribution margin is Rs. 40 per unit.
(iii) Purchase orders are raised on the basis of economic order quantity model. Annual
holding cost is Rs. 100 per unit whereas average cost of placing an order is Rs.6,750.

Required:
Determine at which of the following re-order levels, KL’s profit would be maximised:
▪ 1,000 units
▪ 450 units
▪ Expected demand during lead time (17)

Q.12. Quality Limited (QL) is a manufacturer of washing machines. The company uses perpetual
method for recording and weighted average method for valuation of inventory.

The following information pertains to a raw material (SRM), for the month of June 2010.

(i) Opening inventory of SRM was 100,000 units having a value of Rs. 80 per unit.
(ii) 150,000 units were purchased on June 5, at Rs. 85 per unit
(iii) 150,000 units were issued from stores on June 6.
(iv) 5,000 defective units were returned from the production to the store on June 12.
(v) 150,000 units were purchased on June 15 at Rs. 88.10 per unit.
(vi) On June 17, 50% of the defective units were disposed off as scrap, for Rs.20 per
unit, because these had been damaged on account of improper handling at QL.
(vii) On June 18, the remaining defective units were returned to the supplier for
replacement under warranty.
(viii) On June 19, 5,000 units were issued to production in replacement of the defective
units which were returned to store.
(ix) On June 20, the supplier delivered 2,500 units in replacement of the defective units
which had been returned by QL.
(x) 150,000 units were issued from stores on June 21.
(xi) During physical stock count carried out on June 30, 2010 it was noted that closing
inventory of SRM included 500 obsolete units having net realizable value of Rs.30 per
unit. 4,000 units were found short.

Required:
Prepare necessary journal entries to record the above transactions. (15)

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TABANI’S SCHOOL OF ACCOUNTANCY
COST AND MANAGEMENT ACCOUNTING
Autumn 2020 Q.2

Q.13. Pizza Inc. has pizza outlets in all major shopping malls in the city. It prepares and sells
approximately 4,850 standard pizzas per week. A premium quality imported cheese (cheese),
the key ingredient for pizza preparation is purchased from a supplier at Rs. 1,200 per kg. Other
costs related to cheese are as follows:

Rupees
Administration cost per order 150,000
Transportation cost per order 22,500
Quality inspection cost per order 20,000
Refrigeration cost per kg 250
Warehouse cost per annum 4,420,000

Cost of financing the stock per month 1.5%

Other information:
(i) The company places orders on the basis of Economic Order Quantity (EOQ).
(ii) Each standard size pizza requires 0.25 kg of cheese. However, 3% of cheese is lost in
refrigeration.
(iii) 80% of administration cost and 50% of warehouse cost are variable. All other costs are fixed.
(iv) The company operates throughout the year which is 52 weeks.
The supplier has offered to reduce 5% price if the company agrees to double the size of order
for the coming year. However, it would have following implications:
(Q) 4% of cheese would be lost in refrigeration.
(ii) Variable cost of warehouse, transportation cost and inspection cost would increase by 50%.
(ii) Refrigeration cost would increase by 75%.
Required:
Advise whether Pizza Inc. should accept offer of the supplier. (13)
Spring 2021 Q.4
Q.14. Standard Limited (SL) is in the business of buying and selling electric ovens. It follows
perpetual inventory system and uses weighted average method for valuation of inventory.
Following information is extracted from SL’s records for the month of February 2021:
(i) Opening inventory consisted of 220,000 units having average cost of Rs. 7,000 per unit.
(ii) 280,000 units were purchased on 5 February 2021, at Rs. 7,200 per unit.
(iii) 180,000 units were sold to Khurram Limited (KL) on 10 February 2021.
(iv) 5,000 defective units were returned by KL on 12 February 2021.
(v) 30% of the defective units returned to SL, had a manufacturing fault and were returned to
the supplier on 15 February 2021. Remaining defective units were damaged due to
mishandling at the warehouse. These units were disposed of as scrap on 20 February
2021 for Rs. 2,000 per unit.
(vi) 5,000 units were sent to KL on 22 February 2021 in replacement of the defective units returned.
(vii) 150,000 units were sold on 25 February 2021.

On 28 February 2021, a physical stock count was carried out and the following was discovered:

▪ 4,500 units were identified as obsolete having net realizable value of Rs. 6,000 per unit.
▪ 500 units were found missing.
Required:
Prepare necessary journal entries to record the above transactions relating to inventory. (09)

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TABANI’S SCHOOL OF ACCOUNTANCY
COST AND MANAGEMENT ACCOUNTING

Q.15.
Autumn 2021 (Q.6)

Q.16. Spring 2021 (Q.1)

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TABANI’S SCHOOL OF ACCOUNTANCY
COST AND MANAGEMENT ACCOUNTING

Q.17. Autumn 2022 (Q.2)

Q.18. Alpha Motors (Pvt.) Ltd. uses a special gasket for its automobiles which is purchased from a
local manufacturer. The following information has been made available by the procurement
department:

Annual requirement (no. of gaskets) 162,000

Cost per gasket (Rs.) 1,000
Ordering cost per order (Rs.) 27,000
Carrying cost per gasket (Rs.) 300

The gaskets are used evenly throughout the year. The lead time for an order is normally 11
days but it can take as much as 15 days. The delivery time and the probability of their
occurrence are given below:

Delivery time (in days) Probability of Occurrence

11 68%
12 12%
13 10%
14 6%
15 4%

Required:
(a) Compute the Economic Order Quantity (EOQ) and the total Ordering Costs based on
EOQ. (04)

(b) What would be the safety stock and re-order point if the company is willing to take:

▪ a 20% risk of being out of stock?

▪ a 10% risk of being out of stock? (08)

Note: Assume a 360 day year.

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TABANI’S SCHOOL OF ACCOUNTANCY
COST AND MANAGEMENT ACCOUNTING

Autumn 2023 (Q.1, 3 & 4)

Q.19. Royal Enterprises Limited (REL) operates a factory in Karachi where it produces a single
product, Gamma, using 2 kg of raw material X and 3 kg of raw material Y. Both raw materials are
purchased from a supplier in Peshawar, priced at Rs. 400 per kg for X and Rs. 250 per kg for Y.
Typically, the raw materials are received within 10 days of placing an order. However, there are
occasional delays. Last year, REL placed 24 orders and the deliveries were received as follows:
Number of order(s)
Received within 10 days 20
Received within 11 days 03
Received within 12 days 01
Presently, REL does not maintain any safety stock. In the event of a delay in the receipt of
consignment, raw materials are purchased from a supplier in Karachi at a price 25% higher than
the normal cost to avoid stock-outs and prevent production stoppages. REL is now considering to
maintain a safety stock.
REL produces 1,000 units daily. The cost of holding stock of raw materials X and Y,
equivalent to one day’s usage, is Rs. 1 million per annum.

Required:
Determine whether REL should maintain any safety stock assuming that the current trend of
deliveries would continue. (08)
Q.20. Shahab Industries Limited (SIL) is engaged in the production of a product named Alpha2179,
which requires Beta4358 as its primary raw material. SIL presently uses the EOQ model to
place orders for Beta4358. Below is the relevant information about Beta4358:
Quantity per order 50,000 units
Cost per unit Rs. 48
Ordering cost per order Rs. 200,000
Total ordering and holding costs per annum Rs. 4.8 million

SIL’s supplier of Beta4358 is offering a 2% discount if the quantity per order is 75,000 units
and a 4% discount if the quantity per order is 100,000 units.

Required:
Determine whether SIL should accept either of the two discount offers. (08)

Q.21 Sitara Enterprises (SE) is engaged in manufacturing various products that are supplied to
retailers and large beauty parlours. SE’s cost accounting records show the following data for
the quarter ended 31 August 2023:

Purchase price Total

Raw Opening Closing
Purchases per kg/unit purchases
material inventory inventory
---------- Rupees ----------
A kg 10,000 66,000 9,000 100 6,600,000
B kg 30,000 315,000 48,000 80 25,200,000
C kg - 20,000 2,000 70 1,400,000
D kg 12,000 102,000 11,000 50 5,100,000
E unit 4,000 30,000 5,000 40 1,200,000
F unit 10,000 65,000 12,000 30 1,950,000
Others 12,800,000
Total 54,250,000

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TABANI’S SCHOOL OF ACCOUNTANCY
COST AND MANAGEMENT ACCOUNTING

Additional information:
(i) SE uses perpetual inventory system to record raw materials, which are valued using
FIFO method.
(ii) The values of opening and closing inventories of raw materials, as per general ledger,
are Rs.10.25 million and Rs.15.7 million, respectively.
(iii) Any adjustments in the value of inventory due to NRV or excess/shortage are accounted
for directly to the P&L.
(iv) In view of the prevailing inflation, the suppliers of raw materials had increased the
prices by 25%, at the start of the quarter, i.e., 1 June 2023.
(v) A review of the records has revealed the following:
▪ The issuance of raw material A has erroneously been recorded using the LIFO
method instead of FIFO.
▪ The issuance of 2,000 kg of raw material B was erroneously recorded as issuance
of 3,000 kg of raw material C.

(vi) A physical stock check at quarter-end has identified the following:

▪ There is a shortage of 800 kg of raw material D.
▪ 500 units of raw material E were in excess. An investigation showed that 200 units
of E were erroneously delivered by the supplier, whereas the receipt of 300 units
was not recorded as they were delivered just before the close of business on the
last day.
▪ 400 units of raw material F are damaged. These can be repaired at a cost of
Rs.3,000 or sold on ‘as is where is’ basis for Rs. 8,000.

Required:
Determine the value of the closing inventory of raw materials and the cost of raw material
consumed, after taking into account the above adjustments, for the quarter ended 31 August (09)
2023.

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