ADVANCED MANAGEMENT ACCOUNTING

ACC60804
SOLUTION TUTORIAL 3

1. a. Calculate the economic order quantity (EOQ). (2 marks)

2 𝑥𝑥 40,000 𝑥𝑥 70
EOQ = √
1.40
EOQ = 2,000 units

b. Calculate the total annual ordering costs and total annual holding costs for the inventory item
assuming the company uses the EOQ and no buffer inventory is held. (2 marks)

Total annual ordering costs = 𝐷𝐷 𝑥𝑥 𝑂𝑂𝑂𝑂

𝑄𝑄

Total annual ordering costs = 40,000 𝑥𝑥 70 = 1,400

2,000

Total annual holding costs = 𝑄𝑄 𝑥𝑥 𝐻𝐻𝐻𝐻

2

Total annual holding costs = 2,000 𝑥𝑥 1.40 = 1,400

2

2. a. Determine the number of orders per year that the company will place for item G (3 marks)

2 𝑥𝑥 15,000 𝑥𝑥 80
EOQ item G = √
26.66 13.33 x 200 = 26.66
EOQ = 300 units

No. of orders = 𝐷𝐷
𝐸𝐸𝐸𝐸𝐸𝐸

No. of orders = 15,000 = 50 orders

300

b. Determine the annual holding cost of the stock of item H (3 marks)

2 𝑥𝑥 2,800 𝑥𝑥 28
EOQ item H = √
2 8% x 25 =2
EOQ = 280 units

Total annual holding costs = 𝑄𝑄 𝑥𝑥 𝐻𝐻𝐻𝐻

2

Total annual holding costs = 280 𝑥𝑥 2 = $280

2

1
3. a. Calculate the EOQ.
2 𝑥𝑥 9,000 𝑥𝑥 250
EOQ = √
8 $5 + $3 = $8
EOQ = 750 units

b. Calculate the number of orders that will be placed each year.

No. of orders = 𝐷𝐷
𝐸𝐸𝐸𝐸𝐸𝐸

No. of orders = 9,000 = 12 orders

750

c. Calculate the reorder point.

Reorder = Lead time the daily x weekly usage during the lead time period

Option 1:
Reorder = 5 days x 9000 = 123 units
365

4. a. Calculate the EOQ.

2 𝑥𝑥 40,700 𝑥𝑥 185
EOQ = √
1.10
EOQ = 3,700 units

b. Calculate the number of orders that will be placed each year.

No. of orders = 𝐷𝐷
𝐸𝐸𝐸𝐸𝐸𝐸

No. of orders = 40,700 = 11 orders

3,700

c. Calculate the reorder point.

Reorder = Lead time the daily x weekly usage during the lead time period

Reorder = 2 weeks x 40700 = 1,850 units

44

Reorder = (5 days per week x 2-week) x 40700 = 1,850 units

220

2
5. a. The question requires the calculation of the optimum number of units to be manufactured in
each production run in order to secure the lowest annual cost. The formula for the optimum
number of units to be manufactured (Q) is as follows:

where D = total demand for period, S = set-up costs and H = holding cost per unit.

The set-up costs and holding cost per unit to be used in the formula are relevant or
incremental costs. Those costs that will not change as a result of changes in the number of units
manufactured in each batch should not be included in the analysis. These costs include:

a. Skilled labour costs. (Skilled labour is being paid idle time. Its total cost will not alter as a
result of the current decision.)
b. Fixed overheads. (These costs are independent of the batch size.)

Therefore, the relevant cost of producing product Exe is as follows:

The relevant decision variables for the formula are as

follows:
Annual demand of Exe (D) = 4 000 units Set-up costs (S) = £70 (skilled labour of £66 is not a
relevant cost)

Annual holding costs = £14

i. Storage cost per unit (0.40 m2 x £20) = £8
ii. Incremental interest tied up in each unit of Exe stock (15% X £40 incremental cost of
Exe) = £6

Applying the above figures to the formula, we have:

3
12. b. Limitations include the following:
i. It is very difficult to obtain relevant data.
Incremental holding, ordering and set-up costs are very difficult to estimate in practice. In
addition, many of the fixed costs that were excluded in the analysis may not be fixed over
the whole range of output. Some fixed costs may increase in steps as the quantity
purchased is increased.
ii. Model assumes certainty.
A more sophisticated approach is required where the demand and the cost structure are
uncertain.
iii. Model assumes that demand is constant throughout the year. In practice, there may be
seasonal variations in demand throughout the year.