Page 1
DEFINITION AND EXPLANATION
Economic order quantity (EOQ): Is that size of the order which gives maximum economy in
purchasing any material and ultimately contributes towards maintaining the materials at the optimum
level and at the minimum cost
In order words, the Economic order quantity (EOQ) is the amount of inventory to be ordered at
one time for purposes of minimizing annual inventory cost.
The quantity to order at a given time must be determined by balancing two factors: (1) the cost of
possessing or carrying materials and (2) the cost of acquiring or ordering materials. Purchasing larger
quantities may decrease the unit cost of acquisition, but this saving may not be more than offset by the
cost of carrying materials in stock for a longer period of time.
THE CARRYING COST OF INVENTORY MAY INCLUDE
? Interest on investment of working capital
? Property tax and insurance
? Storage cost, handling cost
? Deterioration and shrinkage of stocks
? Obsolescence of stocks.
FORMULA OF ECONOMIC ORDER QUANTITY (EOQ)
The different formulas have been developed for the calculation of economic order quantity (EOQ).
The following formula is usually used for the calculation of EOQ.
Ch
Cp A * * 2
? A = Demand for the year
? Cp = Cost to place a single order
? Ch = Cost to hold one unit inventory for a year
? * = X
Example
Pam runs a mall order business for gym equipment. Annual demand for the Trico Flexers is
16,000. The annual holding cost per unit is ` 2.50 and the cost to place an order is ` 50.
Calculate economic order quantity (EOQ)
Calculation
order per units 800
50 . 2 $
50 $ * 000 , 16 * 2
?
Page 2
DEFINITION AND EXPLANATION
Economic order quantity (EOQ): Is that size of the order which gives maximum economy in
purchasing any material and ultimately contributes towards maintaining the materials at the optimum
level and at the minimum cost
In order words, the Economic order quantity (EOQ) is the amount of inventory to be ordered at
one time for purposes of minimizing annual inventory cost.
The quantity to order at a given time must be determined by balancing two factors: (1) the cost of
possessing or carrying materials and (2) the cost of acquiring or ordering materials. Purchasing larger
quantities may decrease the unit cost of acquisition, but this saving may not be more than offset by the
cost of carrying materials in stock for a longer period of time.
THE CARRYING COST OF INVENTORY MAY INCLUDE
? Interest on investment of working capital
? Property tax and insurance
? Storage cost, handling cost
? Deterioration and shrinkage of stocks
? Obsolescence of stocks.
FORMULA OF ECONOMIC ORDER QUANTITY (EOQ)
The different formulas have been developed for the calculation of economic order quantity (EOQ).
The following formula is usually used for the calculation of EOQ.
Ch
Cp A * * 2
? A = Demand for the year
? Cp = Cost to place a single order
? Ch = Cost to hold one unit inventory for a year
? * = X
Example
Pam runs a mall order business for gym equipment. Annual demand for the Trico Flexers is
16,000. The annual holding cost per unit is ` 2.50 and the cost to place an order is ` 50.
Calculate economic order quantity (EOQ)
Calculation
order per units 800
50 . 2 $
50 $ * 000 , 16 * 2
?
Underlying Assumption of Economic order Quantity:
? ? ? The ordering cost is constant
(2) The rate of demand is constant
? ? ? The lead time is fixed
(4) The replenishment is made instantaneously, the whole batch is delivered at once.
Illustration 6
Data relating to slotted angles in a steel furniture manufacturing unit is as follows:
(i) Annual consumption 12 tonnes.
(ii) Unit cost ` 100 per kilo.
(iii) Storage/carrying cost 12%
(iv) Procurement cost ` 20 per order.
Calculate
(a) E.O.Q. per order in kilos.
(b) Annual procurement cost.
(c) Annual carrying cost.
Solution
where
A = Annual consumption
0 = Ordering cost per order
P = Unit cost
i = Carrying cost in percentage
100
12
100
20 000 , 12 2
EOQ
?
? ?
?
12
000 , 80 , 4
?
000 , 40 ?
EOQ = 200 units (kgs.) per order
Note: 1 Ton =1,000 kgs.
Page 3
DEFINITION AND EXPLANATION
Economic order quantity (EOQ): Is that size of the order which gives maximum economy in
purchasing any material and ultimately contributes towards maintaining the materials at the optimum
level and at the minimum cost
In order words, the Economic order quantity (EOQ) is the amount of inventory to be ordered at
one time for purposes of minimizing annual inventory cost.
The quantity to order at a given time must be determined by balancing two factors: (1) the cost of
possessing or carrying materials and (2) the cost of acquiring or ordering materials. Purchasing larger
quantities may decrease the unit cost of acquisition, but this saving may not be more than offset by the
cost of carrying materials in stock for a longer period of time.
THE CARRYING COST OF INVENTORY MAY INCLUDE
? Interest on investment of working capital
? Property tax and insurance
? Storage cost, handling cost
? Deterioration and shrinkage of stocks
? Obsolescence of stocks.
FORMULA OF ECONOMIC ORDER QUANTITY (EOQ)
The different formulas have been developed for the calculation of economic order quantity (EOQ).
The following formula is usually used for the calculation of EOQ.
Ch
Cp A * * 2
? A = Demand for the year
? Cp = Cost to place a single order
? Ch = Cost to hold one unit inventory for a year
? * = X
Example
Pam runs a mall order business for gym equipment. Annual demand for the Trico Flexers is
16,000. The annual holding cost per unit is ` 2.50 and the cost to place an order is ` 50.
Calculate economic order quantity (EOQ)
Calculation
order per units 800
50 . 2 $
50 $ * 000 , 16 * 2
?
Underlying Assumption of Economic order Quantity:
? ? ? The ordering cost is constant
(2) The rate of demand is constant
? ? ? The lead time is fixed
(4) The replenishment is made instantaneously, the whole batch is delivered at once.
Illustration 6
Data relating to slotted angles in a steel furniture manufacturing unit is as follows:
(i) Annual consumption 12 tonnes.
(ii) Unit cost ` 100 per kilo.
(iii) Storage/carrying cost 12%
(iv) Procurement cost ` 20 per order.
Calculate
(a) E.O.Q. per order in kilos.
(b) Annual procurement cost.
(c) Annual carrying cost.
Solution
where
A = Annual consumption
0 = Ordering cost per order
P = Unit cost
i = Carrying cost in percentage
100
12
100
20 000 , 12 2
EOQ
?
? ?
?
12
000 , 80 , 4
?
000 , 40 ?
EOQ = 200 units (kgs.) per order
Note: 1 Ton =1,000 kgs.
Annual Size of Number of Procurement Holding Combined
Requirement Order Order Cost Cost Cost
(1) (2) (3) (3)× ` 20 = (4)
) 5 (
100
12
100
2
1
) 2 ( ? ? ? ?
(4) + (5) = (6)
12,000 50 240 4,800 300 5,100
12,000 100 120 2,400 600 3,000
12,000 200 60 1,200 1,200 2,400
12,000 400 30 600 2,400 3,000
12,000 500 24 480 3,000 3,480
Illustration 7
Data relating to slotted angles in a steel furniture manufacturing unit is as follows:
Half yearly demand 1,000 units.
Ordering cost ` 62.50 per order.
Inventory carrying cost ` 2 per unit.
Calculate
(a) EOQ per order in units.
(b) Annual procurement cost.
(c) Annual carrying cost.
from the above data.
Solution
where
A = Annual requirement
O = Ordering cost per unit
C = Carrying cost per unit
2
50 . 62 2 000 , 1 2
EOQ
? ? ?
?
2
000 , 50 , 2
EOQ ?
000 , 25 , 1 ?
EOQ = 353.55 units per order
Page 4
DEFINITION AND EXPLANATION
Economic order quantity (EOQ): Is that size of the order which gives maximum economy in
purchasing any material and ultimately contributes towards maintaining the materials at the optimum
level and at the minimum cost
In order words, the Economic order quantity (EOQ) is the amount of inventory to be ordered at
one time for purposes of minimizing annual inventory cost.
The quantity to order at a given time must be determined by balancing two factors: (1) the cost of
possessing or carrying materials and (2) the cost of acquiring or ordering materials. Purchasing larger
quantities may decrease the unit cost of acquisition, but this saving may not be more than offset by the
cost of carrying materials in stock for a longer period of time.
THE CARRYING COST OF INVENTORY MAY INCLUDE
? Interest on investment of working capital
? Property tax and insurance
? Storage cost, handling cost
? Deterioration and shrinkage of stocks
? Obsolescence of stocks.
FORMULA OF ECONOMIC ORDER QUANTITY (EOQ)
The different formulas have been developed for the calculation of economic order quantity (EOQ).
The following formula is usually used for the calculation of EOQ.
Ch
Cp A * * 2
? A = Demand for the year
? Cp = Cost to place a single order
? Ch = Cost to hold one unit inventory for a year
? * = X
Example
Pam runs a mall order business for gym equipment. Annual demand for the Trico Flexers is
16,000. The annual holding cost per unit is ` 2.50 and the cost to place an order is ` 50.
Calculate economic order quantity (EOQ)
Calculation
order per units 800
50 . 2 $
50 $ * 000 , 16 * 2
?
Underlying Assumption of Economic order Quantity:
? ? ? The ordering cost is constant
(2) The rate of demand is constant
? ? ? The lead time is fixed
(4) The replenishment is made instantaneously, the whole batch is delivered at once.
Illustration 6
Data relating to slotted angles in a steel furniture manufacturing unit is as follows:
(i) Annual consumption 12 tonnes.
(ii) Unit cost ` 100 per kilo.
(iii) Storage/carrying cost 12%
(iv) Procurement cost ` 20 per order.
Calculate
(a) E.O.Q. per order in kilos.
(b) Annual procurement cost.
(c) Annual carrying cost.
Solution
where
A = Annual consumption
0 = Ordering cost per order
P = Unit cost
i = Carrying cost in percentage
100
12
100
20 000 , 12 2
EOQ
?
? ?
?
12
000 , 80 , 4
?
000 , 40 ?
EOQ = 200 units (kgs.) per order
Note: 1 Ton =1,000 kgs.
Annual Size of Number of Procurement Holding Combined
Requirement Order Order Cost Cost Cost
(1) (2) (3) (3)× ` 20 = (4)
) 5 (
100
12
100
2
1
) 2 ( ? ? ? ?
(4) + (5) = (6)
12,000 50 240 4,800 300 5,100
12,000 100 120 2,400 600 3,000
12,000 200 60 1,200 1,200 2,400
12,000 400 30 600 2,400 3,000
12,000 500 24 480 3,000 3,480
Illustration 7
Data relating to slotted angles in a steel furniture manufacturing unit is as follows:
Half yearly demand 1,000 units.
Ordering cost ` 62.50 per order.
Inventory carrying cost ` 2 per unit.
Calculate
(a) EOQ per order in units.
(b) Annual procurement cost.
(c) Annual carrying cost.
from the above data.
Solution
where
A = Annual requirement
O = Ordering cost per unit
C = Carrying cost per unit
2
50 . 62 2 000 , 1 2
EOQ
? ? ?
?
2
000 , 50 , 2
EOQ ?
000 , 25 , 1 ?
EOQ = 353.55 units per order
Illustration 8
From the following information calculate the EOQ of a particular component:
Annual Demand 1,250 units
Ordering Cost ` 40 per order
Inventory Carrying Cost Re. 1 per unit
EOQ = 316.00 units per order
Illustration 9
From the following information calculate the EOQ of a particular component:
Annual Demand 2,500 units
Ordering Cost ` 200 per order
Inventory Carrying Cost ` 0.50 per unit
Solution
EOQ
C
AO 2
?
50 . 0
200 4 500 , 2 2 ? ? ?
?
50 . 0
000 , 00 , 40
?
000 , 00 , 80 ?
? 2.828..43 units per order
Page 5
DEFINITION AND EXPLANATION
Economic order quantity (EOQ): Is that size of the order which gives maximum economy in
purchasing any material and ultimately contributes towards maintaining the materials at the optimum
level and at the minimum cost
In order words, the Economic order quantity (EOQ) is the amount of inventory to be ordered at
one time for purposes of minimizing annual inventory cost.
The quantity to order at a given time must be determined by balancing two factors: (1) the cost of
possessing or carrying materials and (2) the cost of acquiring or ordering materials. Purchasing larger
quantities may decrease the unit cost of acquisition, but this saving may not be more than offset by the
cost of carrying materials in stock for a longer period of time.
THE CARRYING COST OF INVENTORY MAY INCLUDE
? Interest on investment of working capital
? Property tax and insurance
? Storage cost, handling cost
? Deterioration and shrinkage of stocks
? Obsolescence of stocks.
FORMULA OF ECONOMIC ORDER QUANTITY (EOQ)
The different formulas have been developed for the calculation of economic order quantity (EOQ).
The following formula is usually used for the calculation of EOQ.
Ch
Cp A * * 2
? A = Demand for the year
? Cp = Cost to place a single order
? Ch = Cost to hold one unit inventory for a year
? * = X
Example
Pam runs a mall order business for gym equipment. Annual demand for the Trico Flexers is
16,000. The annual holding cost per unit is ` 2.50 and the cost to place an order is ` 50.
Calculate economic order quantity (EOQ)
Calculation
order per units 800
50 . 2 $
50 $ * 000 , 16 * 2
?
Underlying Assumption of Economic order Quantity:
? ? ? The ordering cost is constant
(2) The rate of demand is constant
? ? ? The lead time is fixed
(4) The replenishment is made instantaneously, the whole batch is delivered at once.
Illustration 6
Data relating to slotted angles in a steel furniture manufacturing unit is as follows:
(i) Annual consumption 12 tonnes.
(ii) Unit cost ` 100 per kilo.
(iii) Storage/carrying cost 12%
(iv) Procurement cost ` 20 per order.
Calculate
(a) E.O.Q. per order in kilos.
(b) Annual procurement cost.
(c) Annual carrying cost.
Solution
where
A = Annual consumption
0 = Ordering cost per order
P = Unit cost
i = Carrying cost in percentage
100
12
100
20 000 , 12 2
EOQ
?
? ?
?
12
000 , 80 , 4
?
000 , 40 ?
EOQ = 200 units (kgs.) per order
Note: 1 Ton =1,000 kgs.
Annual Size of Number of Procurement Holding Combined
Requirement Order Order Cost Cost Cost
(1) (2) (3) (3)× ` 20 = (4)
) 5 (
100
12
100
2
1
) 2 ( ? ? ? ?
(4) + (5) = (6)
12,000 50 240 4,800 300 5,100
12,000 100 120 2,400 600 3,000
12,000 200 60 1,200 1,200 2,400
12,000 400 30 600 2,400 3,000
12,000 500 24 480 3,000 3,480
Illustration 7
Data relating to slotted angles in a steel furniture manufacturing unit is as follows:
Half yearly demand 1,000 units.
Ordering cost ` 62.50 per order.
Inventory carrying cost ` 2 per unit.
Calculate
(a) EOQ per order in units.
(b) Annual procurement cost.
(c) Annual carrying cost.
from the above data.
Solution
where
A = Annual requirement
O = Ordering cost per unit
C = Carrying cost per unit
2
50 . 62 2 000 , 1 2
EOQ
? ? ?
?
2
000 , 50 , 2
EOQ ?
000 , 25 , 1 ?
EOQ = 353.55 units per order
Illustration 8
From the following information calculate the EOQ of a particular component:
Annual Demand 1,250 units
Ordering Cost ` 40 per order
Inventory Carrying Cost Re. 1 per unit
EOQ = 316.00 units per order
Illustration 9
From the following information calculate the EOQ of a particular component:
Annual Demand 2,500 units
Ordering Cost ` 200 per order
Inventory Carrying Cost ` 0.50 per unit
Solution
EOQ
C
AO 2
?
50 . 0
200 4 500 , 2 2 ? ? ?
?
50 . 0
000 , 00 , 40
?
000 , 00 , 80 ?
? 2.828..43 units per order
Cost and Management Accounting -II
Activity Based Costing
Payel Roy
(Umeschandra College, Salt Lake campus)
CU Syllabus
Problems of Traditional Costing, Meaning of ABC, Cost analysis under ABC, Application of
ABC
Theory
1. Meaning of ABC
2. Definition of Cost Pool and Cost Driver
3. Steps in ABC
4. Uses of ABC
5. Difference between Traditional Cost System and ABC system
Practical sums
1. Problems based on Traditional Costing system- calculate the Total cost and CPU of a
product
2. Problems based on ABC system- calculate Total cost and CPU of a product
3. Problems involving calculations of Total cost and CPU under both Traditional and ABC
methods.
Theory
Meaning of ABC
The activity-based costing (ABC) system is a method of accounting you can use to find the
total cost of activities necessary to make a product. The ABC system assigns costs to each
activity that goes into production, such as workers testing a product, setting up of machines,
orders passed for purchase of raw materials etc.
Definition of Cost Pool and Cost Driver
Cost pool: It is an aggregate of all the costs associated with performing a particular business
activity.
Cost driver: It is an activity that is the root cause of why a cost occurs. It must be applicable
and relevant to the event that is incurring a cost. A cost driver assists with allocation expenses
in a systematic manner that results in more accurate calculations of the true costs of producing
specific products.
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