Nov 2015 Q4
a) What are the two most relevant costs for determining the Economic Order Quantity? Give THREE (3) specific examples in each case. (6 marks)
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The relevant cost for determining the EOQ are the holding cost and the ordering cost.
The Holding cost includes:
i. -opportunity cost of investment in stock
ii. -incremental insurance cost.
iii. -incremental warehouse and storage cost
iv. -incremental material handling cost.
v. -cost of obsolescence and deterioration of stock.
The ordering cost includes:
i. -Clerical cost of preparing purchase order purchase order
ii. -Receiving deliveries
iii. -paying invoices
b) Examine the THREE (3) motives for Holding stocks. (3 marks)
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Transaction motive – this occurs whenever there is a need to hold stocks to meet production and sales requirement and that it is not possible to meet this requirement instantaneously.
The precautionary motive – If a firm decides to hold an additional amount of stock to cover the possibility that it may have underestimated its future production and sales requirement or when the supply of raw materials may be unreliable because of uncertain event affecting the supply of raw materials this is called precautionary motive for requiring stock.
Speculative motive – When it is expected that future inputs prices may change, a firm might maintain higher or lower levels of stock to speculate on the expected increase or decrease in future prices. Quantitative models does not take into consideration the speculative motives, but management should be aware that optimum stock levels do depend to a certain extent on expected price movement. If input prices is expected to rice then management should stock to take advantage of input price savings.
c) Explain Economic Order Quantity and discuss TWO (2) of its relevance. (3 marks)
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Economic order quantity – this is the ordering quantity where total cost of holding and ordering cost is at its minimum. It is the most economical quantity to order in order to minimize both incremental holding cost and ordering cost.
Relevance of Economic Order Quantity
- It is relevant in the sense that it is the optimal quantity that ensure optimal use of resources.
- It is also relevant because it will assist to ensure that there will be minimal occurrence of stock out and excessive holding of stock with its associated consequence like inability to satisfy customers, deterioration and high rate of losses due to overstocking.
d) Quaku Manu limited purchases and sells CDS. The company has been experiencing stock shortages and excess stocks at certain times in the year. The manager is concerned about the impact of overstocking and understocking and is therefore requesting you to assist in determining the most Economic quantity of CDS to order.
He has made the following information available to you to enable you recommend an appropriate stock to order and hold.
GHC
Sales per annum 20,000,000
Units of items sold 200,000 units
Mark up on cost of purchases is 25% of purchase price
The ordering cost is GHS200 per order whilst holding cost per unit is 5% of unit price.
Required:
i) Determine the economic order quantity. (2 marks)
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ii) What is the annual ordering cost? (2 marks)
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ANNUAL ORDERING COST = 200,000/EOQ X 200 = GHC8,945
200,000/ 4,472 X 200 = GHC 8,945
iii) Determine the annual holding cost. (2 marks)
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EOQ/2 X HOLDING COST PER UNIT = 4,472/2 X 4 = 8,945
iv) How many times in a year will the company order for goods? (1 mark)
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Annual demand / EOQ
200,000/ 4472 = APPROX 45 times
v) What is the purchase value per order quantity? (1 mark)
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EOQ X PURCHASE PRICE
4472 X 80 = GHC 357,760