Coursework

1. Jasmine Limited uses material RZ4. Production requirements average 400 kilograms per week,
but could be as low as 350 kilograms or as high as 480 kilograms.
Each delivery of material RZ4 was 2,000 kilograms. The lead time for placing an order averaged
3 weeks. However, it could be as little as 2 weeks or as much as 5 weeks.
Required
(a) Calculate:
(i) Reorder level
(ii) Minimum stock level
(iii) Maximum stock level
(iv) Average stock
(b) Suggest why the reorder quantity is 2,000 kilograms.
Solution
(a) (i) Reorder level

This is maximum usage x maximum lead time. This is 480 kilograms x 5 weeks = 2,400
kilograms. By setting the reorder level at 2,400 kilograms, there will not be a stock-out
even if simultaneously there is maximum weekly usage of RZ4 and Jasmine Limited has
to wait the full 5 weeks for delivery. So production is safeguarded.

(a) (ii) Minimum stock level

On average, Jasmine Limited does not expect to have to wait 5 weeks for a delivery; nor
does it expect to use 480 kilograms week after week. For this reason the minimum stock
is calculated: Minimum stock level = Reorder level (Average usage x Average lead
time). Therefore, minimum stock level = 2,400 kg (400 kg x 3 weeks) = 1,200 kg.

(a) (iii) Maximum stock level

The maximum stock level is calculated: Reorder level (Minimum usage x Minimum
lead time) + Reorder quantity, RQ In this example this gives 2,400 kg (350 kg x 2
weeks) + 2,000 kg = 3,700 kg. This is the highest point that the stock of RZ4 can reach
because 700 kilograms is the lowest amount of RZ4 that can be used between the
moment when a new order is placed and the moment when the delivery arrives from the
supplier and is ready to use in production.


(a) (iv) Average stock

Remember that in an earlier example the average stock was calculated as RQ/2. However,
this was when the stock was allowed to go to nil whilst waiting for further supplies.
In this example, as long as average usage and average lead time are experienced, the
stock will not fall below its minimum level of 1,200 kilograms. Not surprisingly therefore,
the average stock is now: (RQ/2) + Minimum stock
In this case the average stock is (2,000 kg/2) + 1,200 kg = 2,200 kg.
.
(b) The reorder quantity or RQ is 2,000 kilograms in this example. You should notice the
important effect of this figure in deciding how high stock levels can go, (because it is
included in the formula for maximum stock level) and upon the average stock, (for the
same reason).
The reorder quantity may be 2,000 kilograms because it is the only order size that the
supplier will accept.
It may be 2,000 kilograms because it is the smallest quantity that the supplier will deliver.
It may be that smaller quantities could be ordered, but that the supplier gives Jasmine
Limited a good price per kilogram for ordering 2,000 kilograms each time.

Notes to the solution
1. The order size of 2,000 kilograms represents 5 weeks' average usage of material RZ4. On
this basis orders will be placed every 5 weeks.
2. It may be that a better price still could be obtained from the supplier if orders were placed
in (say) 5,000 kilogram size. However, think what this would do to the maximum stock
and the average stock, and remember that carrying stock costs money.
3. Candidates for the Third Level examination will be required to calculate the optimal
reorder size and we will look at this in the next chapter. If required, candidates at Second
Level will be given the figure.
4. Some candidates like to calculate the average stock as (Maximum stock + Minimum
stock)/2. This is not how the Examiner would like to see it.
5. You should now see that stock control involves a decision on the most economic order
size RQ, and then the setting of a level at which reordering takes place, and upper and
lower limits of stock. Stock movements outside these limits will be looked at very
carefully.

2. Gabriel Limited is a company which makes wooden toys. Required Classify each of the
following costs into (a) direct/indirect (b) prime cost/overhead (c) function:
1. Wood, purchased to make toys.
2. Salary paid to the manager of the wood cutting department.
3. Paint and varnish, purchased for finishing the assembled toys.
4. Petrol for a delivery lorry belonging to the company, and used to deliver finished toys
to customers.
5. Power for operating-wood-cutting machinery.
6. Bank charges.
7. Molded plastic box into which each toy is packed.
8. Telephone rental and charges.
9. Materials used to repair production machine.
10. Advertisement in a trade journal.

Solution
1. Direct Prime cost Production
2. Indirect Overhead Productions
3. Direct Prime cost Production
4. Indirect Overhead Distribution
5. Indirect Overhead Production
6. Indirect Overhead Administration
7. Direct Prime cost Production
8. Indirect Overhead All functions
9. Indirect Overhead Production
10. Indirect Overhead Selling

Notes to the solution
1. Remember that once a decision has been made with regard to the direct/indirect
classification, then the same decision decides prime cost or overhead

2. Paint and varnish is part of the direct material cost of each product. However, the cost of
paint and varnish for a unit of product may be insignificant in comparison to the cost of
wood. As we suggested earlier, in these circumstances it may not be economically worth
identifying paint and varnish as a direct cost, and it would be treated as production
overhead.

3. Bank charges are an administrative overhead. Bank interest on the other hand is a reward
for the use of loan capital. Bank interest would not be regarded as a cost, though in book-
keeping it would be debited to the profit and loss account.

4. The molded plastic box has been regarded as a production cost because it is considered to
be primary packing. Primary packing is regarded as the end of production and secondary
packing as the start of distribution. The cost of a cardboard box into which 30 toys in
their molded plastic boxes were placed would be a distribution cost.

5. Telephone rental and charges are all functions because there will be telephones in all
functional areas of the company. The cost will have to be shared between the functions.
6. An advertisement for a particular product would be identified with that product range.
However, it would still be part of selling overhead, and would not be part of any stock
valuation of unsold units of production.

Here we assume that it is a general advertisement to make toy retailers aware of the
company's existence and of its range of products.