2 Material Cost

Question 1 (Economic Order Quantity):

Arnav Ltd. manufactures a product X which requires two raw materials A and B in a ratio of
1:4. The sales department has estimated a demand of 5,00,000 units for the product for
the year. To produce one unit of finished product, 4 units of material A is required.
Stock position at the beginning of the year is as below:
Product- X 12,000 units
Material A 24,000 units
Material B 52,000 units
To place an order the company has to spend `15,000. The company is financing its
working capital using a bank cash credit @13% p.a.
Product X is sold at `1,040 per unit. Material A and B is purchased at `150 and `200
respectively.
Required:
COMPUTE economic order quantity (EOQ):
(i) If purchase order for the both materials is placed separately.
(ii) If purchase order for the both materials is not placed separately.

Answer:
Workings:
Annual production of Product X = Annual demand – Opening stock
= 5,00,000 – 12,000 = 4,88,000 units
Annual requirement for raw materials = Annual production × Material per unit – Opening
stock of material
Material A = 4,88,000 × 4 units – 24,000 units = 19,28,000 units
Material B = 4,88,000 × 16 units – 52,000 units = 77,56,000 units
(i) Computation of EOQ when purchase order for the both materials is placed
separately

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 Material Cost 2.2

2  AnnualRe quirement for material  Orderingcos t

EOQ =
Carryingcos t per unit per annum

2  19,28,000units `15,000 38,56,000 `15,000

Material A = = = 54,462 units
13%of `150 `19.5

2  77,56,000units `15,000 1,55,12,000 `15,000

Material B = = = 94,600 units
13%of `200 `26

(ii) Computation of EOQ when purchase order for the both materials is not placed
separately
2  (19,28,000  77,56,000)units `15,000
Material A & B =
13%of `190

1,93,68,000 `15,000
= = 1,08,452 units
`24.7
1,08,452  19,28,000
Material A = = 21,592 units
96,84,000
1,08,452  77,56,000
Material A = = 86,860 units
96,84,000
(`150  19,28,000)  (`200  77,56,00)
* = `190
(19,28,000  77,56,000)

Question 2 (Stock levels):

A company manufactures 5,00,000 units of a product per month. The cost of placing an order
is `1,000. The purchase price of the raw material is `50 per kg. The re-order period is 4 to 8
days. The consumption of raw materials varies from 14,000 kg to 18,000 kg per day, the
average consumption being 16,000 kg. The carrying cost of inventory is 20% per annum.
You are required to CALCULATE
(i) Re-order quantity (ii) Re-order level
(iii) Maximum level (iv) Minimum level
(v) Average stock level
Answer:
(i) Reorder Quantity (ROQ) = 34,176 kg. (Refer to working note)

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 2.3 Cost and Management Accounting

(ii) Reorder level (ROL) = Maximum usage × Maximum re-order period

= 18,000 kg. × 8 days = 1,44,000 kg.
(iii) Maximum level = ROL + ROQ – (Min. usage × Min. re-order period)
= 1,44,000 kg. + 34,176 kg. – (14,000 kg.× 4 days)
= 1,22,176 kg.
(iv) Minimum level = ROL – (Normal usage × Normal re-order period)
= 1,44,000 kg. – (16,000 kg. × 6 days)
= 48,000 kg.
1
(v) Average stock level = (Maximum level + Minimum level)   
2
1
  = (1,22,176 kg. + 48,000 kg.) = 85,088 kg.
2
OR
1
= Minimum level + ROQ
2
1
= 48,000 kg. + × 34,176 kg. = 65,088 kg.
2
Working Note
Annual consumption of raw material (A) = (16,000 kg. × 365 days) = 58,40,000 kg.
Cost of placing an order (O) = ` 1,000
Carrying cost per kg. Per annum (c × i) = ` 50 × 20% = ` 10
2AO
Economic order quantity (EOQ) =
C×i

2  58,40,000 kgs.  `1,000

= = 34,176 kg.
` 10

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