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Economic Batch Quantity (EBQ)

⬤  Financial Accounting >
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⬤  IFRS >
Definitions
⬤  Audit Batch Quantity (EBQ), also known as the optimum production quantity
Economic > (EPQ), is the order
size of a production batch that minimizes the total cost.
⬤  Other Accounting Topics >

⬤  Management Accounting ˅

Introduction to Management Accounting

Management Accounting Concepts

Introduction to Variance Analysis

Relevant Cost and Decision Making

Economic Order Quantity (EOQ)

Explanation
Introduction

Batch production is a technique which is commonly used today for distributing the total production in
EOQ and Discounts
a series of small batches rather than mass producing in one go.

Sometimes the production

Economic of(EBQ)
Batch Quantity goods in batches is necessary because, for example, certain equipment
used in manufacturing (e.g. dyes) may wear out and need replacement before the production can run
again.
Inventory Management

Batch production may be desirable in other cases as well. For example, where the objects being
Limiting Factor Analysis
produced are perishable, the entire production requirement for say a year can’t be manufactured in a
week as it might cause the goods to expire after some time. Batch production also reduces the risk of
Budgeting as any minor changes required in the specification of goods (e.g. size, color, etc.) can
obsolescence
be made in future batches according to the feedback received from customers or retailers instead of
Investment
producing Appraisal in one go and hoping for the best.
everything

Whereas EOQ is suitable for determining the order size when the parts, materials or finished goods
are ready to be delivered by external suppliers when the order is placed, EBQ is used to determine the
size of a production run (i.e. batch size) when the manufacturing takes place internally and any raw
materials or parts required for production are either acquired internally or are supplied incrementally
by other companies according to the production requirement.
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Formula
⬤  Financial Accounting >

Economic
⬤  IFRS Batch Quantity = √ C2 x(1C- D/P)
h
s xD
>

Where:
⬤  Audit >
Cs is the setup cost of a batch
⬤  Other Accounting Topics >
D is the annual demand

P is the annual
⬤  Management production capacity
Accounting ˅
Ch is the annual cost of holding one unit of finished inventory
Introduction to Management Accounting
The formula for calculating EBQ is very similar to EOQ with one notable difference in the denominator.
The Management
cost of holding in EBQ
Accounting formula is decreased by the amount of inventory that will be produced and
Concepts
sold on the same day therefore not contributing to the annual cost of holding the inventory.
Introduction to Variance Analysis

Relevant Cost and Decision Making

Economic Order Quantity (EOQ)

Introduction

EOQ and Discounts

Economic Batch Quantity (EBQ)

Inventory Management

Limiting Factor Analysis

Budgeting

Example
Investment Appraisal

Sarah owns and operates a small factory that manufactures plastic bottles which she sells to
bottling companies.

Additional information:

Annual demand is 1 million bottles spread evenly over the year

 Setup cost is $5000 per batch
Menu Holding cost is $3 per annum for each bottle X Home
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Maximum production capacity is 2 million bottles per annum

Currently, bottles are manufactured in 10 batches

⬤  Financial Accounting >

A. Find the optimum production quantity that Sarah should produce to minimize her costs
⬤  IFRS >
B. Calculate the current annual holding cost and setup cost
C. Calculate the savings to Sarah if she adopts the EBQ
⬤  Audit >

Solution
⬤  Other A: Optimum
Accounting Topics Production Quantity >

Economic Batch Quantity

⬤  Management Accounting ˅

√
2 x Cs x D
=
Ch(1 - D/P)
Introduction to Management Accounting

√
Management 2 × 5000×
Accounting 1,000,000
Concepts
=
3 x (1-(1,000,000/2,000,000))
Introduction to Variance Analysis

√
10,000,000,000
=
Relevant Cost and 1.5
Decision Making

= 6,666,666,666
Economic Order Quantity (EOQ)

=Introduction
81,650

EOQ
Sarah and Discounts
should manufacture bottles in batches of 81,650 units.

Solution B: Current
Economic Costs(EBQ)
Batch Quantity

Batch Quantity = Annual Demand ÷ Number of batches

Inventory Management
       = 1,000,000 ÷ 10
Limiting Factor Analysis
       = 100,000 units
Budgeting
Annual Holding Cost = (Batch Quantity/2) × Ch × (1- D/P)
Investment Appraisal
        = (100,000/2) × 3 × (1-(1,000,000/2,000,000))

        = $75,000

Setup Cost = Number of setups × setup cost

       = 10 × 5000

       = $50,000
 Total Current Cost = ($75,000 + $50,000) = $125,000
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Solution C: Savings from EBQ
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Annual Holding Cost:

    = (Batch Quantity/2) × Ch × (1- D/P)

⬤  Financial Accounting >
    = (81,650/2) × 3 × (1-(1,000,000/2,000,000))
⬤  IFRS >
    = $61,238 (A)

Setup Cost
⬤  Audit >
Number of batches = 1,000,000 ÷ 81,650 = 12.2475
⬤  Other Accounting Topics >
Setup Cost = Number of batches × Cost of setup

    = 12.2475
⬤  Management × $5000 = $61,23 (B)
Accounting ˅

Total Cost (EBQ) = (A) + (B) = $122,476 (C)

Introduction to Management Accounting
Total Current Cost = 125,000 (D)
Management Accounting Concepts
Savings = (D) - (C) = 2,524
Introduction to Variance Analysis

Relevant Cost and Decision Making

Economic Order Quantity (EOQ)

1 4
Introduction

EOQ and Discounts

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Economic Batch Quantity (EBQ)

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