Economic Order Quantity
E4-4
# 7, 8, 9, 10, 11
BACCAY
Economic Order
Quantity
Definition: is the amount of inventory
ordered at one time that minimizes
the annual inventory cost.
2 × annual required units ×
cost/order
cost/unit material × carrying
cost %
Objectives for
Material Control
To provide adequate supply for efficient
and uninterrupted operations
To maintain a minimum investment in
materials and supplies
To avoid loss of time and cost of
handling and to protect the company
against possible loss.
Cost accounting by Norma D. De Leon
Elements to
Determine EOQ
Cost of carrying inventory
- are often expressed as
percentages of the average inventory
investment.
examples: interest, property tax &
insurance, storage etc.
- Only the variable costs are
considered.
Cost of acquiring (ordering) materials
- includes preparing a purchase
requisition, purchase order, and
receiving report; handling the incoming
shipment; communicating with vendor,
and accounting for the shipment and
payment.
- Only variable costs are considered.
Formulas
EOQ= Economic order quantity
RU= Required units
CO= Cost per order
CU= cost per unit
CC= Carrying cost percentage
RU⁄EOQ= Number of orders placed
annually
RU×CO⁄EOQ= Annual ordering cost
EOQ⁄2= Average number units in
inventory at
any point in time
CU×CC×EOQ⁄2 = Annual carrying cost
(RU×CO⁄EOQ) + (CU×CC×EOQ⁄2) =
Total annual cost of ordering and
carrying inventory
E4-4 #7
Criggins Sporting Goods INC buys
baseballs at P20 per dozen from its
wholesaler. Criggins sells 48,000 dozen
balls evenly throughout the year. The
firm incurs interest expense of 10% on
its average inventory investment. In
addition, rent, insurance and property
tax for each dozen baseballs in the
average inventory is P.40. The cost
involved in handling each purchase
order is P10
Required: a.) EOQ b.) the total annual
Solution
RU= 48,000 CC= P.40/P20 + 10% =
12%
C0= P10
CU= P20/dozen
2 × 48,000 × 960,000
EOQ= P10 2.4
P20 ×
12%
= 632 dozens
B. Total annual inventory expense
Formula = RU×CO⁄EOQ= Annual ordering
cost
= CU×CC×EOQ⁄2 = Annual
carrying cost
Annual inventory expense=
(48,000 × P10 ⁄ 800) + (P20 × 12% ×
800 ⁄ 2)
= 600 + 960
= P 1560
E4-4 # 8
A customer has been ordering 5,000
specially designed metal columns at
the rate of 1,000 per order during the
past year. The variable production cost
is P8 per unit: P6 for materials and
labor, P2 for factory overhead. It costs
P1,000 to set up for one run of 1,000
columns, and the inventory carrying
cost is 20%. Because this customer
may buy at least 5,000 columns per
year, the company would like to avoid
making five different production runs.
Required: compute the most
Solution
RU= 5,000 columns CC= 20%
CO/setup cost: P 1,000
CU/variable production cost/unit = P8
2 × 5,000 ×
EPR=
P1,000 10,000,000
P8 × 1.6
=20%2,500 columns
E4-4 #9
Stemson Company estimates
that it will need 12,000 units of
Material W next year, at a cost
of P9 per unit. The estimated
carrying cost is 20% and the
cost to place an order is
calculated to be P16.
Required: a.) EOQ b.) the
frequency of order placement
c.) the EOQ if forecast usage is
Solution
A. RU= 12,000 units CC= 20%
CO= P16 CU= P9
EOQ= 2× 12,000 × 384,000
P16 1.8
P9 × 20%
= 462 units
B. Frequency of order
Formula: RU⁄EOQ
= 12,000⁄462
= 26 orders per year
C. EOQ RU= 8,000 CC= 22%
EOQ= 2 × 8000 ×
P16 256,000
P9 × 22% 1.98
= 360 units
E4-4 #10
An item costs P10, has a yearly
volume of 500 units, an
ordering cost of P6 and
carrying cost of 25%
Required: a.) EOQ and total
ordering and carrying cost per
year. b.) Determine the effect
on the total ordering and
carrying cost if the order
quantity is 10% above the EOQ.
Solution
RU= 500 units CC=
25%
CO= P6
CU= P10
2 × 500 6,000
EOQ= 2.5
×P6
10 ×
=25%49 units
Formula = (RU×CO⁄EOQ) + (CU×CC×EOQ⁄2)
= (500 × 6 ⁄ 49) + (10 × 25% × 49 ⁄
2)
= 62.5 + 60
= P122.5
B. 10% increase in EOQ
= (49 × .10) + 49
= 53.9 or 54
Formula = (RU×CO⁄EOQ) + (CU×CC×EOQ⁄2)
= (500 × 6 ⁄ 54) + (10 × 25% × 54 ⁄ 2)
= 55.55 + 67.5
= P123.05
There is no significant
effect to the annual
ordering and carrying cost
if the EOQ is increased by
10%. It is because the
incremental value added is
not material.
E4-4 #11
Joshua Inc. manufactures a line of
walnut office products. Management
estimates the annual demand for the
double walnut letter trays at 6,000
units. The tray sells for P80. the costs
relating to the letter tray a. the variable
manufacturing cost per tray, P50; b. the
cost to initiate a production run, P300;
and c. the annual cost of carrying the
tray in inventory, 20%. In prior years,
the production of the tray has been
scheduled in two equal production runs.
Required: Find the expected annual
cost savings the company could
Current situation:
2 production runs of 3,000 units per run
Average inventory: 3,000 units / 2 = 1,500 units
Present costs:
carrying cost = annual CC % × manufacturing cost ×
average annual inventory
Production initial cost = number of runs × cost to initiate
a run
Carrying cost = ( .20 × P50 × 1500)……… P
15000
Production initiation cost ( 2 × 300)…………600
P 15,600
Solution
Proposed situation:
RU= 6,000 units CC= 20%
CO/set up cost= P300 CU/ VMC/ unit=
P50
2 × 6,000 × 3,600,000
EOQ= P300 10
P50 ×
20%
= 600 trays
Total annual inventory cost
Formula = (RU×CO⁄EOQ) +
(CU×CC×EOQ⁄2)
= (6,000 × 300 ⁄ 600) + (50
× 20% × 600 ⁄ 2)
= 3,000 + 3,000
= P6,000
Current situation = ………… P
15,600
Proposed situation
=…………..6,000
P 9,600
Joshua Inc. could expect annual
savings of P 9,600 if the company
employs the economic order quantity
That in all things, God may be
Glorified!
