ACCOUNTING FOR MATERIALS

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ACCOUNTING FOR MATERIALS

• ECONOMIC ORDER QUANTITY (EOQ)

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ECONOMIC ORDER QUANTITY (EOQ)

• What is EOQ ?
• The optimum order size that will result in the
  total amount of the ordering and holding cost
  being minimised.
• How to determine EOQ?
• Tabulation method
• Graphical presentation
• Quantitative model

3
Ordering Costs

• Clerical costs of preparing a purchase order,
  receiving deliveries and paying invoices
• Common to all stock decisions and thus are not
  relevant
• Only the incremental costs of placing an order
  are used in formulating the quantitavive model

4
Holding Costs

• Includes the following costs
• Opportunity cost of investment in stocks
• Incremental insurance costs
• Incremental warehouse and storage costs
• Incremental material-handling costs
• Cost of obsolescence and deterioration of stocks.
• The costs that vary with the levels of stocks
  are included in the quantitative model (relevant
  costs)

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Assumptions of the EOQ

• Holding cost per unit remains constant
• The average balance in stock was equal to
  one-half of the order quantity
• Demand is known
• Purchasing price/unit is unaffected by the Q
  ordered
• Replenishment of stock is done immediately

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Graphical Presentation/ Tabulation(Q4)

• Order qty 100 200 300 400 500 600 800
• Ave stocks 50 100 150 200 250 300 400
• No. of PO 400 200 133 100 80 67 50
• Hldg cost 50 100 150 200 250 300 400
• Order cost 800 400 266 200 160 134 100
• -----------------------------------------------
  ----
• TC 850 500 416 400 410 434 500
• -----------------------------------------------
  -----

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Quantitative Model

• TC Ordering Costs Holding Costs
• Ordering Costs DO/Q
• (Total Demand for period/Quantity ordered x
  ordering cost per order)
• Holding Costs QH/2
• (Quantity ordered/2 x holding cost per unit)
• Thus
• EOQ v (2DO/H)
• i.e. v(2 x total demand for period x cost per
  order/ holding cost per order)

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Illustrations (Q1 Q 2)

• No. 1
• Total annual demand for a companys product is
  40,000 units. The holding cost RM 1 per unit and
  the ordering cost is RM 2 per order. Calculate
  the EOQ.
• NO. 2
• Find the EOQ when the demand for a product is
  1000 units per month, ordering cost is RM350 per
  order, unit cost is RM8 and estimated holding
  costs are 15 per annum

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Solutions

• No. 1
• EOQ v(2 x 40 000 x 2/1)
• 400 units
• No. 2
• ORM 350 D1000 x 12 12000
• H RM8 x 15 RM 1.20 per unit per
  annum
• Thus EOQ v(2 x 350 x12 000/1.2) 2646 units
• No of order 12 000/2646
• 4 to 5

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Control levels

• Re-order point The point at which the order
  should be placed to obtain additional stocks
• Lead time the time between the placing of
  orders and the actual delivery of the stocks
• Re-order point (level)lead time x quantity
  usage of the lead time

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Control levels (cont)

• Example
• Annual usage of raw material is 6000 units and
  the weekly usage is constant over the year of 120
  units per week. There are 50 working weeks. The
  lead time is 2 weeks.
• Re-order point 120 x 2 240 units

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Control levels (cont)

• Minimum stock level
• Re-order point (level) average use in average
  lead time
• Maximum stock level
• Re-order point (level) EOQ min. use in min
  lead time

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Illustration

• Average use 1000 kilos per day
• Minimum usage 800 kilos per day
• Maximum usage 1350 kilos per day
• Order quantity 9000 kilos
• Delivery reliably expected at the beginning of
  the fourth day.
• Required Find the three control levels

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Solution

• Re-order level max use x lead time
• 1350 x 4 5400 kilos
• Maximum level re-order level EOQ min usage
  x lead time
• 5400 9000 (800 X 4)
• 11200 kilos
• Minimum level re-order level minimum usage x
  lead time
• 5400 (800 x 4)
• 2200 kilos

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JUST IN TIME (JIT) SYSTEM

• Aim to produce the required items, of high
  quality, exactly at the time they are required
• To minimise warehousing and storage costs by only
  acquiring stock when it is actually needed for
  input to the production process
• to eliminate waste by controlling the quality of
  stocks input to the production process
• To reduce the amount of stocks carried as working
  capital through more efficient production planning

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Characteristics of JIT environment

• A move towards zero inventory
• An emphasis on perfect quality ie zero defects
• Elimination of non-value added activities
• Eliminate short set-ups
• 100 on time deliveries
• A constant drive for improvement
• Demand-pull manufacture pull through basis

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Aspects of JIT system

• JIT Purchasing
• Delivery of materials immediately precedes their
  use
• Arranging with supplier for more frequent
  deliveries
• Supplier inspect material and guaranteeing quality

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Aspects of JIT system

• JIT Production
• Works on demand-pull basis and seek to eliminate
  all waste and activities which does not add value
  to the product
• Lead time to selling product
• eg inspection time
• transportation time
• Queuing time
• Storage time
• Processing time