2011 Paper F2 Study Text Sample Download v1

7/30/2019 2011 Paper F2 Study Text Sample Download v1

1/55

Study Text Paper F2: Management Accounting

www.tonysurridge.co.uk

MAIN PAGE CONTENTS FORMULAE

Tony Surridge Online Limited, 2011 1
http://www.tonysurridge.co.uk/http://www.tonysurridge.co.uk/


2/55




Paper F2: MANAGEMENT ACCOUNTINGStudy Textbook

Published by Tony Surridge Online Limited in 2011

Copyright Tony Surridge Online Limited

Part of the Tony Surridge +AddVance study materials range

Tony Surridge Online [email protected]


Tony Surridge Online Limited is grateful to the Association of Chartered Certified Accountants (ACCA) and theChartered Institute of Management Accountants (CIMA) for permission to reproduce past examination

questions. The suggested solutions in the exam answer bank have been prepared by Tony Surridge OnlineLtd, unless otherwise stated.

This E-book is sold subject to the condition that no part of it shall be reproduced, transmitted, or freely distributed, in

any form by any means, electronic, photocopying, recording or otherwise, without the prior permission in writing ofTony Surridge Online Limited. This book is not to be used for commercial use. It is sold on the understanding that aprivate individual has bought it for individual personal use, and prohibits purchase by any company or organisationentity (limited or otherwise) or sole trader or partnership. Such entities must contact [email protected]

separately to purchase a multi-user license.

2Tony Surridge Online Limited, 2011
http://www.tonysurridge.co.uk/mailto:[email protected]://www.tonysurridge.co.uk/mailto:[email protected]:[email protected]://www.tonysurridge.co.uk/mailto:[email protected]://www.tonysurridge.co.uk/


3/55




DOWNLOAD SAMPLE

Welcome to our download sample of the Tony Surridge +AddVance E-book publication:

ACCA Paper F2 Management Accounting Study Text

Thanks for taking time to review a download extract of this Study Text publication whichwe have developed specially for the ACCA Paper F2: Management Accounting. Wehope you like our electronic study material and recognise that at an extremely low pricefrom just 3 (plus VAT where applicable) the complete purchased and downloaded versionrepresents true value for money.

This is only a small sample, taken directly from the full version, and as such not all

hyperlinks will be active. For illustrative purposes, the selection shown here is Tutorial 3 infull, as highlighted in the table of contents. All hyperlinks are fully functional only in the fulldownloaded version when purchased.

You may like to learn some details about the full version: (please note these details mayvary slightly depending on which updated version you have purchased)

Pages 626Activities with answers 53

Diagrams/charts/tables 76Examples 39Mnemonics 23Diagnostic Questions and Answers 235Thousands of hyperlink connections

It is important for you to know that each Tony Surridge +AddVance E-book can only beused on the computer it is initially downloaded to. The data cannot be transferred to anyportable memory or any other computer or electronic device. This condition is enforced toprotect our digital rights. The data can, however, be transferred to a printer linked to the

same computer and printed in colour or black, white and grey. If you wish to use this+AddVance Exam Study Text on two separate computers (such as a desktop and laptop),then you will need to purchase the product twice, and download it once to each computer.

For further details on minimum computer requirements and our license restrictions pleasevisit our webpage at www.tonysurridge.co.uk/exam-material/how-to-buy

Good luck with your studies.

http://www.tonysurridge.co.uk/http://www.tonysurridge.co.uk/exam-material/how-to-buyhttp://www.tonysurridge.co.uk/exam-material/how-to-buyhttp://www.tonysurridge.co.uk/


4/55




No snowflake in an avalanche ever feelsresponsible.

Voltaire



5/55




Tutorial 3

Materials and inventorycontrol

ACCA Paper F2Management Accounting



6/55




Utilisation of stock

Inventories are an investment The need for flexibility Benefits of holding high inventories of raw materials Balance between costs and benefits Inventory control. Features of an effective system of inventory control. A discussion of the materials purchase cycle (diagram provided). The Purchase Requisition. The Purchase Order. Receiving orders. Objectives of effective inventory-keeping.

Speedy receipt and issue of materials. Fast location of materials. Full identification of materials. Information on quantities on quantities held. Safeguarding of materials. Re-order quantity (ROQ) (including the assessment of quantity discounts) Re-order level (ROL) Maximum inventory level Minimum inventory level Average inventory investment Inventory turnover ratio Efficient use of inventory space. There are two aspects concerning the issuing and pricing of materials Issuing from stores. Perpetual inventory. Continuous inventory-taking. Accounting for materials

(a) documents used.(b) the flow of accounts.

General discussion on material related reports.

In this tutorial



7/55




1. UtilisationThe controlling of the movement of materials into, through and out of a factory (or other part of anorganisation) is an extremely important task with which the cost accountant must be fully familiar.Materials, and their associated costs will be found in:

(a) inventories of raw materials (for service providers, as well)(b) incomplete work (work in progress)(c) inventories of finished goods awaiting sale.

Each of these can represent a substantial part of the working capital of the company. An efficientcompany will attempt to minimise this investment whilst at the same time ensuring that there is alwayssufficient:

(a) raw materials for the production department (factory)(b) work in progress to maintain continuity within the production department,(c) finished goods to satisfy customer demand.

2. Inventories are an investmentInventories, like accounts receivable, involve the commitment of a large amount of a firm's resources;more for a manufacturer than a service provider. Their efficient management is of great concern to thefinancial manager. For a manufacturer, inventories include raw materials, bought-in parts, finishedgoods awaiting sale and also work-in-progress, although the later element will not be discussed here.Inventories should not be viewed as an idle asset; rather they are an essential part of a firm'sinvestment and operations. The optimum holding of inventories will maximise the benefits less costsinvolved.

3. The need for flexibility

Holding higher levels of finished goods inventory will enable the company to be more flexible insupplying customers. More customers would receive immediate delivery rather than waiting for newitems to be produced and they might obtain a greater choice of types of products. There would be asmaller chance of sales being disrupted through interruptions in production. These benefits would haveto be balanced against the storage costs incurred, the capital costs of financing the inventory and thecost of inventory becoming obsolete. Flexibility and innovation is also an important consideration.

4. Benefits of holding high inventories of raw materialsBy holding higher levels of raw material inventory, there is a reduced likelihood of stock-outs. Thepenalty for stock-outs may be lost sales or customer dissatisfaction. Alternatively, a stock-out may incura penalty due to delaying the necessary operations within the organisation till the goods arrive. Anotherbenefit of holding higher levels of inventories is that they lead to fewer, but larger, replenishment. Ifgoods are purchased from a supplier, each additional order will have an additional cost associated withit, such as processing the order or handling the purchases when they arrive. If the goods aremanufactured internally, larger but less frequent production runs will lead to substantial savings.

Our mnemonics on the following two screens may help jog your memory if required:

PRAISE - the benefits of holding high levels of inventoryTOSS - the disadvantages of holding high levels of inventory



8/55




Benefits of holding high levels of inventory (stocks)

The possible benefits of holding high levels of stock are:

P Purchase discounts can be obtained for large-lot (quantity) purchases.R Reduction in annual purchasing costs. Each purchase order will have an incremental cost attached

to it, such as processing the order or handling the goods when they arrive. Large purchase orders willreduce the number of purchases made in a period, but will increase stock holding.

A Adds flexibility and versatility to the firms ability to react to and deal with unexpected orders fromcustomers.

I Investment value may increase in times of high inflation, or when supplies are purchased from

overseas sources and the domestic foreign exchange rate softens (or depreciates) against the rate ofthe other cross-currency. (Speculation can be a reason for holding stock.)

S Stock-outs and the associated costs of production down-time are reduced.E Enables optimum-size batch runs when stock (raw materials) are manufactured internally. (It might be

economic for the firm to produce large batches.)

Memory jog: it might be a matter of PRAISE be that we have a highlevel of stock!

Reward of an act is to have done it.

Ralph Waldo Emerson (1803 1882)Notebook F No 1



9/55




Disadvantages of holding high levels of inventory (stocks)

The benefits obtained from holding higher levels of stock are obtained at the cost of possible disadvantages:

T Theft, deterioration, damage etc. become bigger threats.O Opportunity cost of capital tied up (foregone short-term interest rates, or overdraft interest rates

incurred) is increased.

S Subsequent price reductions (and advantageous foreign currency rate movements) are missed.S Stock holding costs occupancy costs, labour costs and other fixed and variable costs are increased.

Memory jog: Because of the potential disadvantages, management

might decide to TOSS, out the idea of having high stock levels.

http://www.tonysurridge.co.uk/http://www.tonysurridge.co.uk/http://www.tonysurridge.co.uk/


10/55




5. Balance between costs and benefitsThe benefits of holding higher levels of inventory are obtained at a price. This is the cost of holdinginventory. The total cost of inventory holding is made up of several components. The most importantis the cost of capital, although other components of inventory-holding cost include storage cost (warehousing occupancy costs), handling costs, insurance, obsolescence and deterioration. Many of the

components of the inventory-holding cost are proportional to the inventory value and hence it is usuallyassumed that the annual inventory-holding cost is some percentage of the average inventory value. Itshould be clear that these are tradeoffs between ordering larger quantities thereby maintaining higherlevels of inventory, and ordering smaller quantities thereby reducing inventory levels. A compromise issought between too small an order and too large an order. The compromise attempts to ensure abalance between the benefits and costs of inventory holding. This is done by finding some size of batchor order which minimises the total costs.

Figure 3.1 summarises the main areas involved in inventory and materials management.

6. Inventory controlInventory (or materials) control is a system to ensure that the required quantity of material of therequired quality is provided at the required time with the minimum of capital investment. It includes suchmanagement areas as:

(a) procurement (purchasing)(b) storage(c) inventory control(d) issuing(e) pricing material to work (jobs, batches, etc.) and inventory valuation

These management areas will be covered in this tutorial.

7. Features of an effective system of inventory controlIt is generally recognised that an effective system of inventory (materials) control will possess many, ifnot all, of the following features:

(a) budgeted control of material purchases(b) centralised purchasing(c) adequate storage facilities(d) classification and coding of materials(e) operation of efficient inventory control records(f) standardisation of materials used in products(g) planning and scheduling of material requirement

(h) use of standard forms, records and computer software(i) departmental co-operation(j) regular reports to management on purchases, issues, inventory turnover, inventory losses, slow-

moving inventory, dormant inventory, etc.(k) internal audits.



11/55




MANAGEMENTOF MATERIALS

INVENTORY(STOCK)

Storage

Procurement(purchasing)

Pricingmaterials to

work

and

Stock valuation

Stock control

Effective stock management Speedy receipt and issue of stock Fast location of stock Full identification of materials Information on stock held Safeguarding of stock Efficient use of storage space

The purchase-receipt-payment cycle The Purchase (stores) Requisition The Purchase Order Receiving orders Responsibility organisation

Levels and measures:

Re-order level (ROL) Economic order quantity (EOQ)

Maximum stock level Minimum stock level Average stock investment Stock turnover ratio

First in, first out (FIFO) Last in, first out (LIFO) Weighted average Periodic weighted average Standard price

Figure 3.1: Management of materials inventory (stock)

1

2

3

4

Not examinedin the PaperF2 syllabus



12/55




8. Materials purchase cycleFigure 3.2 is an outline of a typical materials purchases cycle; Figure 3.3 extends the system toshow a simplified purchase invoice-payment system; Figure 3.4 provides an overview of the samelogical system but one using a network of computers with a single database file. A computer-basedsystem obviously reduces much of the paperwork. The following comments concern these diagrams:

(a) The Cost Accountant (Management Accounting Department) is responsible for the pricing of allissues to work (jobs, batches, etc.) The department will, therefore, receive information from theStores Department concerning receipts and issues of materials and from the PurchasingDepartment regarding the cost of materials which have been bought.

(b) In practice the Goods Received Department may be combined with the Inspection Department.

(c) The Production Department may return surplus materials to the Stores, in which case a MaterialsReturns Note (or equivalent computer transaction) will be used. Alternatively, materials maybe transferred between work within the Production Department which will require a MaterialsTransfer Note (or computer transaction).

(d) The Purchasing Department may have to receive estimates from a number of suppliers before theappropriate supplier is selected. Only then will a Purchase Order be Placed.

(e) After checking and authorising for payment, the Supplier's Invoice will be passed for payment tothe Accounts Department by the purchasing department. The Accounts Department has not beenshown in the Materials Control Cycle since it is not a fundamental part of materials control, althougha simplified diagram of what is involved is shown in Figure 3.3.

Procurement

1. The Purchase RequisitionThe Purchasing Department will initiate its purchasing procedure on the receipt of a PurchaseRequisition. This is the normal means of notifying the Purchasing Department that a particular item isrequired.

The Purchase Requisition may be raised by:

(a) Design department - for samples of new experimental materials.(b) Stores Department - to replenish inventories of existing materials or obtain supplies of new

materials.(c) Other departments - for stationery, other office supplies, capital equipments, etc.

2. The Purchase OrderFor repeat orders, the Purchasing Department will raise a Purchase order which will be sent to thenormal supplier. For materials which have not been used before, the Purchasing Department wouldnormally:

(a) obtain a quotation from various suppliers(b) select the most appropriate supplier having considered such facts as price, deliver time (supplier

lead time), reputation of supplier, etc.(c) place a Purchase Order with the selected supplier.



13/55




PRODUCTIONPOINT

STORES

PURCHASINGOFFICE

STORESRECEIPT

ANDINSPECTION

STOCKLEDGER

INVENTORY ITEM

INVENTORY ITEM

INVENTORY ITEM

INVENTORY

LEDGER

PURCHASEREQUISITION

STOCKLEDGER

COPY TOACCOUNTANT

CHASE COPY

COPY FOR STORES

PURCHASEORDER

STOCKLEDGERFILE COPY

STORESREQUISITION

STOCKLEDGER

FILE COPY

COPY TOCOST ACCT.

COPY TOACCOUNTANT

GOODSRECEIVED

NOTE

Goods orderedare received

RECEIPTADVICE

To supplier

Used to updateinventory

ledger records

Inventoryrecords

maintained bystores staff in

quantity values

Request forreplenishmentof stock to beordered when

inventorybalancesrequire it

Inventoryrecords arealso kept by

the costaccountant inquantitativeand $ values

Materialsre issued

Start here arefollow the

arrowheads

12

3

4

Figure 3.2 : The materials order-purchases cycle

Request for stock



14/55




GOODSRECEIVED NOTE

AUTHORISEDPURCHASE

INVOICERECEIVED

BY FINANCIALACCOUNTANT

THE

ACCOUNTANTWRITES THECHEQUE AND

MAKESPAYMENT TO

THE SUPPLIER

DOCUMENTSARE MERGED

STOCKLEDGER

PURCHASEORDER COPY

PURCHASEINVOICE

THEACCOUNTANTSCHEDULES

PAYMENT

STOCKLEDGER

REMITTANCEADVICE

CHEQUE

Purchase Invoice isreceived andauthorised by thePurchasing Departmentand then sent to the

Accounts Department

Received fromthe supplier

Received from theGoods Received Department(acts as proof of receipt)

A copy of the PurchaseOrder is received from the

Purchasing Department(verifying that the order

was made andauthorised)

Figure 3.3 : Purchase Invoice-Payment System



15/55




APPLICATIONSOFTWARE

PRODUCTION

STORES

PURCHASINGOFFICE

GOODSRECEIPTSSECTION

ACCOUNTINGOFFICE

INPUT:MATERIALSREQUISITIONDATA

INPUT:ORDER REQUEST

INPUT:SELECTION OFSUPPLIER

INPUT:DATA OF GOODSRECEIVED ANDINSPECTED(CONFIRMED)

INPUT:PURCHASE INVOICEDATA

DATABASE FILES(INCLUDING DATABASEMANAGEMENT SYSTEM

(DBMS)SOFTWARE)

Figure 3.4 : Computer database Purchase Order-Invoice-Payment System

APPLICATIONSOFTWARE

APPLICATIONSOFTWARE

APPLICATION

SOFTWARE

APPLICATIONSOFTWARE



16/55




Duplicate copies of the Purchase Order could be prepared for:

(a) the originator of the Purchase Requisition to confirm that the order has been placed,(b) the Stores and Goods Received department to advise them of impending receipts,(c) filing within the Purchasing Department for eventual checking against the Supplier's Invoice,

Goods Received Note and Inspection Report.

3. Receiving orders(a) Good Received Note

When materials are received, the details of the actual receipt will be entered on a Goods ReceivedNote. Since part-orders are often despatched by suppliers, it is important that there is a permanentrecord of the actual receipts of materials so that these can be reconciled with the Purchase Orders.

(b) Inspection ReportWhen the Goods Received Department have checked the quantity of materials, the quality of thematerials can be determined by the Inspection Department. The Inspection Department willprepare an Inspection Report which can be attached to a copy of the Goods Received Note andboth can be passed to the Purchasing Department.

(c) OrganisationWhether or not separate departments are maintained will depend upon the size of theorganisation. However, regardless of the organisation's size, all receipts must be examined forquantity and quality.

At this point, the materials will normally be passed into the Stores.

To minimise the movement of materials, the Goods Received Department, Inspection Departmentand Stores should be located as near as practical to each other.

Storage

1. Objectives of effective inventory-keepingThe objectives of effective and efficient store-keeping are to provide:- speedy receipt and issue of materials- fast location of materials- full identification of materials- information on quantities held- safeguarding of materials- efficient use of storage space

2. Speedy receipt and issue of materialsSome factors which should be considered are:

(a) The store should be as close as possible to the point of entry of the materials.(b) The store should be conveniently placed for user departments.(c) Fast moving inventory should be stored near to the issue point.(d) There should be separate receipt and issue points in the store to reduce possible congestion.(e) Separate issue points could be operated for different groups of materials.

Many organisations use an organisation consisting of a central stores linked to sub-stores located at eachmain production point or area.



17/55




3. Fast location of materialsThe layout of the stores needs careful planning, the main requirements being stocking in a logicalsequence and an 'address' for each item of material.

4. Full identification of materialsWhilst skilled stores assistants will be able to recognise many types of material inventory, on sight, such

a system is not infallible. To aid the identification of materials, they should be classified according totheir general type and allotted a code number. This combination of classification and coding should doaway with long, unwieldy written descriptions and at the same time provide a full and unambiguousidentification. Such a coding system is essential for the operation of a computer-based inventorysystem.

In general terms a material inventory system should observe certain principle, in terms of:(a) simplicity(b) brevity(c) flexibility (insertion and deletion of inventory items)(d) unambiguity

Example 3.1: Inventory Item Code

1st digit : Main class 1 Raw material2 Consumable material3. Component4 Sub-assemblyetc.

2nd digit : Sub-class 1 Metal2 Glass3 Plasticetc.

3rd digit : Group within sub-class 1 Sheet2 Tube3 Moulding4 Castingetc.

4th and 5th digits : Type of material 1 Steel2 Iron3 Copper4 Brassetc.

6th and 7th digits : Thickness in m.m. 01 = 1 mm

06 = 6 mmetc.

8th and 9th digits : Width in c.m. 03 = 3 cm25 = 25 cmetc.

10 - 12th digits : Length in c.m. 036 = 36 cm210 = 210 cmetc.

So, for example:Code 11203 0450150 is 'A raw material, Copper tube 4 mm x 50cm x 150cm'

End of Example 3.1



18/55




Our mnemonics on the following three screens may help jog your memory if required:

LOAD UP SACKS - the principles of an efficient stores layoutSMART - the advantages of using sub-storesSHALE - the disadvantages of using sub-stores

5. Information on quantities heldFor each type of material in the store, there will be a Bin Card maintained. A typical Bin Card is verysimilar to the Inventory Ledger Accounts shown later in the tutorial, except that a bin card is normallymaintained in quantity terms only. The pricing of issues is carried out by the Costing Department usingthe Stores Ledger Account.

At any time, the balance appearing on the bin card should reflect the physical quantity of materialavailable for issue.

6. Safeguading of materialsAll materials must be adequately stored in such a way that they are appropriately protected against:

(a) fire(b) rust and corrosion(c) theft(d) deterioration(e) effects of weather

7. Efficient use of storage spaceThe most appropriate method of storage should be used for the material concerned, e.g. bins, shelves,pallets, etc. As much use as possible should be made of vertical space whilst still keeping materialsconveniently available. Where mechanical handling equipment, e.g. fork-lift trucks, is used, thereshould be clearly marked passageways which should be kept clear at all times.

Work study techniques can be used to good effect in the design stage of a new store or as an specialanalysis of an existing store layout. Congested stores, harassed store staff, long queues at the counterare all indications of lack of stores effectiveness. Valuable time can be lost if there is delay in peoplebeing served at a store and this increases costs.

Inventory Control

Control can be effected by the calculation and use of the following for each material item:- re-order quantity (ROQ)- re-order level (ROL)

- maximum inventory level- minimum inventory level- average inventory level/investment- inventory turnover ratio

1. Re-order quantity (ROQ)This is the amount that should be ordered from the supplier when the inventory falls to the ROL. Thisquantity is determined after consideration has been given to:- quantity discounts for quantity order (bulk -orders)- storage and associated 'inventory holding' costs- ordering costs.



19/55




Efficient stores layout

The principles involved in the design of an efficient stores layout are detailed in the following mnemonic.

L Labelling of bins and racks to ensure quick and accurate identification of stock items.O Older stocks which need to be issued first (physical first in first out (FIFO) issue) need to be rotated

to the front of the stored materials.

A Assessment of the quantity in hand needs to be facilitated. For example bulk materials can bepacked in smaller units thus allowing ease of stock count.

D Disposal of out-of-date, redundant or not required stock is required. Such stock items should besegregated until disposal occurs.

U Use should be made of the height of the ceiling. This will save storage space and associatedoccupancy costs.

P Pallets should be used where possible, particularly for storing heavy stock items. This will facilitate theuse of fork-lift trucks.

S Slow-moving stock can be stored in close-pack and railed racks which enable relatively quick accessto items stored on the racks at the rear.

A Arrange stock so that material handling equipment, such as fork-lift trucks, is able to gain easyaccess at any point.

C Close proximity of stocks items to the point where they are commonly used increases theefficiency of stock issuing.

K Keep stock packed in units of issue, for example a particular item may be issued in quantities of adozen at a time.

S Security of stock is essential, and is achieved by the use of restricted access, security fencing/walls,locks etc.

Memory jog: Storekeepers often have to LOAD UP SACKSand this should be done as efficiently as possible.



20/55




Advantages of using raw materials sub-stores

Some organisation have a policy of using sub-stores which may, or may not, be part of a storage system

that includes a central store. Materials of technical complexity or of small value but with rapid turnoverwould probably be stored close to the point of production. The advantages of having localised sub-storesin addition to the main central store are as follows:

S Speed of issue is quicker. The need-issue-usage cycle is much shorter and the increasedefficiency might reduce production downtime.

M Meets the needs of just-in-time (JIT) planning and operating systems. With JIT, materials areusually delivered (by external suppliers) directly to the point of manufacture.

A Advanced planning is facilitated, such as batching materials or components for manufacture, orby identifying unexpected purchase needs .

R Reduces the cost of internal transport in terms of labour costs and the depreciation of materialshandling equipment.

T Technical expertise is on hand to deal with materials which have special storage needs, such asthe need for certain chemicals to be maintained in a cool condition.

Memory jog: Remember, in some situations it is SMART to use sub-

stores.

Actions will be judged according to intentions.

Muhammad (A.D. 570? 632)The Sayings of Muhammad, 1.Abdullah Al-Suhrawardy, 1941



21/55




Disadvantages of using raw materials sub- stores

The potential disadvantages of using sub-stores, compared with using a main store, are:

S Supervision of storekeepers and store documentation is more difficult.H Higher numbers of staff are involved in the work of stores thus increasing indirect labour costs.A Audit of stores records (e.g. stock counts) is more difficult.L Larger stock holding, because of an increased number of safety stock buffers, increase the working

capital investment costs.

E Exacerbates (increases) the problem of stock security - theft, damage, etc.

Memory jog: Remember SHALE is a material. Shale-oil is oildistilled from shale.

We do as we are; we become as we do.

Saying



22/55




It is possible to calculate an Economic Order Quantity (EOQ) by mathematical means, and we will lookat this next.

(a) The aim is to minimise the total materials costThe aim of the EOQ calculation is to minimise the total materials cost which is calculated as:

Total materials cost in a period = Cost of purchases + Cost of holding inventory + Ordering cost

(b) Assumptions used in the formulaThe EOQ formula is based on the following assumptions:

(i) constant purchase price(ii) constant demand(iii) even usage(iv) constant lead time(v) fixed cost for each order placed

(vi) holding costs are proportional to average inventories

(c) The formula

EOQ is calculated from the following formula:

where: Q = economic order quantityCo = costs per order

D = period demand (in units)Ch = cost of holding one unit in inventory for the same period(often includes an element of cost of capital)

(d) The logic of the EOQ formula

The total inventory cost = Holding cost + Order cost

The two separate costs increase and decrease inversely with each other. For example, if theholding cost increases because of the volume of order then the order cost will decrease.

Mathematical logic shows, that because of this relationship, the total inventory cost occurs whenthe two separate costs are equal, thus:

Our mnemonics on the following two screens may help jog your memory on what costs areincurred holding inventory and the costs of acquiring inventory.

DO LOSE - the costs associated with holding inventoryRIP - the costs of acquiring inventory.

Ch

2CoDQ =



23/55




The costs of holding inventory

The costs associated with holding inventory (sometimes called carrying costs) include the following:

D Depreciation of capital equipment used in stores work, such as fork-lift trucks, pulley systems,cranes, conveyor belts.

O Occupancy costs, such as rents, rates, heating, air-conditioning,

L Labour costs of storekeeping, and the cost of stores management. These are overhead costs.O Opportunity cost of the funds tied up in the stock investment. (The funds could otherwise be

used to reduce bank overdraft, or be invested in short-term securities.)

S Security and protection costs, perhaps including the maintenance of chemical stability and theturning of inventory, etc.

E Evaporation, stock deterioration and other stock damage, as well as loss of monetary value dueto obsolescence.

Memory jog: Firms DO LOSE profit because of incurring stockholding costs.



24/55




Costs of acquiring inventory(purchase-order costs)

Activities associated with an order of stock on which costs are incurred include the following:

R Receiving inventory - inspecting and dealing with the inventory received.I Inward delivery costs - transport costs, insurance, etc.P Purchase order costs - the variable costs incurred by the purchasing staff involved in ordering

and chasing supplies.

Memory jog: Such costs can RIP, into a companys profits!



25/55




EOQ is when :

Ch

2CoDChx

2

Q

:Thus

CoxQ

DorderingofCost

Chx2

QholdingofCost

orderingofcostholdingofCost

=

=

=

=

Activity 3.1A large local government authority places orders for various stationery items atquarterly intervals.

In respect of an item of inventory coded S218, data are:- annual usage 2,500 boxes- cost per box $8

Usage of material is on a regular basis and on average, half of the amountpurchased is held in inventory. The cost of storage is considered to be 25% of theinventory value. The average cost of placing an order is estimated at $25.

The chief executive of the authority has asked you to review the present situation and

to consider possible ways of effecting cost savings.

You are required to:

(a) tabulate the costs of storage and ordering item S218 for each level of ordersfrom four to twelve placed per year;

(b) ascertain from the tabulation the number of orders which should be placedin a year to minimise these costs;

(c) produce a formula to calculate the order level which would minimise these

costs - your formula should explain each constituent part of the formula andtheir relationships;

(d) give an example of the use of the formula to confirm the calculation in (b)above;

(e) calculate the percentage saving on the annual cost which could be made byusing the economic order quantity system;

(f) suggest two other approaches which could be introduced in order to reducethe present cost of storage and ordering of stationery.

End of Activity 3.1



26/55




Activity 3.1: Answer

(a) TABLE

(b) From the tabulation above, 10 orders for 250 boxes should be placed.

(c) There are several different formula which could be given as the answer to this partof the question, therefore, the following should be regarded as one of the possibleanswers.

Continues

Average inventory

Numberof orders

Numberof boxesper order

Boxes Value at

$8

per box

$

Storage cost

at 25% of

inventoryvalue

$

Cost ofordering

$

Total

cost

$

4 625 312.5 2,500 625 100 725

5 500 250.0 2,000 500 125 625

6 417 208.5 1,668 417 150 567

7 357 178.5 1,428 357 175 532

8 313 156.5 1,252 313 200 513

9 278 139.0 1,112 278 225 503

10 250 125.0 1,000 250 250 500

11 227 113.5 908 227 275 502

12 208 104.0 832 208 300 508



27/55




Activity 3.1: Answer Continues

Continues

250

62,500

2

125,000

0.25x8

25x2,500x2EOQ

PCh

2CoDQ

:Therefore

2

QPCh

Q

CoD

wherei.e.materialorderingofcostwithequatedisholdingof

costoccur whenillquantity worder-reoptimalThe

2

QPCh

:formulatedbecancoststorageAnnual

quantityorder-retheisQwhere

Q

CoD

:formulatedbecancostorderingAnnual

:ipsrelationshalMathematic

priceP

valueofpercentageaasstorageofcostCh

orderanofcostCo

unitsindemandannualDwhere

PCh

2CoDEOQ

=

=

=

=

=

=

=

=

=

=

=

(d)



28/55




Activity 3.1: Answer Continues

(e) Assuming the authority places four orders for 625 boxes on each order, the totalcosts from the tabulation in (a) above are $725 but if this were changed to 10orders per year for the economic order quantity of 250 boxes per order, theresultant annual savings would be:

(f) If orders increase from 4 to 10 per year, some of the savings achieved by theauthority will be at the expense of the supplier, who may have to shortenproduction run or need to carry larger inventories. An approach could be madeby asking the supplier to consider quantity discounts if larger orders were

placed; this could result in savings equal to the cost reduction gained by the morefrequent deliveries.

An analysis of usage could be undertaken - many users of the stationery mightdraw excessive amounts of stationery to keep in their private desks or inunauthorised sub-stores. A limit on internal issue quantities could be introducedwhich could lead to lower inventories being held, for example, averageinventory could be 25% of the order quantity instead of 50% of the order quantity.

The above are two other approaches which could be introduced in order toreduce the present cost of storage and ordering of stationery.

End of Answer for Activity 3.1

31.034%100x725

225

$225$500-$725

=

=

Activity 3.2

Tiger Golfing Goods shop buys golf balls at $30 per dozen from its supplier. TigerGolfing Goods wills ell 40,000 dozen balls evenly throughout the year. The shopdesires an 11% annual return on investment on its inventory (i.e. $3.30 per dozenballs). In addition, rent and insurance for each 100 dozen golf balls in inventory is $6per year. The order cost is $8. Calculate the shops economic order quantity to the

nearest dozen golf balls.

End of Activity 3.2



29/55




(e) The economic batch quantityWhen an organisation manufactures its own inventory items in batches, it will produce a supply ofthe items as a batch quantity. The economic batch size is then the quantity that minimises thecombined total of the costs of inventory-holding and the cost of setting up the batch formanufacture. Note, the cost of setting up the batch replaces the normal order cost for externalsupplies.

The formula used is similar to that of the EOQ we have already discussed, except that wheninventory is manufactured internally in a batch, units of the inventory item can start to be deliveredinto stores before the batch production run has been completed. The first units of the batch willtherefore be delivered into stores before the final units have been manufactured, and these unitscan be used immediately.

The average inventory level is therefore not Q/2, because this is the average inventory level whenthe maximum inventory level is Q. With internal batch production, the maximum inventory level is

just:

Maximum inventory level = Q(1 - D/R)where:

Co = Fixed costs per batchR = the rate at which inventory can be manufactured (replenishment rate)

With the other variables being notated in the same way as the EOQ model, the economic batchquantity is therefore:



dozens262

$30)x(0.11$6/100

40,000x$8x2EOQ

=

+

=

D/R)-Ch(1

2CoDEBQ =



30/55




(f) The effect of quantity (bulk-buying) discountsWhen a company has the opportunity to accept a quantity discount from its supplier it becomesnecessary to calculate whether the discount is economically worthwhile. The technique involves

THREE steps:

(i) calculate total cost at EOQ(ii) calculate total cost at the level where the discount sets in(iii) select minimum cost

(Take care, if the cost of holding (Ch) depends on purchase price.)

Activity 3.3

XYZ Company uses 10,000 of components C each month. It manufactures thesecomponents itself, and can produce them at a rate of 480,000 components per year.

The cost of holding a unit in inventory for one year is $6, and the cost of ordering andsetting up a batch production run for component C is $4,200.

Calculate the economic batch quantity for component C.

End of Activity 3.3



components14,967

4.5

0001,008,000,

480,000])/10,000)x[(12-6(1

10,000)x(12x4,200x2

:Thus

D/R)-(1Ch

2CoDEBQ

=

=

=

=



31/55




Activity 3.4

Demand for one of X companys products averages 1,000 per month. It costs $60each time a delivery of goods is received and $4 to store a unit for a year. Each

product uses a unit of raw material that costs $2 to buy in from the supplier, whooffers a 5% discount for orders of 1,000 units of raw material, or more.

How many units of raw material should the company now order at a time to minimisetotal costs?

End of Activity 3.4


Step 1: Calculate the EOQ without the discount

Step 2: Calculate the total purchase and stocking cost with Q = 600 units

Holding cost = Q/2 x Ch = 600/2 x 4 = $ 1,200Ordering cost = D/Q x Co = [(60 x 12,000) / 600] = $ 1,200Cost of purchases = 12,000 x $2 = $ 24,000Total cost $ 26,400

Step 3: Calculate the total purchase and stocking cost with Q = 1,000 units

Holding cost = Q/2 x Ch = 1,000/2 x 4 = $ 2,000Ordering cost = D/Q x Co = [(60 x 12,000) / 1,000] = $ 720Cost of purchases = 12,000 x $2 x 0.95 = $ 22,800Total cost $ 25,520

ConclusionThe discount offers an annual savings in cost of $880. Hence the company shouldorder 1,000 units at a time.


units600

$4

1,000)x(12x$60x2EOQ

=

=



32/55




2. Re-order level (ROL)This is the level to which inventory is allowed to fall before an order for further supplies is placed. Insetting this level, consideration is given to the maximum daily or weekly use, and the maximum leadtime. (Lead time is the period which elapses between placing and order and actually receiving theitem in inventory). The formula is:

ROL = maximum usage (say per day) x maximum lead time (days)

Both the usage and lead time must be expressed using the same time-scale.

3. Maximum inventory levelThis is the largest quantity of a material which should ever be held. It gives an idea of how muchstorage space, shelves, bins etc. may be required. It must never be exceeded without managementpermission. The formula is:

Maximum inventory level = ROL + ROQ - (minimum usage x minimum lead time)

4. Minimum inventory levelThis level is lower than the ROL. On a material reaching the minimum inventory level, the order thathas been placed at the ROL should be 'progress' (chased up). If short-term delivery is confirmed bythe supplier, there is no problem. If there is an exceptional delay, an alternative source of materialsupply should be found quickly to ensure that a inventory-out does not arise. The formula is:

Minimum inventory level = ROL - (average usage x average lead time)

5. Average inventory level/investmentThis can be calculated in quantity terms as follows:

Average inventory level = minimum inventory level + 0.5ROQ

If it is required in financial terms then it is only necessary to multiply the average inventory level by thecost per unit of the material.

All mankind is divided into three classes theimmovable, the moveable, and those who move.

Arab saying



33/55




Activity 3.5

Two materials, P and Q, are used in a company. Details of the materials are:

Maximum usage : 600 kg per weekAverage usage : 400 kg per weekMinimum usage : 200 kg per week

Re-order quantity : P 2,000 kgQ 2,500 kg

Lead time : P 6 8 weeksQ 4 6 weeks

You are required to calculate for each material:

(a) Re-order level (ROL)(b) Maximum inventory level(c) Minimum inventory level(d) Average inventory level

End of Activity 3.5


(a) ROL = maximum usage x maximum lead time

P: 600 x 8 = 4,800 kgQ: 600 x 6 = 3,600 kg

(b) Maximum inventory level = ROL + ROQ - (minimum usage x minimum lead time)

P: 4,800 + 2,000 - (200 x 6) = 5,600 kgQ: 3,600 + 2,500 - (200 x 4) = 5,300 kg

(c) Minimum inventory level = ROL - (average usage x average lead time)

P: 4,800 - (400 x 7) = 2,000 kgQ: 3,600 - (400 x 5) = 1,600 kg

(d) Average inventory level = minimum inventory level + 0.5ROQ

P: 2,000 + (0.5 x 2,000) = 3,000 kgQ: 1,600 + (0.5 x 2,500) = 2,850 kg




34/55




Activity 3.6

Demand for one of X Company's products, Product N, averages 10,000 per month.Product N requires 2 kilogrammes of material M. Each kilogramme of material M

costs $2 to buy in from the supplier. The supplier's lead-time is between one andthree weeks, but on average delivers in 2 weeks. Daily usage of material M canrange between 600 kgms and 1,000 kgms, but on average is 900 kgms. Thecost of storage is 15% per annum of inventory value and it costs $100 each timea purchase is placed. The company works a five-day week.The supplier has just offered a 1.5% discount on purchases for orders placed of20,000 kilogrammes of material M, or more.You are required to answer the following five questions. All answers should berounded to the nearest kilogramme or $.

1. The economic order quantity (ignore the discount offer) is

A 12,629B 12,649C 12,669D 12,689

2. The reorder level isA 13,000 kgmsB 14,000 kgmsC 15,000 kgmsD 16,000 kgms

3. The minimim inventory level isA 6,000 kgmsB 6,200 kgmsC 6,400 kgmsD 6,600 kgms

4. The maximum inventory level isA 24,349B 24,449C 24,549D 24,649

5. By taking the discount the total annual cost of material wouldA increase by $6,839B reduce by $6,839C increase by $6,439D reduce by $6,439

End of Activity 3.6



35/55





1. B

Economic order quantity

2. C

Reorder level

ROL = Maximum lead-time (weeks) x Maximum usage per week

= 3 x (1,000 x 5 days)= 15,000 kgms

3. A

Minimum inventory level

ML = ROL - Average lead-time (weeks) x Average usage per week= 15,000 - (2 x (900 x 5))= 6,000 kgms

4. D

Maximum inventory level

ML = ROL + EOQ - (Minimum lead-time (weeks) x Minimum usage per week)= 15,000 + 12,649 - (1 x 600 x 5)= 24,649 kgms

continues

kgms12,649

0160,000,00

0.3

240,000x$100x2

0.15x$2

2)x10,000x(12x$100x2

Ch

2CoDEOQ

=

=

=

=

=



36/55




The limitations of using the EOQ model is shown in our mnemonic SHOVE on the next screen.

6. Inventory turnover ratioIf this ratio is calculated regularly, it will indicate any trends in material usage. It can be calculated as

follows:

The calculation of the inventory turnover ratio should help to:

(a) validate the ROQ, ROL and other inventory levels,(b) highlight obsolete inventory (inventory having no further use), and(c) highlight dormant inventory (inventory of no immediate further use).

Activity 3.6: Answer continuation

5. B

EOQ with discount

(i) Total annual cost without the discount: Order quantity - 12,649 kgms

$Cost of supplies: 10,000 units x 12 months x 2 kgms x $2 = 480,000Cost of holding inventory: Q/2 x CH: 12,649/2 x $2 x 0.15 = 1,897Cost of ordering inventory:

D/Q x Co: (10,000 x 12 x 2) / 12,649 x $100 = 1,897Total annual cost 483,794

(ii) Total annual cost with the discount: Order quantity - 20,000 kgms

Cost of supplies: $10,000 units x 12 months x 2 kgms x $2 x 0.985 = 472,800

Cost of holding inventory:Q/2 x CH: 20,000/2 x $2 x 0.15 x 0.985 = 2,955

Cost of ordering inventory:D/Q x CO: (10,000 x 12 x 2)/20,000 x $100 = 1,200

Total annual cost 476,955

ConclusionTaking advantage of the discount and setting the order quantity at 20,000 kgmsreduces the total annual cost by $6,839 ($483,794 - $476,955). The discount isrecommended.


periodsametheinlevelinventoryAverage

periodtheinissuedQuantitypercentageturnoverInventory =



37/55




Problems when using EOQ formula

The economic order quantity (EOQ), , is based on minimising the total cost of storage

holding and the ordering/acquisition of materials. However, there are problems associated with the use ofthe formula.

S Suppositions are simplistic, for example the assumption that there is no buffer stock and thataverage stock held would therefore be Q/2 is difficult to accept in practice.

H Holding costs are difficult to calculate and these are assumed to be constant throughout theforecast period. For example, holding costs include the opportunity cost of capital tied up in thestock investment and the rate is difficult to predict.

O Order costs may also be difficult to calculate in advance.V Value (or benefit) of discounts for quantity (large-lot) purchases is not reflected in the equation.

Calculations which assess the benefits of quantity discounts need to be dealt with separately.

E Even consumption, and thus steady-rate purchases, of materials is assumed. This is unlikely inpractice.

Memory jog: Use word association here. The problems of using this

formula might make managers SHOVE it to one side and deal withpurchasing decisions in other ways.

Ch

2CODQ =

Well done is better than well said.

Benjamin Franklin (1706 1790)Poor Richards Almanack.



38/55




Activity 3.7

Material X has been monitored for two periods and the following results obtained:

January - March April - JuneIssues (kilos) 160,000 120,000Average inventory level 40,000 40,000

Required:

(a) Calculate the inventory turnover ratio(b) State your conclusions concerning the figures used.

End of Activity 3.7


(a) Inventory turnover ratio:January - March = 25%April - June = 33%

(b) Conclusions:

Even though the usage has reduced, no action has been taken to reduce theROQ. We know this because the average inventory level is the same. An

investigation is required to ensure that the ROL, Maximum inventory level,Minimum inventory level and ROL are still appropriate top the reduced level ofproduction.


Issuing and pricing

1. There are two aspectsThere are two aspects to issuing materials from inventory:

(i) The actual issuing of the materials from stores.(ii) The pricing of the issues, which have been made, by the Costing Department.

2. Issuing from stores(a) The control of issues of materials to production should be effected by the use of Stores

Requisitions (sometimes called Material Requisitions). These should only be accepted by thestore-keeper if they have been properly authorised by a responsible person, e.g. a foreperson orsupervisor.



39/55




(b) An effective system of storekeeping will ensure that materials are always issued on a FIFO (first in, firstout) basis. This should result in the oldest inventory being used up first. This method of issuingphysical inventory must not be confused with the FIFO method of pricing which will be covered in duecourse.

Notes:

(i) Any returns to store should be documented by using a Stores Returns Note (or Materials ReturnsNote). This will show the quantity and code number of the material and the job for which thematerials were originally issued.

(ii) Any transfer from one job to another should be recorded on a Materials Transfer Note. This willensure that the job giving up the materials is relieved of the cost and the job receiving thematerials is charged with the cost. The stores, of course, will not be involved in the transactionsince the material issue has already been recorded.

Inventory recording and inventory-taking

1. Perpetual InventoryIn order to use control levels effectively it is necessary to know the inventory levels at any time. Asystem of Perpetual Inventory records shows all receipts, issues and balances for each line ofinventory, often using inventory ledger records of the type discussed previously in this tutorial. Theperpetual inventory system may also give inventory values and will give details of control levels (suchas reorder, maximum and minimum levels) and other related information.

2. Continuous inventory-taking

A system of control cannot be regarded as efficient unless the physical inventory-holding agreeswith the inventory balance shown in the accounting records. To ensure that this is achieved, theregular checking of inventory-holding against the records is often used.

The personnel selected for the inventory-taking team should be of the highest integrity and should beresponsible to the Financial Controller or Senior Internal Auditor (if the enterprise operates an internalaudit system) and not someone connected with the stores.

The audit or checking programme should be designed to ensure that a pre-selected number of itemsis fully checked each day. The stores staff should have no prior knowledge of the particular itemswhich are to be checked each day.

This system is known as 'Continuous Inventory-taking' with each item in the store being checked atleast once each year. Continuous inventory-checking should not be confused with PerpetualInventory; continuous inventory-checking is used to confirm that the perpetual inventory system isoperating efficiently.



40/55




Accounting for materials

1. Documents usedThe following documents are typical in a materials costing system:

(a) Purchase invoices are used to write up the accounts payable ledger accounts.(b) Purchase invoices are also used to write up the stores ledger.(c) Purchase day-book totals are used to write up the control totals.(d) Materials requisitions are used to write up the stores ledger accounts.(e) Materials requisitions for direct materials are used to write up job (or process) work-in-progress

accounts.(f) The stores day-book summarises the materials requisitions. The total issues of direct materials

are posted to the work-in-progress ledger control accounts and the total issues of indirectmaterials are posted to the overhead control account.

2. The flow of accounts

The flow of accounts used in the materials costing system is shown in Figure 3.5.

Materials and inventory reports

Regular reports should be prepared to indicate the effectiveness and efficiency (or otherwise) of materialsand inventory. These will include:

(a) inventory turnover report(b) comparison of material costs with output(c) slow moving inventory reports(d) dormant inventory reports

(e) inventory losses reports



41/55




ACCOUNTSPAYABLELEDGER

ACCOUNTS

INVENTORYLEDGER

ACCOUNTS

Work-in-Progress Ledger(Job or process ledger

accounts)

InventoryLedger

Control A/c

Work-in-ProgressLedger

Control A/c

AccountsPayableLedger

Control A/c PurchaseDay-book

total

StoresDay-book

total

OverheadCost LedgerControl A/c

Indirectcosts

Directcosts

Figure 3.5: Cost accounting for materials

The day-book logic is usually maintainedin a computer system although the logicstructure of the computer system is nottransparent to the user.

Purchase invoices might be dealt withthrough a computer inter-changesystem (electronic invoicing) but theupdate and payment system is thesame as used in a manual system

Material (store) requisitions are raised byproduction staff and provide stores staffwith the authority to issue materials, andthe cost accountant with information forposting to accounts using job/departmental codes

PURCHASEINVOICES

MATERIAL(STORE)

REQUISITIONS

AccountsPayableLedger

Control a/c

InventoryLedger

Control a/c

Work-in-progressLedger

Control a/c

OverheadCost LedgerControl a/c



42/55




Main topic Coverage

1 Introduction to materials element of costs. 1. Utilisation of stock2. Inventories are an investment3. The need for flexibility4. Benefits of holding high inventories

of raw materials5. Balance between costs and benefits6. Inventory control.7. Features of an effective system

of inventory control.2 Ways by which materials are issued, ordered

and received.A discussion of the materials purchase cycle(diagram provided).

3 Procurement of materials. 1. The Purchase Requisition.2. The Purchase Order.3. Receiving orders.

4. Storage 1. Objectives of effective inventory-keeping.

2. Speedy receipt and issue ofmaterials.

3. Fast location of materials.4. Full identification of materials.

5. Information on quantities onquantities held.

6. Safeguarding of materials.7. Efficient use of inventory space.

5. Inventory Control 1. Re-order quantity (ROQ) (includingthe assessment of quantity discounts)

2. Re-order level (ROL)3. Maximum inventory level4. Minimum inventory level5. Average inventory investment6. Inventory turnover ratio

6. Issuing and pricing 1. There are two aspects.2. Issuing from stores.

7. Inventory recording and inventory-taking 1. Perpetual inventory.2. Continuous inventory-taking.

8. Accounting for materials 1. Documents used.2. The flow of accounts.

9. Materials and inventory reports General discussion.

The tutorial has dealt with the following topics and concepts:

The tutorial has dealt with the following topics and concepts:

Summary of the tutorial



43/55




Diagnostic Test:Materials and inventory controlComputer-based Assessment: Questions

ACCA Paper F2Management Accounting



44/55




Question 1

A company determines its order quantity using the basic economic order quantity model. If the cost ofordering a batch of materials increases, how will this affect the economic order quantity (EOQ) and annualinventory holding costs (Ch)?

EOQ Ch CostA Higher HigherB Higher No effectC Lower LowerD Lower No effect

Question 2

The EOQ (Economic Order Quantity) model is used to minimise

A costs associated with stock-outs

B inventory ordering costsC inventory holding costsD the sum of inventory ordering and holding costs

Question 3

Holderco Company uses the standard EOQ model for controlling its investment in inventory. The annualdemand for one product so controlled has just increased by approximately 20%. What will be the effect onthe rate of inventory turnover (annual demand divided by average inventory)?

A Decrease by 20%B Decrease by 9.5%C Increase by 20%D Increase by 9.5%

Question 4

A company has correctly calculated its economic order quantity as 800 units, but management would preferto order in batches of 700 units. How will the company's total purchase order cost (Co) and total inventoryholding cost (Ch) change if the economic order quantity is altered from 800 to 700 units?

Co Cost Ch CostA Lower Higher

B Lower LowerC Higher HigherD Higher Lower

A


A

A

A


45/55




Question 5

If the economic order quantity model is employed, what will be the effect of increasing the re-order level?

There will be a decrease in

A holding costsB stock-out costsC the total of holding and order costsD order costs

Question 6

A company requires 20,000 units of a certain component every year. The purchase price per unit is $40and it costs $64 to place and receive delivery of an order irrespective of its size. The company's cost ofholding inventory is 10% of inventory value per annum.

The company currently places orders for 800 units, although a discount scheme for larger units exists whichwork as follows:

Minimum order quantity Discount rate1,000 1%4,000 2%8,000 3%

What size of order should the company place if its aim is to minimise costs?

A 800 units

B 1,000 unitsC 4,000 unitsD 8,000 units

Question 7

Which one of the following may be thought of as a inventory holding cost?

A Disruption of production schedulesB Loss of customer goodwillC Shipping and handling costsD Inventory obsolescence

Question 8

Annual demand for an item is 10,000 units and ordering costs are $50 per order. The cost of holdinginventory is 10% per annum of the purchase price which is currently $10 per item. The economic orderquantity is 1,000 units but the supplier offers a discount of 2% on orders for 2,500 or more items at a time.Accepting the discount opportunity and ordering 2,500 items will cause total annual costs to:

A increase by $450B increase by $425C decrease by $1,550

D decrease by $1,575


A

A

A

A


46/55




Question 9

In the formula Q = 2CoD/Ch, if Co = $50, D = 40,000 and Q = 1,000, then Ch is closest in value to:

A $4.00

B $4.10C $4.80D $5.00

Question 10

The demand for a product is 18,750 units for a three month period. Each unit of product has a purchase priceof $22.50 and ordering costs are $30 per order placed.

The annual holding cost of one unit of product is 15% of its purchase price.

What is the Economic Order Quantity (to the nearest highest unit)?

A 1,282B 1,175C 1,138D 1,155

Question 11

A company determines its order quantity for a raw material by using the Economic Order Quantity (EOQ)model.

What would the effects on the EOQ and the total annual holding cost of a decrease in the cost of ordering abatch of raw material?

EOQ Total annual holding costA Higher LowerB Higher HigherC Lower HigherD Lower Lower

Question 12

A company uses the Economic Order Quantity (EOQ) model to establish reorder quantities. Thefollowing information relates to the forthcoming period:

Order costs = $37.50 per orderHolding costs = 10% of purchase price = $6 per unit per annumAnnual demand = 20,000 unitsPurchase price = $60 per unit

No safety inventories are held.

What are the total annual costs of inventory (i.e. the total purchase cost plus total order cost plus total

holding cost)?


A

A

A

A


47/55




A $1,215,000B $1,201,500C $1,203,000D $1,204,500

The following information is to be used for questions 13 and 14.

A local supermarket inventories a popular tin of vegetables for which the following information is available:

Average usage: 280 tins per dayMinimum usage: 180 tins per dayMaximum usage: 350 tins per dayReplenishment lead time: 6-10 daysRe-order quantity: 2,000 tins

Question 13

Based on the data above, at what level of inventories should a replenishment order be issued?

A 3,500B 3,800C 2,950D 3,220

Question 14

Based on the data above, what should be the maximum level of inventory possible?

A 2,800B 4,400C 4,420D 5,280

Question 15

Which of the following procedures would not be regarded as an aspect of inventory control?

A Forecasting demand for inventory itemsB Protecting stores from theft and damage

C Determination of reorder levelsD Deciding when and how much of a inventory item to order

Question 16

A routine check of inventory records shows that the current inventory level of item 12788 is over 1.5 times themaximum that has been set for it. Any of the following might be causes for this high inventory level EXCEPT

A an error in the quantity of the item delivered in the monthB an error in the re-order quantity for the itemC a reduction in the usage rate for the item

D an increase in the supply lead time for the item


A

A

A

A

A


48/55




The following data refers to Questions 17 - 20

The following data relates to an item of raw material that is used by PRQ Company.

Cost of raw material $20

Normal usage per week 250 unitsMaximum usage per day 66 unitsMinimum usage per day 40 unitsMinimum lead time 10 daysMaximum lead time 20 daysCost of ordering material, per order $400Annual cost of holding inventory, as a % of cost 10%

A year consists of 48 weeks.

Question 17

The economic order quantity for the raw material is

A 2,191 unitsB 2,500 unitsC 4,899 unitsD 5,000 units

Question 18

The re-order level is

A 1,320 unitsB 525 unitsC 3,111 unitsD 2,191 units

Question 19

The maximum inventory level for the raw material is

A 3,625 unitsB 4,218 units

C 3,111 unitsD 2,191 units

Question 20

The minimum inventory level for the raw material is

A 715 unitsB 525 unitsC 425 unitsD 650 units


A

A

A

A


49/55




Question 21

The following details relate to component 1256

Maximum usage per day 10 units

Minimum usage per day 4 unitsMaximum lead time 5 daysMinimum lead time 3 daysOrdering cost $50 per orderInventory holding cost $2 per item per yearAnnual demand 1,750 units

The budget for December is currently being revised to take account of these details. The inventory isbudgeted to be 170 units on 1 December, and the production manager has requested that the inventory be atmaximum on 31 December.

Assuming that the usage of this component is expected to be 140 units during December, the number ofunits to be purchased during December is closest to

A 296 unitsB 304 unitsC 334 unitsD 350 units

Question 22

CAS Premier Company uses 90,000 units of product C every year. It manufactures units of C internally,and can produce them at a rate of 360,000 units per year. The cost of holding a unit of C in inventory for oneyear is $4, and the cost of ordering and setting up a batch production run for C is $3,038.

The economic batch quantity for product C, to the nearest $ is

A 13,301B 13,401C 13,501B 13,061

Question 23

Which of the following statements are correct?

(i) The opportunity cost of funds invested in inventory is interest paid for bank overdraft or interestforegone on short-term yield bearing securities.

(ii) The cost of holding inventory and the cost of acquiring inventory both increase when an organisationincreases the order quantity of a material.

(iii) Possible future obsolescence of inventory is not taken into account in the economic order quantity(EOQ) formula.

(iv) Depreciation of capital equipment used in stores work does not affect cash flow and is therefore notconsidered relevant when the economic order quantity (EOQ) is calculated.


A

A

A


50/55




A (i) onlyB (i) and (ii) onlyC (i), (ii) and (iii) onlyD (i), (ii) and (iv) only

Question 24

Which of the following statements are correct?(i) The cost of holding stock over a period is calculated as 2Q x ch.(ii) The cost of acquiring stock over a period is calculated as D/Q x Co.(iii) The total cost of purchasing material over a period is calculated as: D x p.(iv) The total cost of using material over a period is calculated as: Purchase cost + holding cost -

acquisition cost. (The reason why the acquisition cost is subtracted is because it changes inverselywith the change in holding cost.)

Where: Q = Quantity of purchase

Ch = Cost of holding one item of inventory for a periodD = Demand over the same periodCo = Cost of one orderp = Price of one item of material.

A (i), (ii) and (iii) onlyB (ii) and (iii) onlyC (ii), (iii) and (iv) onlyD (i), (ii), (iii) and (iv)

Question 25

The purchase price of an inventory item is $12.50 per unit. In each three month period the usage of the itemis 10,000 units. The annual holding costs associated with one unit equate to 6% of its purchase price. Thecost of placing an order for the item is $10.

What is the Economic Order Quantity (EOQ) for the inventory item to the nearest whole unit?

A 253B 516C 824D 1,033

Question 26

Newington Company always determines its order quantity for a raw material by using the Economic OrderQuantity (EOQ) model.

What would be the effects on the EOQ and the total annual holding cost for a decrease in the cost ofordering a batch of raw material?

EOQ Annual holding costA Lower HigherB Lower LowerC Higher Lower

D Higher Higher


A

A

A

A


51/55




+AddVance

Route map

ScreenNumber

Tutorial 1

Introduction, management, finance andaccountancy

28

Diagnostic Test 54

Tutorial 2

Costing principles, cost classification and costbehaviour

59

Diagnostic Test 93

Tutorial 3Materials and inventory control 108

Diagnostic Test 146

Tutorial 4

Labour costs and direct expenses 160

Diagnostic Test 194

Tutorial 5

Overhead costs 208

Diagnostic Test 241

Tutorial 6

Marginal costing 255

Diagnostic Test 269

Tutorial 7

Cost accounting 278

Diagnostic Test 294

Tutorial 8

Methods of costing298

Diagnostic Test 355

Tutorial 9

Cost-volume and break-even analysis 371

Diagnostic Test 391

Tutorial 10Relevant costing 407

Diagnostic Test 439

The Contents continue onthe next screen


OnlyTutorial 3

is hyperlinkedfor this Free

Sample


52/55




+AddVance

Route map

Screen

Number

Tutorial 11

Linear programming 455

Diagnostic Test 475

Tutorial 12Budgets and budgetary control 485

Diagnostic Test 537

Tutorial 13Standard costing 549

Diagnostic Test 590

Tutorial 14

Business mathematics and spreadsheetssystems

604

Diagnostic Test 617

Trust in Allah, but tie your camel first.

Arabic proverb



53/55




The computer-based examination

ACCA Paper F2 Management Accounting:

The syllabus is assessed by a two hour paper-based or computer-basedexamination. Questions will assess all parts of the syllabus and will Include both

computational and non-computational elements. The examination will consist of 40two mark questions, and 10 one mark questions.

Formulae Sheet



54/55






55/55



Sorry... But that link will not work in this free sample copy.

To buy the full Study Text version, complete with all links,for your ACCA F2 studies, please go to

www.TonySurridge.co.uk

Dedicated to the Accountancy and Finance Profession
http://www.tonysurridge.co.uk/ecommerce/Exam+Materialhttp://www.tonysurridge.co.uk/ecommerce/Exam+Materialhttp://www.tonysurridge.co.uk/ecommerce/Exam+Material