Material Cost
Material cost is the cost of materials used to manufacture a product or provide a service. Excluded from
the material cost is all indirect materials, such as cleaning supplies used in the production process.
Follow these steps to determine the amount of material cost to assign to a unit of production (such as a
completed finished goods item):
1. Ascertain the standard quantity of the material used to manufacture one unit.
2. Add the standard amount of scrap associated with manufacturing one unit.
3. Determine the standard amount of scrap associated with setting up the production run, and apportion it
to the individual unit.
4. If any scrap is then sold, apportion the revenue back to the individual unit.
What Is Economic Order Quantity (EOQ)?
Economic order quantity (EOQ) is the ideal order quantity a company should purchase to
minimize inventory costs such as holding costs, shortage costs, and order costs. This
production-scheduling model was developed in 1913 by Ford W. Harris and has been refined
over time. The formula assumes that demand, ordering, and holding costs all remain constant.
Definition
Economic Order Quantity is the level of inventory that minimizes the total inventory holding costs and
ordering costs. It is one of the oldest classical production scheduling models. Economic order quantity refers to that
number (quantity) ordered in a single purchase so that the accumulated costs of ordering and carrying costs are at
the minimum level. In other words, the quantity that is ordered at one time should be so, which will minimize the
total of. Cost of placing orders and receiving the goods, and Cost of storing the goods as well as interest on the
capital invested.
Formula and Calculation of Economic Order Quantity (EOQ)
EOQ = Economic Order Quantity,
RU = Annual Required Units,
OC = Ordering Cost for one Unit
UC = Inventory Unit Cost,
CC = Carrying Cost as %age of Unit Cost
Example 1:
Demand for the Child Cycle at Best Buy is 500 units per month. Best Buy incurs a fixed order placement,
transportation, and receiving cost of Rs. 4,000 each time an order is placed. Each cycle costs Rs. 500
and the retailer has a holding cost of 20 percent. Evaluate the number of computers that the store
manager should order in each replenishment lot?
Example 2:
ABC Ltd. uses EOQ logic to determine the order quantity for its various components and is planning
its orders. The Annual consumption is 80,000 units, Cost to place one order is Rs. 1,200, Cost per unit
is Rs. 50 and carrying cost is 6% of Unit cost. Find EOQ, No. of order per year, Ordering Cost and
Carrying Cost and Total Cost of Inventory.
Example 3:
Midwest Precision Control Corporation is trying to decide between two alternate Order Plans for its
inventory of a certain item. Irrespective of the plan to be followed, demand for the item is expected to
be 1,000 units annually. Under Plan 1st, Midwest would use a teletype for ordering; order costs would
be Rs. 40 per order. Inventory holding costs (carrying cost) would be Rs. 100 per unit per annum.
Under Plan 2nd order costs would be Rs. 30 per order. And holding costs would 20% and unit Cost is
Rs. 480. Find out EOQ and Total Inventory Cost than decide which Plan would result in the lowest total
inventory cost?
Example 4:
A local TV repairs shop uses 36,000 units of a part each year (A maximum consumption of 100 units
per working day). It costs Rs. 20 to place and receive an order. The shop orders in lots of 400 units. It
cost Rs. 4 to carry one unit per year of inventory.
Requirements:
(1) Calculate total annual ordering cost
(2) Calculate total annual carrying cost
(3) Calculate total annual inventory cost
(4) Calculate the Economic Order Quantity
(5) Calculate the total annual cost inventory cost using EOQ inventory Policy
(6) How much save using EOQ
(7) Compute ordering point assuming the lead time is 3 days
Fixation of Stock Levels: Formulas and
Calculations
(i) Maximum Level of Stock = (Reorder Level + Reorder Quantity) – (Minimum
rate of consumption x Minimum reorder period)
(ii) Minimum level of stock = Reorder level – (Average rate of consumption x
Average reorder period)
(iii) Safety Stock = (Annual Demand/365) x (Maximum Reorder Period –
Average Reorder Period)
(iv) Reorder level or Ordering level = Maximum rate of consumption × Maximum
reorder period. Alternatively, it will be = safety stock + lead time consumption
[lead time consumption will be = (Annual consumption -s- 360) × lead time]
(v) Danger level = It is slightly below the minimum level. It is a level at which
special efforts should be made to obtain supplies of materials, i.e.
Average Consumption x Maximum reorder period for emergency purchases.
(vi) Average Stock level = Minimum stock Level + 1/2 of Reorder Quantity.
