Economic Order Quantity (Eoq) Part 2

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It is the size of the purchase order which gives maximum economy in purchasing material. This denotes the level of stock which gives effective result and more economical. It is also termed as standard order quantity. The EOQ is defined by considering different costs i.e. Ordering Cost and Carrying Cost or Handling Cost.

Ordering Cost: It is the cost incurred by the firm to place an order and acquire the material i.e. cost of transportation, cost of receiving and inspecting the materials. The ordering cost depends on number of orders and number of items ordered.

If the order size is larger in quantity, orders placing cost per unit is lower and if order size is smaller in quantity, order placing cost per unit is higher.

Carrying Cost: It is the cost that is incurred in maintaining a given level of stock. It

includes cost of handling materials, insurance premium, cost of storage space, obsolescence losses etc., larger size of stock, higher the stock carrying cost per unit per annum and vice versa.

EOQ =

Where, A = Annual consumption

B = Buying cost per order

C = Carrying cost per unit per annum

EOQ = Economic order Quantity

Example:

Satyam, a machine manufacturer, purchases 3600 units of a certain component for his annual usage. The order placing cost is Rs.200 and cost of carrying one unit for a year is Rs. 4. Calculate the economic order quantity.

Solution:

EOQ =

A = 3600 units

B = Rs 200

C = Rs 4

EOQ =

=

Methods of Pricing of the Issue of Materials:

Material requirement for production is very important. The order for new material is very frequent. So, materials are purchased at different prices based on market condition. But they will keep all those materials in stores. Sometimes newly purchased material is used for production and sometimes old material is used for production. In order to estimate the cost of product different methods are used basing on the price of purchase of material and issue of material. There are two methods.

First in, First Out [FIFO]:

In this method we use first purchased material for production. Newly purchased material will be stored in store. After first lot is used , the next lot of material is used for production. The price of first purchase for all the issues is same until the material of first purchase is entirely issued to various jobs, cost of materials issued represents the cost of earlier purchases.

Cost of closing stock shows the cost of latest purchases.

Advantages:

  • Good method for the management of stock as the store consists recent purchase.

  • The value of stock of material is calculated based on present price.

  • No profit or no loss if we use this method.

Disadvantages:

  • The objective of matching of cost with revenues is not achieved

  • If the price of material raising fast the estimation of cost of product is different and difficult as the old material is used for the production.

  • It involves difficult calculation and hence increasing the possibility of clerical mistake.

  • Comparison between similar jobs is very difficult if material issued to the jobs is of different prices.

It is suitable for large size and cost of raw material units and not more than two or three different prices of material are on hand at one time.

Example:

A firm maintains its stores ledger on the basis of FIFO method. Following is the summary of the receipts and issues of raw materials during the month of April 2006:

April 01 Opening balance 300 units @ Rs.22 per unit

’’ 03 Issue vide Material requisition No. 14, 150 units.

’’ 08 Purchase order No.07, 200 units @ 25 per unit.

’’ 12 Purchase order No.09, 400 units @ 23 per unit

’’ 17 Issue vide Material requisition No. 16, 500 units.

’’ 20 Issue vide Material requisition No. 18, 100 units.

’’ 23 Purchase order No. 11, 600 units @ 20 per unit.

’’ 25 Issue vide Material requisition No.26, 600 units.

’’ 28 Purchase order No.12, 200 units @ 26 per unit.

’’ 29 Issue vide Material requisition No.32, 300 units.

’’ 30 Shortage 10 units

Solution:

Stores Ledger Sheet [FIFO]

Table of Stores Ledger Sheet [FIFO]
Title: Table of Stores Ledger Sheet [FIFO]

Date

Particulars

Receipts

Issues

Balance

Qty

Rate

Amount

Qty

Rate

Amount

Qty

Amount

2006

April 1

03

08

12

17

20

23

25

28

29

30

Balance

M.R. No.14

P.O No. 07

P.O No. 09

M.R No. 16

M.R. No.18

P.O No.11

M.R. No.26

P.O No.12

M.R. No.32

Shortage

Total

--

--

--

--

--

--

--

--

--

--

26

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

*40 units @ Rs.26 = Rs.1040

Value of Closing Stock = Rs.1040

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