Management Accounting. Sample Paper 1 Questions and Suggested Solutions

Transcription

1 Management Accounting Sample Paper 1 Questions and Suggested Solutions

2 NOTES TO USERS ABOUT SAMPLE PAPERS Sample papers are published by Accounting Technicians Ireland. They are intended to provide guidance to students and their teachers regarding the style and type of question, and their suggested solutions, in our examinations. They are not intended to provide an exhaustive list of all possible questions that may be asked and both students and teachers alike are reminded to consult our published syllabus (see for a comprehensive list of examinable topics. There are often many possible approaches to the solution of questions in professional examinations. It should not be assumed that the approach adopted in these solutions is the only correct approach, particularly with discursive answers. Alternative answers will be marked on their own merits. This publication is copyright 2013 and may not be reproduced without permission of Accounting Technicians Ireland. Accounting Technicians Ireland,

3 INSTRUCTIONS TO CANDIDATES In this examination paper the / symbol may be understood and used by candidates in Northern Ireland to indicate the UK pound sterling and by candidates in the Republic of Ireland to indicate the Euro. Answer FIVE questions. Answer all three questions in Section A. Answer ANY Two of THREE questions in Section B. If more than the required number of questions is answered in Section B, then only the requisite number, in the order filed, will be corrected. Candidates should allocate their time carefully. All figures should be labelled, as appropriate, e.g., / s, etc. Answers should be illustrated with examples, where appropriate. Question 1 begins on Page 4 overleaf. 3

4 Question 1 SECTION A: Answer all Questions The following information relates to the only product manufactured and sold by Ash plc. / per unit Selling price 70 Direct material cost 25 Direct labour cost 20 Variable production overhead 5 Variable sales & marketing overhead 2 The following levels of activity took place over the first three months of the products life: Sales Production Units Units September 4,750 5,000 October 5,500 6,000 November 6,500 7,000 Additional information is as follows: 1. Budgeted fixed production overhead was / 300,000 per annum. 2. Actual fixed production overhead for the period was / 25,000 per month 3. Sales and marketing overhead of / 25,000 per month and administration overhead of / 18,750 per month were in line with the budget for that period. 4. All fixed overhead costs are budgeted on the basis of a projected volume of 75,000 per year and all costs are expected to be incurred at a constant rate throughout the year. 5. The business does not expect to have any inventory at 1 September Required: a) Prepare a profit statement for each month using each of the following bases: i. Absorption costing ii. Marginal costing b) Calculate the (under)/over absorbed fixed production overhead for each month. (14 Marks) (3 Marks) c) Explain the reason for any difference in the reported profit under the two bases for each month. (3 Marks) 4 Total: 20 Marks

5 Question 2 The following information relates to Lookin plc. a manufacturing company that has two manufacturing departments and two service departments: Manufacturing Dept. 1 / Manufacturing Dept. 2 / Service Dept. 1 / Service Dept. 2 / Total / Allocated Overheads 32,400 29,200 12,400 12,850 86,850 General Overheads Indirect Labour 32,000 Heat & Light 48,600 Repairs & Maintenance 34,700 Canteen Subsidy 5,100 Machine Depreciation 10,400 Machine Insurance 6, ,900 The following additional information was extracted from the company s management accounting records. Manufacturing Dept. 1 Manufacturing Dept. 2 Service Dept. 1 Service Dept. 2 Floor area sq. m 2,500 4,000 1, Direct labour hours 30,000 5, Indirect labour hours 30,000 5, Direct labour rate per hour / Number of staff Machine hours 2,500 25, Machine value / 40, ,000 10,000 - Service Dept. overheads are to be re-apportioned as follows Service Dept. 1 overheads 20% 80% Service Dept. 2 overheads 50% 50% 5

6 Data on two jobs being undertaken by the company is as follows: Job Eng230 Job Art490 Direct materials cost / 240 / 420 Machine hours 5 20 Direct labour hours - Manufacturing Dept Manufacturing Dept Required: a) Prepare a statement showing the overhead cost for each department (include the basis of apportionment, where appropriate). (10 Marks) b) Calculate a suitable overhead absorption rate for each department, using a basis that you deem suitable. (4 Marks) c) Show the total cost of Job Eng230 and the total cost of Job Art490. (6 Marks) Total: 20 Marks 6

7 Question 3 Oak plc. uses a standard costing system. The following information relates to the company s Acorn product for the month of May. Standard data Actual data Sales Sales Volume 10,000 9,700 Selling Price per unit ( / ) Production Materials used per unit (kg) Materials price per kg ( / ) Labour hours per unit Labour rate per hour ( / ) Required: a) Prepare a statement showing the budgeted profit and the actual profit for May. b) Calculate the following variances: i. Sales Price ii. Sales Volume iii. Materials Price iv. Materials Usage v. Labour Rate vi. Labour Efficiency (4 Marks) (12 Marks) c) Outline the key factors that should be considered before deciding whether or not a variance should be investigated. (4 Marks) Total: 20 Marks 7

8 SECTION B Answer any two of the following questions Question 4 Timber plc. manufactures and sells only one type of product, the Lumber. The following information has been projected for the first six months of Sales Volume Administration expenses / Premises costs / January 10,000 12,500 25,000 February 12,000 12,500 25,000 March 15,000 12,500 25,000 April 8,000 10,000 22,000 May 7,500 10,000 22,000 June 6,000 10,000 22,000 July 7, Direct labour cost per unit is / The selling price is projected to be / 15 per unit in January, February and March, rising by 10% on 1 April, and remaining at that level for May & June. 3. The cost of direct materials is estimated to be / 3 per unit. 4. Variable production overhead is 50% of the direct labour cost per unit. 5. Sales and marketing expenditure is projected at / 3 per unit sold. 6. Depreciation is calculated at the rate of 20% per year, using the straight-line method. 7. Inventory of one-third of the following month s projected sales volume is to be held at the end of each month. 8. Receivables at 30 June are estimated to be 10% of June sales revenue. 9. Payables at 30 June are projected to total / 12,000. 8

9 Statement of Financial Position at 1 January 2013 ASSETS / Non-current assets Equipment 165,000 Current Assets Inventory 19,998 Receivables 12,000 Bank 16,750 48,748 Total assets 213,748 EQUITY AND LIABILITIES Equity 204,148 Payables 9,600 Total Equity and Liabilities 213,748 Required: a) Prepare a budgeted monthly Statement of Profit or Loss for the period 1 January 2013 to 30 June (12 Marks) b) Prepare a budgeted Statement of Financial Position as at 30 June (5 Marks) c) Outline the main aims of budgetary control. (3 Marks) Total: 20 Marks 9

10 Question 5 You have recently been appointed as a management accountant in a company. Required: a) Prepare a document for presentation to the company s management team discussing the annual financial budget in the context of: i. the process and role of planning; ii. levels of planning in an organisation; iii. Organisational control processes. (14 Marks) b) Outline the key elements of a Budget Manual. (6 Marks) Total: 20 Marks 10

11 Question 6 The following information relates to inventory holding and materials handling for a particular material in a business warehouse. Minimum usage Maximum usage Average usage Lead time Ordering Cost Purchase Cost Holding cost 500 per working week 3,000 per working week 2,500 per working week days / 360 per order / 5 per unit 8% of purchase cost per year The business works 5 days each week for 50 weeks each year. Required: a) Calculate the following inventory management ratios: i. Inventory Re-Order Level ii. Minimum Inventory Level iii. Economic Order Quantity iv. Maximum Inventory Level (16 Marks) b) Outline the key advantages and disadvantages of using inventory management ratios to manage inventory levels. (4 Marks) Total: 20 Marks END OF PAPER 11

12 SUGGESTED SOLUTIONS Solution 1 a) Profit Statement using Absorption Costing September October November / / / Sales Revenue 332, , ,000 Production costs Opening Inventory 0 13,500 40,500 Direct Materials 125, , ,000 Direct Labour 100, , ,000 Variable Production Overhead 25,000 30,000 35,000 Fixed Production Overhead 20,000 24,000 28,000 Closing Inventory (13,500) (40,500) (67,500) 256, , ,000 Gross profit 76,000 88, ,000 Non production Costs Variable Sales & Marketing Overhead 9,500 11,000 13,000 Fixed Sales & Marketing Overhead 25,000 25,000 25,000 Fixed Administration Overhead 18,750 18,750 18,750 Under-absorbed / Over-absorbed fixed 5,000 1,000 (3,000) production overhead 59,250 55,750 53,750 Net Profit 17,750 32,250 50,250 12

13 b) Profit Statement using Marginal Costing September October November / / / Sales Revenue 332, , ,000 Production costs Opening Inventory 0 12,500 37,500 Direct Materials 125, , ,000 Direct Labour 100, , ,000 Variable Production Overhead 25,000 30,000 35,000 Closing Inventory (12,500) (37,500) (62,500) 237, , ,000 Variable Sales & Marketing Overhead 9,500 11,000 13, , , ,000 Contribution 85,500 99, ,000 Fixed overheads Fixed production overheads 25,000 25,000 25,000 Fixed Sales & Marketing Overhead 25,000 25,000 25,000 Fixed Administration Overhead 18,750 18,750 18,750 68,750 68,750 68,750 Net Profit 16,750 30,250 48,250 c) Difference between reported profits September October November Total / / / / Absorption Costing Profit 17,750 32,250 50, ,250 Marginal Costing Profit 16,750 30,250 48,250 95,250 Difference 1,000 2,000 2,000 5,000 Analysis of the difference September October November Total / / / / Opening Inventory nil nil Closing Inventory ,250 1,250 Difference ,250 Difference x / 4 / 1,000 / 2,000 / 2,000 / 5,000 The absorption costing figures are driven by production volume and include fixed production overhead as part of the cost of production. This fixed production overhead is included at the pre-determined overhead absorption rate of / 4 per unit. Therefore this fixed overhead rate is included in the inventory valuation at the end of each month. This results in a higher net profit each month when using absorption costing because production volume exceeds sales volume each month. The total difference in calculated profits of / 5,000 is represented by the difference in the inventory valuation at the end of November ( / 67,500 using absorption costing - / 62,500 using marginal costing). The marginal costing figures exclude the fixed production overhead element in inventory valuations and hence net profits each month are lower. Profit is recognised only when sales are recorded.

14 Workings Working 1: Fixed production overhead absorption rate per unit Budgeted fixed production overheads / 300,000 Budgeted production 75,000 Fixed production overhead absorption rate per unit = / 300,000/75,000 = / 4 per unit. Working 2: Production cost per unit / Direct Materials cost 25 Direct Labour cost 20 Variable Production Overhead 5 Unit value for Marginal Costing 50 (variable cost per unit) Fixed Production Overhead 4 Unit value for Absorption Costing 54 (variable and fixed cost per unit) Working 3: Inventory valuation September October November Opening Inventory Production 5,000 6,000 7,000 Sales 4,750 5,500 6,500 Closing Inventory ,250 Marginal Costing Valuation (@ / 50 per unit) Absorption Costing Valuation (@ / 54 per unit) / / / 12,500 37,500 62,500 13,500 40,500 67,500 Working 4: Under / Over-absorbed Fixed Production head September October November Production 5,000 6,000 7,000 / / / Fixed Production OAR per unit Absorbed Fixed Production Overhead 20,000 24,000 28,000 Actual Fixed Production Overhead 25,000 25,000 25,000 14

15 Fixed Production Overhead Under/ Over absorbed 5,000 under-absorbed 1,000 under-absorbed 3,000 over-absorbed Basis of Apportionment Dept. 1 / Dept. 2 / Service 1 / Service 2 / Total / Solution 2 a) Overheads cost by Department 15

16 Allocated Overheads 32,400 29,200 12,400 12,850 86,850 Apportioned Overheads Indirect Labour Indirect Labour Hours 27,429 4,571 32,000 Heat & Light Floor Area 15,188 24,300 6,075 3,037 48,600 Repairs & Maintenance Floor Area 10,844 17,350 4,338 2,168 34,700 Canteen Subsidy Number of Staff 4, ,100 Machine depreciation Machine Value 1,664 8, ,400 Machine Insurance Machine Value 1,000 5, ,250 92,896 89,470 23,479 18, ,900 Re-Apportioned Overheads Re-Apportion Service 1 20% / 80% 4,696 18,783 (23,479) 0 Re-Apportion Service 2 50% / 50% 9,028 9,027 (18,055) 0 Total Overheads 106, , ,900 16

17 b) Overhead Absorption Rate for each Department Department 1 Overhead absorption rate based on labour hours as this department is labour intensive / 106,620 30,000 labour hours = / 3.55 per direct labour hour Department 2 Overhead absorption rate based on machine hours as this department is machine intensive / 117,280 25,000 machine hours = / 4.69 per machine hour c) Job Costs Job Eng230 / Direct Materials Direct Labour - Dept. 1 - Dept hours x / 12 per hour 4 hours x / 8 per hour Overhead - Dept. 1 - Dept DLH x / 3.55 per DLH 5 MH x / 4.69 per MH Total Cost Job Art490 / Direct Materials Direct Labour - Dept. 1 - Dept hours x / 12 per hour 5 hours x / 8 per hour Overhead - Dept. 1 - Dept DLH x / 3.55 per DLH 20 MH x / 4.69 per MH Total Cost

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19 Solution 3 a) Budgeted Profit / / Sales Revenue (10,000 x / 25) 250,000 Cost of Sales Materials Cost (10,000 x 1.50 kg x / 8) 120,000 Labour Cost (10,000 x 0.5 x / 10.20) 51, ,000 Budgeted Profit ( / 7.9 per unit) 79,000 Actual Profit / / Sales Revenue (9,700 x / 26.50) 257,050 Cost of Sales Materials Cost (9,700 x 1.80 kg x / 8.30) 144,918 Labour Cost (9,700 x 0.75 x / 11.50) 83, ,580 Actual Profit 28,470 b) Variances i. Sales Price Variance / 9,700 generated revenue of 9,700 x / ,050 9,700 should have generated revenue of 9,700 x / per unit 242,500 14,550 F or (Actual Sales Volume x Actual Selling Price) (Actual Sales Volume x Standard Selling Price) (9,700 x / per unit) - (9,700 x / per unit) / 257,050 - / 242,500 = / 14,550 favourable ii. Sales Volume Variance Oak plc. actually sold 9,700 Oak plc. should have sold 10, A 19

20 x standard contribution per unit ( / 7.9) / 2,370 A or Budgeted Sales Volume Actual Sales Volume = / 7.90 = / 2,370 adverse iii. Material price Variance / 17,460 kg of materials actually cost (17,460 x / 8.30) 144,918 17,460 kg of materials should have cost (17,460 x / 8) 139,680 5,238 A or (Actual Quantity of Inputs x Actual Price) (Actual Quantity of Inputs x Standard Price) (17,460 kg x / 8.30 per kg) - (17,460 kg x / 8.00 per kg) / 144,918 - / 139,680= / 5,238 adverse iv. Materials Usage Variance kg Oak plc. actually used (9,700 x 1.8 kg) 17,460 Oak plc. should have used (9,700 x 1.50 kg) 14,550 2,910A x standard cost per kg ( / 8.00) / 23,280 A or (Actual Quantity of Inputs x Standard Price) (Flexed Quantity of Inputs x Standard Price) (17,460 kg x / 8 per kg) - ((9,700 x 1.5 kg per unit) x / 8 per kg) / 139,680 - / 116,400 = / 23,280 adverse v. Labour Rate Variance / 7,275 labour hours actually cost (7,275 x / 11.50) 83,662 7,275 labour hours should have cost (7,275 x / 10.20) 74,205 9,457A or (Actual Labour Hours x Actual Pay Rate) (Actual Labour Hours x Standard Pay Rate) (7,275hours x / per hour) - (7,275 hours x / per hour) / 83,662 - / 74,205 = / 9,457adverse 20

21 vi. Labour Efficiency Variance hours Oak plc. actually used (9,700 x 0.75 hours) 7,275 Oak plc. should have used (9,700 x 0.50 hours) 4,850 2,425A x standard cost per hour ( / 10.20) / 24,735A or (Actual Labour Hours x Standard Rate) (Flexed Labour Hours x Standard Rate) (7,275 hours x / per hour) - ((9,700 x 0.5 hours per unit) x / per hour) / 74,205 - / 49,470 = / 24,735 adverse c) Factors to be considered before deciding whether or not to investigate a variance i. The size of the variance and whether the impact on profitability is positive or negative. ii. The likelihood of the variance being controllable / uncontrollable. iii. Investigation costs. iv. Benefits to be gained from the investigation v. The likelihood of the variance re-occurring. 21

22 Solution 4 Workings Working 1: Inventory movement Dec Jan Feb Mar Apr May June Sales volume 10,000 12,000 15,000 8,000 7,500 6,000 Closing inventory 3,333 4,000 5,000 2,667 2,500 2,000 2,500 Less opening inventory (3,333) (4,000) (5,000) ( 2,667) (2,500) (2,000) Production requirement 10,667 13,000 12,667 7,833 7,000 6,500 Working 2: Cost per unit of production / Direct labour 2.00 Direct material 3.00 Variable overhead ( / 2.00 x 50%) Working 3: Inventory Valuation & Production Costs Dec Jan Feb Mar Apr May J / / / / / / Closing inventory value 19,998 24,000 30,000 16,000 15,000 / 6.00 per unit Direct / 3 per unit 32,000 39,000 38,000 23,500 21,000 Direct / 2 per unit 21,333 26,000 25,333 15,667 14,000 Variable / 1 per unit 10,667 13,000 12,667 7,833 7,000 Depreciation 2,750 2,750 2,750 2,750 2,750 Sales and marketing expenditure 30,000 36,000 45,000 24,000 22,500 Working 4: Sales Revenue Jan Feb Mar Apr May Jun / / / / / / 22

23 Sales price per unit Total sales revenue 150, , , , ,750 99,000 a) Budgeted Statement of Profit or Loss 1 January 2013 to 30 June 2013 Jan Feb Mar Apr May Jun Total / / / / / / / Sales Revenue 150, , , , ,750 99, ,750 Cost of Sales Opening Inventory 19,998 24,000 30,000 16,000 15,000 12,000 19,998 Direct Materials 32,000 39,000 38,000 23,500 21,000 19, ,000 Direct Labour 21,333 26,000 25,333 15,667 14,000 13, ,333 Variable Production O/head 10,667 13,000 12,667 7,833 7,000 6,500 57,667 Less closing inventory (24,000) (30,000) (16,000) (15,000) (12,000) (15,000) (15,000) Cost of sales 59,998 72,000 90,000 48,000 45,000 36, ,998 Gross Profit 90, , ,000 84,000 78,750 63, ,752 Overheads Sales & marketing 30,000 36,000 45,000 24,000 22,500 18, ,500 Administration 12,500 12,500 12,500 10,000 10,000 10,000 67,500 Premises costs 25,000 25,000 25,000 22,000 22,000 22, ,000 Depreciation 2,750 2,750 2,750 2,750 2,750 2,750 16,500 70,250 76,250 85,250 58,750 57,250 52, ,500 Net Profit / (Loss) 19,752 31,750 49,750 25,250 21,500 10, ,252 23

24 b) Budgeted Statement of Financial Position as at 30 June 2013 ASSETS / / Non-current Assets Equipment 148,500 Current Assets Inventory 15,000 Receivables (10% of June Sales Revenue) 9,900 Bank account 201, ,900 Total Assets 374,400 EQUITY AND LIABILITIES Payables 12,000 Equity 362,400 Total Equity and liabilities 374,400 c) Main Aims of Budgetary Control To provide a formal basis for monitoring the progress of an organisation, and individual sections within the organisation, towards the achievement of the financial objectives, as specified in the budget. To provide targets for goal congruence between organisational and individual objectives - encouraging motivation and participation. To provide a tool for performance measurement this may be developed into a reward / incentive scheme. 24

25 Workings Working 1: Inventory movement Dec Jan Feb Mar Apr May June Sales volume 10,000 12,000 15,000 8,000 7,500 6,000 Closing inventory 3,333 4,000 5,000 2,667 2,500 2,000 2,500 Less opening inventory (3,333) (4,000) (5,000) ( 2,667) (2,500) (2,000) Production requirement 10,667 13,000 12,667 7,833 7,000 6,500 Working 2: Cost per unit of production / Direct labour 2.00 Direct material 3.00 Variable overhead ( / 2.00 x 50%) Working 3: Inventory Valuation & Production Costs Dec Jan Feb Mar Apr May June / / / / / / / Closing inventory value 19,998 24,000 30,000 16,000 15,000 12,000 / 6.00 per unit Direct / 3 per unit 32,000 39,000 38,000 23,500 21,000 19,500 Direct / 2 per unit 21,333 26,000 25,333 15,667 14,000 13,000 Variable / 1 per unit 10,667 13,000 12,667 7,833 7,000 6,500 Depreciation 2,750 2,750 2,750 2,750 2,750 2,750 Sales and marketing expenditure 30,000 36,000 45,000 24,000 22,500 18,000 25

26 Working 4: Sales Revenue Jan Feb Mar Apr May Jun / / / / / / Sales price per unit Total sales revenue 150, , , , ,750 99,000 Working 5: Equity at 30 June 1 January 204,148 Projected Profit / Loss (per Budgeted Statement of Profit or Loss) 158,252 Projected Equity at 30 June 362,400 Working 6: Bank Account at 30 June Opening Bank balance 16,750 Net Profit 158,252 Reduction in inventory 4,998 Reduction in receivables 2,100 Increase in payables 2,400 Depreciation (Non-Cash) 16, ,250 Closing bank balance 201,000 or Opening bank balance 16,750 Receipts December receivables 12,000 Sales January to June 909,750 Receivables at 30 June (9,900) 911,850 Payments December payables (9,600) Expenses January to June (384,000) Expenses January to June (346,000) Payables at 30 June 12,000 (727,600) 26

27 Closing bank balance 201,000 Solution 5 a) Document Re Annual Financial Budget To: Management Team From: Management Accountant Date: X/ X/ XX Re: Budgetary Processes - Planning and Control Process and role of planning The planning and control cycle Formulating Plans (Planning) Comparing actual & planned performance (Controlling) DECISION MAKING Implementing Plans Measuring Performance (Controlling) The process of planning, control and its link with decision-making processes is illustrated in the diagram above. Planning can be defined as The establishment of objectives, the formulation, evaluation and selection of policies, strategies, tactics and action required to achieve these objectives. Planning comprises long-term strategic planning and short-term operational planning Planning is a key function of management which precedes control and feedback to assist in the effective running of an organisation. Levels of planning There are a number of different types of planning: Long-term, strategic planning normally covers a period of 3, 5 or 10 years and is an involved process including assessment of internal and external environments, opportunities and expectations. Once objectives are established, options are evaluated and appraised to formulate the long-term corporate plan. 27

28 Tactical planning is the process of developing specific strategies or tactics relevant to prevailing circumstances (e.g.; a new marketing strategy) in the context of the long-term strategic plan. Short-term planning usually involves the deployment of resources to effectively achieve specific objectives and normally covers a period up to one year. Organisational control processes Organisational control is concerned with the efficient use of resources to achieve a plan. Control involves the measurement of activity, comparison with plans and identification of performance issues. Control will provide information on corrective action required to alter performance so as to conform to plan or to modify original plans. The key elements of control include a specification, measurement of actual performance, comparison between specification and actual performance, feedback on performance, action to control performance, on-going feedback. Control actions must be appropriately timed - otherwise the action may have a detrimental effect. Control is exercised in organisational systems by feedback loops which gather information on performance from the output of the system. The annual budget The detailed annual budget is set in the context of long-term financial objectives (E.g.: achieve a 10% market share; achieve a 20% profit increase). The annual budget is an example of a short-term tactical plan. It sets out a financial plan for the organisation to ensure that resources are appropriately deployed. The annual budget provides clarity of roles and responsibilities and provides a target for coordination purposes Control is exercised through the measurement and comparison of actual results against planned / budgeted performance. Feedback from variance analysis reports should result in corrective action aimed at addressing adverse variances and promoting favourable variances. Decision-making activities may include for example the decision to change supplier to improve an adverse materials price variance There may be a number of budgetary revisions throughout a year to implement tactical plans b) Key Elements of a Budget Manual A Budget Manual is an important tool for the communication of the budgetary process, providing information about budget-setting, budgetary control procedures and the general operation of the budget. The main contents of a Budget Manual should include: Explanation of the budgetary process Organisational structures and responsibilities Main budgets and inter-relationship between them Budget development Accounting procedures 28

29 Solution 6 Workings Minimum usage per day 500 per working week / 5 working days = 100 per working day Maximum usage per day 3,000 per working week / 5 working days = 600 per working day Average usage per day 2,500 per working week / 5 working days = 500 per working day Average usage per year 2,500 per working week x 50 working weeks = 125,000 per year a) i. Inventory Re-Order Level Re-order level = Maximum usage per day x maximum lead time (in days) 600 per day x 20 days = 12,000 ii. Minimum Inventory Level = Re-order level (average usage (per day) x average lead time (in days)) 12,000 - (500 per day x 15 days) = 4,500 iii Economic Order Quantity. Co Cost per order D Demand per year 2 Co D Hc Holding Cost per year Cc = 2 x / 360 x 125,000 = 15,000 ( / 5 x 8%) iv. Maximum Inventory Level (Re-Order Level + Economic Order Quantity) (Minimum Usage Rate x Minimum Lead Time) 12, ,000 - (100 per day x 10 days) = 26,000 29

30 b) Advantages & disadvantages of calculating inventory management ratios to manage inventory levels Advantages of using inventory management ratios include: 1. On average, lower inventory levels resulting in cost savings; 2. Efficiency savings due to economic order quantities; 3. More responsive to inventory demand fluctuations; 4. Avoid costs and losses associated with running out of inventory; 5. Applicable for a wide range of inventory. Disadvantages of such a system include: 1. As there is no sequence to re-ordering, the system can involve variations with many orders at one time and few at other times; 2. Economic order quantity assumptions may not always be valid and may not suit all circumstances; 3. Resources are required to collect data and perform calculations. In general it is recommended that a re-ordering system should be implemented in conjunction with pareto analysis (i.e. with a concentration on high-value / high-activity inventory items) END OF SOLUTIONS 30