Management Accounting. Sample Paper / 2017 Questions and Suggested Solutions

Management Accounting Sample Paper 1 2016 / 2017 Questions and Suggested Solutions

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 www.accountingtechniciansireland.ie) 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 2016 and may not be reproduced without permission of Accounting Technicians Ireland. Accounting Technicians Ireland, 2016 Page 2 of 28 MA Sample Paper 1

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, units etc. Answers should be illustrated with examples, where appropriate. Question 1 begins on Page 4 overleaf. Page 3 of 28 MA Sample Paper 1

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 units 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. Page 4 of 28 MA Sample Paper 1 (14 Marks) (3 Marks)

c) Explain the reason for any difference in the reported profit under the two bases for each month. (3 Marks) Total: 20 Marks Page 5 of 28 MA Sample Paper 1

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 6,250 223,900 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 1,000 500 Direct labour hours 30,000 5,000 - - Indirect labour hours 30,000 5,000 - - Direct labour rate per hour / 12 8 - - Number of staff 30 5 - - Machine hours 2,500 25,000 - - Machine value / 40,000 200,000 10,000 - Service Dept. overheads are to be re-apportioned as follows Service Dept. 1 overheads 20% 80% Service Dept. 2 overheads 50% 50% Page 6 of 28 MA Sample Paper 1

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. 1 40 25 - Manufacturing Dept. 2 4 5 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 Page 7 of 28 MA Sample Paper 1

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 units 10,000 9,700 Selling Price per unit ( / ) 25.00 26.50 Production Materials used per unit (kg) 1.50 1.80 Materials price per kg ( / ) 8.00 8.30 Labour hours per unit 0.50 0.75 Labour rate per hour ( / ) 10.20 11.50 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 Page 8 of 28 MA Sample Paper 1

SECTION B Answer any two of the following questions Question 4 Palomino plc. is involved in the design and manufacture of equine stables. The company has just received an enquiry about the possibility of supplying 40 stables to a large equestrian centre, Killstud plc. in the midlands. The finance director of Killstud plc. has informed Palomino plc. that they have just completed their budgets for the coming financial year and that the maximum price that they will be willing to pay is 17,000 per stable. The management accountant of Palomino plc. has provided you with the following details relating to the costs involved in the construction of the stables. 1. Each stable will require 10 planks of timber. The company has 350 planks of timber in stock and if they are not used in the stables they will be disposed of immediately. The original purchase price for the planks of timber in stock was 210 per unit. The replacement cost of a plank of timber is 250 per unit. The net realisable value of the timber in stock is 110 per plank. 2. Each stable will also require 4 slabs of a special type of concrete. The concrete is sold in batches of 10 slabs. The purchase price of a batch is 1,120. The supplier of the concrete has agreed to offer a discount of 12% on the purchase price of concrete batches over 13 batches. 3. Additionally, each stable will also require 6 strips of studded steel and this type of steel is frequently used by Palomino plc. The company holds 250 strips of this steel in the warehouse at present. These strips of steel cost 155 each three months ago and their replacement cost is 160 per strip. 5. The construction of the stables will require a combination of skilled and unskilled labour. Each stable will require 15 skilled labour hours and 7 unskilled labour hours. The skilled labourers are paid 70 per hour and the unskilled labourers are paid 60% of the skilled hourly rate. If this contract does not go ahead there will be 140 skilled idle hours and the company is reluctant to make redundancies. 6. The project will require a project manager to oversee the work. Palomino plc. currently employs a manager with this required experience. This manager currently earns 65,000. Palomina will pay him an extra 4,000 due to the size of the project. The manager will be replaced by a less experienced manager who will earn 35,000. 8. Variable overheads are absorbed at a rate of 75 per skilled labour hour. 9. Incremental fixed overheads are absorbed at a rate of 42 per skilled labour hour. 10. In order to assess the safety implications of the stables the company used ResearchNet plc. to carry out research. This research cost 15,000 and 3,000 is still outstanding. Page 9 of 28 MA Sample Paper 1

Required: (a) Provide a brief explanation using an example for each of the following terms: (i) Opportunity cost (ii) Sunk cost (iii) Committed cost (6 Marks) (b) Using relevant costing principles, determine whether or not Palomino plc. should undertake the contract. Your answer must include an explanation for the inclusion or exclusion of each of the above points. (10 Marks) (c) List four qualitative factors that should be considered before a final decision is made. (4 Marks) Total: 20 Marks Page 10 of 28 MA Sample Paper 1

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 Page 11 of 28 MA Sample Paper 1

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 units per working week 3,000 units per working week 2,500 units per working week 10-20 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 Page 12 of 28 MA Sample Paper 1

SUGGESTED SOLUTIONS Solution 1 a) Profit Statement using Absorption Costing September October November / / / Sales Revenue 332,500 385,000 455,000 Production costs Opening Inventory 0 13,500 40,500 Direct Materials 125,000 150,000 175,000 Direct Labour 100,000 120,000 140,000 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) 256,500 297,000 351,000 Gross profit 76,000 88,000 104,000 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 Page 13 of 28 MA Sample Paper 1

b) Profit Statement using Marginal Costing September October November / / / Sales Revenue 332,500 385,000 455,000 Production costs Opening Inventory 0 12,500 37,500 Direct Materials 125,000 150,000 175,000 Direct Labour 100,000 120,000 140,000 Variable Production Overhead 25,000 30,000 35,000 Closing Inventory (12,500) (37,500) (62,500) 237,500 275,000 325,000 Variable Sales & Marketing Overhead 9,500 11,000 13,000 247,000 286,000 338,000 Contribution 85,500 99,000 117,000 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 50,250 100,250 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 250 750 nil Closing Inventory 250 750 1,250 1,250 Difference 250 500 500 1,250 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 Page 14 of 28 MA Sample Paper 1

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. Workings Working 1: Fixed production overhead absorption rate per unit Budgeted fixed production overheads / 300,000 Budgeted production 75,000 units 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 units units units Opening Inventory 0 250 750 Production 5,000 6,000 7,000 Sales 4,750 5,500 6,500 Closing Inventory 250 750 1,250 / / / Marginal Costing Valuation (@ / 50 per unit) 12,500 37,500 62,500 Absorption Costing Valuation (@ / 54 per unit) 13,500 40,500 67,500 Page 15 of 28 MA Sample Paper 1

Working 4: Under / Over-absorbed Fixed Production head September October November Production units 5,000 6,000 7,000 / / / Fixed Production OAR per unit 4 4 4 Absorbed Fixed Production Overhead 20,000 24,000 28,000 Actual Fixed Production Overhead 25,000 25,000 25,000 Fixed Production Overhead Under/ Over absorbed 5,000 under-absorbed 1,000 under-absorbed 3,000 over-absorbed Page 16 of 28 MA Sample Paper 1

Solution 2 Basis of Apportionment Dept. 1 / Dept. 2 / Service 1 / Service 2 / Total / 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 4,371 729 5,100 Machine depreciation Machine Value 1,664 8,320 416 10,400 Machine Insurance Machine Value 1,000 5,000 250 6,250 92,896 89,470 23,479 18,055 223,900 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 106,620 117,280 0 0 223,900 a) Overheads cost by Department Page 17 of 28 MA Sample Paper 1

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 240.00 Direct Labour - Dept. 1 - Dept. 2 40 hours x / 12 per hour 4 hours x / 8 per hour 480.00 32.00 Overhead - Dept. 1 - Dept. 2 40 DLH x / 3.55 per DLH 5 MH x / 4.69 per MH 142.00 23.45 Total Cost 917.45 Job Art490 / Direct Materials 420.00 Direct Labour - Dept. 1 - Dept. 2 25 hours x / 12 per hour 5 hours x / 8 per hour 300.00 40.00 Overhead - Dept. 1 - Dept. 2 25 DLH x / 3.55 per DLH 20 MH x / 4.69 per MH 88.75 93.80 Total Cost 942.55 Page 18 of 28 MA Sample Paper 1

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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) 51,000 171,000 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) 83,662 228,580 Actual Profit 28,470 b) Variances i. Sales Price Variance / 9,700 units generated revenue of 9,700 units x / 26.50 257,050 9,700 units should have generated revenue of 9,700 units x / 25.00 per unit 242,500 14,550 F or (Actual Sales Volume x Actual Selling Price) (Actual Sales Volume x Standard Selling Price) (9,700 units x / 26.50 per unit) - (9,700 units x / 25.00 per unit) / 257,050 - / 242,500 = / 14,550 favourable Page 20 of 28 MA Sample Paper 1

ii. Sales Volume Variance units Oak plc. actually sold 9,700 Oak plc. should have sold 10,000 300 A x standard contribution per unit ( / 7.9) / 2,370 A or Budgeted Sales Volume Actual Sales Volume = -300-300 @ / 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 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 units x 1.5 kg per unit) x / 8 per kg) / 139,680 - / 116,400 = / 23,280 adverse Page 21 of 28 MA Sample Paper 1 kg

v. Labour Rate Variance or 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 (Actual Labour Hours x Actual Pay Rate) (Actual Labour Hours x Standard Pay Rate) (7,275hours x / 11.50 per hour) - (7,275 hours x / 10.20 per hour) / 83,662 - / 74,205 = / 9,457adverse / 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 / 10.20 per hour) - ((9,700 units x 0.5 hours per unit) x / 10.20 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. Page 22 of 28 MA Sample Paper 1

Solution 4 (a) (b) (i) An opportunity cost is the value of a benefit foregone when one course of action is adopted in preference to another. (Provide example) (ii) A sunk cost is a past cost which is not relevant to a decision. (Provide example) (iii) A committed cost is a past cost that has not yet been paid but which the business is committed to paying. (Provide example) Materials: Timber 1 51,000 Concrete 2 17,517 Studded Steel 3 38,400 Skilled labour 4 29,900 Unskilled labour 4 11,760 Project manager existing 5 4,000 new 35,000 Variable overheads 6 45,000 Fixed production overheads 7 25,200 Research and development: Sunk 0 Committeed 0 257,777 Revenue 13 440,000 Net relevant profit 182,223 Palomino plc. should undertake the contract as they would achieve a net relevant profit of 182,223. Notes: 1. The project requires (40 x 10) = 400 planks of timber. There are 350 planks of timber in stock. If these planks are not used by the company then they will be sold. Therefore if they are used on this project the company will lose out on selling them. So lost proceeds are 350 x 110 = 38,500. The company will purchase the balance required and this will cost 50 x 250 = 12,500. So the total relevant cost is 51,000. 2. The project requires (40 x 4) = 160 slabs so this equates to 160/10 = 16 batches. 13 batches x 1,120 = 14,560 3 batches x 985.60 = 2,957 Page 23 of 28 MA Sample Paper 1

Total cost 17,517 3. The steel is used regularly by the company so if it is used on this project it will have to be replaced immediately. The relevant cost is 6 x 40 x 160 = 38,400 Jan Feb Mar Apr May Jun / / / / / / Sales price per unit 15.00 15.00 15.00 16.50 16.50 16.50 4. Skilled hours required are (40 x 15) = 600 hours. Because there are 140 hours idle time the relevant cost is 460 x 65 = 29,900. Unskilled hours required are (40 x 7) = 280 hours so cost is 280 x 42 x = 11,760. 5. The relevant cost of the existing project manager is 4,000 as he will receive an additional payment over what he currently earns. A replacement project manager will be employed specifically as a result of this project at 35,000 per annum. 6. Variable overheads are relevant costs as they will only be incurred if the job is undertaken. The cost is 600 labour hours x 75 = 45,000 7. Fixed overheads are relevant costs as they are incremental. The cost is 600 labour hours x 42= 25,200 8. Research and development is not a relevant cost. The cost has been incurred irrespective of whether the construction takes place. The amount paid of 12,000 is known as a sunk cost and the unpaid amount of 3,000 as a committed cost. 9. By undertaking the contract the company would receive (40 stables x 11,000) = 440,000. 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 Page 24 of 28 MA Sample Paper 1

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. 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. Page 25 of 28 MA Sample Paper 1

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 Page 26 of 28 MA Sample Paper 1

Solution 6 Workings Minimum usage per day 500 units per working week / 5 working days = 100 units per working day Maximum usage per day 3,000 units per working week / 5 working days = 600 units per working day Average usage per day 2,500 units per working week / 5 working days = 500 units per working day Average usage per year 2,500 units per working week x 50 working weeks = 125,000 units per year a) i. Inventory Re-Order Level Re-order level = Maximum usage per day x maximum lead time (in days) 600 units per day x 20 days = 12,000 units ii. Minimum Inventory Level = Re-order level (average usage (per day) x average lead time (in days)) 12,000 units - (500 units per day x 15 days) = 4,500 units 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 units = 15,000 units ( / 5 x 8%) iv. Maximum Inventory Level (Re-Order Level + Economic Order Quantity) (Minimum Usage Rate x Minimum Lead Time) 12,000 units + 15,000 units - (100 units per day x 10 days) = 26,000 units Page 27 of 28 MA Sample Paper 1

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 Page 28 of 28 MA Sample Paper 1