Question

Assume you are the management accountant for the Foleo Group. Tracey Chen, the CFO, has called you into a meeting, to discuss the performance of the Warehouse Manager of the Foleo Fones business unit in managing his inventory stocks. After his last meeting with the Production Manager, Allan Raymond, the Business Unit GM, has supplied Tracey with below data relating to the inventory management practices for the current year. Tracey asks you analyse this data and before her Board meeting next week.

Inventory Management Activities

Current Year’s Cost

Selection of Supplier $300

Warehouse rental (variable) $90,000

Handling of inventory $1,100

Transportation of inventory $600

Insurance $7,400

Unloading delivered inventory from freight truck $750

Inspecting delivered orders $900

Spoilage and obsolescence of inventory $6,000

Theft of inventory $4,300

The Production Manager has indicated that the Foleo Fones plant requires 24,000 kg of plastics annually and on average, the lead time for deliveries of the plastics is one month. He has also advised he orders 2,000 kg per month, and that the monthly usage typically fluctuates between 1,800 and 2,500 kg. This practice has resulted regularly in stock-out situations. The Manager has also estimated that the above ordering costs will increase by 5% and the carrying costs by 7% next year.

(a) Using the above data, calculate the following: the amount of ordering cost that should be used in the EOQ formula, the amount of carrying cost that should be used in the EOQ formula, and the optimum order quantity for the plastics raw materials required to produce the SliFones for the CURRENT YEAR using the EOQ formula. (HINT: show all your workings and round up your EOQ if necessary.) (HINT: the above data is for the entire year, so you will need to calculate the total components for the year and then convert them to what you will need for the EOQ formula.)

(b) Based on your calculations above, how many orders at the EOQ would be made for the plastics raw materials this year? (HINT: Show all your workings and round the number of orders up if necessary) (0.25 mark)

(c) Based on the Production Manager’s estimations of cost increases, calculate the EOQ for the plastics raw materials for the NEXT YEAR. (HINT: Show all your workings and round your EOQ up if necessary) (1 mark)

(d) Based on your calculations in part (c), how many orders will now be made for the plastics raw materials next year? (HINT: Show all workings and round the number of orders up if necessary) (0.25 mark)

(e) Using the appropriate formula and your EOQ from part (c) above, calculate the total annual cost of ordering and holding inventory for the plastics raw materials for the coming year (show all your workings). (1 mark)

(f) Calculate the Safety Stock for the plastics raw materials (show all your workings). (0.5 mark)

(g) Calculate the Reorder Point for the plastics raw materials (show all your workings) (0.5 mark)

Answer 1

a. I. Ordering Cost:

Cost	Amount ($)
Selection of Supplier	300
Transportation of Inventory	600
Unloading	750
Inspection	900
	2550

II. Inventory Handling Cost:

Cost	Amount ($)
Warehouse rent (Variable)	90000
Handling of Inventory	1100
Insurance	7400
Spoilage	6000
Theft	4300
	108800

III Optimum Order Quantity:

Required Quantity = 24000kg

Ordering cost per order = 2250/12 = 212.5

Inventory Handling cost per unit= 108800/24000 = 4.53

EOQ = Under root of 2 x Required Quantity x Ordering cost / Inventory handling cost per unit

           = 1500 units

B. According to EOQ Number of orders to be placed in a year = 24000 kg/ 1500 kg = 16 orders

C. Ordering cost for next year = 2250 plus 5% = 2363

      Inventory Handling cost for next year = 108800 plus 7% = 116416

EOQ for next year = root of 2 x 24000 x 188.58 / 4.85 = 1366 units

D. Number of orders for next year = 24000/1366 = 17.56 i.e. 18 orders