Question

Evaluate the role of equivalent units in management decision-making for a manufacturer. Compare and contrast the weighted-average method and the FIFO method of accounting for work residing in work-in-process units.

Summarize the key concepts and benefits of economic order quantity (EOQ). Illustrate the computations and underlying assumptions associated with the use of this tool. Hypothesize how EOQ could conflict with a manager’s performance evaluation goals.

Answer 1

When opening and closing stock of WIP exists, unit cost cannot be calculated by management by simply dividing the total cost by total number of units still in process. In such a situation management converts partly finished units in to equvalent finished units so that the unit cost of these units can be obtained. Equivalent units are used in the production cost reports for the producing departments of manufacturers using a process costing system. Many items are in continuous production, so without some way to calculate equivalent units, it would be difficult to determine how much money was tied up in production costs. Incomplete work must be accounted for on a regular basis so that a value can be placed on the incomplete work.

Equivalent completed units = Actual number of units in the process of manufacture * percentage of work completed.

Valuation of WIP can be made in following 2 ways

First in Fist Out

Weighted average method

FIFO

Under 5hos method the units completed and transfered to next process include completed units of opening WIP and subsequently introduced units. The cost of completed units affected by opening WIP, which is based on the cost of previous month.

Weighted average method

Under this method cost of opening WIP and it's cost are merged with production and cost of current period.

Total equal ent cost= Unit transferred to next process + (Closing WIP * percentage of completion)

Average cost per unit = Total cost ÷ Total equal ent units

EOQ

The size of the order for which ordering cost and carrying cost are minimum is known as Economic Order Quantity.

EOQ=√(2AB÷C)

A= Annual requirement for material

B = Ordering cost per order

C = Carrying cost per year

Advantages

1. helps the company to reduce the holding cost of inventory and ordering cost.

2. management of inventory in an effective way so that it can reduce substantial operational costs which in turn will lead to more profits.

Assumptions associated with EOQ

1. The rate of demand is constant, and total demand is known in advance.
2. The ordering cost is constant.
3. The unit price of inventory is constant, i.e., no discount is applied depending on order quantity.
4. Delivery time is constant.
5. Replacement of defective units is instantaneous.
6. There is no safety stock level, i.e., the minimum stock level is zero.
7. Restocking is made by the whole batch.

What happens if the order quantity calculated based on the EOQ decision model differ form the order quantity that managers making inventory-management decisions would choose to make their performance look best. for example, because there are no opportunity costs are recorded in financial accounting system conflict may arise between the EOQ model is optimam order quantity and the order quantity that purchasing manager consider as optimal. As a result of ignorring the carrying cost the manager will be inclined to purchase larger lot size of materials than the lot size calculatec according to the EOQ model. To achive Congruence between the EOQ decision model and managers performance evaluation.