Download Economic Ordering Quantity-Accounting-Lecture Notes and more Study notes Accounting in PDF only on Docsity! LESSON# 9 ECONOMIC ORDERING QUANTITY Economic order quantity refers to that number (quantity) ordered in a single purchase so that the accumulated costs of ordering and carrying costs are at the minimum level. In other words, the quantity that is ordered at one time should be so, which will minimize the total of (i) Cost of placing orders and receiving the goods, and (ii) cost of storing the goods as well as interest on the capital invested. The economic order quantity can be determined by the following simple formula: EOQ = 2xRUxOC UC x CC% Where; EOQ = Economic Order Quantity. RU = Annually Required Units. OC = Ordering Costs for one order. UC = Inventory Unit Cost. CC = Carrying Cost as %age of Unit Cost. This formula is based on three assumptions: 1. Price will remain constant throughout the year and quantity discount is not involved. 2. Pattern of consumption, variable ordering costs per order and variable inventory carrying charge per unit per annum will remain the same throughout, and 3. EOQ will be delivered each time the stock balance is just reduced to nil. The Economic Order Quantity can be determined by applying the formula as under: Suppose; the Annual consumption is 80,000 units, Cost to place one order is Rs. 1,200 Cost per unit is Rs. 50 Carrying cost is 6% of Unit cost EOQ = 2xRUxOC UC x CC% EOQ = 2 x 80,000 x 1,200 50x6% EOQ = 8,000 As stated above this formula holds good if changes in price are not likely in the near future and consumption is regular. Otherwise, placing orders according to this formula may become expensive. Carrying cost of inventory consists of (i) the costs of physical storage such as cost of space, handling and upkeep expenses, insurance, cost of obsolescence, etc., and (ii) interest on capital invested (the opportunity cost of the capital blocked up). All these costs are expressed in %age of the cost per unit. Table of EOQ Economic order quantity can also be proved through a table, by calculating total cost at different order quantities. docsity.com Following is a table that is showing total cost at five different order quantities, assuming that the annual requirement of the units to be consumed remains the same. Here the total cost comprises of ordering cost and carrying cost. Total Order ng cost i Ordering cost is arrived by multiplying the number of orders in a year with the cost per order. Number of order is calculated by dividing annually required units by the order quantity. Step I: Required Units = Number of orders Order Quantity Step II: Number of orders x Cost per order Total Carrying Cost Carrying cost is arrived by multiplying the average ordering quantity with the carrying cost per unit. Average ordering quantity is calculated by dividing the ordering quantity by 2. (It is assumed that half of the ordering quantity is always kept into the store, this is the reason the ordering quantity is divided by 2) Step I: Ordering Quantity = Average ordering quantity 2 Step II: Carrying cost per unit = Unit Cost x CC %age Step III: Average ordering quantity x Carrying cost per unit Applying these steps at different presumed order quantities (inclusive of the Economic Order Quantity) we can develop a table. Order Quantity Required Units Number of orders Total Ordering Cost Number of orders x Rs. 1,200 Total Carrying Cost Avg Order qty x Rs.3 Total cost 20,000 80,000 4 4,800 30,000 34,800 10,000 80,000 8 9,600 15,000 24,600 8,000 80,000 10 12,000 12,000 24,000 5,000 80,000 16 19,200 7,500 26,700 4,000 80,000 20 24,000 6,000 30,000 docsity.com
