DSM Ltd manufactures speed boats which require propeller TP-M4. The following particulars are collected for the year 2023-24: Annual demand of TP-M4…

CA Intermediate · Cost and Management Accounting · MTP · May 2024
DSM Ltd manufactures speed boats which require propeller TP-M4. The following particulars are collected for the year 2023-24: Annual demand of TP-M4 12,000 unitsCost of placing an order - 1,200 per orderCost per unit of TP-M4 is 1,740/-Carrying cost p.a. 12% The company has been offered a quantity discount of 5% on the purchase of TP-M4, provided the order size is 6,000 units at a time. Required to: COMPUTE the economic order quantity (EOQ)ADVISE whether the quantity discount offer can be accepted.

Suggested Answer and Working Notes:

(i) Calculation of Economic Order Quantity (EOQ) EOQ = √(2 × Annual Demand × Ordering Cost / Carrying cost per unit per annum) = √(2 × 12,000 units × ₹ 1,200 / (₹ 1,740 × 0.12)) = 371 units (Approx) (ii) Evaluation of Profitability of Different Options of Order Quantity (a) When EOQ is ordered (₹) Purchase Cost (12,000 units × ₹ 1,740) 2,08,80,000.00 Ordering Cost* [(12,000 units ÷ 371 units) i.e. 33 × ₹ 1,200] 39,600.00 Carrying Cost** (371 units × ₹ 1,740 × 1/2 × 12/100) 38,732.40 Total Cost 2,09,58,332.40 (b) When Quantity Discount of 5% is offered. (₹) Purchase Cost (12,000 units × ₹ 1,740 × 0.95) 1,98,36,000.00 Ordering Cost* [(12,000 units ÷ 6,000 units) × ₹ 1,200] 2,400.00 Carrying Cost** (6,000 units × ₹ 1,653 × 1/2 × 12/100) 5,95,080.00 Total Cost 2,04,33,480.00 Advise - The total cost of inventory is lower if quantity discount offer is accepted. Hence, the company is advised to accept the quantity discount. * Ordering Cost = (Annual Demand / Order Quantity) × Cost of placing an order ** Carrying Cost = (Cost per unit × Quantity ordered × Carrying Cost) / 2

Topics: Material Cost

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