Hari Udyog is a small-scale manufacturing unit producing a single product X using two raw materials PK and BK in the input ratio of 3 : 2. The…

CA Intermediate · Cost and Management Accounting · RTP · May 2026
Hari Udyog is a small-scale manufacturing unit producing a single product X using two raw materials PK and BK in the input ratio of 3 : 2. The input-output ratio in production is 5:3. Raw material PK is perishable and becomes obsolete if not used within 5 days of purchase, whereas raw material BK is durable and can be stored for more than one year. Material PK is procured locally with a lead time of 1 to 2 days, while material BK is purchased from a neighbouring state and takes 2 to 4 days to reach the factory. The estimated sales volume for April 2025 is 30,000 kg, and the same level of sales is expected to continue throughout the year. The company operates for 25 days a month, and production is carried out evenly. The purchase price per kilogram (excluding taxes) is 15for material PK and 22for material BK. To place an order, the company incurs an administrative cost of 120 per order. The annual carrying cost is estimated at 15% of the value for material PK and 5% for material BK. Currently, material PK is purchased in lots of 8,000 kg to avail a 10% trade discount on the market price. GST at 5% is applicable on material PK, for which input tax credit is available. Material BK is subject to 2% CST, for which no input tax credit is available. You are required to calculate: (i) Economic Order Quantity (EOQ) for each material; (ii) Maximum stock level for Material PK; (iii) Calculate saving/ loss in Material PK if purchase quantity equals to EOQ.

Suggested Answer and Working Notes:

(a) Workings: Monthly Production of X = 30,000 kgs. Raw Material Required = 30,000/3 × 5 = 50,000 kgs. Material PK = 50,000/5 × 3 = 30,000 kg. Material BK = 50,000/5 × 2 = 20,000 kg. (i) Calculation of Economic Order Quantity (EOQ): Material PK = √(2 × Annual consumption × Order cost / Carrying cost per unit p.a.) = √(2 × (30,000 kg. × 12 months) × ₹ 120 / (15% of 15)) = √(8,64,00,000 / 2.25) = 6,196.77 kg. or 6,197 kg. Material BK = √(2 × (20,000 kg. × 12 months) × ₹ 120 / (5% of 22.44*)) = √(5,76,00,000 / 1.122) = 7,164.97 or 7,165 kg. *Purchase price + 2% CST = 22 + 2% of 22 = 22.44 (ii) Calculation of Maximum Stock level: Since, the Material PK is perishable in nature and it required to be used within 5 days, hence, the Maximum Stock Level shall be lower of two: (a) Stock equal to 5 days consumption = (30,000 kg. / 25 days) × 5 days = 6,000 kg. (b) Maximum Stock Level for Material PK: Re-order Quantity + Re-order level - (Min consumption* × Min. lead time) Where, Re-order Quantity = 8,000 kg. Re-order level = Max. Consumption* × Max. Lead time = (30,000/25) × 2 days = 2,400 kg. Maximum stock Level = 8,000 kg. + 2,400 kg. - (30,000/25 × 1 day) = 10,400 – 1,200 = 9,200 kg. Stock required for 5 days consumption is lower than the maximum stock level calculated through the formula. Therefore, Maximum Stock Level will be 6,000 kg. (iii) Calculation of Savings/ loss in Material PK if purchase quantity equals to EOQ. (*Since, production is processed evenly throughout the month hence material consumption will also be even.) Purchase Quantity = 8,000 kg. Purchase Quantity = EOQ i.e. 6,197 kg. Annual consumption 3,60,000 kg. (30,000 × 12 months) 3,60,000 kg. (30,000 × 12 months) No. of orders [Note- (i)] 60 (3,60,000 ÷ 6,000) 60 (3,60,000 ÷ 6,000) Ordering Cost (a) 7,200 (₹ 120 × 60) 7,200 (₹ 120 × 60) Carrying Cost (b) [Note- (ii)] 8,100 (15% of 13.50 × 4,000) 6,972 (15% of 15 × 3,098.5) Purchase Cost (c) (for good portion) 48,60,000 (₹ 13.50 × 3,60,000) 54,00,000 (₹ 15 × 3,60,000) Loss due to obsolescence (d) [Note- (iii)] 16,20,000 [₹ 13.5 × (60 × 2,000)] 1,77,300 [₹ 15 × (60 × 197)] Total Cost [(a) + (b) + (c) + (d)] 64,95,300 55,91,472 If purchase quantity equals to EOQ, there will be a saving of 9,03,828 i.e.64,95,300 -55,91,472. Notes: (i) As after 5 days of purchase the Material PK gets obsolete, the quantity in excess of 5 days consumption i.e. 6,000 kg. are wasted. Hence, after 6,000 kg. a fresh order needs to be given. (ii) Carrying cost is incurred on average stock of Materials purchased. (iii) the excess quantity of material gets obsolete and loss has to be incurred.

Topics: Material Cost

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