Thank you for the lectures. When i was doing a few examples from kaplan study text, I noticed that the the discount was not applied when calculating the holding cost, it was only applied on the purchase cost. So I am a bit confused whether to apply the discount whilst calculating holding cost. Please clarify? Thanks

It depends how the holding cost is given. If it is given as a $ amount per unit (e.g. holding cost is $2 per unit), then it stays at that amount even if there is a discount on the purchase price.
If the holding cost is given as a % of the purchase price, then as the discount reduces the purchase price it also reduces the holding cost.

John, in the exam. at minute 25:00. The holding cost price after discount is 2.4625. Do we have to put it into 4 decimal places or 3? or if there more decimal places, do we have to put all of the numbers?

For reorder cost there are 80 orders during the year and so the total cost is 80 x the cost for each oder.

For the holding cost, the average level of inventory throughout the year is half of the quantity ordered each time, so we are multiplying this by the cost of holding one unit for a year. (We are not calculating it for one order).

I do suggest that you watch the first lecture on inventory control again, where I explain this.

Thank you very much for the lectures,they seem to be a great help.I am just revising work capital and I have come across buffer stock in a few exam questions.i am not sure if I have missed something in the notes/lectures but I have not come across it?

I don’t mention it in this lecture but I do mention it is the revision lectures.

All that buffer (or safety) inventory is, is carrying extra inventory all year to be safe (in case for example that a new delivery is late arriving). It does mean paying more holding cost for the extra, but it doesn’t affect the EOQ calculations.

Hello Sir,
as you said when on the question will mention that eg: inventory cost per unit is $2.5, then when we will calculate the holding cost for discounted quantity, that time we dont need to deduct the discount rate form the inventory cost per unit? thats what u tried to meant?

Inventory costs are either given as a fixed amount per unit (in which case it does not change if a discount on the purchase price is given) or instead it is given as a percentage of the purchase price (in which case it obviously does change if the purchase price is lower because of a discount).

hello john………..I have got a scientific calculator, and its quite big….however on some calculations it represents the answer as a E – 03 or something….can you please tell me what this represents? or do you have any other solution to this problem? thank you in advance.

However, do not worry – if you carry on and take the square root (I assume that you are trying to calculate the EOQ) then it will provide you with a normal number

Ok so for example if i do 0.1 divided by 250, it gives me a answer of 4.e-04 on my calculator……On my phone it gives me a answer of 0.0004…….. how do I get the same number on my calculator exactly? Ive tried taking the square root, but im having no luck…

It will affect the holding cost but only because the holding cost is a % of the purchase price in this question. If the purchase cost is lower then obviously the holding cost in this case will be lower.

There is no reason at all why the order cost should be affected. If we are charged (say) $100 for delivery, then just because the purchase price is lower, it will not mean that the delivery cost is lower.

The EOQ is where the total inventory costs are at a minimum. At any other level the total inventory costs will be higher.
If we order 10,000 then it could be worth having the higher inventory costs because we will get the discount on the purchase price – the only way we can check is by costing out.

However, if we ordered (say) 7,000, then the total inventory costs will be higher than at the EOQ. We will still be having to pay the same purchase price, so it cannot possibly be better that the EOQ.

The best is always the cheaper of the EOQ and the levels at which we first get a discount. No other levels could possibly be better.

Usually in the exam (and in this question) the re-order cost is given as a fixed amount e.g. $20 per order. In this case we assume that it will remain at $20 per order whatever the size of the order.

In practice, it could change with the size of the order, but even then it would not be relevant.

Suppose the reorder cost was a fixed $20 per order plus $0.10 per unit ordered. Obviously as the number of orders changes the total of the $20’s will change over the year. With regard to the $0.10 per unit order, the cost of the individual order will indeed change with the number of units ordered. However, over the year we will still order the same number of units in total, and so over the year, the number of $0.10’s will stay fixed.

So……although there is unlikely to be a variable order cost in the exam, we would still only consider the fixed cost per order in the formula and when dealing with discounts.

Thank you for your lectures, they are helping me understand the subject better alongside Kaplan text books. Could you please help? I have done the order level at 10000 and am getting a different result to you?

40000/10000 x 4 x 20 = 80
10000/2 = 5000 x 2.4625 = 12312.50 + 80 = 12392.50
40000 x 98.5 x 25 = 98500 000 + 12392.50 = $98 512 393

Is opentuition lectures and notes adequate enough to pass f2? I am self studying and my work schedule may not be so flexible to facilitate other tuition providers.

Hi Sir, I am currently using this lecture for paper F9. My question is that there are two remaining lectures for paper F2 which are for EBQ Example 4&5 and Re-order Level. Do the last two lectures apply for paper F9 as well? Because in the course notes for F9, it stops at example 3 and then last page has something about just in time system and that’s about it for that chapter.

I have understood that if the holding cost per unit is fixed, it will not be affected by the discount while calculating the total annual holding cost. But, in the BPP Practise & Revision Kit, there is the exercise below (Answers Bank 6.19 page 128)

“A company uses an item of inventory as follows.
Purchase price $25 per unit
Annual demand 1,800 units
Ordering cost $32
Annual holding cost $4.50 per unit
EOQ 160 units
What is the minimum total cost assuming a discount of 2% given on orders of 300 and over?
A $45,720.00
B $44,953.50
C $45,000.00
D $44,967.00″

I got $44,967.00 and chose D.

But they chose B. They applied the discount in the total holding cost computation. Below are the details:

“With a discount of 2% and an order quantity of 300 units, unit costs are as follows.
Purchases $45,000 × 98% 44,100.00
Holding costs (W1) 661.50
Ordering costs (W2) 192.00
Total annual costs 44,953.50
Workings:
(1) Holding costs = average inventory × holding cost for one unit of inventory for one year
Average inventory = order quantity ÷ 2 = 300 ÷ 2 = 150 units
Holding cost for one unit of inventory for one year = $4.50 × 98% = $4.41
=> holding costs = 150 units × $4.41 = $661.50
(2) Ordering costs = number of orders × ordering costs per order ($32)
Number of orders = Annual demand ÷ order quantity = 1,800 ÷ 300 = 6 orders
=> ordering cost = 6 orders × $32 = $192″

You only assume that the holding cost per unit changes with the cost per unit is you are specifically told that is the case. Otherwise you assume that the holding cost per unit stays constant.

i understand that the TOTAL cost per ANNUM is cheaper at 5,000 units, however when i first did it i chose 10,000 units because the cost per unit is cheaper at that amount…… at 10,000 its 99.73 while at 5,000 its 199.27.

You are dividing by the wrong number of units! You should have divided the total cost p.a. by the total units per year. Over the year we are buying the same number of units in all cases.

Wait a minute!! did he just say the best level is 5,000 each time (at the end of the video)??? I thought it just have to be 10,000 units each time (as proved from the calculations, it offers optimal cost). Great lecture it is.

If there is a discount of 1%, then it means they pay 1% less than the normal price. 1% less means they pay 99% of the price. 2% less means they only pay 98%.

if the holding cost is a fixed cost of say $2,50 per unit and not a percentage of the purchase cost as in this example should the discount still be applied to the fixed holding cost?

@hussain87, If you order 10,000 each time then the average inventory is 5,000 units.
There is a 1.5% discount on the purchase price and so the purchase price is $25 – (1.5% x $25). Or….98.5% x $25.
The holding cost is 10% of the purchase price.

(Did you watch the earlier part of the lecture? The same problem occurred (and was explained) for the previous order quantity!

Naseef says

Mr John,

Thank you for the lectures. When i was doing a few examples from kaplan study text, I noticed that the the discount was not applied when calculating the holding cost, it was only applied on the purchase cost. So I am a bit confused whether to apply the discount whilst calculating holding cost. Please clarify? Thanks

John Moffat says

It depends how the holding cost is given. If it is given as a $ amount per unit (e.g. holding cost is $2 per unit), then it stays at that amount even if there is a discount on the purchase price.

If the holding cost is given as a % of the purchase price, then as the discount reduces the purchase price it also reduces the holding cost.

Naseef says

Thank you very much for taking the time to reply. I understand the logic now. Good day.

Amirul Ariffin says

John, in the exam. at minute 25:00. The holding cost price after discount is 2.4625. Do we have to put it into 4 decimal places or 3? or if there more decimal places, do we have to put all of the numbers?

John Moffat says

For an exercise on quantity discounts it is best to use the exact figure.

kelechi says

Hello, why do we calculate reorder cost for 80 orders as in this example 1, but calculate holding cost for only 1 order. Thanks.

John Moffat says

We are calculating the total cost over a year.

For reorder cost there are 80 orders during the year and so the total cost is 80 x the cost for each oder.

For the holding cost, the average level of inventory throughout the year is half of the quantity ordered each time, so we are multiplying this by the cost of holding one unit for a year. (We are not calculating it for one order).

I do suggest that you watch the first lecture on inventory control again, where I explain this.

philip says

Hi Sir

Thank you very much for the lectures,they seem to be a great help.I am just revising work capital and I have come across buffer stock in a few exam questions.i am not sure if I have missed something in the notes/lectures but I have not come across it?

John Moffat says

I don’t mention it in this lecture but I do mention it is the revision lectures.

All that buffer (or safety) inventory is, is carrying extra inventory all year to be safe (in case for example that a new delivery is late arriving). It does mean paying more holding cost for the extra, but it doesn’t affect the EOQ calculations.

adarsh says

hi sir

is re order level and lead time (constant and uncertain demand ) out of our syllabus ?

I find those those topic bit difficult to deal with :/

John Moffat says

They can be asked. You can find about reorder level and lead time in the revision notes and lectures.

adarsh says

Okay thankyou sir

arman90fy says

Hello Sir,

as you said when on the question will mention that eg: inventory cost per unit is $2.5, then when we will calculate the holding cost for discounted quantity, that time we dont need to deduct the discount rate form the inventory cost per unit? thats what u tried to meant?

John Moffat says

Inventory costs are either given as a fixed amount per unit (in which case it does not change if a discount on the purchase price is given) or instead it is given as a percentage of the purchase price (in which case it obviously does change if the purchase price is lower because of a discount).

arman90fy says

got it, thank you sir……:)

jefzen2610 says

Hi Sir,

Earlier I asked why on example 3 there is 99%, I hadn’t realised it’s the discount of 1%, please ignore me.

Jefzen2610

jefzen2610 says

Hi Sir,

Looking at the answer for Example 3, I would like to know why it has 99% to a purchase cost, could you please explain as I’m puzzled.

Thanks

fahim231 says

hello john………..I have got a scientific calculator, and its quite big….however on some calculations it represents the answer as a E – 03 or something….can you please tell me what this represents? or do you have any other solution to this problem? thank you in advance.

John Moffat says

The same happens with my calculator

However, do not worry – if you carry on and take the square root (I assume that you are trying to calculate the EOQ) then it will provide you with a normal number

fahim231 says

Ok so for example if i do 0.1 divided by 250, it gives me a answer of 4.e-04 on my calculator……On my phone it gives me a answer of 0.0004…….. how do I get the same number on my calculator exactly? Ive tried taking the square root, but im having no luck…

Thanks

cona700 says

Insightful. I was always getting the Holding cost calculation wrong. Good Lecture.

karam says

I just finished watching the lecture and i dont understand why the discount applies to holding costs and purchase costs but not to re order costs.

John Moffat says

The discount only applies to the purchase price.

It will affect the holding cost but only because the holding cost is a % of the purchase price in this question. If the purchase cost is lower then obviously the holding cost in this case will be lower.

There is no reason at all why the order cost should be affected. If we are charged (say) $100 for delivery, then just because the purchase price is lower, it will not mean that the delivery cost is lower.

Munazza says

Why the best re-order qty is 5000 units. what if we order less than 10,000 more than 5000?

John Moffat says

I do deal with this in the lecture.

Think about the graph that I drew.

The EOQ is where the total inventory costs are at a minimum. At any other level the total inventory costs will be higher.

If we order 10,000 then it could be worth having the higher inventory costs because we will get the discount on the purchase price – the only way we can check is by costing out.

However, if we ordered (say) 7,000, then the total inventory costs will be higher than at the EOQ. We will still be having to pay the same purchase price, so it cannot possibly be better that the EOQ.

The best is always the cheaper of the EOQ and the levels at which we first get a discount. No other levels could possibly be better.

Munazza says

OK…now that thing is clear in my mind..may be need some practical examples..

Thanks alot.

Munazza says

Why the Re-order cost is fixed? As the more qty we order the more delivery charges will be.

John Moffat says

Usually in the exam (and in this question) the re-order cost is given as a fixed amount e.g. $20 per order. In this case we assume that it will remain at $20 per order whatever the size of the order.

In practice, it could change with the size of the order, but even then it would not be relevant.

Suppose the reorder cost was a fixed $20 per order plus $0.10 per unit ordered. Obviously as the number of orders changes the total of the $20’s will change over the year. With regard to the $0.10 per unit order, the cost of the individual order will indeed change with the number of units ordered. However, over the year we will still order the same number of units in total, and so over the year, the number of $0.10’s will stay fixed.

So……although there is unlikely to be a variable order cost in the exam, we would still only consider the fixed cost per order in the formula and when dealing with discounts.

I hope that makes sense

Amanpal says

Hi Mr John Moffat

Thank you for your lectures, they are helping me understand the subject better alongside Kaplan text books. Could you please help? I have done the order level at 10000 and am getting a different result to you?

40000/10000 x 4 x 20 = 80

10000/2 = 5000 x 2.4625 = 12312.50 + 80 = 12392.50

40000 x 98.5 x 25 = 98500 000 + 12392.50 = $98 512 393

I am not sure where my mistake is?

Kindest regards

John Moffat says

985000 + 12393.5 does not equally 98512393!! It is equal to 997393.5

(By the way, the answers to all of the examples are at the back of the Course Notes – see the contents page!)

Mona says

i think the mistake is on 40000x 98.5x 25 which should be 40000x 98.5%x 25.

hope you see the point 98.5 is a percentage

Roisin says

Thank you. The lectures explain things very well.

rajive says

Is opentuition lectures and notes adequate enough to pass f2? I am self studying and my work schedule may not be so flexible to facilitate other tuition providers.

John Moffat says

Yes, they are sufficient, provided that you get hold of a Revision / Exam Kit in order to practice lots of questions.

rajive says

Thank u sir.

John Moffat says

You are welcome

Tyler says

Hi Sir, I am currently using this lecture for paper F9. My question is that there are two remaining lectures for paper F2 which are for EBQ Example 4&5 and Re-order Level. Do the last two lectures apply for paper F9 as well? Because in the course notes for F9, it stops at example 3 and then last page has something about just in time system and that’s about it for that chapter.

John Moffat says

No (or Yes )

Paper F9 only tests on the EOQ formula – it does not test on the EBQ formula or on reorder levels.

Tyler says

Why you put “yes” in brackets then? :p

John Moffat says

No, they are not in F9. Yes, what you say is correct.

sdmaalex says

Thanks alot! Great lecture

Daniela says

hi, i am new here. tell me please what text book do you use for your lecture, thanks.

John Moffat says

We use our own Course Notes. You can find the link above the lecture on the right hand side.

r rupalia says

Hi, I am unable to view this clip online, it says page not found. Any help?

Thanks.

John Moffat says

The lecture is working fine. Best if you look at the support page – it must be a problem specific to your device.

Macha says

I have understood that if the holding cost per unit is fixed, it will not be affected by the discount while calculating the total annual holding cost. But, in the BPP Practise & Revision Kit, there is the exercise below (Answers Bank 6.19 page 128)

“A company uses an item of inventory as follows.

Purchase price $25 per unit

Annual demand 1,800 units

Ordering cost $32

Annual holding cost $4.50 per unit

EOQ 160 units

What is the minimum total cost assuming a discount of 2% given on orders of 300 and over?

A $45,720.00

B $44,953.50

C $45,000.00

D $44,967.00″

I got $44,967.00 and chose D.

But they chose B. They applied the discount in the total holding cost computation. Below are the details:

“With a discount of 2% and an order quantity of 300 units, unit costs are as follows.

Purchases $45,000 × 98% 44,100.00

Holding costs (W1) 661.50

Ordering costs (W2) 192.00

Total annual costs 44,953.50

Workings:

(1) Holding costs = average inventory × holding cost for one unit of inventory for one year

Average inventory = order quantity ÷ 2 = 300 ÷ 2 = 150 units

Holding cost for one unit of inventory for one year = $4.50 × 98% = $4.41

=> holding costs = 150 units × $4.41 = $661.50

(2) Ordering costs = number of orders × ordering costs per order ($32)

Number of orders = Annual demand ÷ order quantity = 1,800 ÷ 300 = 6 orders

=> ordering cost = 6 orders × $32 = $192″

Please help. I am confused.

John Moffat says

Your answer is correct and BPPs answer is wrong.

You only assume that the holding cost per unit changes with the cost per unit is you are specifically told that is the case. Otherwise you assume that the holding cost per unit stays constant.

Macha says

Thank you very much!

nari says

i understand that the TOTAL cost per ANNUM is cheaper at 5,000 units, however when i first did it i chose 10,000 units because the cost per unit is cheaper at that amount…… at 10,000 its 99.73 while at 5,000 its 199.27.

John Moffat says

You are dividing by the wrong number of units! You should have divided the total cost p.a. by the total units per year. Over the year we are buying the same number of units in all cases.

nari says

sigh…cant believe i made that error!!

naucelime says

Is it possible for me to save the video after loading it?

John Moffat says

Sorry, but no. It is the only way that we can keep this website free of charge.

abdulrahman says

I am having trouble answering this question can some kindly show me the calculation for this:

A company uses uses item of inventory as follows.

purchase price 25

annual demand 1800

ordering cost 32

annual holding costs 4.50

EOQ 160

what is the minimum total costs assuming a discount of 2% given on orders of 300 and over?

naucelime says

Is it possible after loading the video to save it and viewing it later? internet connection is not good sometimes, thank you

ernamag says

great lecture! I am understanding things i have never understood before.

aubreychipungu says

Wait a minute!! did he just say the best level is 5,000 each time (at the end of the video)??? I thought it just have to be 10,000 units each time (as proved from the calculations, it offers optimal cost). Great lecture it is.

John Moffat says

Yes – that is what I did say, because the answer is 5,000!

Check again (or look at the answer at the back of our Course Notes). The total cost at 5000 is lower than the total cost at 10000

shajnush says

sir how did i get the discount 98 and 99 percent please… can elaborate for me please

John Moffat says

The question says that the discounts are 1% and 2%.

If the discount is 1% then it means the cost is 99% of what it was originally.

shajnush says

sir sorry to pain you..that exactly my question if discount 1% how did u get the result cost 99% i mean how you calculate please

John Moffat says

If there is a discount of 1%, then it means they pay 1% less than the normal price. 1% less means they pay 99% of the price. 2% less means they only pay 98%.

tdcc says

if the holding cost is a fixed cost of say $2,50 per unit and not a percentage of the purchase cost as in this example should the discount still be applied to the fixed holding cost?

John Moffat says

No. If the holding cost is given as a fixed amount per unit then you assume that it does not change.

tdcc says

Thanks much!

hussain87 says

I don’t understand 23.22 can some help me plz.

John Moffat says

@hussain87, If you order 10,000 each time then the average inventory is 5,000 units.

There is a 1.5% discount on the purchase price and so the purchase price is $25 – (1.5% x $25). Or….98.5% x $25.

The holding cost is 10% of the purchase price.

(Did you watch the earlier part of the lecture? The same problem occurred (and was explained) for the previous order quantity!

hussain87 says

@johnmoffat, Thanks a lot god bless u.

John Moffat says

@hussain87, You are welcome

balcune1 says

thank you so glad I found this website! 😀

theodora118 says

@balcune1, me too.

ai1989 says

@theodora118, mee three

desie86 says

i seriously dont know where you got the 99% and 98.5% from please help me out

jeanmarc says

@desie86, The 99% and 98.5% represent the price /unit less the discount at the different level of quantity that might be ordered

wiky1100 says

download ot notes

alyy says

exuse me from which book it’s examples are from ?

John Moffat says

@alyy, It says at the top of this page – the lectures are all based on the Course Notes that are downloadable from this website!

ychang80 says

I really enjoy this lecture, it was very helpful specially with the little tricks we may have on the exam. Thanks much

pepperoniii says

really great lecture resources opentuition! thank you so much

kina says

very well explained! thanks a lot

startlet says

thank you for the valuable information

olofins says

pls labour cost lecture

herbiby says

good job!!!

Fahim Farooq says

gr8, tnx

eunicegachunga says

excellent i was stuck for a whole afternoon

nyoka says

this was really helpful

iraklixxxxx says

tnx

Subhan Paul says

thank you! inventory cost was the problem, i didnt knew one had to charge discount in holding cost per unit as well in calculating total holding cost