Hello Mr John, wonderful lecture.
I came across this EOQ question in BBP revision kit where to find inventory holding cost, we have to find the minimum inventory level (because there is a reorder level) and add to average inventory ordered. I understand this part.
What I don’t understand is, shortly after we r asked to find EOQ using the same info in the question and then also to find the new inventory holding cost, however in finding the new holding cost they still added the same minimum inventory level to the average quantity ordered, even though the EOQ is smaller than the reorder level to start with. Please could you explain?

It’s a bit difficult to fit a full explanation in the limited space here. Best is to watch the F2 Revision lecture on this. It should make sense, but if not then as again (but in the F2 Ask the Tutor Forum)

Very well explained lecture I am planning to sit F2 asap and F5 this june,
out of curiosity I wanted to ask, what is the equation that has to be differentiated to arrive at the formula? Would you mind telling me, I want to give it a go. A bit rusty in maths now but still my favourite subject

If Q is the order quantity (and the other symbols are as per the formula), then the total reorder cost over the year is D/Q x Co; and the total holding cost over the year is Q/2 x Ch.

So the total of the two, TC = (D/Q x Co) + (Q/2 x Ch).

To get the minimum total cost, we differentiate this with respect to Q and then make it equal to zero.

(I have answered because you want to give it a god, but do please appreciate that you can not possibly be expected to differentiate in any ACCA examinations)

great lecture, i must say. However i would like to ask why in some instances when we are calculating the total costs, we add the re-order cost+holding cost plus (purchase price *demand)
whereas you only added the total holding costs with the ordering costs when computing the total costs. Is my method wrong?

It really depends what is asked for in the question – the total costs or the total inventory costs. The question will make it clear.

Usually it is only the total inventory costs that we are bothered about because the total purchase cost will remain unchanged (except, of course, if there are discounts).

Hello Sir, I’m new to this website, forgive me if the question I pose is talked on in later lectures but I was wondering, how the EOQ will me modified for say international businesses? Or will it be stay the same? In the sense that, duty fees will we part of fixed costs per order.

Have you actually watched the lecture (because I go through examples of calculated the total cost in the lecture)?

The EOQ is 1,000, but it is certainly not $’s!!!!

To get the total cost you multiply the average inventory by Ch – this gives the total holding cost.
You multiply the number of orders by Co – this gives the total order cost.

A company uses components at the rate of 500 units per month,which are bought in at a cost of $1.20 each from supplier.It costs $20 each time to place an order,regardless of the quantity ordered.The total holding cost is 20% per annum of the value of inventory held.
The company should order ……….. components
The total annual cost will be???? Can plz give the answer,Sir??

In this question 500 is being ordered for each time. Then y we have not go through with this unit for ordering cost instead of calculating EOQ?i m being confused.in the next question u have calculated 250 as ordering each time. They need 500 means they r ordering 500 each time.m I wrong?plz help me sir.m being confused.

A company orders a particular raw material in order quantities of 250 units. No safety inventory is held, the inventory
holding cost is $3 per unit per annum and the annual demand is 2,500 units.
What is the total annual inventory holding cost of the material?

If they order 250 each time, then the average inventory will be 250/2 = 125 units throughout the year.
The cost per unit is $3 per year, so the total cost will be 3 x 125 = $375

Why is it that when calculating the holding cost, the order quantity is divided by 2 before multiplying it with the odering cost per unit for the period?

Because the level of inventory keeps fluctuating between the order quantity (immediately an order is received) and zero (just before the next order is received).

So on average it will be (order quantity) / 2 throughout the year.

A company uses 5000 units of a component per anum. ordering cost is $36. holding cost of one unit of component is $4 What is the e.o.q for that component, assuming 52 weeks year, what is the average frequency at which purchase orders should be placed? plz help me on this question

I am not sure why you have a problem with the EOQ – you simply stick the figures in the formula.
D = 5,000; Co = 36; and Ch = 4. So the EOQ is 300 units.

As far as the frequency of orders is concerned, since they use 5000 units a year and order 300 each time, it means that they place 5000/300 = 16.67 orders a year. With 52 weeks in a year, this means that they place an order every 52/16.67 = 3.12 weeks on average.

could i download lecture video?? cause my dorm’s internet speed is really bad, so that can’t played.
but i can download it while i’m sleeping and watch it later. ???

Because we are calculating the costs per year, and over the year the total number of units purchased (and therefore the total cost) does not change. It is only the inventory costs that will change depending on the number ordered each time.

The only time we need consider the purchase costs is if the supplier offers a discount for purchasing a large quantity each time, and this is dealt with in a later example.

Grace says

Hello Mr John, wonderful lecture.

I came across this EOQ question in BBP revision kit where to find inventory holding cost, we have to find the minimum inventory level (because there is a reorder level) and add to average inventory ordered. I understand this part.

What I don’t understand is, shortly after we r asked to find EOQ using the same info in the question and then also to find the new inventory holding cost, however in finding the new holding cost they still added the same minimum inventory level to the average quantity ordered, even though the EOQ is smaller than the reorder level to start with. Please could you explain?

John Moffat says

It’s a bit difficult to fit a full explanation in the limited space here. Best is to watch the F2 Revision lecture on this. It should make sense, but if not then as again (but in the F2 Ask the Tutor Forum)

shahz20 says

Very well explained lecture I am planning to sit F2 asap and F5 this june,

out of curiosity I wanted to ask, what is the equation that has to be differentiated to arrive at the formula? Would you mind telling me, I want to give it a go. A bit rusty in maths now but still my favourite subject

John Moffat says

If Q is the order quantity (and the other symbols are as per the formula), then the total reorder cost over the year is D/Q x Co; and the total holding cost over the year is Q/2 x Ch.

So the total of the two, TC = (D/Q x Co) + (Q/2 x Ch).

To get the minimum total cost, we differentiate this with respect to Q and then make it equal to zero.

(I have answered because you want to give it a god, but do please appreciate that you can not possibly be expected to differentiate in any ACCA examinations)

David says

Very easily explained, thanks much!

Mariam says

costs as in the ordering and holding costs?or the fixed,variable etc costs?

John Moffat says

I am not sure what you mean. In the context of inventory control it is the cost of ordering and the cost of holding inventory that are relevant.

Mariam says

major costs associated with holding and ordering costs

John Moffat says

I answered this in my first answer to you (below), and I give examples in the lecture.

Mariam says

i have a question where it states how discounts can affect a certain EOQ calculation (say 2000 units) and subsequent stock costs.

do I have to work out an actual full question with discounts , comparing it to the EOQ

then explain ?

2) I would also like to know what the two major costs associated with

a) holding stock

b) ordering stock

John Moffat says

You will not get a full question because of the nature of the exam.

However you can be asked to calculate both with and without discounts.

With regard to costs there are not just two major costs, there are several. I take about the types of costs in the free lectures.

Mariam says

great lecture, i must say. However i would like to ask why in some instances when we are calculating the total costs, we add the re-order cost+holding cost plus (purchase price *demand)

whereas you only added the total holding costs with the ordering costs when computing the total costs. Is my method wrong?

John Moffat says

It really depends what is asked for in the question – the total costs or the total inventory costs. The question will make it clear.

Usually it is only the total inventory costs that we are bothered about because the total purchase cost will remain unchanged (except, of course, if there are discounts).

Mariam says

so its only when you’re asked for total costs or in a discount question that you compute the total purchase costs plus holding and ordering costs?

John Moffat says

That is correct

Mariam says

thanks! got it

John Moffat says

Great

Edgard says

Hello Sir, I’m new to this website, forgive me if the question I pose is talked on in later lectures but I was wondering, how the EOQ will me modified for say international businesses? Or will it be stay the same? In the sense that, duty fees will we part of fixed costs per order.

mariyam says

Sorry sir…and now i understand…thank you…

mariyam says

Using the formula I got $1000…then how to find total cost..

John Moffat says

Have you actually watched the lecture (because I go through examples of calculated the total cost in the lecture)?

The EOQ is 1,000, but it is certainly not $’s!!!!

To get the total cost you multiply the average inventory by Ch – this gives the total holding cost.

You multiply the number of orders by Co – this gives the total order cost.

mariyam says

Hi sir I don’t understand the answer of the first question…RISVY ‘s question…can you please help me..and what is Cd…

John Moffat says

Which bit did you not understand? Cd was a typing mistake, it should be Ch (which, as I wrote, is the holding cost).

Risvy says

A company uses components at the rate of 500 units per month,which are bought in at a cost of $1.20 each from supplier.It costs $20 each time to place an order,regardless of the quantity ordered.The total holding cost is 20% per annum of the value of inventory held.

The company should order ……….. components

The total annual cost will be???? Can plz give the answer,Sir??

John Moffat says

The annual demand – D = 6000 (12 x 500)

The reorder cost – Co = 20

The holding cost – Cd = $0.24 (20% x $1.20)

If you put them in the formula you will get the EBQ, and then you can calculate the total costs.

Risvy says

Thank u Sir..

John Moffat says

You are welcome

Farzana sultana says

Is the answer 7500

Farzana sultana says

Or the answer is 7440.i have tried in two different way.

Farzana sultana says

In this question 500 is being ordered for each time. Then y we have not go through with this unit for ordering cost instead of calculating EOQ?i m being confused.in the next question u have calculated 250 as ordering each time. They need 500 means they r ordering 500 each time.m I wrong?plz help me sir.m being confused.

John Moffat says

The question does not say that they order 500 each time. It says that they use 500 a month.

(Please ask questions in the Ask the Tutor forum – not as comments on lectures. )

Farzana sultana says

thank u sir.next time i will.

Sagar Mehta says

When calculating Total Holding Costs i.e = Average Inventory X Holding Cost/Unit

400 X $2.5

Answer comes to $900, so why do we round it up to $1000 ?

John Moffat says

Try using a calculator

400 x 2.5 = 1000 (I did it in my head, but do check me )

Sagar Mehta says

lol. my bad

usama says

A company orders a particular raw material in order quantities of 250 units. No safety inventory is held, the inventory

holding cost is $3 per unit per annum and the annual demand is 2,500 units.

What is the total annual inventory holding cost of the material?

how could i attempt this question?

John Moffat says

If they order 250 each time, then the average inventory will be 250/2 = 125 units throughout the year.

The cost per unit is $3 per year, so the total cost will be 3 x 125 = $375

anyundo says

Why is it that when calculating the holding cost, the order quantity is divided by 2 before multiplying it with the odering cost per unit for the period?

John Moffat says

Because the level of inventory keeps fluctuating between the order quantity (immediately an order is received) and zero (just before the next order is received).

So on average it will be (order quantity) / 2 throughout the year.

Emil says

Can you explain me this question, please?

http://i58.tinypic.com/rlhrx2.jpg

John Moffat says

If you look at the formula, then you will see that the order cost is on the top of the formula.

So if the order cost is lower then the EBQ will be lower as well.

If the EBQ is lower, then the average inventory will be lower and therefore the cost over a year of holding inventory will be lower.

If you are still unsure, make up some numbers – calculate the EBQ and the holding cost. Then do it again with a lower order cost and see what happens.

(Please ask questions like this on the F2 Ask ACCA Tutor forum – this page is for comments/questions about the actual lecture)

henry says

A company uses 5000 units of a component per anum. ordering cost is $36. holding cost of one unit of component is $4 What is the e.o.q for that component, assuming 52 weeks year, what is the average frequency at which purchase orders should be placed? plz help me on this question

John Moffat says

I am not sure why you have a problem with the EOQ – you simply stick the figures in the formula.

D = 5,000; Co = 36; and Ch = 4. So the EOQ is 300 units.

As far as the frequency of orders is concerned, since they use 5000 units a year and order 300 each time, it means that they place 5000/300 = 16.67 orders a year. With 52 weeks in a year, this means that they place an order every 52/16.67 = 3.12 weeks on average.

henry says

thanks john

John Moffat says

You are welcome

changdae says

could i download lecture video?? cause my dorm’s internet speed is really bad, so that can’t played.

but i can download it while i’m sleeping and watch it later. ???

John Moffat says

Sorry -the lectures cannot be downloaded.

It is the only way that we can keep this website free of charge.

rutikanga says

hey,possible to see the person delivering lectures? otherwise,its sweet.

John Moffat says

In some lectures, yes – in others, no

Jim says

Why is the purchase cost of the inventory not included in the workings?

John Moffat says

Because we are calculating the costs per year, and over the year the total number of units purchased (and therefore the total cost) does not change. It is only the inventory costs that will change depending on the number ordered each time.

The only time we need consider the purchase costs is if the supplier offers a discount for purchasing a large quantity each time, and this is dealt with in a later example.

Jim says

Ok, thanks.

kimlien says

Thanks a lot, OT!