Why don’t we consider the purchase price alongside the holding and reorder costs. I understand that until the year end we’re gonna have to pay for the yearly demand. But if our reorder quantity is lower, we can save money and earn short-term interest on them as well. Doesn’t that make holding less inventory a bit more advantageous?

The interest is the most likely stock-holding cost in the formula (and is the reason that the stock-holding cost is often given as a % of the purchase price).

Hi John, i would like to know about the holding cost. When you take for example (800/2), why 2 and where does this 2 come from or what does that figure means?

Hi, I need help on this question
A company has the following data;
Economic order quantity =21.9 metres
Minimum Level = 10
Maximum Level = 40
Average Level = 20.99 metres

Is the company doing well? Why would you say they’re doing well or not

I’m assuming they’re not doing well but I can’t back this up…What do you think??

Sorry for posting twice as I am new to this site I confused

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)

Morning John, fellow ACCA students and the team at Open Tuition,

Although I understand and agree with the above formula:

TC= (Q/2 x Ch) + (D/Q x Co)

I’m an F2 student at Kaplan and their study text states

TAC= (PxD) + (Q/2 x Ch) + (D/Q x Co)

Where P = Price per Unit
D = Demand

I can only assume that the inclusion of PxD is linked to the context and requirements of the question posed and therefore the RTQ approach would be the wisest approach.

N.B. My apologies for posting this comment at the foot of the lecture. I appreciate that it is not a comment related to the content of the lecture of EOQ and shall be happy to repost the query in the forum, if required.

The first formula you wrote is the total inventory cost that we are trying to minimise.
The second formula includes the total purchase price, which is normally irrelevant because it will stay constant whatever the order quantity.
It is only really necessary to include the total purchase price if there are quantity discounts, as is explained in the lectures.

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.

@xxjulietxx, There is no need to unless the question asks for it, because that would stay the same whatever happens – it is only the inventory costs that will change.
The time that the purchase cost is needed is when there are discounts for ordering higher quantities.

I had a question that seems really simple but I cant get the same answer as the text. It states the below:

The annual demand for an item of inventory is 2500 units. the cost of placing an order is $80 and the cost of holding an item in stock is $15. What is the EOQ, to the nearest unit. My answer is 26,667 Units and the answer in the text is 163 Units. Can someone please explain this to me?

@melissadejon, Did you not think to yourself that, if annual demand was 2,500, then an eoq of 26,667 was maybe a bit strange? Or is it acceptable to buy more than 10 years’ worth of goods each time you place an order?

Farid says

Hi John

Why don’t we consider the purchase price alongside the holding and reorder costs. I understand that until the year end we’re gonna have to pay for the yearly demand. But if our reorder quantity is lower, we can save money and earn short-term interest on them as well. Doesn’t that make holding less inventory a bit more advantageous?

Thanx in advance

John Moffat says

The interest is the most likely stock-holding cost in the formula (and is the reason that the stock-holding cost is often given as a % of the purchase price).

Farid says

yeah, that seems logical. Thanks for your response

John Moffat says

You are welcome 🙂

kirsley says

Hi John, i would like to know about the holding cost. When you take for example (800/2), why 2 and where does this 2 come from or what does that figure means?

kirsley says

HI again me.. I think its ok. i have reviewed once more. it should be the average inventory and therefore where the holding cost.. am i right?

John Moffat says

Yes – it is to get the average inventory.

SlLO says

Hi, I need help on this question

A company has the following data;

Economic order quantity =21.9 metres

Minimum Level = 10

Maximum Level = 40

Average Level = 20.99 metres

Is the company doing well? Why would you say they’re doing well or not

I’m assuming they’re not doing well but I can’t back this up…What do you think??

Sorry for posting twice as I am new to this site I confused

John Moffat says

The level of inventory is no indication as to whether the company is doing well or not!!

(And please ask questions like this in the Ask the Tutor Forum – not as a comment on a lecture)

abdulaziz says

I’ve always wondered, what is the use of the text books?!!!!! why they are making it so hard??

John Moffat says

I agree 🙂

Rhona says

Thank you for the lecture – EOQ formular is very well explained

John Moffat says

Thank you for the comment 🙂

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)

Kirit says

Morning John, fellow ACCA students and the team at Open Tuition,

Although I understand and agree with the above formula:

TC= (Q/2 x Ch) + (D/Q x Co)

I’m an F2 student at Kaplan and their study text states

TAC= (PxD) + (Q/2 x Ch) + (D/Q x Co)

Where P = Price per Unit

D = Demand

I can only assume that the inclusion of PxD is linked to the context and requirements of the question posed and therefore the RTQ approach would be the wisest approach.

N.B. My apologies for posting this comment at the foot of the lecture. I appreciate that it is not a comment related to the content of the lecture of EOQ and shall be happy to repost the query in the forum, if required.

Thank you.

John Moffat says

The first formula you wrote is the total inventory cost that we are trying to minimise.

The second formula includes the total purchase price, which is normally irrelevant because it will stay constant whatever the order quantity.

It is only really necessary to include the total purchase price if there are quantity discounts, as is explained in the lectures.

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.

Kirit says

EOQ = economic order QUANTITY (Units, components, baked beans tin (?)

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).

Kirit says

Cd= Cost OF HOLdING ONE UNIT

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!

Lebo says

I’m unable to play videos tuitions even to hear them

admin says

TECHNICAL SUPPORT

problems with downloading notes or watching lectures? Please visit the support page: http://opentuition.com/support/

anne85 says

i can only hear the video…cant see anything

zachary1982 says

Hi, I was just watching this video and it suddenly paused. Now when I try to refresh I’m getting a message saying video isn’t found.

John Moffat says

The video is working OK. Maybe clearing your cache will help.

zachary1982 says

Ok thanks…

dsilva says

i have tried to see video lecture for f6 f7 and f9 and another page with a message erro 404 page not found.

John Moffat says

The links all work fine – the problem is at your end. Check the ‘technical support’ tab.

admin says

Install flash player

Riyaz Mangia says

Thank you for this website it’s very influential. It’s helped me a lot with Inventory control

And also with cost behaviour.

annastacia1 says

not getting to watch lectures for any f9 paper ads keep poping up and everytime you click it to close no lectures appear.

John Moffat says

You have a problem with your computer – it is nothing to do with OpenTuition. We do not have pop-up ads.

marcie157 says

Very clearly explained. thank you Open Tuition, brilliant lectures!

Accountaholic says

Thank you Open Tuition…Very precise and clear…!

Where do you hold these lectures and who are these students?!! Can we not come for any lectures?!!!

lusekero77 says

Very clear and easy to understand. Am enjoying F9 now. Thanx

Samuel Mayes says

Superb!

meforoma says

The lecturer has a brilliant sense of Humor ))))

xxjulietxx says

why wasn’t purchasing cost calculated?

(Demand x purchase price)

John Moffat says

@xxjulietxx, There is no need to unless the question asks for it, because that would stay the same whatever happens – it is only the inventory costs that will change.

The time that the purchase cost is needed is when there are discounts for ordering higher quantities.

tauraiversatile says

A good one, keep it up guys!

accakeisha says

oh my!!!the text book looked like greek to me until i listened to this video…..great great tutoring!!!!

sayyeda90 says

i understand OT better than any lecture at class.. 😉

thesaucyone says

im in love with OT! beats going to class anyday and I could go back. I cant rewind a teacher lol! thanxxxxx a mil

tikotiko says

Really super explained

melissadejon says

Hi Guys

I had a question that seems really simple but I cant get the same answer as the text. It states the below:

The annual demand for an item of inventory is 2500 units. the cost of placing an order is $80 and the cost of holding an item in stock is $15. What is the EOQ, to the nearest unit. My answer is 26,667 Units and the answer in the text is 163 Units. Can someone please explain this to me?

melissadejon says

Sorry have a question.

zinnat10 says

@melissadejon, @26,667 units u must do square root then u get 163units

cherylcheeseman says

@melissadejon,

You did not remember to do the square root of 26,667. This will give you 163 units

isatu1994 says

@melissadejon, I will advice that you get a very good calculator that will automatically give you the square root

MikeLittle says

@melissadejon, Did you not think to yourself that, if annual demand was 2,500, then an eoq of 26,667 was maybe a bit strange? Or is it acceptable to buy more than 10 years’ worth of goods each time you place an order?

wasibutt says

Well I must say that these are great lectures, anybody could easily understand every bit of it. Thanks For Such a Gr8 Effort,

activehands says

is amazing how easily Inventory control was explianed.I never knew its this simple