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Inventory Management – Quantity discounts – ACCA Financial Management (FM)

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  2. A company orders 2,000 units at a time and uses 10,000 units per year. units cost $10 each , but the company would be given a 10% discount if it ordered at least 5,000 units per order.

    Q. if the company ordered 5,000 units at a time, what value of discount would it enjoy per year?

    could anybody plz explain the answers in a bit ???

    With regards,
    Abed

  3. A company orders 2,000 units at a time and uses 10,000 units per year. units cost $10 each , but the company would be given a 10% discount if it ordered at least 5,000 units per order.

    Q. if the company ordered 5,000 units at a time, what value of discount would it enjoy per year?

    could anybody plz explain the answers in a bit ???

  4. Hi Sir, thank you for the wonderful lecture. 2 questions:
    1) I understand the buffer inventory is just the extra inventory that we hold just to be safe (and hence need to add to total holding cost for the year). But do not we not have to consider the ordering cost and the purchasing cost of such buffer inventory?

    2) I have seen elsewhere that Total Inventory Cost is equal to Holding Cost+ Ordering Cost +Purchase Cost. In your lecture you always refer to Total Inventory cost as only Holding Cost+ Ordering Cost. Which version should I stick to for the exam?

    Thank you in advance for your guidance.

    Regards,
    Tim

    • 1. No, because it is only bought the one time 🙂

      2. Strictly the inventory cost is just the holding cost plus the ordering cost. However in the exam it doest matter whether or not you also include the purchasing cost, unless either the question specifies to include it or there is a quantity discount in which case it has to be taken into account when deciding the quantity to order.

      • Thank you Sir. Could you please help me to understand a bit more on 1)? Technically speaking even if we purchase the buffer inventory for only one time, say the business is in its first year of operations, then wouldn’t this be part of the “total purchase cost” of total inventory? Also as the business goes on and say some of the buffer inventory is used for sale (for e.g. during a sudden unexpected surge in sales), then the business should need to replenish the buffer inventory to maintain at previous level, so wouldn’t this be included into the “total re-order cost” of inventory for that particular period?

        Thanks a lot for your help in advance!

        Regards,
        Tim

  5. Sir I have three questions regarding this lecture I would be really grateful if you could explain it.
    1) Why is buffer inventory irrelevant to EoQ ?
    2) there were assumptions of constant lead time and demand. why make this assumptions
    3) what causes cost to be higher when using inventory higher than the first discount inventory?
    sorry for My bad english

    • 1. Because the buffer inventory is extra inventory that is held throughout the year at the same level. So the cost of holding it is the same whatever the order quantity each time is.
      2. Because if the lead time and the demand were not constant they would have to oder different quantities each time (high quantities when demand is high and low quantities when demand is low). We assume they are constant and so it is the same order quantity throughout the year.
      3. I am not quite sure what you mean. If you are referring to the example with quantity discounts then any of the discount levels could be the cheapest depending on what the costs are – we obviously choose whichever ends up giving the lowest overall cost.

  6. For example 3
    After calculating the inventory cost for each level of order ie. 5,000 and 10,000, we then add the purchase cost for the entire year.

    Why don’t we include the inventory costs for the entire year at the specific levels and then add the purchase cost for the entire year?

  9. ah! you lectures are fantastic, so clear . I’m planning to take this paper after 7 years break.

    my only problem is a buffer. Where to add this? To the average inventory units on holding cost calculation eg: (5000+buffer)/2 or add new holding cost calculation for the buffer = buffer x (10% x 25X99%) ?

    Does the re order cost need to be adj too? =40,000/(5000+buffer) x20 ?

    it might be helpful to add example, it is tested quite often.

  11. Hi John,

    Thank you for the lecture: its very useful and your lectures are always very clear.

    How might we calculate the new EOQ now that we know the 5000>10000 bracket with a 1% discount is more favourable? I understand that 5000 unit batches are more cost effective than the original EOQ of 800 but we have not shown what the new EOQ is.

    Thanks
    Ty

  13. In this lecture, you said that if given buffer/safety inventory then it must be added to the average inventory when calculating the holding stock which is correct. But sir, in a situation where we are not provided with the unit of buffer, how then do we calculate it. Thanks

  17. Hi John

    Thank you for this lecture.
    Can I ask why when calculating holding cost for 1000 units we do not decrease the price by 10 % but when we calculate holding cost we do?
    Is that not the case that in all circumstances holding cost should be 10% of 25?

    Thanks

    Maria

    • We don’t decrease the price by 10%. The holding cost is always 10% of the purchases price. However if you read the question in the free lecture notes you will see that if we order more than 5,000 each time then the purchase price falls by 1% and therefore the holding cost is lower by 1%. Similarly if we order more than 10,000 each time then purchase price falls by 1.5% and therefore the holding cost is lower by 1.5%.

      I don’t know where you are getting 1,000 units from.

  18. Hii john,
    As i have solved the discount questions from the kaplan book, it is totally different ….they haven’t taken the discount on the holding cost as we took …..they are directly taking the holding cost without discounted amt

    • I cannot comment on what Kaplan has done. What I have done is correct (assuming, of course, that the holding cost is given as a % of the purchase price and not as simply a fixed amount per unit).

  19. The most important thing I learnt is that of a change in policy and taking advantage of settlement discount. Under the change of policy the business should consider both the current and new position for receivables and payables and ascertain any fall or increase to determine the net cost/benefit of the change.

  20. Hi John

    In real life it is likely that a company will be committed to a warehouse already so will have a certain capacity. Therefore EOQ would be irrelevant as purchasing decisions would be based on whether or not there was enough space. Am I correct to think this way?

    I can only think EOQ would be useful if additional storage capacity was being considered or if choosing between different products (seeing what levels of each would be more cost efficient for the space available).

    Be grateful for your thoughts

    Thanks
    Alastair

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