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Hello sir..
Could you explain the following question for me. The question is from ACCA Study Hub Chapter 3 – Managing Inventory (Qn No 10)
Alpha Co buys material X from a supplier that is located next to its factory. When Alpha places an order for material X, the supplier sets up a special production run, and it can take several days for the order to be fulfilled. The supplier delivers material X to Alpha Co in small batches from the time the order is placed until the order is complete.
Alpha currently uses the economic order quantity model to determine the order quantity of material X, but a new management accountant has suggested that the economic batch quantity model (EBQ) would be more appropriate. This would have no effect on the total quantity of material X used during the year.
10. What would be the effect of adopting the EBQ model?
Order quantity Number of orders per year
Decrease Increase
Decrease Decrease
Increase Decrease
Increase IncreaseThe provided answer is as follows:
The correct answer is C.
The order quantity increases when the EBQ is used instead of the EOQ. If inventory is replaced gradually, average inventory holdings will be lower than if inventory were replaced instantaneously, and therefore total inventory holding costs fall. The EBQ takes this into account and therefore increases the order quantity.
If the quantity ordered rises each time an order is placed, then a lower frequency of orders will be required.
Is it because of the extra element of [1-(Demand/Replenishment rate)] in the EBQ equation as compared to EOQ in the denominator, the resultant QUANTITY is increasing (DUE TO A LOWER DENOMINATOR VALUE).
In the study hub, it says that with the EOQ, there is an immediate re-stocking of inventory. However, with the EBQ, inventory is re-stocked gradually each time a batch is produced.
What does this actually mean ???
Thanks in advance..!
With EOQ, orders are placed with a supplier and the full amount of the order is received when the supplier delivers.
With EBQ, the business is making the goods itself in its factory. It takes time for the entire order to be produced and so the goods are delivered to the warehouse over a period rather than all at once.
This is all explained in full in my free lectures. The lectures are a complete free course for Paper MA and cover everything needed to be able to pass the exam well.
Thanks for the explanation sir..!
But isn’t Alpha Co purchasing Material X from an outside supplier, so why are they even considering EBQ.
Shouldn’t EOQ be used when we are purchasing Material X instead of producing it on our own ???
Sorry – I should have mentioned that in my previous reply.
Although they are ordering from an outside supplier, the question says that instead of the supplier delivering the entire order at once (as is usually the case) they are delivering small amount each time as they make the order. This makes it similar to the situation where they produce their own items and is why it makes sense to use the EBQ formula.
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