- June 2, 2021 at 6:59 pm #622830Joseph.AndrewsMember
- Topics: 45
- Replies: 23
Could u please say whether did I calculate the interest on overdraft correctly (about question Dusty Co in Sept-Dec 2019)?
We pay interest on overdraft over average inventory where increase or decrease in average inventory and so the overdraft will increase or decrease to finance it (just like what we always doing in questions on the management of receivables) – But WHY do we pay interest on average inventory & not on total inventory?
Increase in average inventory means less cash so we take money from bank so we pay more interest 🙁
Decrease in average inventory means more cash so we don’t take money from bank so we pay less interest 🙂
[My Answer to Dusty Co]
If there were no increase or decrease in average inventory then we would be paying interest on current average inventory such as:
Average Inventory = 62,500 x $14 = 875,000
Interest on overdraft = 875,000 x 3% = $26,250
BUT in EOQ there is a reduction in average inventory from (62,500 units to 30,000 units in EOQ Policy) so decrease in inventory will have a saving of interest on overdraft.
Decrease in average inventory = (62,500 – 30,000) x $14 = 455,000
Saving of interest on overdraft = 455,000 x 3% = $13,650
Overall saving = $3,549 + $13,650 = $17,199
Thanks for your time!June 3, 2021 at 6:58 am #622875John MoffatKeymaster
- Topics: 56
- Replies: 51582
Yes, that is correct.
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