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Can you please confirm that the interest cost on inventory is charged on the total inventory purchase cost or average inventory purchase cost?
I am confused because there is a question Dusty Co where we are told to calculate finance cost based on average inventory so I thought to confirm from you whether it is always charged on average inventory or it could be otherwise charged on total inventory purchase cost?
Interest will always be paid on the cost of the average inventory because we always assume that the interest is chargeable on a day by day basis.
There is little question in the Kaplan text where the example of finance cost is given in the example:
[Question]
Monthly demand is 10,000 for a product. The purchase price is $10/unit and the company’s cost of finance is 15% pa. Warehouse storage cost is $2/unit. This supplier charges $200 per order for delivery.Calculate the EOQ.
[Answer]
Squareroot 2 x 200 x 10,000 / (10 x 15%) + 2
EOQ = 3703Can you please tell me the reason for finance cost being included with the holding cost in EOQ calculations (in the denominator)? I haven’t seen any other costs to be included with the holding cost in the EOQ formula!
Secondly, let suppose if we have to calculate finance cost on average inventory then it should be like this (I know that this question doesn’t ask me that but let suppose!)
My problem is that if the finance cost is charged on average inventory then it should be applied on like this:
Average Inventory = 10,000 / 2 = 5000
Purchase cost = 5000 x 10 = 50,000
Interest charge = 50,000 x 15% = 7500Did I calculate the interest on overdraft correctly?
The interest cost of holding inventory is actually the most likely cost (and I do explain the reason for this in my free lectures on Inventory Control!).
Your interest cost for the month is correct.
Do watch my free lectures on this. The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.
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