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Economic Batch Quantity (EBQ) : Prepared By: Talha Majeed Khan (M.Phil) Lecturer UCP, Faculty of Management Studies

The document discusses different inventory valuation methods: FIFO, LIFO, and AVCO. FIFO assumes the oldest inventory is issued first, while LIFO assumes the newest inventory is issued first. AVCO calculates an average unit cost based on all inventory items. The document provides examples to illustrate how to calculate inventory values and costs under the FIFO method. It also discusses the advantages and disadvantages of each valuation method.

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2K views

Economic Batch Quantity (EBQ) : Prepared By: Talha Majeed Khan (M.Phil) Lecturer UCP, Faculty of Management Studies

The document discusses different inventory valuation methods: FIFO, LIFO, and AVCO. FIFO assumes the oldest inventory is issued first, while LIFO assumes the newest inventory is issued first. AVCO calculates an average unit cost based on all inventory items. The document provides examples to illustrate how to calculate inventory values and costs under the FIFO method. It also discusses the advantages and disadvantages of each valuation method.

Uploaded by

zubair
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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Economic Batch Quantity (EBQ)

Prepared by:
Talha Majeed Khan (M.Phil) Lecturer UCP,
Faculty of Management Studies
• Economic Batch Quantity (EBQ)
The Economic Batch Quantity (EBQ) is a modification of the EOQ and
is used when resupply is gradual instead of instantaneous.

• Example: Economic Batch Quantity


If the daily demand for an item of inventory is ten units, and the
storekeeper orders 100 units in a batch. The rate of production is 50 units
a day.
a. On the first day of the batch production run, the stores will run out of its
previous inventories, and re-supply will begin. 50 units will be produced
during the day, and ten units will be consumed. The closing inventory at
the end of day 1 will be 50-10= 40 units.
b. On day 2, the final 50 units will be produced and a further ten units will
be consumed. Closing inventory at the end of day 2 will be (40+50-10) =
80 units.
c. In eight more days, inventories will fall to zero.

The minimum inventory in this example is zero, and the maximum


inventory is 80 units. The maximum inventory is the quantity ordered
(Q=100) units minus demand during the period of the batch production
run is Q*D/R
• Where,
D = the rate of demand
Q = the quantity ordered
R = the rate of prodcution
In our example, the maximum inventory is (100-10/50*100)= 100-20=80 units.
The maximum inventory level, given gradual re-supply is thus Q-QD/R= Q(1-D/R)

• Example of Bulk Discounts


The annual demand for an item of inventory is 45 units. The item costs £200 a unit to purchase,
the holding cost for one unit for one year is 15% of the unit cost and ordering costs are £300 an
order.
The Supplier offers a 3% discount for orders of 60 units or more, and a discount of 5% for orders
of 90 units or more.
Required:
Calculate the cost-minimizing order size.
•Solution:
(a). The EOQ ignoring discounts is = = 30

Purchases (no discount) 45*200 = 9,000


Holding Costs = 450
Ordering Costs = 450
Total annual costs = 9,900

Workings:

(1). Holding Costs:


Holding costs = Average stock * Holding cost for one unit of inventory per annum
Average Inventory = Order quantity/2
= 30/2 = 15 units
Holding Costs for one unit of inventory per annum = 15% *£200 = 30
Holding costs = 15 units * £30
= £450
(2). Ordering Costs
Ordering costs = Number of orders * ordering costs per order (£300)
Number of orders = Annual demand / order quantity
= 45/30
= 1.5 orders
Ordering costs = 1.5 orders * £300
=£450

(b). With a discount of 3% and an order quantity of 60 units, units costs are as follows:
Purchases £9,000 * 97% = 8,730
Holding costs = 873
Ordering costs = 225
Total annual costs = 9,828
• Working:
Holding costs
Holding costs = Average inventory * holding cost for one unit of inventory per annum
Average inventory = order quantity / 2
= 60 / 2 = 30 units
Holding cost for one unit of inventory per annum = 15% of 97% *£200= £29.10
Holding costs = 30 units * £29.10
= £873
Ordering Costs
Ordering costs = Number of orders * ordering costs per order (£300)
Number of orders = Annual demand / order quantity
= 45 / 60
= 0.75 orders
Ordering costs = 0.75 orders * £300
= £225
(c). With a discount of 5% and an order quantity of 90, units costs are as follows:
Purchases £9,000*95% = 8,550.0
Holding costs = 1,282.5
Ordering costs = 150.0
Total Annual costs = 9,982.5
Workings:
Holding costs:
Holding costs = Average inventory * holding cost for one unit of inventory per annum
Average inventory = order quantity / 2
= 90 / 2
= 45 units
Holding cost for one unit of inventory per annum = 15% * 95% * £200
= £28.50
Holding costs = 45 units * £28.50
= £1,282.50
Ordering Costs
Ordering costs = Number of Orders * ordering cots per order (£300)
Number of orders = Annual demand / order quantity
= 45 / 90
= 0.5 orders
Ordering costs = 0.5 orders * £300
= £150

The cheapest option is to order 60 units at a time


Inventory Valuation
• The correct pricing of issues and valuation of inventory are of
the utmost importance because they have a direct effect on the
calculation of profit. Several methods can be used in practice.

FIFO(First in, First Out)


FIFO assumes that materials are issued out of inventory in the
order in which they were delivered into inventory. Issues are
priced at the cost of the earliest delivery remaining in inventory.
Advantages & Disadvantages of FIFO method:
Advantages Disadvantages
It is a logical pricing method which FIFO can be cumbersome to operate
probably represents what is physically because of the need to identify each batch
happening: in practice the oldest inventory of material separately
is likely to be used first

It is easy to understand and explain to Managers may find it difficult to compare


managers costs and make decisions when they are
charged with varying prices for the same
materials

The inventory valuation can be near to a In a period of high inflation, inventory issue
valuation based on replacement cost prices will lag behind current market value
Example FIFO
• Transactions during May 20X6
Quantity Unit Cost Total Cost Market Value per unit
Units £ £ on date of transaction
£

Opening balance, 1 May 100 2.00 200

Receipts, 3 May 400 2.10 840 2.11

Issues, 4 May 200 2.11

Receipts, 9 May 300 2.12 636 2.15

Issues, 11 May 400 2.20

Receipts, 18 May 100 2.40 240 2.35

Issues, 20 May 100 2.35

Closing Balance, 31 200 2.38


May
1,916
Date Receipts Issues Inventory
Quantity Unit Amount Quantity Unit Amount Quantit Unit Amount
Price £ Price £ y Price £
£ £ £
1.5.X3 100 2.00 200.00

3.5.X3 400 2.10 840.00 100 2.00 200.00


400 2.10 840.00
500 1,040.00
4.5.X3 100 2.00 200.00 300 2.10 630.00
100 2.10 210.00
9.5.X3 300 2.12 636.00 300 2.10 630.00
300 2.12 636.00
600 1266.00
11.5.X3 300 2.10 630.00 200 2.12 424.00
100 2.12 212.00
18.5.X3 100 2.40 240.00 200 2.12 424.00
100 2.40 240.00
300 664.00
20.5.X3 100 2.12 212.00 100 2.12 212.00
100 2.40 240.00
31.5.X3 200 452.00
Advantages & Disadvantages of LIFO Method
Advantages Disadvantages
Inventories are issued at a price which is The method can be cumbersome to operate
close to current market value because it sometimes results in several
batches, being only part-used the
inventory records before another batch is
received
Managers are continually aware of recent LIFO is often the opposite to what is
costs when making decisions, because the physically happening and can therefore be
cost being charged to their department or difficult to explain to managers
products will be current costs
As with FIFO, decision making can be
difficult because of the variations in prices
Advantages & Disadvantages of AVCO

Advantages Disadvantages
Fluctuation in prices are The resulting issue prices is
smoothed out making it easier to rarely an actual price that has
use the data for decision making been paid and can run to several
decimal places
It is easier to administer than Prices tend to lag a little behind
FIFO and LIFO, because there is current market values when there
no need to identify each batch is gradual inflation
separately

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