Management Accounting - Accounting Technicians · PDF fileManagement Accounting Sample Paper 1...

Management Accounting

Sample Paper 1 2016 / 2017

Questions and Suggested Solutions

of 28 MA Sample Paper 1

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INSTRUCTIONS TO CANDIDATES

In this examination paper the £ / € symbol may be understood and used by candidates in Northern Ireland

to indicate the UK pound sterling and by candidates in the Republic of Ireland to indicate the Euro.

Answer FIVE questions.

Answer all three questions in Section A. Answer ANY Two of THREE questions in Section B.

If more than the required number of questions is answered in Section B, then only the requisite number,

in the order filed, will be corrected.

Candidates should allocate their time carefully.

All figures should be labelled, as appropriate, e.g. €, £ / € ’s, units etc.

Answers should be illustrated with examples, where appropriate.

Question 1 begins on Page 4 overleaf.


SECTION A: Answer all Questions

Question 1

The following information relates to the only product manufactured and sold by Ash plc.

£ / €per unit

Selling price 70

Direct material cost 25

Direct labour cost 20

Variable production overhead 5

Variable sales & marketing overhead 2

The following levels of activity took place over the first three months of the products life:

Sales Production

Units Units

September 4,750 5,000

October 5,500 6,000

November 6,500 7,000

Additional information is as follows:

1. Budgeted fixed production overhead was €300,000 per annum.

2. Actual fixed production overhead for the period was €25,000 per month

3. Sales and marketing overhead of €25,000 per month and administration overhead of €18,750 per

month were in line with the budget for that period.

4. All fixed overhead costs are budgeted on the basis of a projected volume of 75,000 units per

year and all costs are expected to be incurred at a constant rate throughout the year.

5. The business does not expect to have any inventory at 1 September

Required:

a) Prepare a profit statement for each month using each of the following bases:

i. Absorption costing

ii. Marginal costing

(14 Marks)

b) Calculate the (under)/over absorbed fixed production overhead for each month.

(3 Marks)


c) Explain the reason for any difference in the reported profit under the two bases for each month.

(3 Marks)

Total: 20 Marks


Question 2

The following information relates to Lookin plc. a manufacturing company that has two manufacturing

departments and two service departments:

Manufacturing

Dept. 1

£ / €

Manufacturing

Dept. 2

£ / €

Service

Dept. 1

£ / €

Service

Dept. 2

£ / €

Total

£ / €

Allocated Overheads 32,400 29,200 12,400 12,850 86,850

General Overheads

Indirect Labour 32,000

Heat & Light 48,600

Repairs & Maintenance 34,700

Canteen Subsidy 5,100

Machine Depreciation 10,400

Machine Insurance 6,250

223,900

The following additional information was extracted from the company’s management accounting

records.

Manufacturing

Dept. 1

Manufacturing

Dept. 2

Service

Dept. 1

Service

Dept. 2

Floor area sq. m 2,500 4,000 1,000 500

Direct labour hours 30,000 5,000 - -

Indirect labour hours 30,000 5,000 - -

Direct labour rate per hour £/€ 12 8 - -

Number of staff 30 5 - -

Machine hours 2,500 25,000 - -

Machine value £/€ 40,000 200,000 10,000 -

Service Dept. overheads are to

be re-apportioned as follows

Service Dept. 1 overheads 20% 80%

Service Dept. 2 overheads 50% 50%


Data on two jobs being undertaken by the company is as follows:

Job Eng230 Job Art490

Direct materials cost £ / € 240 £ / € 420

Machine hours 5 20

Direct labour hours

- Manufacturing Dept. 1 40 25

- Manufacturing Dept. 2 4 5

Required:

a) Prepare a statement showing the overhead cost for each department (include the basis of

apportionment, where appropriate).

(10 Marks)

b) Calculate a suitable overhead absorption rate for each department, using a basis that you deem

suitable .

(4 Marks)

c) Show the total cost of Job Eng230 and the total cost of Job Art490.

(6 Marks)

Total: 20 Marks


Question 3

Oak plc. uses a standard costing system. The following information relates to the company’s Acorn

product for the month of May.

Standard data Actual data

Sales

Sales Volume units 10,000 9,700

Selling Price per unit (£/€) 25.00 26.50

Production

Materials used per unit (kg) 1.50 1.80

Materials price per kg (£/€) 8.00 8.30

Labour hours per unit 0.50 0.75

Labour rate per hour (£/€) 10.20 11.50

Required:

a) Prepare a statement showing the budgeted profit and the actual profit for May.

(4 Marks)

b) Calculate the following variances:

i. Sales Price

ii. Sales Volume

iii. Materials Price

iv. Materials Usage

v. Labour Rate

vi. Labour Efficiency

(12 Marks)

c) Outline the key factors that should be considered before deciding whether or not a variance should

be investigated.

(4 Marks)

Total: 20 Marks


SECTION B

Answer any two of the following questions

Question 4 Palomino plc. is involved in the design and manufacture of equine stables. The company has just

received an enquiry about the possibility of supplying 40 stables to a large equestrian centre,

Killstud plc. in the midlands.

The finance director of Killstud plc. has informed Palomino plc. that they have just completed

their budgets for the coming financial year and that the maximum price that they will be willing to

pay is €17,000 per stable.

The management accountant of Palomino plc. has provided you with the following details relating

to the costs involved in the construction of the stables.

1. Each stable will require 10 planks of timber. The company has 350 planks of timber in stock

and if they are not used in the stables they will be disposed of immediately. The original purchase

price for the planks of timber in stock was €210 per unit. The replacement cost of a plank of

timber is €250 per unit. The net realisable value of the timber in stock is €110 per plank.

2. Each stable will also require 4 slabs of a special type of concrete. The concrete is sold in

batches of 10 slabs. The purchase price of a batch is €1,120. The supplier of the concrete has

agreed to offer a discount of 12% on the purchase price of concrete batches over 13 batches.

3. Additionally, each stable will also require 6 strips of studded steel and this type of steel is

frequently used by Palomino plc. The company holds 250 strips of this steel in the warehouse at

present. These strips of steel cost €155 each three months ago and their replacement cost is €160

per strip.

5. The construction of the stables will require a combination of skilled and unskilled labour. Each

stable will require 15 skilled labour hours and 7 unskilled labour hours. The skilled labourers are

paid €70 per hour and the unskilled labourers are paid 60% of the skilled hourly rate. If this

contract does not go ahead there will be 140 skilled idle hours and the company is reluctant to

make redundancies.

6. The project will require a project manager to oversee the work. Palomino plc. currently

employs a manager with this required experience. This manager currently earns €65,000.

Palomina will pay him an extra €4,000 due to the size of the project. The manager will be replaced

by a less experienced manager who will earn €35,000.

8. Variable overheads are absorbed at a rate of €75 per skilled labour hour.

9. Incremental fixed overheads are absorbed at a rate of €42 per skilled labour hour.

10. In order to assess the safety implications of the stables the company used ResearchNet plc. to

carry out research. This research cost €15,000 and €3,000 is still outstanding.


Required:

(a) Provide a brief explanation using an example for each of the following terms:

(i) Opportunity cost

(ii) Sunk cost

(iii) Committed cost

(6 Marks)

(b) Using relevant costing principles, determine whether or not Palomino plc. should undertake the

contract. Your answer must include an explanation for the inclusion or exclusion of each of the

above points.

(10 Marks)

(c) List four qualitative factors that should be considered before a final decision is made. (4 Marks)

Total: 20 Marks


Question 5

You have recently been appointed as a management accountant in a company.

Required:

a) Prepare a document for presentation to the company’s management team discussing the annual

financial budget in the context of:

i. the process and role of planning;

ii. levels of planning in an organisation;

iii. Organisational control processes.

(14 Marks)

b) Outline the key elements of a Budget Manual.

(6 Marks)

Total: 20 Marks


Question 6

The following information relates to inventory holding and materials handling for a particular material in

a business’ warehouse.

Minimum usage 500 units per working week

Maximum usage 3,000 units per working week

Average usage 2,500 units per working week

Lead time 10 - 20 days

Ordering Cost £ / € 360 per order

Purchase Cost £ / € 5 per unit

Holding cost 8% of purchase cost per year

The business works 5 days each week for 50 weeks each year.

Required:

a) Calculate the following inventory management ratios:

i. Inventory Re-Order Level

ii. Minimum Inventory Level

iii. Economic Order Quantity

iv. Maximum Inventory Level

(16 Marks)

b) Outline the key advantages and disadvantages of using inventory management ratios to manage

inventory levels.

(4 Marks)

Total: 20 Marks

END OF PAPER


SUGGESTED SOLUTIONS

Solution 1

a) Profit Statement using Absorption Costing

September October November

£/€ £/€ £/€

Sales Revenue 332,500 385,000 455,000

Production costs

Opening Inventory 0 13,500 40,500

Direct Materials 125,000 150,000 175,000

Direct Labour 100,000 120,000 140,000

Variable Production Overhead 25,000 30,000 35,000

Fixed Production Overhead 20,000 24,000 28,000

Closing Inventory (13,500) (40,500) (67,500)

256,500 297,000 351,000

Gross profit 76,000 88,000 104,000

Non production Costs

Variable Sales & Marketing Overhead 9,500 11,000 13,000

Fixed Sales & Marketing Overhead 25,000 25,000 25,000

Fixed Administration Overhead 18,750 18,750 18,750

Under-absorbed / Over-absorbed fixed

production overhead

5,000 1,000 (3,000)

59,250 55,750 53,750

Net Profit 17,750 32,250 50,250


b) Profit Statement using Marginal Costing


£/€ £/€ £/€

Sales Revenue 332,500 385,000 455,000

Production costs

Opening Inventory 0 12,500 37,500

Direct Materials 125,000 150,000 175,000

Direct Labour 100,000 120,000 140,000

Variable Production Overhead 25,000 30,000 35,000

Closing Inventory (12,500) (37,500) (62,500)

237,500 275,000 325,000

Variable Sales & Marketing Overhead 9,500 11,000 13,000

247,000 286,000 338,000

Contribution 85,500 99,000 117,000

Fixed overheads

Fixed production overheads 25,000 25,000 25,000

Fixed Sales & Marketing Overhead 25,000 25,000 25,000

Fixed Administration Overhead 18,750 18,750 18,750

68,750 68,750 68,750

Net Profit 16,750 30,250 48,250

c) Difference between reported profits

September October November Total

£/€ £/€ £/€ £/€

Absorption Costing Profit 17,750 32,250 50,250 100,250

Marginal Costing Profit 16,750 30,250 48,250 95,250

Difference 1,000 2,000 2,000 5,000

Analysis of the difference

September October November Total

£/€ £/€ £/€ £/€

Opening Inventory nil 250 750 nil

Closing Inventory 250 750 1,250 1,250

Difference 250 500 500 1,250

Difference x €/£ 4 €/£1,000 €/£2,000 €/£2,000 €/£ 5,000

The absorption costing figures are driven by production volume and include fixed production overhead

as part of the cost of production. This fixed production overhead is included at the pre-determined

overhead absorption rate of €/£ 4 per unit. Therefore this fixed overhead rate is included in the


inventory valuation at the end of each month. This results in a higher net profit each month when using

absorption costing because production volume exceeds sales volume each month.

The total difference in calculated profits of £/€ 5,000 is represented by the difference in the inventory

valuation at the end of November (£/ €67,500 using absorption costing - £/ €62,500 using marginal

costing).

The marginal costing figures exclude the fixed production overhead element in inventory valuations

and hence net profits each month are lower. Profit is recognised only when sales are recorded.

Workings

Working 1:

Fixed production overhead absorption rate per unit

Budgeted fixed production overheads £/€300,000

Budgeted production 75,000 units

Fixed production overhead absorption rate per unit = £/€300,000/75,000 = £/€4 per unit.

Working 2:

Production cost per unit £/€

Direct Materials cost 25

Direct Labour cost 20

Variable Production Overhead 5

Unit value for Marginal Costing 50 (variable cost per unit)

Fixed Production Overhead 4

Unit value for Absorption Costing 54 (variable and fixed cost per unit)

Working 3:

Inventory valuation


units units units

Opening Inventory 0 250 750

Production 5,000 6,000 7,000

Sales 4,750 5,500 6,500

Closing Inventory 250 750 1,250

£/€ £/€ £/€

Marginal Costing Valuation (@ £/€50 per unit) 12,500 37,500 62,500

Absorption Costing Valuation (@ £/€54 per unit) 13,500 40,500 67,500


Working 4:

Under / Over-absorbed Fixed Production head


Production units 5,000 6,000 7,000

£/€ £/€ £/€

Fixed Production OAR per unit 4 4 4

Absorbed Fixed Production Overhead 20,000 24,000 28,000

Actual Fixed Production Overhead 25,000 25,000 25,000

Fixed Production Overhead Under/ Over absorbed 5,000

under-absorbed

1,000

under-absorbed

3,000

over-absorbed


Solution 2

a) Overheads cost by Department

Basis of

Apportionment

Dept. 1

£ / €

Dept. 2

£ / €

Service 1

£ / €

Service 2

£ / €

Total

£ / €

Allocated Overheads 32,400 29,200 12,400 12,850 86,850

Apportioned Overheads

Indirect Labour Indirect Labour Hours 27,429 4,571 32,000

Heat & Light Floor Area 15,188 24,300 6,075 3,037 48,600

Repairs & Maintenance Floor Area 10,844 17,350 4,338 2,168 34,700

Canteen Subsidy Number of Staff 4,371 729 5,100

Machine depreciation Machine Value 1,664 8,320 416 10,400

Machine Insurance Machine Value 1,000 5,000 250 6,250

92,896 89,470 23,479 18,055 223,900

Re-Apportioned Overheads

Re-Apportion Service 1 20% / 80% 4,696 18,783 (23,479) 0

Re-Apportion Service 2 50% / 50% 9,028 9,027 (18,055) 0

Total Overheads 106,620 117,280 0 0 223,900


b) Overhead Absorption Rate for each Department

Department 1

Overhead absorption rate based on labour hours as this department is labour intensive

£ / € 106,620

30,000 labour hours = £ / € 3.55 per direct labour hour

Department 2

Overhead absorption rate based on machine hours as this department is machine intensive

£ / € 117,280

25,000 machine hours = £ / € 4.69 per machine hour

c) Job Costs

Job Eng230

£ / €

Direct Materials 240.00

Direct Labour

- Dept. 1

- Dept. 2

40 hours x £ / € 12 per hour


480.00

32.00

Overhead

- Dept. 1

- Dept. 2

40 DLH x £ / € 3.55 per DLH

5 MH x £ / € 4.69 per MH

142.00

23.45

Total Cost 917.45

Job Art490

£ / €

Direct Materials 420.00

Direct Labour

- Dept. 1

- Dept. 2



300.00

40.00

Overhead

- Dept. 1

- Dept. 2

25 DLH x £ / € 3.55 per DLH

20 MH x £ / € 4.69 per MH

88.75

93.80

Total Cost 942.55


Solution 3

a) Budgeted Profit

£/€ £/€

Sales Revenue (10,000 x £/€25) 250,000

Cost of Sales

Materials Cost (10,000 x 1.50 kg x £/€8) 120,000

Labour Cost (10,000 x 0.5 x £/€10.20) 51,000

171,000

Budgeted Profit (£/€ 7.9 per unit) 79,000

Actual Profit

£/€ £/€

Sales Revenue (9,700 x £/€26.50) 257,050

Cost of Sales

Materials Cost (9,700 x 1.80 kg x £/€8.30) 144,918

Labour Cost (9,700 x 0.75 x £/€11.50) 83,662

228,580

Actual Profit 28,470

b) Variances

i. Sales Price Variance

£/€

9,700 units generated revenue of 9,700 units x £/€26.50 257,050

9,700 units should have generated revenue of 9,700 units x £ / € 25.00 per unit 242,500

14,550 F

or

(Actual Sales Volume x Actual Selling Price) – (Actual Sales Volume x Standard Selling Price)

(9,700 units x £ / € 26.50 per unit) - (9,700 units x £ / € 25.00 per unit)

£ / € 257,050 - £ / € 242,500 = £ / € 14,550 favourable


ii. Sales Volume Variance

units

Oak plc. actually sold 9,700

Oak plc. should have sold 10,000

300 A

x standard contribution per unit ( £/€ 7.9) £/€2,370 A

or

Budgeted Sales Volume – Actual Sales Volume = -300

-300 @ £/ €7.90 = £/€2,370 adverse

iii. Material price Variance

£/€

17,460 kg of materials actually cost (17,460 x £/€8.30) 144,918

17,460 kg of materials should have cost (17,460 x £/€8) 139,680

5,238 A

or

(Actual Quantity of Inputs x Actual Price) – (Actual Quantity of Inputs x Standard Price)

(17,460 kg x £ / € 8.30 per kg) - (17,460 kg x £ / € 8.00 per kg)

£ / € 144,918 - £ / € 139,680= £ / € 5,238 adverse

iv. Materials Usage Variance

kg

Oak plc. actually used (9,700 x 1.8 kg) 17,460

Oak plc. should have used (9,700 x 1.50 kg) 14,550

2,910A

x standard cost per kg ( £/€ 8.00) £/€23,280 A

or

(Actual Quantity of Inputs x Standard Price) – (Flexed Quantity of Inputs x Standard Price)

(17,460 kg x £ / € 8 per kg) - ((9,700 units x 1.5 kg per unit) x £ / € 8 per kg)

£ / € 139,680 - £ / € 116,400 = £ / € 23,280 adverse


v. Labour Rate Variance

£/€

7,275 labour hours actually cost (7,275 x £/€11.50) 83,662

7,275 labour hours should have cost (7,275 x £/€10.20) 74,205

9,457A

or

(Actual Labour Hours x Actual Pay Rate) – (Actual Labour Hours x Standard Pay Rate)

(7,275hours x £ / € 11.50 per hour) - (7,275 hours x £ / € 10.20 per hour)

£ / € 83,662 - £ / € 74,205 = £ / € 9,457adverse

vi. Labour Efficiency Variance

hours

Oak plc. actually used (9,700 x 0.75 hours) 7,275

Oak plc. should have used (9,700 x 0.50 hours) 4,850

2,425A

x standard cost per hour ( £/€10.20) £/€24,735A

or

(Actual Labour Hours x Standard Rate) – (Flexed Labour Hours x Standard Rate)

(7,275 hours x £ / € 10.20 per hour) - ((9,700 units x 0.5 hours per unit) x £ / € 10.20 per hour)

£ / € 74,205 - £ / €49,470 = £ / € 24,735 adverse

c) Factors to be considered before deciding whether or not to investigate a variance

i. The size of the variance and whether the impact on profitability is positive or negative.

ii. The likelihood of the variance being controllable / uncontrollable.

iii. Investigation costs.

iv. Benefits to be gained from the investigation

v. The likelihood of the variance re-occurring.


Solution 4

(a) (i) An opportunity cost is the value of a benefit foregone when one course of action is

adopted in preference to another. (Provide example) (ii) A sunk cost is a past cost which is not relevant to a decision. (Provide example)

(iii) A committed cost is a past cost that has not yet been paid but which the business is

committed to paying. (Provide example)

(b)

€

Materials:

Timber 1 51,000

Concrete 2 17,517

Studded Steel 3 38,400

Skilled labour 4 29,900

Unskilled labour 4 11,760

Project manager existing 5 4,000

new 35,000

Variable overheads 6 45,000

Fixed production overheads 7 25,200

Research and development:

Sunk 0

Committeed 0

257,777

Revenue 13 440,000

Net relevant profit 182,223

Palomino plc. should undertake the contract as they would achieve a net relevant profit of

€182,223.

Notes:

1. The project requires (40 x 10) = 400 planks of timber. There are 350 planks of timber

in stock. If these planks are not used by the company then they will be sold. Therefore

if they are used on this project the company will lose out on selling them. So lost

proceeds are 350 x €110 = €38,500. The company will purchase the balance required

and this will cost 50 x €250 = €12,500. So the total relevant cost is €51,000.

2. The project requires (40 x 4) = 160 slabs so this equates to 160/10 = 16 batches.

13 batches x €1,120 = €14,560

3 batches x €985.60 = €2,957


Total cost €17,517

3. The steel is used regularly by the company so if it is used on this project it will have to

be replaced immediately. The relevant cost is 6 x 40 x €160 = €38,400

4. Skilled hours required are (40 x 15) = 600 hours. Because there are 140 hours idle time the

relevant cost is 460 x €65 = €29,900.

Unskilled hours required are (40 x 7) = 280 hours so cost is 280 x €42 x = €11,760.

5. The relevant cost of the existing project manager is €4,000 as he will receive an additional

payment over what he currently earns. A replacement project manager will be employed

specifically as a result of this project at €35,000 per annum.

6. Variable overheads are relevant costs as they will only be incurred if the job is undertaken.

The cost is 600 labour hours x €75 = €45,000

7. Fixed overheads are relevant costs as they are incremental. The cost is 600 labour hours x

€42= €25,200

8. Research and development is not a relevant cost. The cost has been incurred

irrespective of whether the construction takes place. The amount paid of €12,000 is

known as a sunk cost and the unpaid amount of €3,000 as a committed cost.

9. By undertaking the contract the company would receive (40 stables x €11,000) = €440,000.

Solution 5

a) Document Re Annual Financial Budget

To: Management Team

From: Management Accountant

Date: X/ X/ XX

Re: Budgetary Processes - Planning and Control

Process and role of planning

Jan Feb Mar Apr May Jun

€ / £ € / £ € / £ € / £ € / £ € / £

Sales price per unit 15.00 15.00 15.00 16.50 16.50 16.50


The process of planning, control and its link with decision-making processes is illustrated in the diagram

above. Planning can be defined as ‘The establishment of objectives, the formulation, evaluation and

selection of policies, strategies, tactics and action required to achieve these objectives. Planning

comprises long-term strategic planning and short-term operational planning’

Planning is a key function of management which precedes control and feedback to assist in the effective

running of an organisation.

Levels of planning

There are a number of different types of planning:

Long-term, strategic planning normally covers a period of 3, 5 or 10 years and is an involved

process including assessment of internal and external environments, opportunities and

expectations. Once objectives are established, options are evaluated and appraised to formulate

the long-term corporate plan.

Tactical planning is the process of developing specific strategies or tactics relevant to prevailing

circumstances (e.g.; a new marketing strategy) in the context of the long-term strategic plan.

Short-term planning usually involves the deployment of resources to effectively achieve specific

objectives and normally covers a period up to one year.

Organisational control processes

Organisational control is concerned with the efficient use of resources to achieve a plan. Control involves

the measurement of activity, comparison with plans and identification of performance issues. Control will

provide information on corrective action required to alter performance so as to conform to plan or to

modify original plans.

The key elements of control include a specification, measurement of actual performance, comparison

between specification and actual performance, feedback on performance, action to control performance,

on-going feedback. Control actions must be appropriately timed - otherwise the action may have a

detrimental effect.

Formulating Plans (Planning)

Measuring Performance (Controlling)

Implementing Plans

Comparing actual & planned performance

(Controlling) DECISION MAKING

The planning and control cycle


Control is exercised in organisational systems by feedback loops which gather information on

performance from the output of the system.

The annual budget

The detailed annual budget is set in the context of long-term financial objectives (E.g.: achieve a 10%

market share; achieve a 20% profit increase).

The annual budget is an example of a short-term tactical plan. It sets out a financial plan for the

organisation to ensure that resources are appropriately deployed.

The annual budget provides clarity of roles and responsibilities and provides a target for co-

ordination purposes

Control is exercised through the measurement and comparison of actual results against planned /

budgeted performance.

Feedback from variance analysis reports should result in corrective action aimed at addressing

adverse variances and promoting favourable variances.

Decision-making activities may include for example the decision to change supplier to improve

an adverse materials price variance

There may be a number of budgetary revisions throughout a year to implement tactical plans

b) Key Elements of a Budget Manual

A Budget Manual is an important tool for the communication of the budgetary process, providing

information about budget-setting, budgetary control procedures and the general operation of the budget.

The main contents of a Budget Manual should include:

Explanation of the budgetary process

Organisational structures and responsibilities

Main budgets and inter-relationship between them

Budget development

Accounting procedures


Solution 6

Workings

Minimum usage per day

500 units per working week / 5 working days = 100 units per working day

Maximum usage per day

3,000 units per working week / 5 working days = 600 units per working day

Average usage per day

2,500 units per working week / 5 working days = 500 units per working day

Average usage per year

2,500 units per working week x 50 working weeks = 125,000 units per year

a) i. Inventory Re-Order Level

Re-order level = Maximum usage per day x maximum lead time (in days)

600 units per day x 20 days = 12,000 units

ii. Minimum Inventory Level

= Re-order level – (average usage (per day) x average lead time (in days))

12,000 units - (500 units per day x 15 days) = 4,500 units

iii Economic Order Quantity

. Co Cost per order

D Demand per year

2 Co D Hc Holding Cost per year

Cc

= 2 x £ / € 360 x 125,000 units = 15,000 units

(£ / € 5 x 8%)

iv. Maximum Inventory Level

(Re-Order Level + Economic Order Quantity) – (Minimum Usage Rate x Minimum Lead Time)

12,000 units + 15,000 units - (100 units per day x 10 days) = 26,000 units


b) Advantages & disadvantages of calculating inventory management ratios to manage

inventory levels

Advantages of using inventory management ratios include:

1. On average, lower inventory levels resulting in cost savings;

2. Efficiency savings due to economic order quantities;

3. More responsive to inventory demand fluctuations;

4. Avoid costs and losses associated with running out of inventory;

5. Applicable for a wide range of inventory.

Disadvantages of such a system include:

1. As there is no sequence to re-ordering, the system can involve variations – with many

orders at one time and few at other times;

2. Economic order quantity assumptions may not always be valid and may not suit all

circumstances;

3. Resources are required to collect data and perform calculations.

In general it is recommended that a re-ordering system should be implemented in conjunction with

‘pareto analysis’ (i.e. with a concentration on high-value / high-activity inventory items)

END OF SOLUTIONS

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