MGT402 Cost & Management Accounting Assignment 1 Solution Fall 2012

PUNJNAD Textile Industries (PTI) – a privately owned textile spinning unit is engaged in yarn manufacturing
since its incorporation. The unit produces high quality yarn which is sold out immediately like a hot cake. 5
years back, Mr. Entrepreneur – the owner of PTI had signed a contract with a local cotton supplier – Mr.
Supplier for supplying fine quality cotton bails to PTI as per specified requirement for five years at a cost of
Rs. 500 per bail. PTI estimated its requirement of 12,500 cotton bails per year for smooth operations. Both the
owner and the supplier were happy for signing the contract and a feeling of earning the good amount of profit.
Mr. Entrepreneur also estimated Rs. 2,000 as cost on issuing every new order and 10% as carrying and storage
cost associated with the inventory.
Mr. Supplier successfully supplied the cotton bails to PTI for 4 years but in 5th year of the contract, due to
heavy flood, cotton crops could not be reaped at full. But, due to the signed contract with PTI, Mr. Supplier
managed to supply cotton bails to PTI as per the agreed specification and completed the contract period
successfully.
This year, due to bumper cotton crop in the region, Mr. Supplier has desired to renew the cotton supply
contract with the condition to supply 25% extra bails over the previous contract for the next 5 years. Mr.
Entrepreneur as satisfied with the cotton quality supplied earlier is considering this new option and has called
upon his manager costing – Mr. Management Accountant to compare the proposal with the contract just
ended. The manager has advised him to reject the proposal as extra quantity purchased would increase the
carrying and storage cost by 2%.
REQUIREMENT:
Being a student of cost & management accounting you are asked to calculate the following:
1. The most economical order quantity in case of both the proposals (current as well as previous)
2. The total ordering cost which has to be borne by PTI on both the proposals (current as well as
previous)
3. The total Carrying cost which has to be borne by PTI on both the proposals (current as well as
previous)
4. Using the order quantities, total ordering cost and total carrying cost calculated above; calculate the total cost for both proposals. Also suggests the most suitable proposal for PTI on total cost basis.

Complete Correct Solution:

          Economic Order Quantity in Previous Proposal:

      Required Quantity= Rq= 12,500

      Ordering Cost        = Co= 2,000

      Inventory Unit cost =Uc= 500 per bail

     Carrying & Storage Cost 10% Uc=Cc= 50

     As Economic Ordering Quantity;

EOQ = (2(Rq*Co/Uc*Cc) ^ (1/2)

                          = (2(12,500*2,000)/ (500*s50) ^ (1/2)

                         = (2000) ^ (1/2)

 EOQ   = 145 units

 The most economical order quantity in case of previous proposals is 45 units.

Economic Order Quantity in Current Proposal:

 

     New Required quantity= Rnq= 15,625 (N-1)

     Carrying & Storage Cost 2% Uc=Cc= 10

 Economic Order Quantity;

 EOQ = (2(Rq*Co/Uc*Cc) ^ (1/2)

                                                = (2(15625*2,000)/ (500*10) ^ (1/2)

                                                =    (12,500) ^ (1/2)

  =   112     units                                       

The most economical order quantity in case of current proposal is 112 units.

Answer # 2

The total ordering cost which has to be borne by PTI on both the proposals:

Ordering Cost in Previous Proposal:

Ordering Cost = Number of orders x Cost per order

                          = 86(N-2)*2,000

                          = 172,414          ……………………….. A

       Ordering Cost in Current Proposal:

              Ordering Cost = Number of orders x Cost per order

                                       =    140(N-3) * 2,000

                                       =    279,018 …………………….. B

Total Ordering Cost = A+ B

                                            = 451,432

Answer # 03

           The total Carrying cost which has to be borne by PTI on both the      proposals:

   Carry cost on the Previous Proposal;

                                  Average ordering quantity x carrying cost per unit

 = 6,250*25,000

Total carrying cost = Rs. 156,250,000 ……………. A

Carry cost on the Current Proposal;

                                  Average ordering quantity x carrying cost per unit

   = 7813*5,000

Total carrying cost = Rs. 39,062,500 ………………. B

 Total Carrying cost on both the Proposal = A+B                           

      = 195,312,500

Answer #4

Total cost for the Previous Proposal:

                     = order quantities (total ordering cost + total carrying cost)

                    = 145 (172,414+ 156,250,000)

                    = Rs. 22,681,250,000

         Total cost for the Current Proposal:

                    = 112* (279018+ 39,062,500)

                    = Rs. 4,406,250,000

 

The total cost for the Current Proposal is less than Previous Proposal So , the Current Proposal for the PTI is most suitable on the cost basis.  

Working:

     N-1.

       Previous required quantity                  = Rq= 12,500

       25 %Increased due to new contract   =            3,125

                                                                               15,625

        N-2.

      No of Orders = Required Units/Orders Quantity

                             = 12,500/145

                             = 86

N-3.

      No of Orders = Required Units/Orders Quantity

                             = 15625/112

                             = 140

                       

 

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