Determining Re-Order Level And Economic Order Quantity

Importance of computing re-order level and economic order quantity

Re order level is that level of inventories where a new order would be placed by manufacturing unit. Determination of re order level requires two step. In the first step, it is required to determine daily, monthly or weekly usage. In the concerned question, daily average use of apple in the manufacture of apple is determined. Second step involves determination of lead-time. Lead-time is the time that manufactures take to provide the suppliers with ordered units (Alawattage et al. 2017). Therefore, determination f re ordering level requires two-step calculation.

Maximum daily usage= 75000 apples per week

Lead time= 2 to 3 weeks = 3*7= 21 days

The formula used for calculating re order level is maximum daily usage multiplied by lead-time

Re order level= 75000 * 21 = 1575000 units of apples

Determination of re order level is considered crucial because it enables them to ensure to a high degree certainly that business will never run out of stock. It acts as an indicator that stock needs to be purchased or replenished and accordingly action should be taken. Re order, level enables efficient management of inventory. In order to understand effective management of stocks, it is considered vital to understand about re ordering level.  A clear understanding of re ordering inventory level enables business to evade two types of issues. One is overstocking issue due to over estimation re order point (Ouyang et al. 2015). Another is stock outs issue due to under estimation of re order point.

Economic ordering quantity is the optimum level of quantity at which the total variable cost required to hold and order inventory is minimized.

The formula used for calculating economic order quantity is

EOQ =

Where D is annual demand = 75000*48= 3600000

C_o= Cost per order

C_H = holding cost

Therefore, EOQ =  = 57965 units of apple

Determination of economic order quantity figure is important for business as it is that level of quantity at which total cost to manufactured products is minimized. The concept is applicable to any quantity decision that requires tradeoff between variable and fixed cost. It provides business with near optimal quantities of order that involves penalties of small management of cash. This would assist management in determining maximum amount of savings. Order quantity decision rile will further assist management in estimating maximum cost management penalty (Wagenhofer 2016). EOQ model helps in customizing recommendations that are provided concerning economic number of units that have been produced.

Inventory is regarded s one of the most important assets for any business. Ordering costs is the fixed cost that is incurred by any business from ordering inventories. Ordering cost helps in determination of economic order quantity that leads to minimization of total costs. An organization is able to minimize or mitigate their ordering cost by placing large blanket of orders by covering long period of time. Importance of ordering cost is realized when an organization seeks reduction of total cost of carrying inventory. Monitoring of ordering cost is essential for properly balancing sizes of orders and thereby reducing the overall cost (Jawad et al. 2015). It is of utmost important for organization to have track of ordering cost for maintaining costs relating to inventory at balanced level that will result in efficient management of inventories.

The formula used for calculating re-order level and economic order quantity

Overhead cost is one of the important elements of total cost of inventory. It is essential for every organization to identify the cost of providing goods and services. For the preparation of cost statements, an organization is required to determine overhead costs by proper allocation, absorption and apportionment of overheads. Overhead usually comprised of indirect cost of employees, indirect materials and indirect expenses that are not directly allocable or identifiable in an economically feasible way (Chiarini and Vagnoni 2015). Recording and managing of overhead cost helps organization in managing their overhead costs in an appropriate way that enables them to create a competitive ground in market place. One of the success factors for any business is managing its expenses efficiently and in this regard, a pivotal role is played by overhead costs (Otley and Emmanuel 2013). The reason attributable to importance of recording overhead costs is realizing favorable margin of profit.

Overhead	Basis	Machinery	Assembly	Finishing	Maintenance	Canteen	Total
Supervisors Salaries	Allocated	1950000	1170000	1625000	975000	780000	6500000
Specific overheads	Allocation	7800	9750	16250	7150	9750	50700
Rent and rates	Floor area	52442	56186	67424.5	29965	14982.5	221000
Machine Insurance	Machine value	40001	33332	20000.5	6669	3997.5	104000
Machine depreciation	Machine value	105001	87503	52500.5	17498	10497.5	273000
Production supervisors salaries	DLH	118183	177274.5	94542.5	0	0	390000
Heating and Lightning	Floor area	18505.5	19831.5	23796.5	10575.5	5291	78000
Total overheads		2291932.5	1553877	1899514.5	1046857.5	824518.5	7616700

Recording of overhead cost can be applied either in single or overhead account or in separate accounts. There are two principles guiding apportionment of overhead costs that is benefits received and cause and effect. Analysis of overhead should be done into fixed overheads and variable overheads. Absorption of variable overhead to products and services should be done based on utilization of actual capacity. Overhead cost is associated with finding an allocation base that is responsible for driving overhead cost known as cost driver (Dekker 2016). It can be explained with the help of an instance, suppose the production process of an organization is labor intensive, direct labor cost or direct labor hour is likely to drive the overhead costs. The higher the amount of overhead cost incurred if direct labor hours worked is more. Preparing of overhead cost sheet enables management to track the actual overhead costs that have been incurred. Overhead costs that are applied to jobs are monitored using such cost analysis. Allocation of overhead costs involves determination of amount of allocation bas that has been incurred by job and pre determined rate of overhead (Nielsen et al. 2015).

Two different methods of cost apportionment:

Direct method- Under this method, cost of each service departments is allocated to each operating department based on share of each department in allocation base. It does not take into consideration services of other departments. This method of cost allocation ignores service offered by service department in the cost allocation process (Lukka and Vinnari 2014).   Prior to allocation, there is no interaction between support departments.

Reciprocal method- Reciprocal method is the most complicated and appropriate method of allocating cost. Under this method, allocation of costs attributable to service department is done in both the directions that is forward and backward. Simultaneous use of equations is required under this method. Reciprocal method makes use of simultaneous equations for determining true cost of service department (Bromwic and Scapens 2016). Based on given ratio or percentage, such costs are distributed to production department. Accurate distribution of cost in one single step is one of the benefits of reciprocal method. However, computations under this method are relatively complex compared to direct method.

Overhead	Basis	Machinery	Assembly	Finishing	Maintenance	Canteen	Total
Supervisors Salaries	Allocated	490000	370000	440000	0	0	1300000
Specific overheads	Allocation	3066	3366	4366	0	0	7800
Rent and rates	Floor area	13446	14022	15751	0	0	34000
Machine Insurance	Machine value	7385	6359	4308	0	0	16000
Machine depreciation	Machine value	19384	16692	11307	0	0	42000
Production supervisors salaries	DLH	18182	27273	14545	0	0	60000
Heating and Lightning	Floor area	4742	4946	5556	0	0	12000
Total overheads		556205	442658	495833	0	0	1471800

Inventory management and ordering cost

An organization is required to perform the reallocation of costs because the service departments cost is incurred without getting any benefits in return. Reallocation the cost incurred in service department to production department will help in absorption of additional costs incurred. However, these costs can be offset by business in determining their selling price of products. Costs associated with service departments are allocated to internal cost centers that is consumed by its products.

The module of IT applications in management accounting first seemed difficult to me in understanding the concepts. Initially I questions about various concepts that seemed difficult, bit later I started gaining interest in learning. I used to face difficulties in dealing with accounting and solving then I was hesitant to apply my knowledge as it was not clear. I have learned that the business process of organization can be improved by theoretical approaches and techniques by the application of principles of management accounting. IT Applications of management accounting has depicted that there are various alternatives to traditional accounting.

Management accounting is the practice for feeding information into the financial system and assists managers in making effective decisions so that effective control over corporate resources can be exercised. Advanced management accounting incorporating the use of information technology in the forms of software’s that provides business with great analytical tool. Some of the applications that I have learnt that Advanced Excel provides business with inventory management, corporate budgeting, consolidating results and creating forms and finding profits and break even points. Detailed analysis of stock movement and inventory level of business at any point of time can be ascertained. This particular module of management accounting has assisted me in handling how to make use of analytical tool. While learning about management accounting, I have known that Excel is used by large and small business for the purpose of budgeting and acts like a productivity tool.

One of the integrated parts of most business organization is Microsoft Excel spreadsheet software. Business establishment uses excel for various purposes. This popular Excel spreadsheet software has the capability of doing more than just figures. It has a simple interface that allows users to understand it and perform basic activities. While using and learning about this Excel software, I have come across its many benefits such as flexibility and easy managing of financial data of organization. Businesses are able to define information structure with ease using this software. Firms are able to calculate annual, quarterly and half yearly annual report by defining custom formulas. They can effectively keep a track of project status report, sales lead and invoice reports. Statistical formulas and graphing are well equipped in software that assist users in performing analytics related tasks. MS Excel spreadsheet software is used by small and midsized organizations for carrying out accounting and financing activities. A checkbook ledger and basic accounting program can be created by organization so that they can keep record and track of their business financial transactions. Accountants are able to compare income and expenditures generated by business by entering expenditures and deposits onto each row that provide them flexibility to create graphs and charts. While learning about importance of Excel in business environment, I have become acquitted with its wide variety of usage then it comes to handling data relating to sales, production, and distribution data. A complete track of sales of products can be kept by small business using this software. Small business owners are able to plan their business using such information and data for enhancing sales of their product in the market (Chenhall and Moers 2015). Managers and accountants are able to keep a track of their business progress over a considerable time period and help in identification of low and high trend of sales and accordingly taking the action. Management accounting provides business with data driven tool that help managers in taking decisions.

Overhead cost allocation and apportionment

Moreover, information about clients and customers can also be stored using MS Excel spreadsheet. Business can use this information to contact with customers as it acts kike their database. While practicing use of Excel, I have learned that adding new flied and updating spreadsheet does not affect or change the content present or mentioned therein.  Therefore, the module has assisted me in shaping my analytical skills relating to accounting. This will help me in enhancing my skills so that I can apply in future at managerial level. Knowledge gained by me has nurtured my accounting skills that I can apply it practically in my profession. In nutshell, the impact of learning this module has contributed positively in enhancing and upgrading my accounting knowledge.

MS Excel software has proven to provide business with many advantages in their day to day business activities. For small business establishment, it is essential to have knowledge of such software so that they are able to reap the results of benefits provided by MS Excel. Beyond my simplistic example, there are many more powers and usage of Mc Excel in business and those usages can be leveraged by business in making more productive, faster and cost efficient. Today’s working environment requires business and its employees to be proficient in Excel. From my point of view, Excel is an essential computing tool for end users.

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