Question

An audit senior at your place has requested you to undertake a review of the client’s inventory system by determining the critical inventory levels, economic order quantity, cost of issues and valuation of closing inventory. The client file contains the following schedules in relation to inventory:

Minimum Usage - 500 units per working week

Maximum Usage - 3000 units per working week

Average usage - 2500 units per week

Lead time - 10 – 20 days

Ordering costs - K260 per order

Purchase cost - K5 per unit

Holding cost - 8% of purchase costs per year

Required (a) Calculate the following:

(i) Inventory re-order level

(ii) Minimum inventory level

(iii) Economic order quantity

(iv) Maximum inventory levels

Answer 1

(i) Inventory re-order level = Maximum daily usage rate * Maximum lead time in days

= (3000/7) * 20= 8571 units

(ii) Minimum inventory level = Reorder level – (Average daily usage rate * Average lead time in days)

= 8571 - ( (2500/7)* ((10+20)/2))

=8571- (357 *15) = 3216 units

(iii) Economic order quantity = square root of (2*S*D)/H

• S: Ordering Cost = 260
• D: Annual Quantity Demanded = 2500*52 = 130,000
• H: Holding Cost = 8% of purchase costs i.e. = 8%*5 = 0.4

= square root of (2*S*D)/H

= square root of (2*260*130000)/0.4 = 13000 units

(iv) Maximum inventory levels = Reorder level + Reorder quantity – (Minimum usage *
Minimum lead time)

* Reorder quantity= (Average daily usage rate * Average lead time in days) = ( (2500/7)* ((10+20)/2)) = 5357

=8571 + 5357 - ((500/7)*10) = 13214 units