Test 1: Material Cost: answer key

Question 1 · 2 marks · Chapter 2: Material Cost · medium

Scenario. Pragati Precision Works Ltd. manufactures precision housings for industrial pumps. Its annual plan is 24,000 housings, requiring 36,000 machine hours and 18,000 direct labour hours. A polymer compound, P-40, is consumed in a stable proportion for every housing. The stores and purchase departments are reviewing its order size because frequent purchases increase administration costs, while oversized lots tie up working capital and expose the compound to deterioration. The purchase manager estimates annual P-40 consumption at 14,400 kg from the approved bill of materials. Each purchase order attracts fixed costs for vendor coordination, documentation, inward inspection and receiving, regardless of quantity. The quoted price includes delivery to the factory; no discount, rebate or additional inbound charge applies. There is no minimum order quantity, and the supplier is assumed to deliver each complete order immediately. Operational and inventory data: | Particulars | Details | | Planned output | 24,000 housings | | Machine hours | 36,000 hours | | Direct labour hours | 18,000 hours | | Annual requirement of P-40 | 14,400 kg | | Purchase price | ₹40 per kg | | Ordering cost | ₹500 per order | | Storage | 8% p.a. of unit price | | Interest on average inventory | 12% p.a. | | Insurance and obsolescence | 5% p.a. combined | Management assumes uniform consumption, a constant purchase price, known annual demand and fixed ordering and carrying rates. No safety stock is included. For comparing order quantities, only ordering and carrying costs vary because annual purchase quantity and unit price remain unchanged. The case requires the order quantity that minimises these costs and a comparison with a larger lot size.

Calculate the Economic Order Quantity (EOQ) of polymer compound P-40 for Pragati Precision Works Ltd.

1. 1,000 kg
2. 1,200 kg (correct answer)
3. 1,500 kg
4. 1,800 kg

Answer: B — 1,200 kg

Explanation. Step 1: Total carrying rate = 8% + 12% + 5% = 25% p.a. Step 2: Carrying cost per kg = ₹40 × 25% = ₹10. Step 3: EOQ = √(2AO/C) = √(2 × 14,400 × ₹500 / ₹10) = √14,40,000 = 1,200 kg. Therefore, the economic order quantity is 1,200 kg. Using only storage cost instead of the combined carrying rate would produce an incorrect answer because financing, insurance and obsolescence must also be considered.

Where it goes wrong. Using only the storage percentage while ignoring interest, insurance and obsolescence.

Authority. ICAI SM: Cost and Management Accounting, Chapter 2 (Material Cost)

Question 2 · 2 marks · Chapter 2: Material Cost · hard

If Pragati Precision Works Ltd. follows the EOQ policy, how many purchase orders should it place during the year?

1. 10 orders
2. 14 orders
3. 15 orders
4. 12 orders (correct answer)

Answer: D — 12 orders

Explanation. Annual requirement = 14,400 kg and EOQ = 1,200 kg. Number of orders = Annual requirement ÷ EOQ = 14,400 ÷ 1,200 = 12 orders. Thus, the company should place 12 orders annually. The calculation concerns the number of replenishment cycles, not the average inventory held. Selecting 14 or 15 orders by rounding an incorrect EOQ calculation would be inappropriate because the given figures divide exactly.

Where it goes wrong. Multiplying annual requirement by EOQ instead of dividing annual requirement by EOQ.

Authority. ICAI SM: Cost and Management Accounting, Chapter 2 (Material Cost)

Question 3 · 2 marks · Chapter 2: Material Cost · medium

What is the minimum annual inventory-related cost comprising ordering and carrying costs when Pragati Precision Works Ltd. purchases P-40 at EOQ?

1. ₹12,000 (correct answer)
2. ₹10,000
3. ₹15,000
4. ₹18,000

Answer: A — ₹12,000

Explanation. At EOQ of 1,200 kg, annual orders = 14,400 ÷ 1,200 = 12. Ordering cost = 12 × ₹500 = ₹6,000. Average inventory = 1,200 ÷ 2 = 600 kg. Annual carrying cost = 600 × ₹10 = ₹6,000. Total relevant inventory cost = ₹6,000 + ₹6,000 = ₹12,000. Purchase cost is excluded because annual consumption and purchase price remain unchanged under alternative order quantities.

Where it goes wrong. Including the entire annual purchase expenditure in the relevant inventory cost or using the full EOQ instead of half the EOQ for average inventory.

Authority. ICAI SM: Cost and Management Accounting, Chapter 2 (Material Cost)

Question 4 · 2 marks · Chapter 2: Material Cost · hard

Suppose Pragati Precision Works Ltd. decides to order 2,400 kg instead of the calculated EOQ of 1,200 kg. How much additional annual inventory-related cost will it incur?

1. ₹1,500
2. ₹2,500
3. ₹3,000 (correct answer)
4. ₹4,000

Answer: C — ₹3,000

Explanation. At an order quantity of 2,400 kg, annual orders = 14,400 ÷ 2,400 = 6. Ordering cost = 6 × ₹500 = ₹3,000. Average inventory = 1,200 kg, giving carrying cost = 1,200 × ₹10 = ₹12,000. Total relevant cost = ₹15,000. At EOQ, the corresponding cost is ₹12,000. Additional cost = ₹15,000 − ₹12,000 = ₹3,000. The larger lot reduces ordering expenditure but increases carrying expenditure.

Where it goes wrong. Calculating only the increase in carrying cost without deducting the reduction in ordering cost.

Authority. ICAI SM: Cost and Management Accounting, Chapter 2 (Material Cost)

Question 5 · 2 marks · Chapter 2: Material Cost · medium

Scenario. Apex Polychem Ltd. manufactures moulded containers for pharmaceutical and personal-care customers. The annual market demand is forecast at 50,000 containers, and Apex expects to supply 20% of that market. Each container uses one unit of resin R-100, so the resin requirement must be derived from the company's expected sales. The production line is budgeted for 32,000 machine hours. The supplier's ordinary rate is ₹100 per unit, and the regular and discounted offers have identical quality and delivery terms. The procurement team incurs a fixed ₹250 per order for documentation, supplier coordination, receiving and inspection. Carrying cost is calculated on the purchase value of average inventory. The finance department has supplied the annual carrying-cost components below; they apply to unit purchase price and must be aggregated before the EOQ calculation. Consumption is even, price is constant under each alternative, and there is no safety stock or storage-capacity restriction. The supplier grants a 2% discount on every unit in an order of at least 2,000 units. Annual requirement remains the company's full-year resin need, and the company may repeat the discounted order size as required. Other terms remain unchanged. Relevant data: | Particulars | Details | | Annual market demand | 50,000 containers | | Apex's expected market share | 20% | | Resin per container | 1 unit | | Regular purchase price | ₹100 per unit | | Ordering cost | ₹250 per order | | Storage cost | 4% p.a. | | Interest on average inventory | 12% p.a. | | Insurance | 2% p.a. | | Obsolescence | 2% p.a. | | Discount threshold and rate | 2,000 units; 2% | Management must compare the regular-price EOQ policy with the discount offer. The comparison must include annual purchase, ordering and carrying costs. Under the discounted policy, carrying cost must be recalculated using the discounted unit price, not the original price.

Using Apex Polychem Ltd.'s expected market share, calculate the EOQ of resin R-100 at the regular purchase price.

1. 400 units
2. 450 units
3. 600 units
4. 500 units (correct answer)

Answer: D — 500 units

Explanation. Step 1: Annual company sales = 50,000 × 20% = 10,000 containers. Since each container requires one resin unit, annual material demand is 10,000 units. Step 2: Total carrying rate = 4% + 12% + 2% + 2% = 20%. Carrying cost per unit = ₹100 × 20% = ₹20. Step 3: EOQ = √(2 × 10,000 × ₹250 / ₹20) = √2,50,000 = 500 units. The total market demand must not be incorrectly treated as the company's individual requirement.

Where it goes wrong. Using the entire market demand of 50,000 units instead of applying the company's 20% market share.

Authority. ICAI SM: Cost and Management Accounting, Chapter 2 (Material Cost)

Question 6 · 2 marks · Chapter 2: Material Cost · hard

Determine the total annual cost, including purchase, ordering and carrying costs, if Apex Polychem Ltd. follows the regular-price EOQ policy.

1. ₹10,08,000
2. ₹10,12,000
3. ₹10,10,000 (correct answer)
4. ₹10,15,000

Answer: C — ₹10,10,000

Explanation. Annual demand = 10,000 units and EOQ = 500 units. Annual purchase cost = 10,000 × ₹100 = ₹10,00,000. Number of orders = 10,000 ÷ 500 = 20. Ordering cost = 20 × ₹250 = ₹5,000. Average inventory = 250 units. Carrying cost = 250 × ₹20 = ₹5,000. Total annual cost = ₹10,00,000 + ₹5,000 + ₹5,000 = ₹10,10,000. Purchase expenditure cannot be omitted because the question expressly requires total annual cost.

Where it goes wrong. Reporting only ordering and carrying costs while excluding annual purchase expenditure.

Authority. ICAI SM: Cost and Management Accounting, Chapter 2 (Material Cost)

Question 7 · 2 marks · Chapter 2: Material Cost · medium

Calculate the total annual cost of resin R-100 if Apex Polychem Ltd. accepts the 2% quantity discount and orders 2,000 units each time.

1. ₹10,00,850 (correct answer)
2. ₹10,10,000
3. ₹10,20,000
4. ₹9,99,600

Answer: A — ₹10,00,850

Explanation. Discounted price = ₹100 − 2% = ₹98. Annual purchase cost = 10,000 × ₹98 = ₹9,80,000. Carrying cost per unit = ₹98 × 20% = ₹19.60. Number of orders = 10,000 ÷ 2,000 = 5; ordering cost = 5 × ₹250 = ₹1,250. Average inventory = 1,000 units; carrying cost = 1,000 × ₹19.60 = ₹19,600. Total = ₹9,80,000 + ₹1,250 + ₹19,600 = ₹10,00,850.

Where it goes wrong. Applying the 20% carrying rate to the original ₹100 price instead of the discounted ₹98 price.

Authority. ICAI SM: Cost and Management Accounting, Chapter 2 (Material Cost)

Question 8 · 2 marks · Chapter 2: Material Cost · hard

What is the net annual financial advantage or disadvantage of accepting Apex Polychem Ltd.'s quantity discount compared with the regular-price EOQ policy?

1. Advantage of ₹7,500
2. Advantage of ₹9,150 (correct answer)
3. Disadvantage of ₹10,000
4. Advantage of ₹20,000

Answer: B — Advantage of ₹9,150

Explanation. Regular EOQ policy total annual cost = ₹10,10,000. Discount policy total annual cost = ₹10,00,850. Net advantage = ₹10,10,000 − ₹10,00,850 = ₹9,150. Although the discount reduces annual purchase expenditure by ₹20,000, carrying expenditure increases and ordering expenditure decreases. Consequently, the net advantage is not equal to the gross purchase-price saving. The correct decision must be based on the complete annual cost under both alternatives.

Where it goes wrong. Treating the entire ₹20,000 purchase-price saving as the company's net financial benefit.

Authority. ICAI SM: Cost and Management Accounting, Chapter 2 (Material Cost)

Question 9 · 2 marks · Chapter 2: Material Cost · medium

Scenario. Vikram Steels Ltd. produces machined housings and forged sub-assemblies for industrial equipment makers. Its annual plan covers 12,000 housings and 8,000 sub-assemblies, using 48,000 machine hours and 26,000 direct labour hours. Approved bills of materials provide annual requirements for two inputs, alloy A and binder B. Both are regularly available, but their prices, consumption and order-processing costs differ, so the company is considering separate EOQs. For each material, the purchase department incurs a fixed cost per order for tender comparison, purchase-order processing, supplier follow-up, goods receipt and inspection. Carrying cost is a percentage of the material's unit purchase price. The components include storage, financing, insurance and obsolescence; none is to be omitted or counted twice. Consumption is uniform, prices and rates remain constant, and each order is received as one complete lot. No safety stock is held for this exercise. The production manager confirms that the annual requirements below already reflect standard quantities for planned output. The other factory figures describe operating context but do not enter the EOQ calculations. Material-wise procurement data: | Particulars | Alloy A | Binder B | | Annual requirement | 24,000 kg | 18,000 kg | | Purchase price | ₹60 per kg | ₹80 per kg | | Ordering cost per order | ₹360 | ₹750 | | Storage cost | 4% p.a. | 3% p.a. | | Interest on average inventory | 10% p.a. | 10% p.a. | | Insurance | 1% p.a. | 1% p.a. | | Obsolescence | 5% p.a. | 1% p.a. | Management will order the two materials independently. The purchase committee requires each material's EOQ and annual order count, followed by combined annual ordering-plus-carrying cost. Order counts and relevant costs must first be calculated separately, then aggregated.

Calculate the EOQ of alloy A for Vikram Steels Ltd., considering all applicable carrying-cost components.

1. 1,000 kg
2. 1,100 kg
3. 1,200 kg (correct answer)
4. 1,500 kg

Answer: C — 1,200 kg

Explanation. The total carrying rate for alloy A is 4% + 10% + 1% + 5% = 20% p.a. Carrying cost per kg = ₹60 × 20% = ₹12. Annual demand = 24,000 kg and ordering cost = ₹360. EOQ = √(2 × 24,000 × ₹360 / ₹12) = √14,40,000 = 1,200 kg. Insurance and obsolescence are part of the carrying cost and must be included alongside storage and financing charges.

Where it goes wrong. Ignoring obsolescence or insurance while aggregating the annual carrying-cost percentage.

Authority. ICAI SM: Cost and Management Accounting, Chapter 2 (Material Cost)

Question 10 · 2 marks · Chapter 2: Material Cost · hard

Determine the EOQ of binder B, given its annual consumption, unit purchase price, ordering cost and carrying-cost components.

1. 1,500 kg (correct answer)
2. 1,200 kg
3. 1,600 kg
4. 1,800 kg

Answer: A — 1,500 kg

Explanation. Total carrying rate for binder B = 3% + 10% + 1% + 1% = 15%. Carrying cost per kg = ₹80 × 15% = ₹12. Annual requirement = 18,000 kg and ordering cost = ₹750. EOQ = √(2 × 18,000 × ₹750 / ₹12) = √22,50,000 = 1,500 kg. The carrying-cost base is the purchase price of binder B, not the purchase price of alloy A, because the two materials have independent valuation bases.

Where it goes wrong. Applying alloy A's carrying-cost rate or unit price to binder B.

Authority. ICAI SM: Cost and Management Accounting, Chapter 2 (Material Cost)

Question 11 · 2 marks · Chapter 2: Material Cost · medium

If Vikram Steels Ltd. orders both materials at their respective EOQs, what is the total number of purchase orders required annually?

1. 28 orders
2. 30 orders
3. 36 orders
4. 32 orders (correct answer)

Answer: D — 32 orders

Explanation. For alloy A, annual orders = 24,000 ÷ 1,200 = 20. For binder B, annual orders = 18,000 ÷ 1,500 = 12. As the materials have independent requirements and separate ordering policies, their order counts must be added. Total annual orders = 20 + 12 = 32 orders. Dividing the combined annual material requirement by one of the two EOQs would be incorrect because their economic order quantities differ.

Where it goes wrong. Combining annual consumption of both materials and dividing it by a single material's EOQ.

Authority. ICAI SM: Cost and Management Accounting, Chapter 2 (Material Cost)

Question 12 · 2 marks · Chapter 2: Material Cost · hard

Calculate the combined minimum annual ordering and carrying cost of alloy A and binder B when both are purchased at their respective EOQs.

1. ₹28,800
2. ₹32,400 (correct answer)
3. ₹30,000
4. ₹36,000

Answer: B — ₹32,400

Explanation. Alloy A: Ordering cost = 20 × ₹360 = ₹7,200; carrying cost = 600 × ₹12 = ₹7,200. Total = ₹14,400. Binder B: Ordering cost = 12 × ₹750 = ₹9,000; carrying cost = 750 × ₹12 = ₹9,000. Total = ₹18,000. Combined annual relevant cost = ₹14,400 + ₹18,000 = ₹32,400. Average inventory must be calculated separately for each material before adding the costs.

Where it goes wrong. Using the combined average inventory quantity with a single carrying-cost rate instead of calculating the two materials independently.

Authority. ICAI SM: Cost and Management Accounting, Chapter 2 (Material Cost)

Question 13 · 2 marks · Chapter 2: Material Cost · medium

Scenario. A manufacturer purchases a component at ₹250 per unit. Its annual storage cost is 3.2%, financing cost is 8.8%, insurance cost is 1.6% and obsolescence cost is 2.4% of the unit purchase price. What is the annual carrying cost per unit?

A manufacturer purchases a component at ₹250 per unit. Its annual storage cost is 3.2%, financing cost is 8.8%, insurance cost is 1.6% and obsolescence cost is 2.4% of the unit purchase price. What is the annual carrying cost per unit?

1. ₹40 (correct answer)
2. ₹32
3. ₹36
4. ₹44

Answer: A — ₹40

Explanation. Total annual carrying-cost rate = 3.2% + 8.8% + 1.6% + 2.4% = 16%. Annual carrying cost per unit = ₹250 × 16/100 = ₹40. Carrying cost is an annual monetary amount per unit, whereas 16% represents the percentage rate. Using only the storage and financing components would give ₹30 and understate the total cost by excluding insurance and obsolescence.

Where it goes wrong. Confusing the aggregate carrying-cost percentage with the monetary carrying cost per unit per annum.

Authority. ICAI SM: Cost and Management Accounting, Chapter 2 (Material Cost)

Question 14 · 2 marks · Chapter 2: Material Cost · hard

Scenario. A manufacturing unit consumes 18,000 units of a raw material annually. The purchase price is ₹40 per unit, ordering cost is ₹500 per order and the annual carrying-cost rate is 20% of the purchase price. Calculate its EOQ.

A manufacturing unit consumes 18,000 units of a raw material annually. The purchase price is ₹40 per unit, ordering cost is ₹500 per order and the annual carrying-cost rate is 20% of the purchase price. Calculate its EOQ.

1. 1,200 units
2. 1,400 units
3. 1,500 units (correct answer)
4. 1,800 units

Answer: C — 1,500 units

Explanation. Annual carrying cost per unit = ₹40 × 20% = ₹8. Substituting into the EOQ formula: EOQ = √(2AO/C) = √(2 × 18,000 × 500 / 8) = √22,50,000 = 1,500 units. The unit purchase price must first be converted into annual carrying cost per unit. Directly substituting the percentage figure of 20 in place of ₹8 would produce an incorrect EOQ.

Where it goes wrong. Using the carrying-cost percentage as the monetary carrying cost per unit without multiplying it by purchase price.

Authority. ICAI SM: Cost and Management Accounting, Chapter 2 (Material Cost)

Question 15 · 2 marks · Chapter 2: Material Cost · medium

Scenario. A company has annual consumption of 18,000 units, an ordering cost of ₹500 per order and an annual carrying cost of ₹8 per unit. If its EOQ is 1,500 units, determine the annual ordering cost and annual carrying cost at EOQ.

A company has annual consumption of 18,000 units, an ordering cost of ₹500 per order and an annual carrying cost of ₹8 per unit. If its EOQ is 1,500 units, determine the annual ordering cost and annual carrying cost at EOQ.

1. ₹5,000 and ₹7,000 respectively
2. ₹6,000 and ₹6,000 respectively (correct answer)
3. ₹7,500 and ₹5,000 respectively
4. ₹4,500 and ₹6,500 respectively

Answer: B — ₹6,000 and ₹6,000 respectively

Explanation. Number of orders = 18,000 ÷ 1,500 = 12. Annual ordering cost = 12 × ₹500 = ₹6,000. Average inventory = 1,500 ÷ 2 = 750 units. Annual carrying cost = 750 × ₹8 = ₹6,000. Both costs are equal at EOQ, which is an important property of the basic EOQ model when its assumptions hold. Using the full order quantity as average inventory would double the carrying-cost calculation.

Where it goes wrong. Calculating carrying cost on the entire order quantity instead of average inventory.

Authority. ICAI SM: Cost and Management Accounting, Chapter 2 (Material Cost)

Question 16 · 2 marks · Chapter 2: Material Cost · hard

Scenario. A company consumes 18,000 units annually. Its ordering cost is ₹500 per order and its carrying cost is ₹8 per unit annually. EOQ is 1,500 units. If management instead places orders of 3,000 units, how much additional annual ordering and carrying cost will arise?

A company consumes 18,000 units annually. Its ordering cost is ₹500 per order and its carrying cost is ₹8 per unit annually. EOQ is 1,500 units. If management instead places orders of 3,000 units, how much additional annual ordering and carrying cost will arise?

1. ₹2,000
2. ₹2,500
3. ₹4,000
4. ₹3,000 (correct answer)

Answer: D — ₹3,000

Explanation. At 3,000 units per order, annual orders = 18,000 ÷ 3,000 = 6. Ordering cost = 6 × ₹500 = ₹3,000. Average inventory = 1,500 units; carrying cost = 1,500 × ₹8 = ₹12,000. Total = ₹15,000. At EOQ, ordering cost and carrying cost are each ₹6,000, making the minimum total ₹12,000. Additional cost = ₹15,000 − ₹12,000 = ₹3,000.

Where it goes wrong. Considering only the reduction in ordering cost and ignoring the increased cost of carrying average inventory.

Authority. ICAI SM: Cost and Management Accounting, Chapter 2 (Material Cost)

Question 17 · 2 marks · Chapter 2: Material Cost · medium

Scenario. A company consumes 32,400 units of a component annually. Its purchase price is ₹50 per unit, annual carrying-cost rate is 20%, and EOQ is calculated at 1,800 units. What is the ordering cost per order?

A company consumes 32,400 units of a component annually. Its purchase price is ₹50 per unit, annual carrying-cost rate is 20%, and EOQ is calculated at 1,800 units. What is the ordering cost per order?

1. ₹400
2. ₹500 (correct answer)
3. ₹600
4. ₹800

Answer: B — ₹500

Explanation. Annual carrying cost per unit = ₹50 × 20% = ₹10. Rearranging the EOQ formula, O = EOQ² × C ÷ 2A. Therefore, O = (1,800 × 1,800 × ₹10) ÷ (2 × 32,400) = ₹3,24,00,000 ÷ 64,800 = ₹500 per order. The annual demand and carrying cost are known, so the original EOQ relationship can be rearranged to determine the missing ordering cost.

Where it goes wrong. Substituting annual demand in the numerator instead of rearranging the formula correctly to isolate ordering cost.

Authority. ICAI SM: Cost and Management Accounting, Chapter 2 (Material Cost)

Question 18 · 2 marks · Chapter 2: Material Cost · hard

Scenario. A company consumes 30,000 units of a material annually. The actual order quantity is 1,500 units. Purchase price is ₹50 per unit, carrying cost is 12% per annum of purchase price and ordering cost is ₹450 per order. Determine the total annual ordering and carrying cost under this policy.

A company consumes 30,000 units of a material annually. The actual order quantity is 1,500 units. Purchase price is ₹50 per unit, carrying cost is 12% per annum of purchase price and ordering cost is ₹450 per order. Determine the total annual ordering and carrying cost under this policy.

1. ₹12,000
2. ₹13,000
3. ₹14,000
4. ₹13,500 (correct answer)

Answer: D — ₹13,500

Explanation. Annual orders = 30,000 ÷ 1,500 = 20. Ordering cost = 20 × ₹450 = ₹9,000. Carrying cost per unit = ₹50 × 12% = ₹6. Average inventory = 1,500 ÷ 2 = 750 units. Annual carrying cost = 750 × ₹6 = ₹4,500. Total annual relevant inventory cost = ₹9,000 + ₹4,500 = ₹13,500. The actual order quantity need not be EOQ for the cost formula to be applied.

Where it goes wrong. Assuming that ordering and carrying costs must be equal for every purchasing quantity, even when the order quantity is not EOQ.

Authority. ICAI SM: Cost and Management Accounting, Chapter 2 (Material Cost)

Question 19 · 2 marks · Chapter 2: Material Cost · medium

Scenario. A manufacturer has an annual requirement of 20,000 units, ordering cost of ₹200 per order and annual carrying cost of ₹8 per unit. Its calculated EOQ is 1,000 units. If the ordering cost per order increases fourfold while all other factors remain unchanged, what will be the revised EOQ?

A manufacturer has an annual requirement of 20,000 units, ordering cost of ₹200 per order and annual carrying cost of ₹8 per unit. Its calculated EOQ is 1,000 units. If the ordering cost per order increases fourfold while all other factors remain unchanged, what will be the revised EOQ?

1. 1,000 units
2. 1,500 units
3. 2,000 units (correct answer)
4. 4,000 units

Answer: C — 2,000 units

Explanation. EOQ is proportional to the square root of ordering cost when demand and carrying cost remain constant. Revised ordering cost = ₹200 × 4 = ₹800. Revised EOQ = √(2 × 20,000 × ₹800 ÷ ₹8) = √40,00,000 = 2,000 units. Alternatively, the original EOQ of 1,000 units is multiplied by √4 = 2. Therefore, the revised EOQ is 2,000 units, not four times the original quantity.

Where it goes wrong. Increasing EOQ fourfold when ordering cost increases fourfold, instead of applying the square-root relationship.

Authority. ICAI SM: Cost and Management Accounting, Chapter 2 (Material Cost)

Question 20 · 2 marks · Chapter 2: Material Cost · hard

Scenario. A manufacturing company operates for 300 working days annually. It consumes 36,000 units of a component each year and purchases material at an EOQ of 1,200 units. Assuming uniform consumption, how many working days will normally elapse between two successive orders?

A manufacturing company operates for 300 working days annually. It consumes 36,000 units of a component each year and purchases material at an EOQ of 1,200 units. Assuming uniform consumption, how many working days will normally elapse between two successive orders?

1. 10 working days (correct answer)
2. 12 working days
3. 15 working days
4. 8 working days

Answer: A — 10 working days

Explanation. Annual number of orders = Annual demand ÷ EOQ = 36,000 ÷ 1,200 = 30 orders. The company operates for 300 working days. Average interval between successive orders = 300 ÷ 30 = 10 working days. This is also obtained by dividing the EOQ of 1,200 units by daily consumption of 36,000 ÷ 300 = 120 units. The calculation uses working days rather than assuming a 365-day calendar year.

Where it goes wrong. Dividing the annual requirement by working days and treating daily consumption as the ordering interval.

Authority. ICAI SM: Cost and Management Accounting, Chapter 2 (Material Cost)

Question 21 · 2 marks · Chapter 2: Material Cost · medium

Scenario. A company consumes 36,000 units annually. The ordering cost is ₹320 per order, purchase price is ₹80 per unit and the calculated EOQ is 1,200 units. Determine the annual carrying-cost percentage applicable to the material's purchase price.

A company consumes 36,000 units annually. The ordering cost is ₹320 per order, purchase price is ₹80 per unit and the calculated EOQ is 1,200 units. Determine the annual carrying-cost percentage applicable to the material's purchase price.

1. 15%
2. 18%
3. 20% (correct answer)
4. 25%

Answer: C — 20%

Explanation. Rearranging EOQ² = 2AO/C, annual carrying cost per unit C = 2AO ÷ EOQ². Substituting: C = (2 × 36,000 × ₹320) ÷ (1,200 × 1,200) = ₹16 per unit annually. Carrying-cost percentage = ₹16 ÷ ₹80 × 100 = 20%. The purchase price is required to convert the calculated monetary carrying cost into a percentage. Confusing the monetary amount with its percentage gives an incorrect result.

Where it goes wrong. Calculating the carrying-cost amount correctly but failing to divide it by purchase price to derive the percentage.

Authority. ICAI SM: Cost and Management Accounting, Chapter 2 (Material Cost)

Question 22 · 2 marks · Chapter 2: Material Cost · hard

Scenario. A company requires 24,000 units of a component annually at a regular purchase price of ₹50 per unit. Ordering cost is ₹300 per order and annual carrying cost is 20% of purchase price. A supplier offers a 3% discount if the company orders 4,000 units at a time. Calculate the total annual cost under the discounted purchasing arrangement, including purchase, ordering and carrying costs.

A company requires 24,000 units of a component annually at a regular purchase price of ₹50 per unit. Ordering cost is ₹300 per order and annual carrying cost is 20% of purchase price. A supplier offers a 3% discount if the company orders 4,000 units at a time. Calculate the total annual cost under the discounted purchasing arrangement, including purchase, ordering and carrying costs.

1. ₹11,81,200
2. ₹11,90,000
3. ₹12,12,000
4. ₹11,85,200 (correct answer)

Answer: D — ₹11,85,200

Explanation. Discounted purchase price = ₹50 × 97% = ₹48.50. Annual purchase cost = 24,000 × ₹48.50 = ₹11,64,000. Carrying cost per unit = ₹48.50 × 20% = ₹9.70. Orders = 24,000 ÷ 4,000 = 6; ordering cost = 6 × ₹300 = ₹1,800. Average inventory = 2,000 units; carrying cost = 2,000 × ₹9.70 = ₹19,400. Total annual cost = ₹11,64,000 + ₹1,800 + ₹19,400 = ₹11,85,200.

Where it goes wrong. Using the undiscounted purchase price for carrying-cost calculation or forgetting to include the full annual purchase cost.

Authority. ICAI SM: Cost and Management Accounting, Chapter 2 (Material Cost)

Question 23 · 2 marks · Chapter 2: Material Cost · medium

Scenario. A company consumes 24,000 units annually at ₹50 per unit. Ordering cost is ₹300 per order and carrying-cost rate is 20% of purchase price. A supplier offers a 3% discount for orders of 4,000 units. What is the annual saving from accepting the discount compared with ordering at EOQ without any discount?

A company consumes 24,000 units annually at ₹50 per unit. Ordering cost is ₹300 per order and carrying-cost rate is 20% of purchase price. A supplier offers a 3% discount for orders of 4,000 units. What is the annual saving from accepting the discount compared with ordering at EOQ without any discount?

1. ₹26,800 (correct answer)
2. ₹24,000
3. ₹28,000
4. ₹30,000

Answer: A — ₹26,800

Explanation. Regular EOQ = √(2 × 24,000 × ₹300 ÷ ₹10) = 1,200 units. At EOQ, purchase cost = ₹12,00,000, ordering cost = ₹6,000 and carrying cost = ₹6,000; total = ₹12,12,000. Under the discount arrangement, discounted price = ₹48.50 and total annual cost, including ordering and carrying, is ₹11,85,200. Annual saving = ₹12,12,000 − ₹11,85,200 = ₹26,800. Both alternatives must be compared on the same total-cost basis.

Where it goes wrong. Calculating the gross purchase-price discount of ₹36,000 as the entire saving while ignoring the changed ordering and carrying costs.

Authority. ICAI SM: Cost and Management Accounting, Chapter 2 (Material Cost)

Question 24 · 2 marks · Chapter 2: Material Cost · hard

Scenario. At its EOQ of 2,400 units, a company incurs minimum annual ordering and carrying costs of ₹48,000 combined. Management subsequently decides to increase its order quantity to 3,600 units. Assuming no change in annual demand, ordering cost per order or carrying cost per unit, determine the revised combined annual ordering and carrying cost.

At its EOQ of 2,400 units, a company incurs minimum annual ordering and carrying costs of ₹48,000 combined. Management subsequently decides to increase its order quantity to 3,600 units. Assuming no change in annual demand, ordering cost per order or carrying cost per unit, determine the revised combined annual ordering and carrying cost.

1. ₹48,000
2. ₹52,000 (correct answer)
3. ₹54,000
4. ₹56,000

Answer: B — ₹52,000

Explanation. At EOQ, annual ordering cost equals annual carrying cost. Each is therefore ₹48,000 ÷ 2 = ₹24,000. New order quantity is 3,600 ÷ 2,400 = 1.5 times EOQ. Ordering cost varies inversely with order quantity: ₹24,000 ÷ 1.5 = ₹16,000. Carrying cost varies directly with order quantity: ₹24,000 × 1.5 = ₹36,000. Revised combined cost = ₹16,000 + ₹36,000 = ₹52,000.

Where it goes wrong. Increasing both ordering and carrying costs in direct proportion to the new order quantity instead of recognising their opposite relationships.

Authority. ICAI SM: Cost and Management Accounting, Chapter 2 (Material Cost)

Question 25 · 2 marks · Chapter 2: Material Cost · medium

Scenario. A company purchases raw material at ₹100 per unit and incurs an annual carrying-cost rate of 18%. At its EOQ, the annual carrying cost is ₹10,800. Annual material consumption is 48,000 units. Determine the annual number of purchase orders under the EOQ policy.

A company purchases raw material at ₹100 per unit and incurs an annual carrying-cost rate of 18%. At its EOQ, the annual carrying cost is ₹10,800. Annual material consumption is 48,000 units. Determine the annual number of purchase orders under the EOQ policy.

1. 24 orders
2. 30 orders
3. 36 orders
4. 40 orders (correct answer)

Answer: D — 40 orders

Explanation. Annual carrying cost per unit = ₹100 × 18% = ₹18. Average inventory = Annual carrying cost ÷ Carrying cost per unit = ₹10,800 ÷ ₹18 = 600 units. At EOQ, order quantity = 2 × Average inventory = 2 × 600 = 1,200 units. Annual number of orders = Annual consumption ÷ EOQ = 48,000 ÷ 1,200 = 40 orders. The carrying expenditure relates to average stock, not the entire order quantity.

Where it goes wrong. Treating average inventory of 600 units as the EOQ rather than doubling it to obtain the order quantity.

Authority. ICAI SM: Cost and Management Accounting, Chapter 2 (Material Cost)