Test 2: Material Cost: answer key

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

Scenario. Zenith Consumer Care Ltd. manufactures personal-care products at its integrated production facility. The company operates three production lines, with annual production capacity of 18,00,000 units. Manufacturing operations require approximately 42,000 machine hours and 24,000 direct labour hours annually. A specialised chemical additive, Z-17, is consumed regularly in the manufacturing process. The purchase department must maintain sufficient stock to ensure uninterrupted production despite fluctuations in consumption and supplier delivery periods. The stores department has analysed the consumption and delivery records for Z-17. Consumption is measured in kilograms per working day, and all lead times are expressed in working days. The company maintains a replenishment quantity of 2,000 kg for this material. It does not hold any additional stock above the calculated inventory limits for this exercise. The following information is available: | Particulars | Quantity | | Maximum consumption | 180 kg per day | | Normal consumption | 150 kg per day | | Minimum consumption | 120 kg per day | | Maximum re-order period | 8 days | | Average re-order period | 6 days | | Minimum re-order period | 4 days | | Re-order quantity | 2,000 kg | | Lead time for emergency purchase | 3 days | The company follows the standard inventory-control approach prescribed in its cost accounting procedures. The re-order level is established using maximum consumption and maximum lead time. Minimum stock is determined after considering normal consumption during the average lead period, while maximum stock considers the re-order quantity and minimum consumption during the minimum lead period. Average stock is calculated using the mean of minimum and maximum stock levels. The purchase manager requires the stores department to determine each stock level accurately before approving its annual inventory-control schedule.

What is the Re-order Level (ROL) of chemical additive Z-17 for Zenith Consumer Care Ltd.?

1. 1,200 kg
2. 1,350 kg
3. 1,440 kg (correct answer)
4. 1,500 kg

Answer: C — 1,440 kg

Explanation. Re-order Level = Maximum consumption × Maximum re-order period. Substituting the data: 180 kg × 8 days = 1,440 kg. Therefore, the company should place a fresh order when stock reaches 1,440 kg. The normal consumption rate and average lead time are relevant to minimum stock calculations, not the primary ROL formula. Using 150 kg per day would incorrectly calculate the level using normal rather than maximum consumption.

Where it goes wrong. Using normal or average consumption instead of maximum consumption while calculating the re-order level.

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

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

Calculate the minimum stock level of Z-17 that Zenith Consumer Care Ltd. should maintain.

1. 540 kg (correct answer)
2. 600 kg
3. 720 kg
4. 840 kg

Answer: A — 540 kg

Explanation. Minimum Stock Level = Re-order Level − (Normal consumption × Average re-order period). ROL = 180 × 8 = 1,440 kg. Normal consumption during average lead time = 150 × 6 = 900 kg. Minimum stock level = 1,440 − 900 = 540 kg. This represents the minimum quantity maintained after accounting for normal consumption during the average replenishment period. Deducting minimum consumption instead would overstate the stock level.

Where it goes wrong. Deducting minimum consumption during minimum lead time instead of normal consumption during average lead time.

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

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

What is the maximum stock level of Z-17 under the company's inventory-control policy?

1. 2,720 kg
2. 2,840 kg
3. 3,020 kg
4. 2,960 kg (correct answer)

Answer: D — 2,960 kg

Explanation. Maximum Stock Level = Re-order Level + Re-order Quantity − (Minimum consumption × Minimum re-order period). ROL = 1,440 kg; re-order quantity = 2,000 kg; minimum consumption during minimum lead time = 120 × 4 = 480 kg. Maximum stock level = 1,440 + 2,000 − 480 = 2,960 kg. The re-order quantity must be added before deducting the minimum consumption during the shortest delivery period.

Where it goes wrong. Using average consumption or average lead time in the maximum stock formula instead of minimum consumption and minimum lead time.

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

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

Determine the average stock level of chemical additive Z-17 for Zenith Consumer Care Ltd.

1. 1,500 kg
2. 1,750 kg (correct answer)
3. 1,800 kg
4. 2,000 kg

Answer: B — 1,750 kg

Explanation. Average Stock Level = (Minimum Stock Level + Maximum Stock Level) ÷ 2. Minimum stock level = 540 kg and maximum stock level = 2,960 kg. Average stock level = (540 + 2,960) ÷ 2 = 3,500 ÷ 2 = 1,750 kg. This calculation uses the midpoint of the minimum and maximum levels. Using the re-order quantity directly as average inventory would ignore the opening minimum stock maintained by the company.

Where it goes wrong. Calculating average stock as half the re-order quantity without considering the minimum stock level.

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 specialised polymer sheets used by automobile component manufacturers. The factory operates at an annual practical capacity of 12,00,000 sheets, utilising approximately 30,000 machine hours and 21,000 direct labour hours. The manufacturing process requires a chemical compound, C-90, which is purchased from a single approved supplier. A shortage of this compound can interrupt the entire production line because alternative materials are not immediately available. The stores manager has reviewed the previous year's consumption records and supplier delivery performance. The company maintains a fixed replenishment quantity of 3,000 kg. It also maintains emergency procurement arrangements for situations where the available stock reaches a critically low level. The emergency supplier can deliver material within two working days. The relevant inventory data are: | Particulars | Quantity | | Maximum consumption | 240 kg per day | | Normal consumption | 200 kg per day | | Minimum consumption | 160 kg per day | | Maximum re-order period | 7 days | | Average re-order period | 5 days | | Minimum re-order period | 3 days | | Re-order quantity | 3,000 kg | | Emergency purchase lead time | 2 days | All consumption and lead-time figures are expressed in working days and are assumed to be uniform within their respective categories. The company determines its re-order level by using maximum consumption and maximum lead time. The minimum stock level is calculated by deducting normal consumption during the average lead period from the re-order level. Maximum stock is determined by adding the replenishment quantity and deducting minimum consumption during the minimum lead period. Safety stock represents the stock maintained in excess of expected consumption during the average lead time. Danger level is determined separately for emergency procurement. Management requires these calculations to prevent avoidable production stoppages while avoiding unnecessary inventory accumulation.

Calculate the Re-order Level of compound C-90 for Apex Polychem Ltd.

1. 1,680 kg (correct answer)
2. 1,500 kg
3. 1,200 kg
4. 1,400 kg

Answer: A — 1,680 kg

Explanation. ROL = Maximum consumption × Maximum re-order period. Maximum consumption is 240 kg per day and maximum re-order period is 7 days. Therefore, ROL = 240 × 7 = 1,680 kg. This level ensures that an order is placed early enough to cover the maximum consumption expected during the maximum delivery period. The figure of 200 kg per day represents normal consumption and cannot replace maximum consumption in this calculation.

Where it goes wrong. Multiplying normal daily consumption by maximum lead time instead of multiplying maximum daily consumption by maximum lead time.

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

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

At what stock quantity should Apex Polychem Ltd. stop normal material issues and make only emergency purchases?

1. 320 kg
2. 360 kg
3. 400 kg (correct answer)
4. 480 kg

Answer: C — 400 kg

Explanation. Danger Level = Average consumption × Lead time for emergency purchases. Average consumption is 200 kg per day, and emergency procurement requires 2 days. Danger Level = 200 × 2 = 400 kg. At this level, normal material issues are stopped and only emergency issues are permitted. Using maximum consumption would give an unnecessarily high danger level, while using the minimum consumption rate would risk insufficient emergency coverage.

Where it goes wrong. Using maximum consumption instead of average consumption for calculating the danger level.

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

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

Determine the maximum stock level of compound C-90.

1. 3,900 kg
2. 4,200 kg (correct answer)
3. 4,400 kg
4. 4,680 kg

Answer: B — 4,200 kg

Explanation. Maximum Stock Level = ROL + Re-order Quantity − (Minimum consumption × Minimum re-order period). ROL = 240 × 7 = 1,680 kg. Minimum consumption during minimum lead time = 160 × 3 = 480 kg. Thus, maximum stock = 1,680 + 3,000 − 480 = 4,200 kg. The 3,000 kg replenishment quantity is added to the re-order level, not substituted for it. The minimum consumption deduction reflects usage before delivery under the shortest lead time.

Where it goes wrong. Subtracting minimum consumption for the average lead time instead of the minimum lead time.

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

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

Calculate the safety stock maintained by Apex Polychem Ltd. in excess of the expected consumption during the average lead time.

1. 480 kg
2. 600 kg
3. 720 kg
4. 680 kg (correct answer)

Answer: D — 680 kg

Explanation. Safety stock is the stock maintained in excess of expected lead-time consumption. ROL = Maximum consumption × Maximum lead time = 240 × 7 = 1,680 kg. Expected consumption during average lead time = 200 × 5 = 1,000 kg. Safety stock = 1,680 − 1,000 = 680 kg. The calculation identifies the protective quantity above normal lead-time demand. Using minimum lead time would understate the cushion required under the stated average-demand comparison.

Where it goes wrong. Treating the entire re-order level as safety stock instead of deducting expected consumption during the average lead time.

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

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

Scenario. Vikram Steels Ltd. manufactures precision-engineered steel components for automobile and heavy-equipment manufacturers. Its plant operates three shifts and has an annual production capacity of 9,00,000 components. The production process requires a specialised alloy whose shortage can delay customer deliveries and interrupt scheduled production. The company therefore maintains safety stock to protect itself against unexpected demand during the replenishment period. The inventory committee has observed that increasing safety stock reduces stock-out losses but increases inventory carrying costs. Stock-out may result in lost contribution, additional procurement expenditure and damage to customer relationships. The committee has accordingly evaluated historical unexpected-demand observations and estimated a monetary stock-out loss of ₹100 for every unit of unmet demand. The annual carrying cost of maintaining one unit of safety stock is ₹20. The historical unexpected-demand distribution is: | Unexpected demand (units) | Probability | | 100 | 0.10 | | 70 | 0.20 | | 40 | 0.30 | | 10 | 0.40 | | Total | 1.00 | The inventory committee is evaluating safety stock alternatives of 100, 70, 40, 10 and zero units. For each alternative, the unmet demand is the excess of unexpected demand over the safety stock maintained. Expected stock-out cost is calculated by multiplying the unmet quantity at each demand level by its probability and the stock-out loss per unit. Carrying cost is calculated by multiplying the selected safety stock by the annual carrying cost per unit. Both costs relate to the same annual planning horizon. The committee will select the safety stock level that produces the lowest combined expected stock-out and inventory carrying cost, rather than selecting the highest possible safety stock merely to eliminate stock-outs.

If Vikram Steels Ltd. maintains safety stock of 40 units, what will be its expected annual stock-out cost?

1. ₹900
2. ₹1,000
3. ₹1,200 (correct answer)
4. ₹1,500

Answer: C — ₹1,200

Explanation. At safety stock of 40 units, shortages arise when unexpected demand is 100 or 70 units. At demand of 100 units, shortage = 60 units; expected shortage = 60 × 0.10 = 6 units. At demand of 70 units, shortage = 30 units; expected shortage = 30 × 0.20 = 6 units. Total expected shortage = 12 units. Expected stock-out cost = 12 × ₹100 = ₹1,200. Demand of 40 or 10 units creates no shortage.

Where it goes wrong. Multiplying the entire unexpected demand by probability instead of multiplying only the quantity exceeding safety stock.

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

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

What is the combined annual expected stock-out and carrying cost if Vikram Steels Ltd. maintains safety stock of 70 units?

1. ₹1,700 (correct answer)
2. ₹1,400
3. ₹2,000
4. ₹2,300

Answer: A — ₹1,700

Explanation. At 70 units of safety stock, a shortage occurs only when unexpected demand reaches 100 units. Shortage = 100 − 70 = 30 units. Expected shortage = 30 × 0.10 = 3 units. Expected stock-out cost = 3 × ₹100 = ₹300. Carrying cost = 70 × ₹20 = ₹1,400. Combined cost = ₹300 + ₹1,400 = ₹1,700. The probability of demand of 70 units or less does not create any stock-out at this safety level.

Where it goes wrong. Ignoring carrying cost or including stock-out costs for demand levels that are fully covered by safety stock.

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

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

Which safety stock level should Vikram Steels Ltd. select to minimise the combined expected stock-out and inventory carrying costs?

1. 100 units
2. 70 units (correct answer)
3. 40 units
4. 10 units

Answer: B — 70 units

Explanation. The total costs for the alternatives are: 100 units = ₹5,000; 70 units = ₹1,700; 40 units = ₹2,000; and 10 units = ₹3,200. For 70 units, carrying cost = 70 × ₹20 = ₹1,400 and expected stock-out cost = ₹300. Its combined cost of ₹1,700 is the lowest among the alternatives. The highest safety stock eliminates stock-outs but creates excessive carrying cost, while lower quantities increase expected stock-out losses.

Where it goes wrong. Selecting the highest safety stock solely to eliminate stock-outs without comparing the additional carrying cost.

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

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

How much annual cost will Vikram Steels Ltd. save by maintaining the optimum safety stock instead of maintaining zero safety stock?

1. ₹1,700
2. ₹2,000
3. ₹2,100
4. ₹2,300 (correct answer)

Answer: D — ₹2,300

Explanation. At zero safety stock, expected shortages are 100 × 0.10 + 70 × 0.20 + 40 × 0.30 + 10 × 0.40 = 40 units. Expected stock-out cost = 40 × ₹100 = ₹4,000, with no carrying cost. At the optimum safety stock of 70 units, total cost is ₹1,700. Saving = ₹4,000 − ₹1,700 = ₹2,300. The comparison must include both expected shortage and carrying costs for each alternative.

Where it goes wrong. Comparing only carrying costs or treating the cost of zero safety stock as zero because no inventory is held.

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

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

Scenario. A manufacturing company consumes a component at a maximum rate of 250 units per working day. The maximum lead time is 12 working days. Calculate its Re-order Level.

A manufacturing company consumes a component at a maximum rate of 250 units per working day. The maximum lead time is 12 working days. Calculate its Re-order Level.

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

Answer: C — 3,000 units

Explanation. Re-order Level = Maximum consumption × Maximum re-order period. = 250 × 12 = 3,000 units. The company should place an order when stock reaches 3,000 units so that replenishment can cover the maximum expected usage during the maximum lead period. Multiplying by an average or minimum delivery period would produce a lower and potentially inadequate re-order level.

Where it goes wrong. Using average lead time instead of maximum lead time in the re-order level calculation.

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

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

Scenario. A factory has a re-order level of 3,000 units. Its normal consumption is 180 units per day and the average re-order period is 8 days. Calculate its minimum stock level.

A factory has a re-order level of 3,000 units. Its normal consumption is 180 units per day and the average re-order period is 8 days. Calculate its minimum stock level.

1. 1,440 units
2. 1,560 units (correct answer)
3. 1,620 units
4. 1,800 units

Answer: B — 1,560 units

Explanation. Minimum Stock Level = Re-order Level − (Normal consumption × Average re-order period). Normal consumption during average lead time = 180 × 8 = 1,440 units. Minimum stock level = 3,000 − 1,440 = 1,560 units. The calculation deducts expected normal usage during average replenishment time. Deducting 1,440 units directly as the minimum stock level would confuse the consumption during lead time with the closing minimum inventory.

Where it goes wrong. Reporting average lead-time consumption itself as the minimum stock level instead of deducting it from ROL.

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

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

Scenario. A factory has a re-order level of 3,000 units and a replenishment quantity of 2,400 units. Minimum consumption is 150 units per day and the minimum re-order period is 5 days. Determine the maximum stock level.

A factory has a re-order level of 3,000 units and a replenishment quantity of 2,400 units. Minimum consumption is 150 units per day and the minimum re-order period is 5 days. Determine the maximum stock level.

1. 4,650 units (correct answer)
2. 4,350 units
3. 4,500 units
4. 4,800 units

Answer: A — 4,650 units

Explanation. Maximum Stock Level = Re-order Level + Re-order Quantity − (Minimum consumption × Minimum re-order period). Minimum consumption during the minimum lead period = 150 × 5 = 750 units. Maximum stock = 3,000 + 2,400 − 750 = 4,650 units. The formula considers the stock received through replenishment and deducts the minimum consumption expected before delivery. Omitting the deduction would overstate maximum stock.

Where it goes wrong. Adding the re-order level and quantity without deducting minimum consumption during the minimum delivery period.

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

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

Scenario. The minimum and maximum stock levels of a component are 1,560 units and 4,650 units respectively. Calculate its average stock level.

The minimum and maximum stock levels of a component are 1,560 units and 4,650 units respectively. Calculate its average stock level.

1. 3,000 units
2. 3,050 units
3. 3,250 units
4. 3,105 units (correct answer)

Answer: D — 3,105 units

Explanation. Average Stock Level = (Minimum Stock Level + Maximum Stock Level) ÷ 2. = (1,560 + 4,650) ÷ 2 = 6,210 ÷ 2 = 3,105 units. The average stock level represents the midpoint between the minimum and maximum levels. The calculation does not require multiplying either stock level by the consumption rate or adding the entire re-order quantity again.

Where it goes wrong. Using the difference between maximum and minimum stock instead of calculating their arithmetic average.

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

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

Scenario. A company has a re-order level of 3,600 units. Normal consumption is 300 units per day and the average replenishment period is 10 days. Calculate the safety stock maintained in excess of expected consumption during the average lead time.

A company has a re-order level of 3,600 units. Normal consumption is 300 units per day and the average replenishment period is 10 days. Calculate the safety stock maintained in excess of expected consumption during the average lead time.

1. 450 units
2. 600 units (correct answer)
3. 750 units
4. 900 units

Answer: B — 600 units

Explanation. Expected lead-time consumption = Normal consumption × Average lead time = 300 × 10 = 3,000 units. Safety stock = Re-order Level − Expected lead-time consumption = 3,600 − 3,000 = 600 units. This is the quantity maintained as a cushion above expected lead-time requirements. The full re-order level cannot be treated as safety stock because it also covers normal consumption during replenishment.

Where it goes wrong. Treating the re-order level itself as safety stock without deducting normal lead-time consumption.

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

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

Scenario. A manufacturing unit maintains a minimum stock of 800 units. Normal consumption is 120 units per day, while the average re-order period is 5 days. Determine the Re-order Level using the alternative formula.

A manufacturing unit maintains a minimum stock of 800 units. Normal consumption is 120 units per day, while the average re-order period is 5 days. Determine the Re-order Level using the alternative formula.

1. 1,200 units
2. 1,300 units
3. 1,400 units (correct answer)
4. 1,500 units

Answer: C — 1,400 units

Explanation. The alternative formula is ROL = Minimum Stock Level + (Average consumption × Average re-order period). Average consumption during replenishment = 120 × 5 = 600 units. Therefore, ROL = 800 + 600 = 1,400 units. The minimum stock level is added because it represents the reserve remaining after normal consumption over the average lead period. Subtracting the consumption would reverse the relationship and produce an incorrect re-order level.

Where it goes wrong. Subtracting average lead-time consumption from minimum stock instead of adding it.

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

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

Scenario. A factory consumes a material at an average rate of 240 units per day. Its emergency supplier requires 3 days to deliver material. Determine the danger level.

A factory consumes a material at an average rate of 240 units per day. Its emergency supplier requires 3 days to deliver material. Determine the danger level.

1. 720 units (correct answer)
2. 600 units
3. 750 units
4. 840 units

Answer: A — 720 units

Explanation. Danger Level = Average consumption × Lead time for emergency purchases. Emergency lead time = 3 days and average consumption = 240 units per day. Therefore, danger level = 240 × 3 = 720 units. This is the critical level at which normal issues should stop and only emergency issues should be permitted. The ordinary maximum lead time is not relevant because the question specifically gives the emergency purchase lead time.

Where it goes wrong. Using normal supplier lead time instead of the lead time for emergency purchases.

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

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

Scenario. The average daily consumption of a raw material is 160 units. Maximum daily consumption is 220 units. Assuming average consumption is the arithmetic mean of minimum and maximum consumption, determine the minimum daily consumption.

The average daily consumption of a raw material is 160 units. Maximum daily consumption is 220 units. Assuming average consumption is the arithmetic mean of minimum and maximum consumption, determine the minimum daily consumption.

1. 80 units
2. 90 units
3. 120 units
4. 100 units (correct answer)

Answer: D — 100 units

Explanation. Average consumption = (Minimum consumption + Maximum consumption) ÷ 2. Substituting: 160 = (Minimum consumption + 220) ÷ 2. Multiplying both sides by 2 gives 320 = Minimum consumption + 220. Therefore, minimum consumption = 320 − 220 = 100 units per day. The minimum rate is obtained by rearranging the average-rate relationship, not by subtracting the average from maximum consumption.

Where it goes wrong. Calculating minimum consumption as maximum consumption minus average consumption without applying the arithmetic-mean relationship.

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

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

Scenario. The minimum stock level of a material is 900 units and its re-order quantity is 1,800 units. Calculate the average stock level using the minimum stock level and half the re-order quantity.

The minimum stock level of a material is 900 units and its re-order quantity is 1,800 units. Calculate the average stock level using the minimum stock level and half the re-order quantity.

1. 1,500 units
2. 1,700 units
3. 1,800 units (correct answer)
4. 2,100 units

Answer: C — 1,800 units

Explanation. Average Stock Level = Minimum Stock Level + ½ Re-order Quantity. Half the re-order quantity = 1,800 ÷ 2 = 900 units. Average stock level = 900 + 900 = 1,800 units. The formula adds the normal half-order stock to the minimum stock maintained. Taking only half the re-order quantity would omit the minimum stock reserve and understate average inventory.

Where it goes wrong. Using half the re-order quantity as the complete average stock level while ignoring minimum stock.

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

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

Scenario. A manufacturing company has the following material-consumption and replenishment information: Maximum consumption: 90 units per week; normal consumption: 60 units per week; minimum consumption: 30 units per week; maximum lead time: 5 weeks; average lead time: 4 weeks; minimum lead time: 2 weeks; re-order quantity: 600 units. Determine the maximum and average stock levels respectively.

A manufacturing company has the following material-consumption and replenishment information: Maximum consumption: 90 units per week; normal consumption: 60 units per week; minimum consumption: 30 units per week; maximum lead time: 5 weeks; average lead time: 4 weeks; minimum lead time: 2 weeks; re-order quantity: 600 units. Determine the maximum and average stock levels respectively.

1. 900 units and 550 units
2. 990 units and 600 units (correct answer)
3. 1,050 units and 650 units
4. 1,000 units and 600 units

Answer: B — 990 units and 600 units

Explanation. ROL = 90 × 5 = 450 units. Minimum stock = 450 − (60 × 4) = 210 units. Maximum stock = 450 + 600 − (30 × 2) = 990 units. Average stock = (210 + 990) ÷ 2 = 600 units. Therefore, the required pair is 990 units and 600 units. All rates and lead times are expressed in weeks, so no conversion into days is necessary.

Where it goes wrong. Mixing consumption rates and lead times expressed in different periods, or using normal consumption in the maximum stock calculation.

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

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

Scenario. A factory operates for 5 working days per week. A component has maximum consumption of 45 kg per working day, and the maximum supplier lead time is 4 weeks. Calculate its Re-order Level in kilograms.

A factory operates for 5 working days per week. A component has maximum consumption of 45 kg per working day, and the maximum supplier lead time is 4 weeks. Calculate its Re-order Level in kilograms.

1. 720 kg
2. 810 kg
3. 880 kg
4. 900 kg (correct answer)

Answer: D — 900 kg

Explanation. Maximum re-order period must be converted into working days because consumption is stated per working day. Four weeks × 5 working days = 20 working days. ROL = Maximum consumption × Maximum lead time = 45 kg × 20 days = 900 kg. Multiplying daily consumption directly by four weeks would mix incompatible units and understate the re-order level.

Where it goes wrong. Multiplying daily consumption by the number of weeks without converting weeks into working days.

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

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

Scenario. A company estimates that unexpected demand during the replenishment period will be 80 units with probability 0.25, 40 units with probability 0.50 and zero units with probability 0.25. Stock-out loss is ₹60 per unmet unit, while annual carrying cost is ₹25 per unit of safety stock. Which of the following safety stock levels minimises the combined expected stock-out and carrying cost?

A company estimates that unexpected demand during the replenishment period will be 80 units with probability 0.25, 40 units with probability 0.50 and zero units with probability 0.25. Stock-out loss is ₹60 per unmet unit, while annual carrying cost is ₹25 per unit of safety stock. Which of the following safety stock levels minimises the combined expected stock-out and carrying cost?

1. 40 units (correct answer)
2. 60 units
3. 80 units
4. 20 units

Answer: A — 40 units

Explanation. At 40 units, expected shortage is (80 − 40) × 0.25 + (40 − 40) × 0.50 = 10 units. Expected stock-out cost = 10 × ₹60 = ₹600. Carrying cost = 40 × ₹25 = ₹1,000. Total = ₹1,600. At 20 units, total cost is ₹2,000; at 60 units, ₹1,800; and at 80 units, ₹2,000. Therefore, 40 units gives the lowest combined cost.

Where it goes wrong. Selecting a safety stock level based solely on shortage prevention rather than minimising total expected inventory cost.

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

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

Scenario. Using the unexpected-demand distribution and cost information in the preceding question, calculate the combined expected annual stock-out and carrying cost if the company maintains safety stock of 20 units.

Using the unexpected-demand distribution and cost information in the preceding question, calculate the combined expected annual stock-out and carrying cost if the company maintains safety stock of 20 units.

1. ₹1,500
2. ₹1,800
3. ₹2,000 (correct answer)
4. ₹2,400

Answer: C — ₹2,000

Explanation. At 20 units of safety stock, shortage at demand of 80 units = 60 units, with expected shortage of 60 × 0.25 = 15 units. At demand of 40 units, shortage = 20 units, with expected shortage of 20 × 0.50 = 10 units. Total expected shortage = 25 units. Stock-out cost = 25 × ₹60 = ₹1,500. Carrying cost = 20 × ₹25 = ₹500. Combined cost = ₹1,500 + ₹500 = ₹2,000.

Where it goes wrong. Calculating expected stock-out cost correctly but omitting the annual carrying cost of the safety stock.

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