ACCA MA Syllabus C. Cost Accounting Techniques - Minimise inventory costs - Notes ^{7 / 22}

Some organisations replenish inventory levels gradually by manufacturing their own products internally.

They need to decide whether to produce large batches at long intervals or produce small batches at short intervals.

In order to decide which course of action to take, an Economic Batch Quantity (EBQ) model is used.

The maximum inventory level will never be as great as the batch size, because some of the batch will be used up while the remainder is being produced.

Whereas in the EOQ calculation, we were interested in determining the size of an order, in EBQ, we are concerned with determining the number of items to be produced in a batch.

Where:

Q = the batch size
D= demand during the time period
Ch = cost of holding one unit of inventory for one time period
C0 = cost of setting up a batch ready to be produced
R = annual replenishment rate

The formula for the EBQ will be provided in your examination.

Illustration

Annual demand 5,000 units
Rate of production per annum 500,000 units
Cost to product 1 unit $30
Holding cost 10% of cost to produce 1 unit 
Machine set up cost $200/batch 

Calculate the EBQ.

Solution

Sq Root ((2 x 200 x 5,000) / (3 x (1 - 5,000 / 500,000)))

EBQ = 821 units

This formula is not given in the exam: