ACCA MA Syllabus C. Cost Accounting Techniques - Optimal reorder quantities with discounts - Notes ^{6 / 22}

When bulk orders are placed, it is often possible to negotiate a quantity discount on the purchase price.

Although the purchase price and annual ordering cost will decrease, the annual holding cost will increase.

Should the discount be accepted?

Steps involved in calculating the EOQ when discounts are available

1. Calculate EOQ - ignore all discounts.

2. If the EOQ is smaller than the minimum purchase quantity to obtain a bulk discount, calculate the total cost for the EOQ.

3. Recalculate the annual total annual costs for a purchase order size that is only just large enough to qualify for the bulk discount.

4. Compare the costs derived from steps (2) and (3). Select the minimum cost alternative.

5. If there is a further discount available for an even larger order size, repeat the same calculations for the higher discount level.

Illustration

Greg has demand for 40,000 chairs per annum. 

The purchase price of each chair is $25.

The cost to place one order is $20.

Inventory holding costs for 1 unit for 1 year amount to 10% of purchase price.

He has been offered a discount of 1.5% if he purchases 10,000 units or more.

The EOQ is 800 units.

Should he take the discount?

Solution

Total cost without the discount is $1,002,000

Total purchase cost 40,000*$25 = $1,000,000
Total order cost 40,000/800 * $20 = $1,000
Total holding cost 800/2 * $2.5 = $1,000

Total cost with the discount is $997,393

Total purchase cost 40,000*25*98.5% = $985,000
Total order cost 40,000/10000 * $20 = $80
Total holding cost 10000/2 * 2.5*98.5% = $12,313

He saves $4,607 if he orders 10,000 units at a time, therefore he should take the bulk discount.