Purchase discount and labour cost at Utkal Cycles
Utkal Cycles purchases 36,000 gear assemblies a year at Rs 50 each. Its ordering cost is Rs 200 per order and carrying cost is 15% of inventory value. The current order size is 3,000 units. A supplier offers a 3% discount if the firm orders 6,000 units at a time. Separately, the labour records for last month show 25 workers paid Rs 90 per hour for a 40-hour week; the firm paid for 4,200 hours, including 180 idle hours caused by a machine breakdown and 300 overtime hours paid at double rate. Output was 1,800 assemblies against a standard of 2 hours per assembly. The production manager wants to know whether the discount is worth taking and how the idle time and overtime premium should be treated in product cost. The owner is also worried that labour cost per assembly is rising.
1. Compute the economic order quantity and evaluate the supplier's 3% discount for a 6,000-unit order. Show annual ordering, carrying, purchase and total relevant cost.
Read the worked answer
EOQ = √(2 × annual demand × ordering cost ÷ carrying cost per unit)
Carrying cost per unit = 15% × Rs 50 = Rs 7.50.
EOQ = √(2 × 36,000 × 200 ÷ 7.50) = √1,920,000 = 1,386 units approximately.
| Cost at order size 1,386 | Rs |
|---|---|
| Purchase: 36,000 × 50 | 18,00,000 |
| Ordering: (36,000 ÷ 1,386) × 200 | 5,194 |
| Carrying: (1,386 ÷ 2) × 7.50 | 5,198 |
| Total | 18,10,392 |
At 6,000 units the price falls by 3% to Rs 48.50.
| Cost at order size 6,000 | Rs |
|---|---|
| Purchase: 36,000 × 48.50 | 17,46,000 |
| Ordering: 6 orders × 200 | 1,200 |
| Carrying: 3,000 × 7.50 | 22,500 |
| Total | 17,69,700 |
The discount saves Rs 40,692 before considering storage, obsolescence, insurance and cash-flow effects. Financially it is attractive, but the decision should be conditional on storage capacity and the risk of holding six months' stock.
2. Compute labour cost per assembly and state how idle time and overtime premium should be treated.
Read the worked answer
Basic wages paid: 4,200 hours × Rs 90 = Rs 3,78,000. Overtime premium: 300 hours × Rs 90 = Rs 27,000. Total labour cost paid: Rs 4,05,000.
Idle time: 180 hours × Rs 90 = Rs 16,200. It arose from a machine breakdown, so it is an abnormal idle-time cost. It should not be spread over good assemblies; it should be charged to overhead or to costing profit and loss.
Productive hours = 4,200 − 180 = 4,020 hours. Labour cost per assembly excluding abnormal idle time = (4,05,000 − 16,200) ÷ 1,800 = Rs 216. If idle time were wrongly treated as product cost, the figure would be 4,05,000 ÷ 1,800 = Rs 225, which overstates product cost.
The overtime premium needs judgement. If the 300 overtime hours were caused by a specific rush order, the premium is a direct cost of that order. If overtime is a general feature of poor scheduling, the premium should be treated as overhead. Only the basic rate for productive hours belongs in normal product cost.
3. What recommendation would you give on order size and labour control?
Read the worked answer
Accept the 6,000-unit order size only if the firm has safe storage and the supplier's quality and delivery are reliable; the annual saving of about Rs 40,700 is material. Otherwise, negotiate a smaller discounted lot or ask for a price reduction at the EOQ.
For labour, investigate the machine breakdown because abnormal idle time of Rs 16,200 is avoidable. Introduce preventive maintenance, daily machine checks and a breakdown log. Control overtime by scheduling urgent work in advance and requiring approval before overtime is worked. Compare actual productive hours with the standard: standard hours allowed are 1,800 × 2 = 3,600 hours, while productive hours used are 4,020, giving an efficiency of 3,600 ÷ 4,020 = 89.6%. The labour cost per assembly is rising partly because of low efficiency and partly because overtime premium is being spread over output. Report idle time and overtime premium separately so that the production manager is accountable for them.