ELEMENTS OF COST OF ORDER MANAGEMENT

Cost of order management :-The expected total cost of an order by a group of activities, when the defined scope of work has been completed and its management is done by specific forecasting and plan . Effective management must take into account coordinating all the different pieces of this chain as quickly as possible without losing any of the quality or customer satisfaction, while still keeping costs down. The organizations and managers are most of the times interested in and worried for the costs. The control of the costs of order of the past, present and future is part of the job of all the managers in a company. In the companies that try to have profits, the control of costs affects directly to them. Knowing the costs of the products is essential for decision-making regarding price and mix assignation of products and services.

Elements of cost/ order cost

Material (Material is a very important part of business)

o

Direct material

Labor
o

Direct labor

Overhead (Variable/Fixed)
o o o o o o o o o o

Indirect material Indirect labor Maintenance & Repair Supplies Utilities Other Variable Expenses Salaries Occupancy (Rent) Depreciation Other Fixed Expenses And these also

Primary Cost/Revenue Elements

A primary cost or revenue element is a cost or revenue-relevant item in the chart of accounts, for which a corresponding general ledger (G/L) account exists in Financial Accounting (FI). You can only create the cost or revenue element if you have first defined it as a G/L account in the chart of accounts and created it as an account in Financial Accounting. The R/3 System checks whether a corresponding account exists in Financial Accounting. Examples of primary cost elements include: Material costs Personnel costs Energy costs
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Secondary Cost Elements Secondary cost elements can only be created and administrated in cost accounting (CO). They portray internal value flows, such as those found in internal activity allocation, overhead calculations and settlement transactions. When you create a secondary cost element, the R/3 System checks whether a corresponding account already exists in Financial Accounting. If one exists, you cannot create the secondary cost element in cost accounting.

Examples of secondary cost elements include: Assessment cost elements Cost elements for Internal Activity Allocation Cost elements for Order Settlement

COST OF ORDER ARE MANAGED BY

1. Replenishment System 2. Fixed Order Quantity System Replenishment System Under this system the quantity to be ordered is not fixed. Instead ordering time and maximum stock level for each material are fixed. There are frequent reviews of the stock. The quantity ordered is decided based on the lead time of the material, maximum stock level and the stock held on the date of review. Fixed Order Quantity System The quantity to be ordered is fixed under this method. Re-orders are made once the stock reaches a certain pre-determined level called Re-order level. This is typically fixed based on the average consumption during the lead time plus some buffer stock. The best way to determine the fixed quantity to be ordered would be using the concept of Economic Order Quantity. This concept is designed in a manner to ensure that the overall inventory costs are lowest. In other words Economic Order Quantity (EOQ) is that quantity level to be ordered each time so as to keep the inventory costs to the minimum.

There are three alternate methods to determine the Economic Order Quantity namely i) Algebraic method ii) Tabular method iii) Graphical method Algebraic Method: Two components of Inventory costs that are considered in computing the EOQ are ordering cost and storage cost. With increase in lot size of purchases, the ordering cost decreases and storage cost increases. On the other hand with decrease in lot size of purchases, the ordering cost increases and storage cost decreases. EOQ deals with striking a balance between these two factors. The following algebraic formula is used to compute EOQ. EOQ = 2CO/S Where C = Annual consumption of the material O = Ordering cost per order S = Annual storage cost per unit The above formula has been derived as below At EOQ, Total Ordering Cost = Total Storage Cost i.e. (# of orders X Ordering cost per order) = (Avg units stored X Annual storage cost per unit)
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(C / EOQ X O ) = (EOQ /2 X S) Cross multiplying we would have (EOQ)2 = 2CO / S Therefore, EOQ = 2CO/S Example: From the following information determine the Economic Order Quantity of Material X Consumption of Material X per month 500 units Cost of placing an order $ 40 Purchase price per unit of X $ 200 Storage cost 1.5% per annum Solution: EOQ = 2CO / S = 2 x (50012) x 40 / 3 = 400 units Note: S = $200 X 1.5% = $ 3 Tabular Method: When there are quantity discounts offered by the supplier at different lot sizes purchased i.e. purchase price of material varies at different quantity levels, the tabular method is used to determine Economic Order Quantity. It is illustrated in the below example.

Example: The supplier of Material ABC has given the below quantity discount offer Price per unit ($) 120 118 116 114 112 Units Less than 250 units 250 and less than 800 units 800 and less than 2,000 units 2000 and less than 4,000 units 4000 units and above

Inventory carrying costs are 10% p.a. Order placing cost per order is $ 600. Annual consumption of the material is 4,000 units. Compute the Economic Order Quantity Solution: Follow the below steps to find out EOQ under Tabular method 1) Pick up one lot size from each of the tiers. It is recommended to pick up a lot size that is an exact fraction of Annual Consumption 2) Compute the total inventory cost for each lot size picked 3) The lot size where the total cost is lowest would be the EOQ

Price Lot per Size (U) (P) 200 $ 120 unit

Purchase Cost (X = C x P) $ 480,000

Orderin # of orders (N = C / U) Cost g

Storage cost p.u Storage Cost (Z = U / 2 x S) Total Cost (X + Y + Z)

(Y = N x (S = P x O) 10%) $ 12,000 $ 12.00 $ 11.80 $ 11.60 $ 11.40 $ 11.20 $

20

$ 493,200 $ 483,075 $ 471,640 $ 468,600 $ 471,000

1,200 $ 1,475 $ 4,640 $ 11,400 $ 22,400

250

$ 118

$ 472,000

16

$ 9,600

800

$ 116

$ 464,000

$ 3,000

200 0 400 0

$ 114

$ 456,000

$ 1,200

$ 112

$ 448,000

$ 600

C = Annual Consumption of Material = 4,000 units O = Ordering cost per order = $ 60 Since the total cost at 2,000 units lot size is lowest, it is the optimal quantity to buy.