MATERIAL COST

MATERIAL
Defined

as anything that can be

stored, stacked or stockpiled.
Direct
material and Indirect
material

INVENTORY

The aggregate of those items of tangible personal

property which:
Are held for sale in the ordinary course of business,
Are in the process of production for such sales, or
Are to be currently consumed in the production of goods
or services to be available for sale.
- Accounting Principles Board

INVENTORY CONTROL

systematic control and regulation of purchase,

storage and usage of materials in such a way so as
to maintain an even flow of production, at the same
time avoiding excessive investment in inventories.
Efficient material control cuts out losses and
wastes of materials that otherwise pass unnoticed.

OBJECTIVES OF MATERIAL
CONTROL
No under-stocking
No overstocking
Economy in purchasing
Proper quality
Minimum wastage
Information about materials

PRINCIPLES OF IC

Proper coordination and cooperation between various

departments dealing in materials
Central purchasing dept. competent and expert
purchase manager
Proper classification and codification of materials
Properly plan material requirement
Perpetual inventory system should be operated
Maintaining proper records
Proper storage of materials
Various stock levels should be fixed
Budgeted purchases
Internal audit and checks
Regular reporting to management

TECHNIQUES OF IC

ABC technique
Stock levels
EOQ economic order quality
Proper purchase procedure
Proper storage of materials
Inventory turnover ratio
Perpetual inventory system
Fixation of material cost standards(Standard costing)
Preparation of material budgets (Budgetary control)

ABC TECHNIQUE

ABC analysis is thattechnique of material control

in which we divide ourmaterialinto three
categories andinvestmentis done according to the
value and nature of that categorys materials.
After this, we control of material according to
their level of investment. We need not to control
all the categories but we have to control those
materials
which
are
in
A
category.

STOCK LEVELS
IN ORDER TO GUARD AGAINST UNDER
STOCKING AND OVERSTOCKING, MOST OF
THE COMPANIES ADOPT A SCIENTIFIC
APPROACH OF FIXING STOCK LEVELS,
THESE ARE:
MAXIMUM LEVEL
MINIMUM LEVEL
RE-ORDER LEVEL
RE-ORDER QUANTITY
THESE LEVELS ARE NOT PERMANENT AND
MUST BE CHANGED TO SUIT CHANGING
CIRCUMSTANCES.

MAXIMUM LEVEL

This is that level above which stocks should not

normally be allowed to rise. Only in favourable
purchasing condition this level can be exceeded.
It is computed by the following formula:
Maximum level = Reorder level + Reorder quantity
(Minimum consumption x Minimum
period)

MINIMUM LEVEL

It is that level below which stock should not

normally be allowed to fall . This is essentially a
safety stock and is not normally touched. In case of
stock falling below this level, there is a risk of
stoppage in production and thus top priorities
should be given to the acquisition of fresh
supplies. It is computed as:
Minimum level = Reorder level (Normal
consumption x Normal reorder
period)

REORDER LEVEL OR ORDERING LEVEL

This is that level of material at which purchase

requisition is initiated for fresh supplies. This level is
fixed in such a way that by reordering when materials
fall to this level, then in the normal course of events,
new supplies will be received just before minimum level
is reached. Its formula is:
Re-order level = Maximum consumption x Maximum reorder period

DANGER LEVEL

Sometimes stock levels go below minimum level due

to non supply of materials. In order to meet such
situation a danger level is fixed.
Danger level = Normal consumption x Max. reorder
period under emergency condition.

AVERAGE STOCK LEVEL

Avg. stock level = (Minimum level + Maximum
level)
Alternatively,

Avg. stock level = Minimum level + ( Reorder

quantity)

VARIOUS STOCK LEVELS WITH CONSTANT LEAD TIME

AND CONSTANT RATE OF CONSUMPTION

LEAD TIME

Lead time is the time interval between the time

when an item reaches re-order level and a fresh
order is placed, to the time of actual receipt of
materials. When purchased materials are
received, the maximum level is reached. As,
materials are consumed, the stock level starts
coming down. Fresh supplies are received when
stock reaches minimum level.

ECONOMIC ORDER QUANTITY (EOQ)

Re-order quantity is the quantity for which order is
placed when stock reaches reorder level. It is known
as Economic order quantity because it is the
quantity which is most economical to order. EOQ is
the size of the order which contributes towards
maintaining the stocks of material at the optimal
level and at a minimum cost

THE FORMULA
EOQ = 2*A*B
CS
Where EOQ = Economic Order Quantity
B= Buying or ordering cost per order
A = Annual quantity required in units
C =Carrying cost per unit as a percentage of average inventory

EXAMPLE
The annual consumption of a part X is 5000
units. The procurement cost per order is $10 and
the cost per unit is $0.5. The storage and
carrying cost is 10% of the material unit cost.
Required:
Calculate the EOQ

SOLUTION

O= $10 Q= $5000, C= $0.5*10%

EOQ = 2AB
CS
EOQ = 2 * 5000 *10
0.5*10%
= 1414 units

Cost $

120

Minimum cost

80

Total cost
Carrying cost

40

Ordering cost
EOQ=1414 units
400

Unit per order

1200

2000

The graph shows the line representing ordering

cost sloping downward, indicating lower cost
when a large quantity is purchased and the line
representing cost of carrying stock going upward,
indicating a higher cost for a large quantity

STOCK CONTROL LEVEL

The stores should control its stock at an
appropriate level so as to minimize the costs
related to stock
These cost can be classified into three categories:

Costs

of obtaining stock
Carrying cost
Stock-out-Cost

COST OF OBTAINING
STOCK/ORDERING COST
Purchase costs of goods acquired
Carriage inwards
Administrative costs of purchasing and accounts
department

STOCK-OUT COST
Loss of sale revenue due to the stop in production
Reduction in future sales because of the loss of
goodwill
Higher costs for urgent and small order of
materials

COST OF STORAGE (CARRYING

COST)
Storage and handling cost
Interest on capital tied up by the stock
Insurance and security
Stock loss due to deterioration, obsolescence and
pilferage
Audit, stocktaking and stock recording cost

Average usage

100 units per week

Minimum usage

70 units per week

Maximum usage

140 units per week

Lead time (the time

3-5 weeks
between ordering and
replenishment of
goods)
Ordering cost per order $180
Annual cost of carrying $5.2
a unit in stock

Calculate:

Economic

Order Quantity (EOQ)

Reorder level
Reorder quantity
Minimum level
Maximum level

Economic Order Quantity (EOQ)

EOQ =

2 * $180 *5200
5.2
= 600 units

Reorder level
Re-order level
= (Maximum consumption * Maximum re-order period )
= 140 units *5
= 700 units

Minimum level
Minimum level
= Re-order level Average usage in average lead time
= 700 units (100 units *4)
= 300 units

Maximum level

Maximum level
= Re-order level + EOQ Minimum anticipated usage
in Minimum lead
= 700 units +600 units (70 units *3)
= 1090 units

Reorder quantity
Reorder quantity = Maximum stock (Reorder level
Minimum usage in minimum lead
time)
= 1090 units (700 units 70 units *3)
= 600 units

INVENTORY TURNOVER

Inventory or stock turnover ratio tells us how many times

in a year stock is used up or replaced. The greater the
stock turnover, the more efficient is the stock policy.
STR is the ratio which the cost of materials consumed per
annum bears to the average stock of raw materials.
STR= Cost of materials consumed during the period
Average stock of materials during the period
STR is an indicator of the rate of consumption i.e.,
whether materials are moving fast or slowly.
High STR Fast moving, Low STR Slow moving
STR(days)= Days of the period
Stock turnover rate
Short ST period is considered to have fast moving materials

SLOW MOVING, NON- MOVING,

OBSOLETE MATERIALS
Slow moving are those which have low turnover
ratio.
Dormant materials are those which have no demand
at present, say, due to seasonal demand, but such
materials may be required in the future.
Obsolete materials represent those materials which
have become useless with the passage of time.

DETECTION OF SLOW MOVING AND NON- MOVING MATERIALS

In order to detect the slow and non moving materials,

stock turnover rate should be computed for each item
of material.
Std. STR = Budgeted consumption
Average stock level

The std. rate should be compared with actual rate, if

the actual turnover is less than standard, it implies
that the item is slow moving.

PURCHASE OF MATERIALS
Just In Time(JIT) purchasing is the purchase of
materials immediately before these are required for
the use in production.
JIT, as an innovative manufacturing system, refers to
acquiring materials and manufacturing goods only as
needed to fill customer orders. Also called lean
production system, it is a demand-pull manufacturing
system because each component in a production line
is produced as soon as and only when needed by the
next step in the production line.

Centralised purchasing
Decentralized purchasing

Material control procedures

Purchase

Receipt
Storage

Issue

Stocktaking

PURCHASE PROCEDURE
Initiation of purchase procedure by means of purchase
requisition
Inviting tenders and selecting suppliers
Preparation and execution of purchase orders
Receipt of materials
Inspection and testing of materials
Debit note upon the supplier in respect of rejected
materials.
Passing invoices for payment.

PURCHASE PROCEDURES
Establishing

optimal stock levels is of vital

importance of in controlling of stock
Once
the optimal stock levels are
established, the store department is
responsible for ensuring that optimal
stock levels are maintained for each item
of materials in stock. Normally, a bin card
is used to record the quantity of materials
in stock for each item

 When

items of materials have reached their

re-order point, the storekeeper will make out
a purchase requisition requesting the
purchasing department to contact with
appropriate supplier
When the purchasing department receives the
purchase requisition, the purchasing officer
will examine the different sources of supply
for the purpose of securing the highest quality
materials at the lowest price

 On

the receipt of the goods, the stores

department will inspect and compare the
supply with the purchase order
When the departmental foreman receives a
production order, he will give a materials
requisition to the storekeeper. On the receipt
of requisition, the storekeeper checks for
correctness and authorisation. If satisfactroy,
the issue will be made and entered the details
in bin cards. He then forwards the store
requisition to accounts department

 When

the accounts department receives the

stores requisition, it will price each of the
items listed on it by appropriate pricing
methods (e.g FIFO etc). Then, the amount of
materials issued is charged to appropriate
job or overhead account and the stock values
are reduced

STOREKEEPING
Storekeeping is the function of receiving of materials ,
storing them and issuing them to workshops or
departments.
There are mainly two types of stores organisation i.e.,
central stores and departmental sub- stores.
Imprest system of stores management.

CLASSIFICATION AND
CODIFICATION
Codification is the procedure of systematic
assignment of symbols for each item of store. Such
codes may be either alphabetical, numerical or both.
Classification of materials refers to grouping of
materials according to their nature in suitable
categories.
Ex: Copper, iron, aluminium metals
Soaps, cotton waste, lubricating oil
Consumable stores
Systems of coding:
Numerical and decimal
Alphabetical and mnemonic
Alpha-numerical

STORES RECORDS
The stores record are two types:
Perpetual inventory records: These records show the
movement of stores, i.e., the receipt of materials,
issues of materials to production department and also
balance in stock. Two basic perpetual inventory
records are : Bin card, Stores Ledger
Documents: The documents are used to authorize
movements of materials into and out of stores. These
documents include Goods return note, bill of
materials, material requisition note, material
transfer note etc.

BIN CARD(STOCK CARD)

A bin card is a quantitative record of receipts, issues

and closing balances of materials items in store. It
does not contain information about the prices of
material.

Two bin system:

In this system, two bins are maintained for each
item of material. One bin constitutes the main or the
regular bin from which materials are issued and the
other bin contains the minimum stock from which
issues are made only when stock in
regular bin is
exhausted.

Bin card shows quantities of each type of material

received, issued and on hand.

Tata McGraw-Hill
Publishing Company
Limited, Management
Accounting

BIN CARD

AXIS Company Ltd

Bin Card
Description .

Bin card .

Stores ledger number

Date received

Code number.
Unit number ..

Date Received

Issue

Reference Quantity Referenc

e
Figure 4: Bin Card

Balanc
e
quantity quantit
y

Chec
k

8-48

STORES LEDGER
The stores ledger is maintained in the cost accounting
department and is one of the basic records for material
accounting in a cost system.
It gives monetary values of materials in addition to
information given in bin card.

 Tata McGraw-Hill
Publishing Company
Limited, Management
Accounting

RECORDING/ACCOUNTING FOR
MATERIAL COST

When a perpetual inventory system is used to account for

materials inventory, a stores ledger records
card is maintained.
Inventory Record Card
Item.

Description.

Received
Date

Quantity

Issued
Amount

Date

Balance
Quantity

Figure 6: Inventory Record Card

Amount

Date

Quantity Amount

8-50

STORES LEDGER ACCOUNT FORMAT

Date

Receipts
Ref. Qty.
GRN units

Rate
Rs.

Issues
Amt.
Rs.

Ref.
SR

Qty.
units

Rate
Rs.

Balance
Amt.
Rs.

Qty.
units

Rate
Rs.

Amt.
Rs.

DOCUMENTS AUTHORISING
MOVEMENT OF MATERIALS
Goods

received note- store keeper

Stores requisition note(Material
requisition note)
Bill of materials
Materials return note
Materials transfer note

INVENTORY SYSTEMS:
Periodic Inventory Systems:
Under this system, stock taking is undertaken at the
end of the accounting year. As the stock taking involves
verifying the physical quantities of stores in hand,
some firms temporarily suspend plant operations when
this is done.(Annual Stock taking)
Perpetual Inventory systems:
the method of recording stores balances after each
receipt and issue to facilitate regular checking and
obviate closing down for stock-taking.

MATERIALS ABSTRACT

Is a document which is a classified record of material

issues, returns and transfers

MATERIAL HANDLING:
Is the movement of materials from one place or
position to another. It may me horizontal or vertical.
It is mainly concerned with movements of materials
from time of their purchase upto and including
delivery of finished goods to customers.

METHODS OF PRICING MATERIAL

ISSUES

When materials are issued from stores to production

department, a question arises regarding the price at
which materials issued are to be charged. This is
because same type of materials may have been
purchased in different lots at different times at several
different prices. This means that actual cost can take
on several different values and some method of pricing
the issue of materials must be selected.

PRICING OF THE ISSUES OF

MATERIAL
Pricing

of materials may change from time to

time.
Materials are usually acquired by several
deliveries at different prices
Actual costs can then take on several
different values
Therefore, the materials pricing system
adopted should be the simplest and the most
effective one

METHODS OF STOCK VALUATION

First-in-first-out (FIFO)
Last-in-first-out (LIFO)
Simple average method
Weighted average cost (WAC)
Specific identification/unit cost method

FIRST-IN-FIRST-OUT
This

method assumes that the first stock to be

received is the first to be issued
The cost of materials used is based on the
oldest prices
The closing stock is valued at the most recent
prices

LAST-IN-FIRST-OUT (LIFO)
This

method assumes that the last stock to

be received is the first to be issued
Therefore, the cost of materials used is based
on the most recent prices
The closing stock is valued at the oldest
prices

SIMPLE AVERAGE COST

Simple average price is calculated by adding all the

different prices of all the different prices of
materials in stock, from which the materials to be
priced could be drawn, by the number of prices used
in that total. This method does not take into account
the quantities of materials in stock while
calculating the average.

WEIGHT AVERAGE COST (WAC)

This

method gives due weightage to the

quantities held at each price when
calculating the average price. The
weighted average price is calculated by
dividing the total cost of material in stock,
from which the material to be priced could
have been drawn, by the total quantity of
material in that stock. closing stock are
valued at the weighted average cost

SPECIFIC IDENTIFICATION/UNIT
COST METHOD
This method assumes that each item of the stock
has its own identity
The costs of materials used and closing stock are
determined by associating the units of stock with
their specific unit cost

MATERIAL LOSSES
Loss of materials may arise during handling,
storage or during process of manufacture. Such
losses or wastages are classified into two:
Normal loss necessarily to be incurred and
unavoidable. Ex. Breakage, evaporation etc.
Abnormal loss arises due to inefficiency in
operations, uncertainty. Ex. Theft, fire, accident
etc.

WASTAGE, SCRAP, SPOILAGE,

DEFECTIVES:
Waste - that portion of a basic raw material lost in
processing, having no recovery value.
Scrap the incidental residue from certain types of
manufacture usually of small amount and low value,
recoverable without further processing .
Spoilage spoiled work results when materials are
damaged in manufacturing operations is such a way
that they cannot be rectified and brought back to
normal specifications. It may have a realizable value
and in certain cases this is sold as seconds.
Defectives that production which is below standard
specifications or quality and can be rectified by
incurring
additional
expenditure
known
as
rectification cost.