MATERIAL COST

MATERIAL COSTMATERIALDefined as anything that can be stored, stacked or stockpiled.Direct material and Indirect material

INVENTORYThe 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, orAre 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 CONTROLNo under-stockingNo overstockingEconomy in purchasingProper qualityMinimum wastageInformation about materials

PRINCIPLES OF IC

Proper coordination and cooperation between various departments dealing in materialsCentral purchasing dept. competent and expert purchase managerProper classification and codification of materialsProperly plan material requirementPerpetual inventory system should be operatedMaintaining proper recordsProper storage of materials Various stock levels should be fixedBudgeted purchasesInternal audit and checksRegular reporting to management

TECHNIQUES OF ICABC techniqueStock levelsEOQ economic order qualityProper purchase procedureProper storage of materialsInventory turnover ratioPerpetual inventory systemFixation of material cost standards(Standard costing)Preparation of material budgets (Budgetary control)ABC TechniqueABC 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 LEVELSIn 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 levelRe-order levelRe-order quantity

These levels are not permanent and must be changed to suit changing circumstances.

Maximum levelThis 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 levelIt 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 levelThis 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 re-order period

Danger levelSometimes 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 levelAvg. 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 timeLead 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 costThe formulaEOQ = 2*A*B CSWhere 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 inventoryExample 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 = 2ABCSEOQ = 2 * 5000 *100.5*10%= 1414 unitsCost $Unit per orderOrdering costCarrying costTotal cost408012040012002000Minimum costEOQ=1414 unitsThe 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 quantityStock control levelThe stores should control its stock at an appropriate level so as to minimize the costs related to stockThese cost can be classified into three categories:Costs of obtaining stockCarrying costStock-out-Cost

Cost of obtaining stock/ordering costPurchase costs of goods acquiredCarriage inwardsAdministrative costs of purchasing and accounts department

Stock-out costLoss of sale revenue due to the stop in productionReduction in future sales because of the loss of goodwillHigher costs for urgent and small order of materialsCost of storage (carrying cost)Storage and handling costInterest on capital tied up by the stockInsurance and securityStock loss due to deterioration, obsolescence and pilferageAudit, stocktaking and stock recording costAverage usage100 units per weekMinimum usage70 units per weekMaximum usage140 units per weekLead time (the time between ordering and replenishment of goods)3-5 weeksOrdering cost per order$180Annual cost of carrying a unit in stock$5.2Calculate:Economic Order Quantity (EOQ)Reorder levelReorder quantityMinimum levelMaximum level

Economic Order Quantity (EOQ)EOQ = 2 * $180 *52005.2= 600 unitsReorder levelRe-order level= (Maximum consumption * Maximum re-order period )= 140 units *5= 700 unitsMinimum levelMinimum level= Re-order level Average usage in average lead time= 700 units (100 units *4)= 300 unitsMaximum levelMaximum level= Re-order level + EOQ Minimum anticipated usage in Minimum lead= 700 units +600 units (70 units *3)= 1090 unitsReorder quantity

Reorder quantity = Maximum stock (Reorder level Minimum usage in minimum leadtime)= 1090 units (700 units 70 units *3)= 600 unitsINVENTORY TURNOVERInventory 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 periodAverage stock of materials during the periodSTR is an indicator of the rate of consumption i.e., whether materials are moving fast or slowly.High STR Fast moving, Low STR Slow movingSTR(days)= Days of the period Stock turnover rateShort ST period is considered to have fast moving materials

Slow moving, non- moving, obsolete materialsSlow 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 materialsJust 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 purchasingDecentralized purchasingMaterial control proceduresPurchaseReceiptStorageIssueStocktakingPurchase procedureInitiation of purchase procedure by means of purchase requisitionInviting tenders and selecting suppliersPreparation and execution of purchase ordersReceipt of materialsInspection and testing of materialsDebit note upon the supplier in respect of rejected materials.Passing invoices for payment.

Purchase proceduresEstablishing optimal stock levels is of vital importance of in controlling of stockOnce 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 itemWhen 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 supplierWhen 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 orderWhen 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 departmentWhen 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 reducedStorekeepingStorekeeping 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 codificationCodification 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 metalsSoaps, cotton waste, lubricating oil Consumable storesSystems of coding:Numerical and decimalAlphabetical and mnemonicAlpha-numericalStores recordsThe 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 LedgerDocuments: 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. Tata McGraw-Hill Publishing Company Limited, Management Accounting8-48Bin CardBin card shows quantities of each type of material received, issued and on hand.quantityQuantity Code number. Unit number ..Bin card .ReferenceReferenceCheck Balance quantityIssueReceivedDate Stores ledger numberDate receivedDescription . AXIS Company Ltd Bin CardFigure 4: Bin CardStores ledgerThe 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 Accounting8-50Recording/Accounting for Material CostWhen a perpetual inventory system is used to account for materials inventory, a stores ledger records card is maintained. Inventory Record Card Item. Description. ReceivedIssuedBalance DateQuantity AmountDateQuantity AmountDateQuantity AmountFigure 6: Inventory Record CardStores ledger account format Date ReceiptsIssues Balance Ref. GRNQty. units Rate Rs.Amt. Rs. Ref. SRQty. units Rate Rs.Amt. Rs. Qty. units Rate Rs.Amt. Rs. Documents authorising movement of materialsGoods received note- store keeperStores requisition note(Material requisition note)Bill of materialsMaterials return noteMaterials 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 abstractIs 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 issuesWhen 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 materialPricing of materials may change from time to time.Materials are usually acquired by several deliveries at different pricesActual costs can then take on several different valuesTherefore, the materials pricing system adopted should be the simplest and the most effective one

Methods of stock valuationFirst-in-first-out (FIFO)Last-in-first-out (LIFO)Simple average methodWeighted average cost (WAC)Specific identification/unit cost methodFirst-in-first-outThis method assumes that the first stock to be received is the first to be issuedThe cost of materials used is based on the oldest pricesThe closing stock is valued at the most recent pricesLast-in-first-out (LIFO)This method assumes that the last stock to be received is the first to be issuedTherefore, the cost of materials used is based on the most recent prices The closing stock is valued at the oldest pricesSimple average costSimple 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 costSpecific identification/unit cost methodThis method assumes that each item of the stock has its own identityThe costs of materials used and closing stock are determined by associating the units of stock with their specific unit cost

Material lossesLoss 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.