Costing and Control of Materials

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Chandrakant@SOM,KIIT University

Direct Material
Direct materials are those materials which are directly identifiable and traceable as a part of the final product.

It may be raw material like wood used in making tables and chairs, Component parts used in a product ,e.g., tyres and tubes in a car, Any material used in primary packing of the products, like cans for tinned food and drink.

Materials cost constitutes a prime part of the total cost of production of manufacturing firms. Therefore it becomes very important to have efficient control of materials. Materials control basically aims at efficient purchasing of materials, their efficient storing and efficient consumption.

4/29/2014

Chandrakant@SOM,KIIT University

Control of Materials
Why control necessary? Pre-requisites to an effective control system:
Materials of the desired quantity will be available when needed. Materials will be purchased only when a need exists and in economical way. Purchases of materials will be made at most favorable prices. Vouchers for the payments of materials will be approved only if the materials have been received in good conditions. Materials will be protected against loss by proper physical control. Issue of materials will be properly authorized and accounted for. All materials, at all times, will be charged, as the responsibility of some individual.

4/29/2014

Chandrakant@SOM,KIIT University

Purchase of Materials
The purchasing dept is responsible for ordering/purchasing materials and supplies for production. The purchase manager is responsible for ensuring that the items ordered:
Meet the quality standards Are acquired at the lowest price, and Are delivered on a timely basis.

A typical purchase procedure involves three steps:

Purchase Requisition Purchase Order Receipt of materials
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Storing and Issue of Materials

Materials are transferred from the receiving dept to the stores. The person in charge of the stores is responsible for proper storage, protection and issue of all materials. The documents required to authorize and record materials movements in/out of the store:
Stores Ledger Bin Cards Materials Requisition Note
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Pricing of Materials
Why is pricing important?
Since it has a direct bearing on the cost of goods sold and consequently on profit.

The different pricing methods are: Actual Cost method First in First out method (FIFO) Last in First out method (LIFO) Simple Average Cost Method Weighted Average cost method Standard Cost Method Base Stock Method Market Price Method
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Provisions of AS-2
The provisions of AS-2 allow the following methods:
For the items which are not ordinarily interchangeable and produced and segregated for specific projects: Actual Cost method For the items other than above: FIFO and Weighted Average Method For convenience, if the results closely approximate the actual cost: Standard Cost Method
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Concept Problem-2
From the following information prepare a Stores Ledger Account under FIFO and LIFO method: 1-1-2003 5-1- 2003 10-1-2003 12-1-2003 15-1-2003 19-1-2003 22-1-2003 27-1-2003 31-1-2003
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Opening Stock 1000 units at Rs. 5 each. Purchased 900 units at Rs.6 each. Issued 1200 units. Purchased 800 units at Rs. 6.20 each. Purchased 300 units at Rs.6.40 each. Issued 400 units. Issued 600 units. Purchased 200 units at Rs.6.50 each. Issued 600 units.
Chandrakant@SOM,KIIT University 8

Concept Problem-3
From the following information prepare a Stores Ledger Account under Average Method (Simple and Weighted Average):
Date 01-06-09 05-06-09 07-06-09 10-06-09 13-06-09 250 2.60 200 Receipts Qty 200 300 Rate (Rs) 2.00 2.40 250 Issue Qty

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Chandrakant@SOM,KIIT University

Inventory Control
Inventory control is of great importance in order to ensure smooth and uninterrupted production. It is also necessary because of the following significant factors:
Demand fluctuations Uncertainty about lead time Avoiding over-stocking and under-stocking

The consequences may be:

Capital tied up Opportunity lost Credit Crunch
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Inventory Control Techniques

ABC Analysis (Paretos 80:20 Analysis) Economic Order Quantity (EOQ) VED Analysis FSND Analysis Fixation of Inventory Levels

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Chandrakant@SOM,KIIT University

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ABC Analysis
This analysis recommends that the management should focus on key issues of decision making to simplify the decision making process. It will help the management to put their energy and efforts towards the majority areas requiring utmost attention. As per this analysis, the total inventory list will be divided into three classes A, B and C:
Class of items % of items % of value

A B C

15 35 50

80 15 5

The control of inventory is exercised as follows:

A Class items
1. 2. 3. 4.
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B Class items
1. 2. 3. 4. Moderate control Periodic follow up Moderate value analysis Handled by middle management

C Class items
1. 2. 3. 4. Loose control Follow up in exceptional cases Minimum value analysis Can be delegated
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Very strict control Maximum follow up Rigorous value analysis Handled by senior officers

Chandrakant@SOM,KIIT University

Economic Order Quantity

Objective: To find out and maintain optimum level of investment in inventory to minimize the total cost associated with it. EOQ is the level of inventory order that minimizes the total cost associated with inventory management. The total cost includes:
Carrying Cost: Are associated with the maintenance/holding of inventory. Ordering Cost: Are costs associated with acquisition of/placing order for inventory.
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Economic Order Quantity(EOQ)

Economic Order Quantity (EOQ)

EOQ =

2 x Annual Consumption X Ordering Cost Storage(holding)cost per unit Storage (holding) cost per unit = Cost per unit X Storage cost(%)

Fixation of Inventory levels:

Re-order level: = Maximum usage X Maximum lead time or = Minimum stock level + (Average or Normal usage X Average lead time) Minimum stock level = Re-order level (Average usage X Average lead time) Maximum stock level = Re-order level + Re-ordering quantity (Minimum usage X Minimum lead time) Danger level = Average usage X Maximum re-order period for emergency purchases Average stock level = Minimum stock level + of Re-order quantity or = (Minimum stock level + Maximum stock level)