Direct Materials

Refer to raw materials which can be traced and identified from the product or finished
goods. Costs of these raw materials are quite expensive and some companies even
take loan to purchase these materials
Constitutes a large part of total costs of product. Therefore materials need to be
controlled to minimize material losses, wastages, pilferage and obsolescence etc.

Material control system

To ensure materials of right quality are purchased at the right quantity, right time and
at the right price.
The importance of material control:
- High quality and expensive materials should be purchased only when it is
required and with the approval of the top management
- Materials should be purchased from suppliers who are able to supply high
quality material at a reasonable price and are able to deliver promptly
- Materials received should be inspected properly
- The materials should be kept in a safe place and physical stock levels should
be inspected regularly
- There should be proper documentation and the accounting system and control
should be designed, planned and implemented effectively
- There is proper stock management to ensure that stocks are available when it
is required
Organizing material control
Material control procedure comprise as follows:
Procurement/purchasing
Storage/storekeeping
Stock control
Issuance
Stock valuation and pricing issues
Procurement/purchasing procedures
It begins when the production dept or any other dept needs material. Material requisition
form will be sent from this dept to the store to request materials. Thus, this document is
used to request materials from store dept. Need to specify the code, quantity and material
description in the form. If the materials required are available, then the storekeeper will
issue the materials to the dept.
If the materials are unavailable due to smaller quantity or insufficiency then the store
clerk will issue a Purchase Requisition Note to the Purchasing Dept. This document is to
inform the purchasing manager to initiate the purchase of the materials as the materials
are almost finished or have reached the reorder level. The store clerk will indicate the
quantity, code and description of materials on this document.
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The Purchasing manager will contact the suppliers to supply the materials hence a
Purchase Order (PO) will be sent to the suppliers. A Purchase Order is a document to
order materials from suppliers where quantity, description and price of materials will be
indicated on the document. A copy of purchase order will be sent to the Goods Received
Dept and Accounts Dept.
Later, when the suppliers receive the PO, the materials will be sent to the Goods
Received Dept together with a copy of invoice and delivery note. The Goods Received
Dept will check the quantity, the description and coding of the materials against the
actual details of invoice and the purchase order. Once everything is satisfied, a Good
Received Note (GRN) will be issued by the Good Received Dept which confirms the
quantity of materials and its description and suppliers information are verified
accordingly. Then, the materials, the GRN will be sent to the Inspection Dept to check the
quality of materials.
The Inspection Dept will check as to the quality of the material whether it reaches the
companys standard quality or other specification required. Once satisfied, an Inspection
Report will be issued and later the materials, a copy of GRN and the Inspection Note will
be send to the store to be kept.
Once the procedures above have been carried out, the Accounts Dept will make the
payment to the suppliers.
Store keeping
To ensure all materials are properly kept and stored in accordance and efficient manner to
avoid material pilferage, deterioration and material losses. Thus, well equipped stores
need to be maintained to ensure substantial contribution to efficient operations.
Nowadays, all materials use coding system to classify the materials for store keeping and
usage reason. Bin card system is used for keeping detailed receipts and issues of
materials for storekeeping purposes (in quantity terms).
Stock Control
Need to control the stock level to ensure sufficient stocks of materials are maintained to
meet production requirements and to avoid stockout from happening. Stockout is a
situation where stocks of materials are insufficient and will result to stoppage in
production and company will not be able to meet the customers needs and requirement
and as a result company will loose its revenue and good faith.
Objectives of stock control are to avoid over-stocking of materials and under-stocking of
materials. Overstocking of materials is a situation where excessive materials are available
in the store and therefore this will incur additional storage costs, inspection costs etc. This
situation needs to be avoided as unnecessarily purchasing causes the money of the
company is tied up for this material cost and additional costs will incur eg storage cost,
interest cost, rental cost etc. Under-stocking of materials is a situation where insufficient

of materials is available in the store and thus might lead to stoppage in production and
later company will suffer losses of revenues.
In controlling the stocks of material, certain level of materials will be determined such as
minimum stock level, maximum stock level, reorder level and minimum stock level. Also
the quantity of material to order also could be determined.
Terms related to stock control:
Lead time or procurement time the period of time between ordering and
replenishment, ie when the goods are available for use.
Economic order quantity (EOQ) the reorder quantity which minimizes the
balance of cost between carrying costs and ordering costs
Buffer stock or minimum stock or safety stock a stock allowance to cover errors
in forecasting the lead time or the demand during the period
Maximum level a stock level calculated as the maximum desirable which is
used as an indicator to management to show when stocks have risen too high
Reorder level- the level of stock at which a further replenishment order should be
placed.
Stock Level
Reorder level = maximum usage x maximum lead time
Minimum level = reorder level average usage x average lead time
Maximum level = reorder level + EOQ minimum usage x minimum lead time
Average stock level= ( minimum level + maximum level) /2
Or minimum stock level + 1/2 x ROQ
Economic Order Quantity (EOQ)
Quantity of materials ordered which minimizes the balance of cost between ordering and
carrying costs.
Ordering cost costs incur to obtain the stock. Eg clerical and administrative costs,
transportation costs, set up and tooling costs associated with the production run.
Normally these costs are charged per order or per trip.
Carrying cost cost to secure the stocks or handling the stock in warehouse. Eg interest
on capital invested in stock, storage charges, stores staffing, material handling cost,
insurance and security etc. Normally expressed as cost per unit.
Traditional method using formulae to determine EOQ
EOQ = 2C0D/Cc
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Where

C0 = ordering cost per order

D = demand per annum
Cc = carrying cost per item per annum

Assumptions of EOQ
There is a known constant stockholding cost
There is a known, constant ordering cost
That rates of demand are known
That there is known, constant price per unit
That replenishment is made instantaneously, ie the whole batch is delivered at once.

Tabulation method
Need to prepare a table that comprise the following information:
Quantity (Q)
No of order (D/Q)
Average stock (Q/2)
Ordering cost
(D/Q x Cost of ordering)
Carrying cost
(Q/2 x cost of carrying)
Total costs
Quantity is referring to the size of quantity to be ordered from supplier.
Number of orders is the number of orders need to be placed in a year
Total costs is the total cost of ordering plus carrying cost.
To determine the EOQ using tabulation is to choose the minimum total costs and the
correspond quantity (Q) will be the answer for economic order quantity.
Perpetual inventory system
Is a system where all inflows and outflows of the materials are recorded in the store
ledger card. All receipts, issues and balances for each stock are recorded to facilitate
regular checking.
Continuous stocktaking
Physical checking on the quantities of material is carried out to confirm the figures
recorded in the store ledger card. Each sample of materials are taken at random and
counted on continuous basis until the end of the year every materials have been checked
at least once. Continuous stocktaking is essential in order to ensure that the perpetual
inventory system is functioning efficiently and any minor stock discrepancies are checked
immediately and corrections can be taken.
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The effective stock control system is the combination of perpetual inventory stock system
and continuous stock taking.
Periodic stocktaking
Physical checking on all materials are carried out and counted once in a year.
Stock discrepancies are the differences between the actual stocks and the recorded
stocks.. The causes of discrepancies are:
Incorrect entries and calculation
Breakages, pilferage, evaporation, material damages
Placing of stocks in the wrong bin
Incorrect coding causing wrong bin card to be recorded
Misplaced of materials
No proper documentation
Stock Valuation and Pricing Issues
Need to value the materials in order to determine the cost of materials issued or charged
to the production and also to determine the value of materials on hand.
Three methods that can be used:
i. FIFO (first in first out).
ii. LIFO (last in first out)
iii. WAM (weighted average method)
FIFO

All issues of materials are priced at the price of the oldest batch of materials stock
until all units in the batch have been used up. The price of the next oldest batch
will then be used and so on.

Advantages:
- It is an actual cost system
- Unrealized profits and losses do not arise because it is an actual cost
system
- The stock balances show a fair representation of current commercial value
- It is based on the sound principle that earlier purchases will be used up
first

Disadvantages:
- Product cost based on the oldest materials prices which does not reflect the
current cost
- Administratively troublesome and expensive in operation to keep track of
each batch of materials
- In period of rising prices (inflation), product cost are understated and net
profit is overstated. In period of decreasing prices (deflation), product
costs are overstated and net profit is understated.
LIFO

Last items of materials purchased will be the first to be issued and used. Thus the
remaining balance of materials on hand are those being priced at the cost of
earlier purchases.
Advantages:
- It is an actual cost
- Product costs will tend to be close to current prices and therefore be more
realistic
- In period of rising prices (inflation), product costs are overstated, thus net
profit are understated. This provides a hedge against inflation.
Disadvantages:
- Frequently result in many batches being only partly charged to production
when new batches arrive
- Closing stocks on hand will be valued at oldest prices
- Administratively troublesome and expensive in operation to keep track of
each batch of materials

WAM
Weighted average price is used for the issuance of the material. Average price of
material is calculated after each receipt, taking into account both the quantity and
value of stocks.
Advantages:
- Less complicated to administer than FIFO and LIFO
- Effect on product cost somewhere between FIFO and LIFO
- When prices are fluctuating, this method is more likely to give more
satisfactory results than FIFO and LIFO
Disadvantages:
- It does not represent actual buying price
STOCK DISCREPANCIES
Difference between physical amount of stocks in hand and the amount shown in
the stock records
Cause of discrepancy should be investigated, and appropriate action need to be
taken.
Possible causes of stock discrepancies:
- Employees may steal the stock
- Breakages of materials which is not recorde
- Misplaced of material
- Clerical erros in stock recording
- Miscounting of stock units
- Excess stock return from production without proper documentation

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