• Raw material is the first element of cost and normally constitutes 30 to 60

percentages of total costs. So efficiency as regards to the material is the vital factor
in total cost of production and in the profit earned.

• Effectiveness of material control to have a system which ensures proper quantity of

material of proper quality and price at proper time and at the same time avoidance
of unnecessary blocking up of capital in the store.

• So this raises following questions with regard to raw material –

a) What to purchase
b) Where to purchase
c) How much to purchase
d) When to purchase

• Standard procedure for purchase of material –

a) Receipt of purchase requisitions from stores (for general material) and
production department (for special material) by the purchase department.
b) Inviting tenders
c) Receiving quotations
d) Preparation of comparative statement
e) Call the meeting of purchase committee & select the supplier to whom order is
to be placed.
f) Preparation of purchase order and send the same to the supplier as well as to
the concerned department.
g) Receipt of materials by the concerned department and get it inspected for both
quantity and quality.
h) Materials sent to the store and arrangement for payment being made.

• Duties & functions of purchase department:

a) Ascertain and selection of source of supply and knowing market conditions as to
the demand and supply position and price trends.
b) Knowing in some detail the production process and requirement of materials.
c) Procuring materials as required and placing orders for their purchase.
d) Following up suppliers so as to avoid delays in procurement of materials.
e) Making sure that the right types of materials have been received in right
quantities according to the purchase order.
f) Securing adjustment on claim for discrepancies in materials received.
g) Approving of bills of supplier for payment
h) Maintaining proper record of materials purchased.

ABDR Page 1
 Fixation of stock levels

One of the most important questions of material management is when to purchase and
how much to purchase. Suppose minimum quantity of raw material required for
production per day is 50 tonnes and it takes 6 days for the material to receive at the
factory after placement of order. So order for the raw material to be placed before the
stock of raw materials goes below 300 tonnes. If the order is placed when the stock
available is 200 tonnes, then production will be stopped for 2 days before the new stock
arrives at the factory. So some production unit likes to maintain a safety stock (say 100
tonnes). So they will place the order when the stock level is 400 tonnes.

Also the maintaining a large quantity of stock will mean- 1) block of capital, 2) more
storage expenses, 3) more wastage particularly in case of perishable goods. Also
maintaining a small quantity of stock will have the following disadvantages – 1) more
ordering cost, 2) discounts are less likely to be offered, 3)stoppage of production.

Factors affecting fixation of stock levels

A) Rate of consumption:

• It is to be ascertained and expected on the basis of previous data and

expected increase or decrease of production.
• Expressed in terms of consumption quantity per day/week/month
• It is to be recognised as below –
a) Maximum rate of consumption
b) Minimum rate of consumption
c) Normal/average rate of consumption

B) Lead time/supply time/delivery time/procurement time/reorder period :

• It is the time gap between the placement of order and receiving material and
to be ascertained on the basis of previous data,
• Expressed in terms of days/weeks/months
• It is to be recognised as below –
a) Maximum lead time
b) Normal/average lead time
c) Minimum lead time
d) Urgent/emergency lead time

ABDR Page 2
 1. Re-order level

When stock of a material reaches at this level the storekeeper should initiate action
for purchase of material.

Re – order level = maximum consumption during the period * maximum lead time

= safety stock + lead time consumption

2. Maximum stock level

It represents the upper limit beyond which stock level normally not allowed to rise.

Maximum level = Re-ordering level+ Re-order quantity – {min. consumption * min.

Lead time}

3. Minimum stock level

It is the lower limit below which the stock level is normally not allowed to fall.

Minimum level = Re-ordering level - {normal consumption *average lead time}

4. Danger level

It is fixed below the minimum level. When the stock reaches the minimum level
urgent action for replenishment of stock is required.

Danger level = minimum consumption*emergency delivery time

5. Safety stock level

Safety stock = (Annual demand/365) * (Max. Lead time – avg. Lead time)

6. Average stock level

Average stock level = (Minimum level + Maximum Level)/2

= minimum level + ½ Re-order quantity

ABDR Page 3
 Illustration 1

Two components A & B are used as follows –

Normal usage 50 units per week
Minimum usage 25 units per week
Maximum usage 75 units per week
Re-order quantity A 300 units; B 500 units
Re-order period A 4 to 6 weeks, B 2 to 4 weeks

Calculate for each components (a) reorder level (b) minimum level (c) maximum
level (d) average stock level

Solution

(a) Reorder level = max consumption * max lead time

A = 75*6 = 450 units
B = 75*4 = 300 units

(b) Maximum level = Re-ordering level+ Re-order quantity – {min. consumption *

min. lead time}
A = 450+300 – (25*4) = 600 units
B = 300+500 – (25*2) = 750 units

(c) Minimum level = Re-ordering level - {normal consumption *average lead time}
A = 450 – (50*5) = 200 units
B = 300 - (50*3) = 150 units

(d) Average stock level = (Minimum level + Maximum Level)/2

A = (600+200)/2 = 400 units
B = (750+150)/2 = 450 units

Or

Average stock level = minimum level + ½ Re-order quantity

A = 200 + 300/2 = 350 units
B = 150 + 500/2 = 400 units

Illustration 2

If the minimum stock level and average stock level of raw material A are 4,000 and 9000
Units respectively. Find out the reorder quantity.

ANS: Average stock level = minimum level + ½ Re-order quantity

9000 = 4000 + ½ Re-order quantity
Reorder quantity = 10,000 units

ABDR Page 4
 ECONOMIC ORDER QUANTITY

Now to decide how much to purchase. The quantity to be ordered at one time is known
as “ordering quantity” and should be decided carefully. Two most important associated
with the stock are ordering and carrying cost.

Ordering cost is the total expense involved in the placing the order and purchase
procedure. Such cost is not affected by quantity involved. It is affected by number
purchase order. Ex- clerical labour, expenses for publishing tender, inviting quotation,
transport cost etc.

Carrying cost is the cost involved in carrying the material in the stores. Ex – interest on
capital blocked, safety, insurance, go down rent, obsolescence cost.

The optimum quantity to be ordered, so that both combination of ordering and carrying
cost will be minimum. This quantity is called economic order quantity/optimum order
quantity/ standard order quantity/ minimum order quantity.

If the price to be paid is stable, EOQ can be determined by the following formulae –

2 AO
EOQ = --------
C
Where A = annual consumption
O = ordering cost per order
C = carrying cost per unit per annum

So with the above formulae, we can derive –

1) No of order = A/EOQ
2) Total ordering cost = No of order * ordering cost per order
3) Annual carrying cost = carrying cost per unit per annum * (EOQ/2)
4) Total ordering & carrying cost at EOQ = 2 A*O*C
5) Total inventory cost = total cost of material + total ordering cost + total carrying cost

EOQ assumptions:
1) There is a known stock holding cost
2) There is known constant ordering cost
3) Rates of demand are known
4) Constant price per unit known
5) Replenishment of stock made simultaneously

ABDR Page 5
 Illustration

Your factory buys and uses a component for production at RS 10 per unit. Annual
requirement is 2000 units. Carrying cost of inventory is 10% p.a. and ordering cost is RS
40 per order. The purchase manager agrees that as the ordering cost is high, it is
advantageous to place a single order for the annual requirement. He also says that if we
order 2000 units at one time, we can get 3% discount from the supplier. Evaluate the
proposal and make your recommendation.

Solution:
2*2000*40
EOQ = --------------- = 400 units
1
Annual No. Of Order Ordering Average Carrying Total
requirement orders size cost @ RS stock cost 10% ordering +
(units) 40 (50% of of RS 10 carrying
order per unit cost
placed in
units
2000 10 200 400 100 100 500
2000 5 400 200 200 200 400
2000 4 500 160 250 250 410
2000 2 1000 80 500 500 580
2000 1 2000 40 1000 970# 1010

# 1000 units * RS 9.70 * 10%

Therefore recommendation is to place orders of 400 units at a time i.e. 4 times in a

year.

Illustration (calculation of EOQ by Tabulation method)

A) X ltd. Has received an offer of quantity discounts on its order of materials as under

Price per ton (RS) Tonnes

1200 less than 500
1180 500 and up to 1,000
1160 1,000 and up to 2,000
1140 2,000 and up to 3,000
1120 3,000 and above
The annual requirement for material is 5000 tonnes. The ordering cost per order is
RS 1,200 and the stock holding cost is estimated at 20% of material cost per annum.
You are required to compute economic order quantity.
B) What would be your answer to the above if there is no discount offered and price
per ton is RS 1,500?
Solution

ABDR Page 6
 A)

Annual No. Order Ordering Average Carrying Total Cost of Total

requirement Of size cost storage cost cost purchase material
order (tonnes) (50% of cost
RS. 5*PRICE PER 4+6 RS.
order TONNE*
placed) 20%
(1,200 * 2)
(1) (2) (3) (4) (5) (6) (7) (8) (9)
5,000 20 250 24,000 125 30,000 54,000 60,00,000 60,54,000
5,000 10 500 12,000 250 59,000 71,000 59,00,000 59,71,000
5,000 5 1,000 6,000 500 1,16,000 1,22,000 58,00,000 59,22,000
5,000 2 2,500 2,400 1250 2,85,000 2,87,400 57,00,000 59,87,400
5,000 1 5,000 1,200 2500 5,60,000 5,61,200 56,00,000 61,61,200

As the total material cost for the order size of 1,000 units is the lowest. Thus EOQ = 1,000
tonnes per order.

B)

If no discount is offered, then EOQ can be calculated using the formulae

2*5000*1200
EOQ = ------------------- = 200 tons
1500*20%

Illustration:
A manufacturing company purchases 24,000 pieces of component from a subcontractor at
RS 500 per piece and uses them in assembly department. The cost of placing order and
following it up is RS 2500. The estimated stock holding cost is approximately 1% of the
average stock held. The company is at present placing order which at present vary between
an orders placed every two month (i.e. six order p.a.) to one order per annum. Which policy
would you recommend?
Solution:
Statement showing costs for optimum number of orders to be placed
No of orders 1 2 3 4 5 6
1.Order size (pieces) 24,000 12,000 8,000 6,000 4,800 4,000
2.Average stock 12,000 6,000 4,000 3,000 2,400 2,000
3.Value of average 60,00,000 30,00,000 20,00,000 15,00,000 12,00,000 10,00,000
stock@ RS 500
4.Stock holding cost 60,000 30,000 20,000 15,000 12,000 10,000
(1% of above)
5.Order cost@ Rs 2,500 5,000 7,500 10,000 12,500 15,000
2,500
Total cost 62,500 35,000 27,500 25,000 24,500 25,000

ABDR Page 7
Alternative solution:

2*24,000*2,500
EOQ = ---------------------- = 4,899 pieces
500*1%

No of orders = 24,000/4899 = 4.9 or say 5 orders

Ordering cost = RS 2,500 * 5 = RS 12,500.00

Carrying cost = RS 500*0.01*4899/2 = RS 12,247.50
-----------------
RS 24,747.50
------------------

COSTING OF INCOMING MATERIALS

• All costs up to the point when materials are ready at the stores for issue should
be added to the cost. Expenses incurred after this point should be treated as
overheads or indirect expenditure.
• This means price charged by the supplier less any trade discount obtained
should be added to the transportation expenses, import duty, and octroi
charges.
• The purchase office expenses, store keeper wages, rent of godown and also
expenses of receiving department should be treated as indirect expenses.

Illustration:

A sugar factory has a permanent cane staff consisting of one superintendent @ RS

1,000 P.M and two assistants @ RS 500 p.m. Two-thirds of the time is devoted to
cane development and the rest to cane purchase for crushing during the season,
usually 120 days. During season 150 weighment clerks have to be employed @ RS20
per day. The price paid is RS200 per tonne plus a commission of 2% to the farmer’s
cooperative society. Average railway freight per tonne works out to RS10. Average
quantity of cane crushed per day is 1500 tonnes. The annual depreciation and
repairs of weighing machine is RS3600. Ascertain the cost of cane per tonne for
costing purposes.

ABDR Page 8
 Solution:

Statement showing cost of cane (per ton)

RS
Price paid to farmers per ton of cane 200.00
Commission @2% 4.00
Freight 10.00
Cane purchase staff (8,000/120)/1,500 0.04
Weighment (3000/1500) 2.00
Depreciation & repairs of weighment machines (3,600/120)/1,500 0.02
Cost of one tonne per cane 216.06

Illustration:

A factory has received one consignment containing two important materials X & Y and
the invoice pertaining to the same discloses the following information:
Rs
Materials “X” 1000 tonnes @ RS 2 per tonne 2,000
Materials “Y” 1200 tonnes @ RS 1.60 per tonne 1,920
Insurance 98
Freight etc. 110
Sales tax 196

Due to mishandling in the factory store, loss of 20 tonnes of material “X” and 12 tonnes
of materials “Y” was recorded. What rate you would adopt for issuing the materials to
jobs. If a provision of 20% is to be made for probable risk of obsolescence, what would
be the new rate?

Solution:
Statement of cost of material

Material X Material Y
Rs Tone Rs Tone
Payment to the supplier 2,000 1,000 1,920 1,200
Add: insurance 50 48
freight 50 60
Sales tax 100 96
Total 2,200 1,000 2,124 1,200
Less: loss of tones due to ------- 20 ------ 12
mishandling
2,200 980 2,124 1,188
Rate of issue 2,200/980 2,124/1,188

= 2.24 = 1.79

ABDR Page 9
 If the provision of 20% is to be made for probable risk of obsolescence, then new rates
will be:
Material X Material Y
Rate calculated above 2.24 1.79
Add: 20% for obsolescence 0.45 0.36
New rate 2.69 2.15

Note: insurance, freight and sales tax have been apportioned as below
a) Insurance in the ratio of material cost i.e. 200:192
b) Freight in the ratio of weight of material i.e. 10:12
c) Sales tax in the ratio of material cost i.e. 200:192

Illustration:

A timber merchant brought 5,000 c.ft. of timber logs on 1st January,2005 @ RS20 per
c.ft. He stored them in timber yard for six months for seasoning. In the timber yard the
following expenses were incurred during the period of seasoning.
a) Rent of the yard (area of the yard 4000 sq.ft.) RS.125 p.m.
b) Salaries of 5 chowkidars @ RS 100 P.M to each.
c) Incidental expenses @ 150 p.m.
d) Share of annual general overhead of the business Rs2,000.
e) Insurance charges @ 1% on the value of logs to be seasoned.

50% of the floor area of the yard has been set apart for the seasoning of the timber
and the remaining area for stocking the seasoned timber. Loss in volume of logs due
to seasoning may be taken as 10%. Calculate cost rate of the seasoned logs per c.ft.
as on 30th june,2005.

Solution:
Statement of cost
QTY AMOUNT
c.ft. RS.
Cost of timber lots 5,000 1,00,000
Add: expenses of seasoning
a. Rent for six months(1/2) 375
b. Salaries for 6 months(1/2) 1,500
c. incidental expenses for 6 months(1/2) 450
d. overhead for 6 months (1/2) 500
e. insurance (1% of 1,00,000) 1,000
5,000 1,03,850
Less: loss in volume (10%) 500
Total cost timber logs seasoned 4,500 1,03,850
Cost per c.ft. 1,03,825/4,500 = RS23.07

ABDR Page 10
 ILLUSTRATION:

The particulars relating to 1,200kg of a certain raw materials purchased by a company

during June were as follows:
a) Lot price quoted by supplier and accepted by company for placing the purchase order
Lot up to 1,000 kg @ RS22 per kg
Between 1,000 – 1,500 kg @ RS 20 per kg for supplier to factory
Between 1,500 – 2,000 kg @ RS 18 per kg

b) Trade discount 20%

c) Additional charge for containers @ RS 10 per drum of 25 kg
d) Credit allowed on return of containers @ RS 8 per drum
e) Sales tax @ 10% on raw materials and 5% on drum
f) Total freight paid by the purchase RS 240
g) Insurance at 2.5 % (on net invoice value) paid by the purchaser.
h) Stores overhead applied at 5% on total purchase cost of material.

The entire was received and issued for production. The containers were returned in the due course.
Draw a suitable statement to show (a) total cost of material purchased (b) unit cost of materials
issued to production.

Solution:

Statement of cost of material

Raw material 1,200 kg @ RS20 24,000.00

LESS: trade discount 20% (4,800.00)
19,200.00
Container 48 @ RS 10 480.00
19,680.00
Sales tax: raw material @ 10% 1,920
Sales tax: containers @ 5% 24 1,944.00
Net invoice value 21,624.00
Freight paid 240.00
Insurance @ 2.5% on 21,624 540.60
22,404.00
Less: credit for containers 48 @ RS 8 (384.00)
22,020.60
Stores overhead @ 5% on 22,020.60 1,101.03
Total cost of material 23,121.63
Cost per unit = RS 23,121.63/1,200 = RS 19.27

ABDR Page 11
 SELECTIVE INVENTORY MANAGEMENT

A.B.C system of selective inventory management

ABC analysis technique is based on classifying materials into three categories according to their
importance.

• The A category items are small in number but high in value and are strictly controlled.
Perpetual inventory records are maintained in respect of these materials. For these items
ordering levels will be fixed and fresh orders will be placed as soon as actual stock reaches
that level.
• The C categories of materials are high in number but small in value. So for these items large
orders are placed at once, say once in a year to cover whole year consumption. Since
investment is very low, there will not be much loss by way of obsolescence or interest cost,
but cost of placing repeated orders will be avoided.
• The B categories of materials are intermediate between two in importance and are
controlled to some extent. Whether or not perpetual inventory records are maintained in
respect of these items depend on their number and value. For these items orders are placed
after periodic review.

X axis – percentage of items

Y axis – percentage of value

120

100

80

60

40

20

0
0 20 40 60 80 100 120

ABDR Page 12
 Inventory turnover ratio

Turnover of raw materials during the year

Total raw materials issued for production / raw materials consumed during production
= --------------------------------------------------------------------------------------------------------------------
- Total cost of average inventory of raw materials during the year

** Average inventory = (Minimum level + maximum level stock)/2

= Minimum level + ½ *ordering quantity

= (opening stock + closing stock)/2

** Raw materials consumed = opening stock + purchases – closing stock

Illustration:

Calculate the stock turnover ratio from the following -

A) For A co. ; opening stock – RS20,000;closing stock – RS16,000;purchases – RS68,000

B) For B co. ; maximum stock level RS4,000; minimum stock level RS2,000; consumption during
the year RS9,000
C) For C co. ; maximum stock level 1,200 units; minimum stock level 600 units; consumption
during the year 6,000 units; re-order quantity 800 units

Solution:

A co Stock turnover ratio = 20,000 + 68,000 – 16,000 = 4 times

* (20,000+16,000)/2

B co Stock turnover ratio = 9,000 = 3 times

* (4,000+3,000)/2

B co Stock turnover ratio = 6,000 = 6 times

* 600 + (800/2)

ILLUSTRATION: From the following data for the year ended 31st march, 2004 calculate the inventory
turnover ratio of the two items and put forward your comments for them.

Material A Material B
RS RS
Opening stock 10,000 9,000
Purchases 52,000 27,000
Closing stock 6,000 11,000

ABDR Page 13
 Solutions:

Material A Material B
RS. RS.
Opening stock 10,000 9,000
Add: purchases 52,000 27,000
62,000 36,000
Less: closing stock 6,000 11,000
Materials consumed during the year 56,000 25,000
Average stock =(opening stock + closing stock)/2 (10,000 + 6,000)/2= (9,000 + 11,000)/2=
8,000 10,000
Inventory turnover ratio = material consumed / 56,000/8,000 = 7 25,000/10,000 = 2.5
average stock

A high ratio indicates that stock is fast moving whereas a low ratio indicates slow moving stock.
Thus material A is fast moving item

Pricing of issue of materials

1. FIFO (first in first out) method

It is the price paid for the material first taken into stock from which the material to
be priced could have been drawn.

Advantages:

(i) Inventory reflects the current market value, (ii) when the price level is declining,
FIFO method shows a lower profit for tax implications (iii) next to average cost
method; FIFO is the most commonly followed method

Disadvantages:

(i)When there is price fluctuations, FIFO method makes price fluctuating from period
to period. (ii)In case of increasing price levels, inventory will be at higher price, so
higher profit figure and higher tax liability.

ABDR Page 14
 Illustration:

The following is a history of the receipts and issue of motives in a factory during
February, 2004.

February 1 Opening balance 500 kg @ RS. 25

February 8 issue 250 kg
February 13 receipts 200 kg @ Rs. 24.50
February 14 Refund from a work order 15 kg @ Rs. 24
February 16 Issue 180 kg
February 20 Receipts 240 kg @ Rs, 24.37
February 24 Issue 304 kg
Issues are to be priced on the principle of FIFO stock verifier of the factory noted on
15th a shortage of 5 kg. Write out the complete store ledger account in respect of the
motives for February, 2004.

Solution:

Stores ledger account for February, 2004

Receipt Issue Balance

GR QTY. PRICE AMOUNT SR QTY. PRICE AMOUNT QTY. PRICE AMOUNT REMARKS
Date NO KG KG RS NO KG KG RS KG KG RS
Feb
1 500 25 12,500
8 250 25 6,250 250 25 6,250
250 25
13 200 24.50 4,900 200 24.50 11,150
250 25 *shortag
200 24.50 e noted
14 15 24 360 15 24 11,510 on 15th
65* 25 of 5 kg
200 24.50 valued
16 180 25 4,500 15 24 6,885 on FIFO
65 25 basis
200 24.50
15 24
20 240 24.37 5,848.80 240 24.37 12,733.80
65 25
200 24.50
15 24
24 24 24.37 7,469.88 216 24.37 5,263.92

ABDR Page 15
 2) LIFO (Last in first out method)

It is the price paid for the materials last taken into stock from which material to be
priced could have drawn.

Advantages:

a) The issue will be priced at the market rate prevailing, so cost will be at about the
market price.
b) In case of rising prices this method has the advantage of showing a lower profit.

Disadvantages:

a) Since the inventory is shown at oldest rate, it does not reflect the current conditions
b) In case the prices are falling this method will increase the profitability.

Illustration: The following are the records of issue and receipts of certain materials in a
factory during a week:

January

Opening balance 50 tones @ RS10 per tonne

1 issued 30 tonnes
2 receipt 60 tones @ RS10.10 per tonne
3 issue 25 tones (stock verification reveals loss of one ton)
4 received back from orders 10 tones ( previously issued RS 9.90 per ton)
5 issued 40 tones
6 receipt 22 tonnes @ RS 10.20 per ton
7 issued 33 tonnes

At what price should you issue the materials on January 1,3,5,7 respectively? Use two important
methods for this purpose and show the comparative result.

Solution: (a)

According to the FIFO method, the price of the issue is as follows

January 1 30 tonnes @ RS 10 per tonne RS 300

3 25 Tonne: 19 tonnes @ RS 10 per tonne RS 190
6 tonnes @ RS 10.10 per tonne RS 60.60
5 40 Tonne: 10 tonnes @ RS 9.90 per tonne RS 99
30 tonnes @ RS 10.10 per tonne RS 303
7 33 Tonne: 24 tonnes @ RS 10.10 per tonne RS 242.40
9 tonnes @ RS 10.20 per tonne RS 91.80
RS 1286.80
NOTE: the price for one ton which is found short on stock verification
will be included in works overhead@ RS 10

ABDR Page 16
 (B)

According to the LIFO method, the price of the issue is as follows

January 1 30 tonnes @ RS 10 per tonne RS 300

3 25 Tonne @ RS 10.10 per tonne RS 252.50
5 40 Tonne: 34 tonnes @ RS 10.10 per tonne
RS 343.40 RS
6 tonnes @ RS 10 per tonne 60
7 33 Tonne: 22 tonnes @ RS 10.20 per tonne
RS 224.40 RS
11 tonnes @ RS 10 per tonne 110
RS 1290.30
NOTE: the price for one ton which is found short on stock verification will be included in
works overhead@ RS 10.10

Illustration:

A manufacturing company issues materials to the jobs on the last in first out basis. At end of
the each quarter all materials are valued at the cost of the last delivery. The company made
the following purchase of commodity X.

12.01.2004 12 gross at RS 40 per gross

21.01.2004 12 gross at RS 45 per gross
28.02.2004 12 gross at RS 50 per gross
15.03.2004 12 gross at RS 60 per gross
Issue to the job made as follows
20.01.2004 10 gross
17.02.2004 10 gross
18.03.2004 10 gross
Write up the stores ledger account for the quarter ending 31.03.2004.

Solution:

Stores ledger account (LIFO method)

Receipts Issues Balances

IIN GROSS

IIN GROSS

IIN GROSS

REMARKS
AMOUNT

AMOUNT

AMOUNT
QUNTITY

QUNTITY

QUNTITY
G.R.NO.

S.R.NO.
PRICE

PRICE

PRICE
Date

RS.

RS.

RS.

12.01 12 40 480 12 40 480

20.01 10 40 400 2 40 80
21.01 12 45 540 2 40 80
12 45 540
17.02 10 45 450 2 40 80
2 45 90
28.02 12 50 600 2 40 80
2 45 90
12 50 600
15.03 12 60 720 2 40 80
2 45 90
12 50 600

ABDR Page 17
 12 60 720
18.03 10 60 600 2 40 80 Closing
2 45 90 stock
12 50 600 RS 890
2 60 120
31.03 18 890

3)Average stock method:

Simple average price: “A price which is calculated by dividing the total of the prices of the
material in the stock from which the materials to be priced could be drawn, by the number
of prices used in that total.”

Weighted average price: “A price which is calculated by dividing the total cost of the
material in the stock from which the materials to be priced could be drawn, by the total
quantity of materials in that stock.”

50 units @ RS 5 RS 250
60 units @ RS 6 RS 360
Total of 110 units RS 610
Simple average price (5+6)/2 RS 5.50
Weighted average price (610/110) RS 5.55

Advantages of Weighted average price:

i)This method stabilises cost when prices rapidly fluctuate ii) this is the most acceptable
methods of pricing

Disadvantages of Weighted average price:

i)This method requires considerable amount of clerical work in computing ii)the rate is
influenced by high or low prices in the past and does not reflect current conditions.

Illustration:

Following is the receipts and issue of certain materials in a factory during a week.

March
2nd Opening balance 50 tones @ RS10 per ton
rd
3 Issued 30 tones
4th Receipt 60 tones @ RS10.125 per ton
5th Issued 25 tones (stock verification
records normal loss of 1 ton
6th Receipt back from the completed work order 10 tones(previously issued @
9.94 per ton
7th Issued 40 tones

Assume that the issue of material is priced on the weighted average method, calculate
the price of issue on 3rd, 5th & 7th march.

ABDR Page 18
 Solution:

Valuation of issue (weighted average method)

Date of issue Qty of issue Rate at which issues are to be priced Amount
03.04 20 tons 10.00 per ton 300.00
05.04 25 tons (20*10)+(60*10.125)
80-1

10.22 approx. Per ton 255.48

07.04 40 tons (54*10.22)+(10*9.94)
54+10

10.18 approx. Per ton 407.20

Normal and abnormal losses

It is a principle in the costing that expenses and losses which have to be

necessarily incurred are treated as part of cost but expenses and losses which
are really avoidable and which are, therefore incurred, so to say, unnecessarily
should not be included in the costs.

Unavoidable expenses and losses are called normal losses or wastages and
avoidable losses and wastages are abnormal.

Normal losses in material happen due to nature or issue of materials i.e. some
materials may lose weight while being stored or if a large quantity of stock is
purchased broken down to be issued in small quantities there will be a small
loss. There are two ways to treat normal losses 1) either price of the material to
be inflated or 2) charged as factory expenses. For ex – 10 tons of coal purchased
@ RS 200 per ton and expected that 9.5 tones will be actually available for use.
Then either price of coal issued for production may be inflated to RS 210.53
(2000/9.5) or price of the 0.5 ton Rs 100 to be charged to factory expenses.

Abnormal loss arises due to mischief, bad luck, inefficiency. Thus loss of material
due to theft, fire damages due to careless handling would be a case of abnormal
loss. Abnormal loss charged to the costing profit and loss account and not to be
included in the cost of production directly or indirectly.

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