2210212017 | Ready reotar (oa Nalas ya ‘After studying this chapter, you should be able to: + Understand the meaning and importance of material control and the various techniques used + Know how stock levels are set to keep them at optimum level + Understand the steps in the procedure of purchasing materials + Know the importance of good storekeeping and how it is achieved + Explain perpetual inventory records and various documents used to ‘authorize the movement of materials into and out of stores + Understand the various methods of pricing the material issues and their effect on cost and profit Describe the types of material losses and their accounting treatment [ MEANING OF MATERIAL -— ‘The term ‘material’ refers to all commodities that are consumed in the process of manufacture. Itis defined as ‘anything that can be stored, stacked or stockpiled’ Materials are classified into ‘direct’ materials and ‘indirect’ materials. “Direct material cost is the cost of material which can be direcly allocated to a cost centre ora cost object in an economically feasible way.” CAS - I of ICAI. Direct materials include rot only the raw materials entering at the start of the production but all of the following: (@ Component parts used in a product, ¢g., tyres and tubes in a car or picture tube in a television set () Any material used in production but wholly consumed in the production process, eg,, fertilizer used in growing plants. (©) Any primary packing material, i¢., any container sold with the final product, ¢g., ‘cans for tinned food and drink, bottles for beer, ete. Indirect materials are those which cannot be easily identified with a particular cost centre or cost object. Examples are coal, grease and oil, soap and sandpaper,22002017 Ready “Teas Resay Ready Ready iture & sros(9) >ncipal solar | Le 22 ‘Material Cost The term ‘inventory is used to cover the stocks of raw materials, components, work-in- progress and finished goods. It has been defined by the Accounting Principles Board as ‘the aggregate of those items of tangible personal property which () are held forsale in the ordinary course of busines; (i) are in the process of production for such sales; or (if) are to be currently consumed in the production of goods or services to be available for sale.’ MATERIAL CONTROL (Inventory Control) \_© Significance _No cost accounting system can become effective without proper and efficient control of materials. This is so because quite often material is the single largest element of cost and as such, an efficient system of material control leads to a significant economy in the total cost. Material is as much cash as cash itself and any theft, waste and excessive use of materials leads to immediate and direct financial losses. Where slack methods exist, it is easy for such losses to pass unnoticed. Meaning and Definition Material or inventory control may be defined as ‘systematic control and regulation of purchase, storage and usage of materials in such a way so as to maintain 4a 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 snnoticed ‘Thus an efficient system of material contro! should be comprehensive enough to cover purchase system, storage system, issue to production and determination of stock levels for each item of material. L Ghiectives of Material or Inventory Control The broad objectives of material control are listed below: 1. No under-stockingUnder-stocking inevitably leads to materials running out of stock at some time or the other. Shortage of material may arise at a time when they are ‘urgently needed and production may then be held up. The delay or stoppage in production due to non-availability of materials is very costly and results in loss of profits. 2. No over-stocking Investment in materials must be kept as low as possible considering the production requirements and the financial resources of the business. Over- stocking of materials locks up capital and causes high storage costs, thereby resulting in adverse effect on profits. This may also result in loss due to obsolescence. 3. Economy in purchasing The purchasing of materials is a highly specialized function. By purchasing materials at the most favourable prices, the purchaser is able to make a valuable contribution to the reduction in cost. 4. Proper quality While purchasing materials, due consideration should be given to the quality. It sno use purchasing materials of inferior quality or very superior quality, reach type of product, there is a particular type of quality of material which is needed and that quality alone should be purchased. 5. Minimum wastage In order to minimize the loss of materials, proper storage conditions must be provided to different types of materials. Losses of materials occur due to deterioration, obsolescence, pilferage and theft and evaporation. Alll round efforts should be made to keep these losses to the minimum. 6. Information about materials Not only should materials be available when ‘equired, there should also be a system to give complete and up-to-date accounting information about the availability of materials. Sometimes inadequate information about vailability of materials may cause new purchases to be made of materials already in stock,23;02t20t? Ready Ready) TReaay | Ready >incipal solar Material Cost 23 Essential Requirements or Principles of Inventory Control Idealy, material control must ensure thatthe followang:eequirements are fully met |. There should be proper coordination and cooperation between various departments dealing in materials, viz,, Purchasing Department, Stores Department, Receiving dnd Inspecting Department, Accounting Department, etc. 2, There should be a central purchasing department under the control of a competent and expert purchase manager. 3, There should be proper classification and codification of materials. 4. Material requirements should be properly planned. 5. The perpetual inventory system should be operated so that up-to-date information js available about the quantity of material in stock 6. Adequate records should be introduced to coritrol materials during production and the quantities manufactured for stock. 7. The storage of all materials should be well planned, subject to adequate safeguards and supervision. 8. The various stock levels like minimum, maximum, etc,, should be fixed for each item of material. 9, Purchases of materials should be contralled through budgets. 10, An efficient system of internal audit and internal check should be operated so that all transactions involving materials are checked by reliable and independent persons. 11. There should be regular reporting to management regarding purchases, issues and stock of materials. Special reports should be prepared for obsolete items, spoilage, returns to suppliers, etc. TECHNIQUES OF INVENTORY CONTROL ‘Various techniques commonly used for inventory control are listed below: \AABC technique \3Btock levels--Minimum, maximum and reorder levels <3 Fconomic order quantity (EOQ) yer purchase procedure 5, Proper storage of materials Inventory tumover ratio to review slow and non-moving materials 7. Perpetual inventory system. 8. Fixation of material cost standards (Used in Standard Costing) 9, Preparation of material budgets (Used in Budgetary Control) \ ABC TECHNIQUE (Selective Control) () 2” ey, i > er ‘ABC technique is a value based system of material control. In this technique, materials Gre anslysed according to their vale so that costly and more valuable materials are piven greater attention and care. All items of materials are classified according to their value high, medium and low values, which are known as A, B and C items, respectively. ABC technique is sometimes called Always’ Better Control method. A" ltems—These are high value items which may consist of only a small percentage of the total items handled. On account of their high cost, these materials should be under the tightest control and the responsibility of the most experienced personnel220212017 Ready Ready | Resay Ready “Ready —] nepal rotar 24 Material Cost (B’Items—These are medium value materials which should be uncer the normal control procedures. seme qters—These are low value materials which may represent a very large number of items. These materials should be under simple and economical methods of control The Point of classifying stock into A, B and C categories is to ensure that material ‘management focuses on A items where sophisticated controls should be installed. B items may be given less attention and C items least attention. Thus ABC technique isa selective control which aims at concentrating efforts on those mutetials where attention is needed most. This is so because it is unwise to give equal attention to all items in stock. The items are listed and ranked in the order of theit descending importance showing quantity and value of each item. This is illustrated belont with arbitrary percentage figures Category % of total value % of total quantity ‘Type of control A 70 10 Strict control B B 30 Moderate control c 3 0 Loose control Total 100 100 the total quantity but account for 25 per cent of the total value. These are B items which need routine type of control. Finally, the items representing 60 per cent ofthe total quantity cota only for 5 per cent of total value. These C items are kept under simple physical Spatel The rules regarding purchasing, storing and issuing of various categories of tems Should be formed according to the value and importance of materials, ‘The information in the above table has been presented in the following diagram, 100 95 70 a) 3 Ps ° 70 40.50 700 % of total quantity Fig. 2: ABC Categories of tock (cumulative percentages)‘Material Cost 25 220212017 ‘Advantages The advantages of ABC technique are as follows’ 1. Closer and stricter control can be exercised on those items which represent large amounts of capital invested. =m 2. Investment in inventory is regulated and funds can be utilized in the best possible way. Economy in stock carrying costs, It helps in maintaining enough safety stock for ‘C’ category items. Selective control helps in maintaining high stock turnover rate. STOCK LEVELS In order to guard against under-stocking and over-stocking, most of the large companies Fea adopt a scientific approach of fixing stock levels. These levels are: (i) maximum level; (i) minimum level; (i) reorder level; and (io) reorder quantity. By adhering to these levels, each item of material will automatically be held within appropriate limits of control. These | levels are not permanent and must be changed to suit changing circumstances. Thus, ‘changes will take place if consumption of material is increased or decreased or if—in the light of a review of capital available, —it is decided that the overall inventory must be increased or decreased. ‘Modern inventory management makes use of operations research and statistical techniques in fixing stock levels. However, given below is the description of various levels along with formulae that are commonly used in their computations Ready Factors Some of the factors which influence stock levels are: 1. Anticipated rate of consumption Amount of capital available Availability of storage space Storage/warehousing costs Procurement costs Reliability of suppliers Minimum order quantities imposed by suppliers Risk of loss due to: (a) obsolescence; (5) deterioration; (c) evaporation; and (d) fall in market prices, Rey Reads Ready Maximum Level | \ This is that level above which stocks should not normally be allowed to rise. The maximum. level may, however, be exceeded in certain cases, eg., when unusually favourable purchasing condition arise. It is computed by the following formula Maximum _ Reorder, Reorder _{ Minimum Minimum level = level * quantity ~ [consumption * reorder period | ‘The following factors are taken into account in setting this level: 1. Rate of consumption of material | 2. Risk of obsolescence and deterioration el 3. Storage space available 4. Costs of storage and insurance >rinipat solar2210212017 | Ready —] Reaay Ready Ready “| Reaay | >neipal raotar 26 Material Cost Availability of funds needed Seasonal considerations, e., bulk purchases during off-season at low prices Reorder quantity Restrictions imposed by government or local authority in respect of certain materials in which there are inherent risks of fire, explosion, ete. The idea of setting maximum stock level is to ensure that capital is not unnecessarily blocked in stores and also to avoid loss due to obsolescence and deterioration. Minimum Level Itis 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 priority should be given to the acquisition of fresh supplies. It is computed by the following formula: Minimum _ Reorder [Normal Normal Jevel__= level _~ {consumption * reorder period In fixing this level, the following factors are considered: 1. Rate of consumption. 2. The time required to acquire fresh supplies under top priority conditions so that stoppage in production can be avoided Reorder Level or Ordering Level This is that level of material at which purchase requisition is initiated for fresh supplies This level is fixed somewhere above minimum level. This 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 the minimum level is reached. Its formula is: Reorder” Maximum. Madmum level consumption “reorder period’ The following factors are considered in fixing this level: owly 1, Rate of consumption of the material 2. Minimum level Theor}: Delivery time—ie, the time normally taken from the time of initiating a purchase 4 requisition to the receipt of materials. This is also known as lead tine Variations in delivery time — Danger Level Sometimes purchased materials are not received in time and stock level goes below the minimum level. In order to meet such a situation a danger level is fixed. Danger level is 2 level at which normal issues are stopped and materials are issued for important jobs only. This level ig generally fixed somewhat below the minimum level. When stock reaches danger level, urgent action is needed for the replenishment of stock so that stoppage in production can be avoided. Purchasing materials on an urgent basis results in higher purchasing cost. Its formula is: Danger Normal, Max. reorder period level“ consumption * under emergency conditions2200212017 Ready | Reaay Reaay ~ [Ready iturez 112s) ¥ I >einipal 120127 [Material Cost 27 Average Stock Level ‘This is computed as follows ‘Average stock level = % (Minimum level + “Alternatively, Average stock level = Minimum level +¥ (Reorder quantity) Figure 2.2 shows the various stock levels. This is based on the assumption of constant lead time and constant rate of consumption with no interruption in production. However, in actual practice, both lead time and rate of consumption may not remain uniform. Lead time is the time interval between the time when an item reaches reorder 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. yum level) bee Maximum love! oo] \3 e rot \3 600-| } Fol \ oo Reorder level 5 ) / & 400 i | mL ion i mo] \tantine 100-4 Sa as ee vee ores 45 678 8 0 i Time (weeks) Fig. 2.2: Various Stock Levels, With Constant Lead Time and Constant Rate of Consumption Mlustration 2.1 ‘Two materials A and B are used as follows: Minimum usage 50 units per week each Maximum usage 150 units per week each Normal usage 100 units per week each Reorder quantity _A—600 units, B—1000 units Delivery period A—4 to 6 weeks, B—2 to 4 weeks. Calculate various stock levels.28 ‘Material Cost Solution: 2210212017 + Reorderlevel_ =Maximum consumption x Maximum reorder period A=150 units x 6 weeks 100 units B= 150 units x 4 weeks 600 units Reorder_( Normal, Normal delivery evel ~ (consumption period | A =900 — (100 units x 5 weeks) = 400 units ae 00 - (100 units x 3 weeks) = 300 units Average reorder period has been taken as normal reorder period. | | Maximum Reorder | Reorder_( Minimum Minimum | level = Jevel * quantity ae * delivery time Regs 4 =900 units + 600 units ~ (50 units x 4 weeks) = 1,300 units 8 = 600 units + 1,000 units - (60 units x 2 weeks) = 1,500 units Average stock level | | (Minimum level + Maximum level) cm A =¥% (400 units + 1,300 units) = 850 units B =% (300 units + 2,500 units) = 900 units \_ Ré order Quantity (Economic Order Quantity or OQ) = ‘Reorder quantity is the quantity for which order is placed when stock reaches reorder level. By fixing this quantity, the purchaser doesn’t have to recalculate the quantity to be x Purchased each time he orders for materials, Reorder quantity is known as Economic Order Quantity because it is the quantity < which is most economical to order. In other words, economic order quantity is that — size of the order which gives maximum economy in purchasing any material and ultimately contributes towards maintaining the material at the optimum level and at minimum cost. While setting economic order quantity, two types of costs should be taken into account: 1. Ordering cost This is the cost of placing an order with the supplier. Because of $0 mai many factors involved, itis quite difficult to quantify this cost. It mainly includes the cost of stationery, salaries of those engaged in receiving and inspection, salaries of those engaged in placing orders, etc. 2. Cost of carrying stock This is the cost of holding the stock in storage. It includes the following: (@) Cost of operating the stores, (salaries, rent, stationery, etc:) (®) The incidence of insurance cost (6) Interest on capital locked up in store (@) Deterioration and wastage of materials ¥ Note: At BOQ, ordering cost and cost of carrying stock are equal, ie, when the total of the two types of costs isthe lowest. ‘The above two types of costs are of opposing nature. If, for instance, an attempt is made to reduce the costs of carrying stock by keeping stocks as low as possible, the cost = | _ teeta22022017 [Rea | Ready Ready | Reaay | w >yincpal n20!a7 | Ready Material Cost 29 9 Ye Ni = Cost (8) Units per order Fig. 23: Economic, Order Quantity of ordering will go up because the number of replenishment orders will automatically rise. On the other hand, if in order to save ordering costs, order is placed for a larger quantity at one time, the stock will remain longer in stores and the cost of carrying stock will go up. The problem is, therefore, to balance these two types of costs and the economic order quantity is fixed at a point where the aggregate cost is the minimum. This is shown in Figure 2.3, in which the line of cost of ordering has been shown sloping downward indicating lower cost when large quantity is purchased and the line representing cost of carrying stock going upward indicating higher costs for holding larger stocks. The economic order quantity, which is the ideal order size, is at a point where total cost curve is at its lowest point, >\_-Mathematical Formulae of OQ ‘The above graphic methods of determining economic order quantity may not provide the most accurate answer, Economic order quantity can also be calculated with the help of a formula as given below: 2A. BOCs Wes" where FOQ = Economic Order Quantity A= Annual consumption in units B = Buying or ordering cost per order C= Cost per unit S = Storage or carrying cost as a percentage of average inventory Alternatively, FOQ Ss where S = Storage cost per unit per annum210 Material Cost Illustration 2.2 22n2r2017 Estimated requirement for the year 600 units Cost per unit 20 —— Ordering cost (per order) 2 Carrying cost (% of average inventory) 20%. Solution: . Rest (2x 600-12 20%20% In this illustration, if carrying cost is given as €4 per unit per annum, FOQ will be calculated as follows: (rs nog= PAE pe soxTs itustration 2.3 EOQ= = 60 units 60 units Rea] The annual demand for a product is 6,400 units. Inventory carrying cost is 1.50 per unit per annum. If the cost of one procurement is €75, determine: (@) Economic order quantity (©) No. of orders per year (©) Time between two consecutive orders Solution: 3 _ AB _ [2x6a00%75 , 3 @) BOQ = (== = JPR = = 800 units (b) No. of orders per year = Annual demand + EOQ ,A00 + 800= 8 orders in a year (©) Time between two consecutive orders | 12 months = 8 orders = 1% months “Ready Tabular Method | Economic order quantity can also be determined with the help ofa table prepared for this purpose. This method is particularly used when prices vary according to the quantity to be purchased. A table is prepared to show the various costs for different ordering quantities | thus, enabling one to find out the most economic size of the quantity to orderr ie, where the total cost isthe least of all. This is illustrated below: “Ready | ‘tare & iene Mlustration 2.4 Determine EOQ from the following information using tabular mathod: a Annual consumption — 12,000 units Cost of ordering — 15 per order Cost of material — %1.25 per unit Carrying cost — 20 per cent of average inventory mm _ reotar22n2r2017 Ready [ Resay ‘tare & ost) incl notar Matra Cost au Solution: ‘The following table may be prepared to determine the economic order quantity giadas Ui par Was per——Orkrig—— 100 150 0 BD ii Lost 1364 165 136 Sit 2 1000 1250 180 2s 8 B 3 1154 185 8 310 iu 37 vor 210 107 317 5 soo 100 zs 100 3 ‘The above table shows that 1,200 units is the ideal size of the order because total cost at this level is the least of all. This means the number of orders per year should be ten. Other order quantities (more than or less than 1,200 units) are not so economical because total cost is higher than this level. The result ofthis table can be verified with the help of ‘mathematical formula as shown below: RAB _ [2x12,000xi5 PAB = 1,200 w CS ~V 125%20% ~ ano units FOQ= INVENTORY TURNOVER Inventory or stock turnover ratio tells us how many times in a year stock is used up and replaced. The greater the stock turnover, the more efficient is the stock policy. An example will clarify this point. Suppose two firms A and B are both selling the same product at the same price and both realize €1 crore a year in sales income. Neither of these firms has any ‘cash and both have to borrow at say, 10 per cent interest rate. A has an average stock of 25 lakh at sales value whereas B’s average stock is only 1 lakh. A’s stock turnover ratio is 4 (ie, 1 crore +25 lakh), and B’s is 100 (ie., 1 crores = 1 lakh), A needs to avail of overdraft of 225 lakh and B needs only %1 lakh. A has to pay interest of %2.5 lakh a year, B only 310,000 @ 10%. This example makes it clear that high stock turnover requires less investment in stock and saves money and is thus an indicator of efficiency of stock ‘management. Stock turnover rate is the ratio which the cost of materials consumed per annum bears to the average stock of raw materials, Thus ‘Cost of materials consumed during the period “Average stock of materials during the period Stock Turnover Ratio =an2r2or7 “TReaay | | Reaay Roady [Resa >nepal totar 212 ‘Material Cost Stock tumover ratio is an indicator of the rate of consumption, ie., whether materials * are moving fast or slowly. A high stock turnover ratio indicates fast moving materials and a low ratio indicates slow moving materials, The turnover of different materials may be compared to detect those items which do not move regularly. This will enable the management to avoid keeping capital locked up in undesirable items of materials. Stock turnover rate may also be calculated in terms of days. This is done by dividing 365 days by the inventory turnover ratio, Thus: Stock Tumover in terms of days © Days of the period © Stock turnover rate If the length of the stock tumover period is short, the material is considered to be fast moving, Mlustration 2.5 ‘The following information relates to the year 2011-12: ‘Material A Material B z z Opening stock 25,000 87,500 Closing stock 15,000 62500 Purchases 1,90,000 125,000 Calculate stock turnover rations of A and B and give your comments. Solution: Average stock Average stock Opening stock Add: Purchases Less: Closing stock Cost of materials consumed Stock turnover ratio ‘Material A Material B 1,50,000 75,000 Opening stock + Closing stock 2 Material A ‘Material B 25,000+15,000 _ 87,500 +62,500 a rr = 20,000 = 875,000 e e 25,000 87,500 1,90,000 _1,25,000 215,000 212,500 15,000 62,500 2,00,000 1,50,000 Cost of materials consumed Average stock2amar2017 Ready Ready >rincipal raotar ist Material Cost 365 (No. of days in year) Stock turnover ratio Stock turnover ratio expressed in number of days 365 Material A SE = 37 days (approx) 8 Moria B 26 sundays appro) Thus, material A is fast moving as compared to material B as it takes on!y 437 days to consume the average stock, whereas in the case of B, it takes 183 days to conse the average stock. Considering the low turmover ratio of B,its stock level should be retin dnd if its rate of consumption does not change, its purchases may be reduced. ‘The stock turnover is a good measure of the efficiency of material utilization. SLOW, NON-MOVING AND OBSOLETE MATERIALS Lae Many businesses have problems of slow-moving, non-moving and obsolete materials Slow moving materials are those which have a low turnover ratio, ie, their rate of consumption or sale is low compared to their stock holding. Stocks of such materials should be maintained at the lowest levels. Dormant materials or non-moving materials are those which have no demand at present, say, due to seasonal demand. Such materials may be required in future. ‘Obsolete materials represent those materials which have become useless with the passage of time, say, due to change in the design of the product or methods of manufacture. These materials are no longer in demand because a better substitute has been found or the product in which these materials were required is no longer in production. Failure of the store-keeper to report on slow moving materials and recommend their use as substitute where they could be so used is another factor causing obsolescence. ‘The main reasons for slow-moving, non-moving and obsolete materials are: 1, Failure of the production control department to notify contemplated change in material requirements to material control department. Technical changes and use of substitute materials. Failure of the purchasing department to cancel outstanding orders for such materials. Purchase of items of obsolete and surplus materials. Failure of store-keeper to report on slow moving items and recommend their use as substitutes. 6. No review of the stores ledger. Detection of Slow and Non-moving Materials In order to detect the slow and non-moving materials, a standard stocks tumover rate should be computed for each item of material. This may be computed as follows: Budgeted consumption “Average stock levelan220t7 Faaty Roady Ready Ready ies] res) >eneipal notar k . 214 Material Cost ‘This standard rate should be compared with actual stock tumover rate. If the actual (mover rate is less than standard, it implies that its actual rate of consumption is less than the stipulated rate and the item is thus slow moving. Monthly or quarterly reports on such materials should be prepared for presentation to the management. These reports should show tumover rate, purchases and consumption of these items in quantities as well as values. This will help in not only detecting but also controlling slow and non-moving items. PURCHASE OF MATERIALS Purchasing isthe function of buying raw materials, general supplies, tools, office stationery and other items. The essentials of efficient purchasing are right quantity, right quality, right time, right price, right source and delivery at the right place. Justin-time purchasing is the purchase of materials immediately before these are required for use in production. According to CIMA, London JIT purchasing is ‘matching reccpts of materials closely with usage so that raw material inventory is reduced to near zero level’ The purpose of JIT purchasing is to reduce stock levels to the minimum through creating closer relationship with suppliers and arranging frequent deliveries of materials in smaller Ghanities. It results in enormous savings in storage costs, material handling costs, spoilage, obsolescence etc. An important effect of JIT purchasing is that with frequent purchasing [he issue price is likely to be closer to market prices. In order to save on ordering costs long term agreements may be entered into with suppliers. Centralized and Decentralized Purchasing Broadly speaking, purchase function may be organized in two ways, ie,, centralized Purchasing and decentralized purchasing. Centralization Centralization of purchasing means that all purchases are made by 2 sangle purchase department. Head ofthis department is designated as Purchase Manager or Chief Buyer. Decentralization In decentralized purchasing, each branch or department makes its own purchases. If the branches or plants are located at different placds; thé decentralized purchasing can better meet the situation by making purchases in the local market by plant or branch managers. Advantages of Centralized Purchasing 1. Specialized and expert purchasing staff can be concentrated in one department 2. A firm policy can be initiated which may result in favourable terms of purchase, @8., higher trade discount or easy terms of payment 3. Standardization of quality of raw material is facilitated. 4+ Better control over purchasing is possible because reckless buying by various individuals is avoided. Keeping all records of purchase transactions at one place also helps in control.2210202017 Ready Ready Ready >incoal reotar “| Ready | “[Reaty | Cost tual less ion ‘ion .weas Ege “although Material Cost 215 Disadvantages of Centralized Purchasing and maintenance of a special purchasing department leads to higher 1, The creation concerns may not be in a position to afford. administration costs which small c 2, Centralized purchasing is not suitable for plants or branches located at different places which are far apart. PURCHASE PROCEDURE the details of a purchase procedure may differ from firm to firm, the important dfeps in purchasing and receiving of materials are as follows, assuming that purchases are centralized: 1. Purchase Requisition Purchases of materials are initiated th is a formal request by the head of a d ‘manager to purchase the specified mate certain authorized persons as follows: () Storckeeper When materials reach ordering level, the storekeeper should initiate purchase procedure (i Production planner for special materials required for the manufacture of a new product. (iit) Plant engineer for repairs and maintenance materials. (io) Department heads (e., office manager) for any materials required for his department, like filing cabinets, stationery and office sundries. Sn XYZ CO. LTD PURCHASE REQUISITION No. Date... Date required rough purchase requisitions. A purchase requisition {epartment or an authorized officer to the purchase rials (Fig. 2.4). Such requisitions are received from Department To be delivered at . Please purchase.the items listed below: Tem No. | Quantity | Description and Code No. Purpose For use of purchase department only Purchase order No. Requisition by. ‘Supplier Approved by .~. Delivery date Fig. 24: Purchase Requisitionr 216 Purposes A purchase requisition serves the following purposes: 1. It initiates the purchase and sets the purchasing process in motion. 2. It provides a written record of details like quantities, specification, etc., of materials to be purchased. 3. Itprovides dates for reference, eg,, date when materials are required. Dates are Particularly important in case Tesponsibility for stoppage in | production due to shortage of materials | is to be determined. 2212/2017 Ready | 2. Selection of Suppliers a5) suppliers for each type of material and selects a ‘The important rule is to buy the best quality m: Ready i ! in dealing with suppliers. [Rey | made by raising a purchase order. “| Ready 3. Purchase Order and Follow-up Material Cost Steps in Purchase Procedure 1. Initiation of purchase procedure by means of a Purchase Requisition 2. Inviting tenders and selecting suppliers 3. Preparation and execution of purchase orders . Receipt of materials Inspection and testing of materials . Debit note upon the supplier in respect of rejected materials [ 2. Passing invoices for payment. When the purchasing department receives a duly authorized purchase requisition, a source of supply has to be selected. The purchase department generally maintains a lst of particular supplier after inviting tenders. Pemade from dependable sources of supply and ethical standards should be maintained In many industries, lng term contracts are entered into with suppliers. For example, renunreanwacturer may contract ahead for the supply of tyres and tubes for a year’s Sckeitthe cane. Such an arrangement has the advantage of not having to keep large Stocks ifthe continuity of supply can be relied upon. Moreover, the supplier gets 2 regular customer and may offer favourable terms. Periodic withdrawals against the contra are = g F g z E z i 4 a s a z = between the parties concerned. For this reason, authority to sign purchase orders check also be restricted to selected responsible officials. Form of Purchase Order ie given in Fig. 25, Large companies generally prepare five copies of the purchase order. The original is ent fo the supplier. Second copy is retained by the purchase department for its own file ‘Third copy is sent to the receiving department as an advance intimation to expect the nepal t2ota722022017 Ready Rey Ready | Reaay | >eneipal sot27 Material Cost 2a7 XYZ CO. LTD PURCHASE ORDER No. Date supplier Please supply the following materials subject to the terms and conditions ‘given on the reverse side of this purchase order: ‘Quanity | Description Rate ‘Amount | z t Please quote Purchase Order No. on all advice notes and invoices. Place of delivery Date of delivery Terms of payment . Purchase Manager Fig. 2.5: Purchase Order materials. Fourth copy is sent to the cost accounting department for entry in the ordered Column of the appropriate stores ledger account. The last copy is sent to the department requisitioning the material as an intimation of the order and expected date of receipt of materials. Itis very important to follow up purchase orders so as to ensure timely delivery. Lack of follow-up measures may cause delay in arrival of materials resulting in stoppage in production for want of materials. 4. Receipt of Materials ‘All incoming materials should be received by the Receiving Department. This department performs the functions of unpacking the goods received and verifying their quantities and Conditions. The quantity is checked against the purchase order copy and the supplier's advice note which is normally received along with the goods. Fall particulars of the goods received are entered in a Goods Received Note (Fig. 2.6). Goods Received Note serves the following purposes: 1. It informs the storekeeper and the requisitionist of the receipt of materials. 2. Itnotifies the accounting department that the materials have been received and that ‘a voucher can be prepared. 3, When it includes columns of cost, it can serve as a source of entry in the stores ledger. Original copy of the Goods Received Note is sent to the purchase department to be marked completed. Second copy is sent to the storekeeper or the requisitionist along withgqai2ot? Featy Ready iree rest) >encipal solar bh 218 Material Cost _— XYZ CO. LTD GOODS RECEIVED NOTE Supplier... = NO. ens — so Date nnn Advice Note NO. nnn, Purchase Order No. Quantity Description No. of packages | Gross weight Inspection report Quantity | Quantity | Reasons for passed rejected relection Received by Inspected bY vnc Dale, i RSPEI BY seers DAB) Fig. 2.6: Goods Received Note the goods. Third copy is sent tothe accounting department for entry in the stores ledger and the last copy is retained by the receiving department for its own file. 5. Inspection and Testing of Materials Goods received should be inspected for quality to ensure that they comply with the specifications stated on the purchase order, Where technical or laboratory inspection is Recessary, the goods are passed to a laboratory which will provide a report on the quality of goods. ‘An inspection report is preparet to show the results of the inspection. This report is Either prepared separately or incorporated in the Goods Received Note as shawn in Fig. 26. In either case, the report is forwarded to the purchasing department, 6. Return of Rejected Materials Where materials received are damaged or are not in accordance with the specifications, these are usually retuned to the supplier along with a Debit Note, informing him that his,an2i2or? Ready] [Rear tare & sos(9) y >ncipal rotar 1 Raaay J [Ready — ost 219 Material Cost ee XYZ CO. LTD DEBIT NOTE To (Supplier) an . No. a Date We are debiting your account with the value of under-mentioned materials for the reasons stated. Meanwhile we wait for your instructions. Guantity Description Rate “Amount z z Reasons | : Date received Purchase Order No. Goods Received Note No. Supplier's Invoice No. meet Signature . be Fig. 2.7: Debit Note 7. Passing Invoices for Payment ‘When the invoices are received by the purchasing department, the process of assembling the business papers connected with each purchase and preparation of voucher begins. Invoices are numbered serially and entered in the Invoice Register. The following documents are assembled in support of the invoice: (a) Purchase Order; (b) Goods Received Note; (c) Inspection Report, if not incorporated in the Goods Received Note and (d) Debit or Credit Note. ‘After comparing these documents with the invoice, if itis found that the invoice is in order, the purchase manager will sign it and pass it to the accounts department for payment. All calculations are checked before a voucher authorizing payment is prepared. ‘All related documents like Purchase Order, Goods Received Note are marked with the invoice number to preclude the passing of a possible duplicate invoice. PURCHASE PRICE L ‘The invoice received from the supplier provides a base figure of purchase price. The following adjustments have to be made in this figure to arrive at the real material cost. Quantity discount This is an allowance made by the supplier to the purchaser to ‘encourage large orders. The discount often varies according to the size of the order, i, the larger the quantity ordered, the higher is the discount, within fixed limits, Quantity discount is allowed by a supplier as a measure of the savings in his cost which arise from the production and distribution on a large scale. Part of these savings enjoyed by the supplier is passed on to the purchaser in the form of quantity discount. The amount of the quantity discount is deducted from the purchase’ price to arrive at the material cost.2210212017 Ready Ready Ready Roady Yencpal iota i tt 220 Material Cost tage discount This is an allowance made by the supplier to a purchaser who has to alike material eg. discount allowed by the manufacturer tothe wholessen The nies 20 cover the expenses (eg, storage, re-packing) and profit ofthe dealer whe i, providing from the peepee original supplier to distribute his goods. This discount is also ledurres from the purchase price to arrive at the material cost, Cash discount This discount is allowed by the supplier to a purchaser to encourage SO dare ee part or invoice, eg, 2% discount may be allowed if payment is made wakes eaiays and 4% discount if payment is made within 7 days. As exch dissent aes form of jiyetest on capital its treatment isa subject of debate among cost accountants Generally, “1 Sonsidered a financial and non-costing item and thus is not included in east reece sagglaxand other levies Items, like sales tax, excise duty, customs duty and octroi, should be added to the purchase price Zransport charges “These include sea, land and air freight, dock charges, insurance, Sr these chenals Purchased. Sometimes the purchase price quoted by the supplier nua, 2 ee Charges, but where the price does not include these charges these eenla te added io tit Purchase price. Where it is impracticable to do so (eg. where ah oxie are too ‘mall or invoices are received late) these may be charged as factory overheads. Cost of containers The supplier may pr may not charge separately for containers. If canines age is made, no adjustment is required in the purchase price However, if Bed) the acae agbatately charged, all such costs should be included in the purchece Price £¢ (0 the cost of containers if these are not returnable; and (i) the differs between the Sost of container and the amount refunded when container is rehumed, whe containers are returnable, oes vebeePing is the function of receiving of materials, storing them and issuing these to Objectives of Good Storekeeping Good! storekeeping should achieve the following objectives: Protection of materials from losses due to fre, evaporation, obsolescence, etc. Avoiding over-stocking and under-stocking. Economical use of storage space Up-to-date stores records Immediate location of materials required Facilitating perpetual inventory Speedy receipts and issues of stores Minimize storage cost Functions and Duties of Storekeeper Various functions and duties of a storekeeper are as follows: 1. Maintaining materials in a tidy manner |Cost 221 Material Cost 221022017 asto Proper maintenance of records of materials received, issued to production and in pee stock + ee 3. Accepting materials into the stores after having ascertained that the delivery complies with specifications detailed on Goods Received Note ge Issuing materials against duly authorized Stores Requisitions hin 5. Requisitioning further supplies from the purchasing department when reorder level ae of js reached on any material | ly, Preventing the entry of unauthorized persons in the storeroom | c 7. Periodic comparison of bin card balances with physical quantities in the bins | 7 8. Advising management on obsolete and slow-moving stocks _ e Stores Organization s a ‘There are mainly two types of stores organization, ie, central stores and departmental 8 sub stores. From control point of view, it is ideal to have one central store for receiving, and issuing all materials. However, this is not always practicable because in large factories, Ready ‘where there are many production departments, the location of the central store may not f he convenient to all such departments. : ‘Thus, where it is not advantageous to keep central stores, departmental sub-stores | should be maintained. It is recommended that control over all sub-stores should be +4 __| centralized and storekeeper of each sub-store should be responsible to the chief storekeeper. [naam This will ensure a uniform policy of purchasing, storing and issuing materials. ‘Advantages and Disadvantages of Central Stores, ‘The advantages of central stores as compared to departmental sub-stores arc «is follows: 1. Smaller stocks are required and overall capital tied up is reduced. A number of Reedy j departmental stores inevitably lead to higher stock holding cost. j 2. Specialized and expert staff can be concentrated in one department. | 3. Stocks may be checked with greater care. {| 4, Better supervision and control is ensured, [Pes 5. Clerical costs are reduced because of centralization of stores records. Bulk buying is facilitated as purchase requisitions are made out by the concern as a unit and not on a departmental basis. 7. It results in fewer obsolete articles. i The disadvantages of central stores are: 1. Transportation costs are increased particularly when departments requiring materials are located at a considerable distance from the central store. 2. Inconvenience and delay is caused in delivering goods to departments. 3. Production stoppage in departments is possible because of breakdowns in transport or hold ups in central stores. | Imprest System Sometimes large organizations use the imprest system of stores management. This is similar in operation to imprest system of petty cash. Under this system, a number of sub-stores reotar2321201? Ready Rea Ready >ncipal solar x00" 222 ‘Material Cost exist each drawing their supplies from the central store. Each sub-store is given, as a Commencing stock, sufficient supplies fora little more than the re-stocking period. At the end of the period, the storekeeper of each sub-store will requisition from the central stores ‘he numberof articles required to bring the stock upto the predetermined quantity For grample, let us assume the imprest amount set for a material is 400 kgs. During the week ending on 24 February, issues of materials have reduced the stock © 140 kgs tng Sub-storekeeper will issue a requisition from the central store for 260 kgs to enstve that at the beginning of the next week, 400 kgs are in stock. This system combines the advantages of central buying and storing with the benefits of having stocks conveniently available at several issuing point. The system also helps in «xercising an excellent control over sub-stores as over-issues will not be re-imbursed ant the sub-storekeeper will have to explain discrepancies, if any. CLASSIFICATION AND CODIFICATION OF MATERIALS Magpesrand descriptions of materials are often long and vague. In order to avoid length and ambiguity in description and names of materials, a symbol may be assigned to etch ken of material which is known as a code. Codification is the procedure of systematic by substituting a code for a longer name and or a cumbersome description Classification of materials refers to grouping of materials according to their nature in {uitable categories. For example, copper, iron, aluminium may be classified as metas tee like soap, cotton waste and lubricating oil, may be classified as consumable stores all ems of tools including jigs and fixtures may be classified as tools. Advantages The advantages to be derived from the use of a satisfactory system of Classification and codification of materials are as follows: 1 Ambiguity in description is avoided as a paticular code can refer to only one type of item 2. Clerical effort is reduced as length in description is minimized 3. Secrecy of materials used in production is maintained 4. Coding is essential in mechanized accounting Principles of Coding ‘While assigning codes, the following principles should be kept in mind: 1. Exclusive Each code number should relate to only one type of material and there should be no duplication. 2. Clear The code must be clear and should identify the material without any ambiguity. Brief | Codes should be brief because long codes take longer to write and are prone to error. » 5. Mnemonic As far as possible, codes should be easier to remember, such as, HCW for Hard Copper Wire. Yr220022017 Ready | Reaay | Ready ius] sres(9) ¥ >eincpal 120t27 ‘st Material Cost systems of Coding 1, Numerical and Decimal In this method, a number is allotted to each item. Sub- groups are indicated by decimals. For example, ina foundry, the following codes may be assigned: Coal 31 Wood 2 Copper 3 Steel 34 Aluminium % Bronze 36 Further, physical characteristics can be indicated in the code by decimals. This is shown below for copper, of which the numerical code as shown above is 33. Copper Sheets, 33.1 Copper Bars 332 Copper Granules + 33 Copper Wire 33.4 Copper Tubes 335 Sub-division of, say, copper bars into various grades may be coded as follows: Copper bar grade 1 33.21 Copper bar grade 2 33.22 Copper bar grade 3 33.23 This numerical method allows a wide range and is, therefore, most suited where the number of items is very large. 2. Alphabetical or Mnemonic _In this method, each item of store may be denoted by a combination of alphabets. As alphabets represent the first sound of description of ‘materials, it becomes easy to remember the codes. The system is, thus, also known as ‘Mnemonic’. Examples: Mild Copper Bar MCB Cast Iron Sheet as Stainless Steel Wire ssw 3, Alpha-numerical This is a combination of numerical and alphabetical methods. Examples: Mild Copper Bar of 6” Length MCB6 Toughened Stee! Tubes of 3/4” diameter TST34 Brass Strips of 1/4” thickness Bsi4 ‘The codes of materials should appear on all documents relating to the movement and use of materials and should be marked against the appropriate bins. As a note of ‘caution, codes must be handled with extreme care. Ifa slight mistake is made in quoting. the code, the entire work order may have to be scrapped, entailing considerable loss to the factory.2210212017 Resa | Rea ire rest) >encipal solar ~~ 224 Material Cost STORES RECORDS The stores records are of two types: 1. Perpetual Inventory Records These records show the movement of stores, ie, the receipt of materials, issues of materials to production department and also balance in stock Bin card and stores ledger are the two basic perpetual inventory records. 2.Documents The documents are used to authorize movement of materials into and Out of stores. These documents include Goods Received Note, Bill of Materials, Materials Requisition Note, Materials Return Note and Material Transfer Note. Bin Card (Stock Card) Ltn is a conainer in which material is kept Separate bin cards are maintained by the Storekeeper for each item of material in store, The bin cards show the details of receipts and issues of materials and the balance in stock at any time. This record is of immense help to the storekeeper in controlling the stock position. A bin card is attached to the bin, drawer or any other container in which material is stored. An entry is made at the time of each receipt or issue and the new balance in stock is calculated. All these entries of receipts and issues are supported by documents, such as Goods Received Note, Materials Return Note, Stores Requisition Note, etc. Alternatively, bin cards are kept on a table in trays. Fig. 2.8: General Purpose Bins A bin card is a quantitative record of receipts, issues and closing balances of material items in store. It does not contain information about the prices of materials. A specimen bin card is given in Fig. 2.9. 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 Pin contains the minimum stock from which issues are made only when stock in the regular bin is exhausted. At the time of stock verification, itis usually sufficient to verify stock in the regular bin as the stock in the minimum stock bin is already known,Cost Material Cost aos 221022017 a XYZ 60. LTD BIN CARD 7 he Bin No. Minimum Level | 1 Description x Reorder Level. | ‘Code No Reorder Quantity " Stores Ledger Folio Fees Is oe Receipts Issues Balance | Stock Verification Re 2eF. No.| Quantity | Ref. No. | Quantity | Quantity| Date | initials | Feats | | Resa] Fig. 2.9: Bin Card Ready ‘The idea of two bin system is to provide automatic information about reaching minimum stock level so that issue of materials for regular production is stopped. At this stage, materials are issued only for urgent orders till fresh supplies of materials are | ' received. Ready Illustration 2.6 ‘The following are the receipts and issues of material X in a factory during December. 1 Opening stock 200 kes 5. Received from supplier S, 400 kgs (GRN No. 448) 8 Issued to production department 240 kgs (S.R. No. 883) 10 Issued to production department 160 kgs (S.R. No. 897) 12 Received from supplier S, 500 kgs (GRN No. 455) 15 _ Issued to production department 400 kgs (S:R. No. 912) 16 Received from supplier S, 250 kgs (GRN No. 461) 19. Received from supplier S, 500 kgs (GRN No. 462) 21 Issued to production department 250 kgs (S.R. No. 940) 24 Issued to production department 260 kgs (S.R. No. 950) :. 27. Issued to production department 340 kgs (S.R. No. 974) (GRN denotes Goods Received Notes. SR denotes Stores Requisition). The minimum stock level of material X is 200 kgs. Reorder level is 350 kgs and ———— reorder quantity is 500 kgs. Code No. of material is MN 240. Prepare a Bin Card No. 148 for material X with all necessary details showing the transactions in December. Ready wes | sres(9) RRPPR PRR ERE >enelpal 120t272ar0ei2o7 | Reaay TReaay Ready “Ready >neipal toler ~ Material Cos: Solution: BIN CARD Bin No. 18 Min. Level 200 kgs Description x Reorder Level 350 kgs Code No. MN 240 Reorder Qty 500 kgs Stores Ledger Folio: ml a Date Receipts Issues Balance | Stack Verifi- cation Sev N) | antty | Ret No. | Quantity | Quantity (GRN No) (SRNo) | ~ igs gs Dec. 1 - = ~ - 200 Dec, 5 448 400 — - 600 Dec. 8 = 883 240 360 Dee. 10 = - 997, 160 200 Dec. 12 455 500 = - 700 Dec, 15 — — | 9» 400 300 Dec. 16 461 250 - = 550 Dec. 19 462 500 = = 14050 Dec, 21 - - 340 250 800, Dec, 24 = - 950 260 540 27 = = 7: Dee. 4 340 | 200 Stores Ledger he stores ledger is maintained inthe cost accounting department and is one of the basic records for material accounting in a cost system. This sececd gives the same information gearing stores as bin card and in addition, it gives the monetary values of materials, There are mainly three sections inthis ledger, i, receipts, issues and balance, each of these with appropriate sub-divisions showing date, ‘quantity, unit price and total cost. Two Ta Honal sections are usually included, ie, On Onder ana Maeaae Reserved columns. fee On Order’ column prevents placing of duplicate orden an ‘Reserve’ column indicates the materials reserved for a specific job order Bin Card and Stores Ledger—Distinction ‘The main points of difference between bin card and stores ledger are as follows: 1. Bin card is a record of quantities only, whereas stewce edger records both quantities and money values of materials, 2. Bin card is maintained by the storekeeper, whereas stores ledger is kept by the cost office. 3: Posting in bin card normally takes place before a transaction occurs, while in stores ledger, it is posted after the transaction227 Material Cost Cost junoooy sa8po7 saiojs OUT Std -suunj asou) 10} uoguunoyu apysoid jou op Aiyesous8 suogsonb asne2oq suwunjo> _Poar9sayf, Pu J9PIO UO, oN soIdeYP snp 70 pus ay YE SuORNjog PUR swo|qor Ut paredaid uaeq sey YON Jap] SIONS MON a 7 [2 {lw [a ow ow ow qwy jaiey | AD | wy jarew | AD | yeu | wy leew | AD | yeu |ereq [AD | yeu jeied | AD | you |eeT oveeg sense sidan penses | 10010 uo gue Bayes enue] ON on 2909 por Busing numer wn ~ vonsuaeeg annooov 13001 s3u01s g | E 3 } 3 H 3 lee | : E EO E 2 E $3 g T tT 28 |e Principal rotar220022017 Ready | Reaay iuree ros(0) y >ncipa solar Material Cost DOCUMENTS AUTHOR. ZING MOVEMENTS OF MATERIALS Goods Received Note \_dtores Requisition Note (or Materials Requisition Note) Th 3 document which is used to authorize and record the issue of materials from store, Zhe storekeeper should issue materials on the presentation ve duly authorized stores viusition note (See Fig. 2.11) It should be appreciated that this ie» key décument in Virtually all costing systems and serves the dual purpose of (@) authorizing the storekeeper to issue material ©) providing a written record of usage of materials A Separate requisition may be prepared for each item of material ora single requisition may Be prepared to cover the issuance of a number of items, The shee requisition note thay be prepared in duplicate or triplicate. The original Copy is passed to the stores department while duplicate is retained by the XYZ CO. LTD ‘STORES REQUISITION NOTE Materials required for job No. ae No, Department . Date Quantity Description Code No, Cost Office | Rate | Amount t < | Bin No. Issued by... ‘Stores ledger folio. Received by Priced by Fig. 2.11: Stores Requisition Notezama2o17 Ready Ready] ies] os(0) nepal taotar Cost ed for vin i i re Material Cost 2.29 {erials (Specification of Materials) ‘sition which lists all the materials required for the completion of a job. ‘als is a special form of stores requisition note which is generally used By departments having standard materials requirements or a comparatively fixed list of by vaEils For instance, in assembly type production, there will be no variation in the aaaremat of materials which are used, In such a case, much time would be saved if bill of ampenale (on which names or codes of all materials required are pre-printed) is used cease then only quantity i tobe indicated against the code or name of material required (Gee Fig. 2.12) Where the job is of a special nature, a special bill of materials must be prepared and a copy ofthis s generally passed tothe stores department in advance to enable t to arrange for materials not in stock ‘The main adoantages of using bill of materials are: 1. A ill of materials eliminates the need for preparing separate material requisition ypotes for various types of materials required for a particular job. This saves time and promotes efficiency. 2. The storekeeper can be given advance waming of requirements of materials usually not available in store. It thus avoids delay in production. 3, When pre-printed forms of bill of materials are used in standard type of output, it saves 2 lot of clerical labour and risk of error is also reduced. 4. Costing of jobs becomes easier and speedier. Bill tis a master requi So, a bill of materi ae XYZ CO. LTD BILL OF MATERIALS Job No. No. .. Department Date Tem No. | Quantity | Description | Code No.| Remarks | Cost Office Rate | Amount t t 2 L Prepared Bye wn nenennen Date of issue ‘Checked by Issued by Fig, 2.12: Bill of Materials230 _Materials Return Note neat? “ When materials issued are in excess of requirements, the unused materials are returned se to stores together il Material Cost the bin ewe (a,te stores, these should be placed in appropriate bing cei entries made in the bin card (See Fig. 2.13) Materials Return Note is usually prepared in triplicate by the stores clerk. One copy is Sent to the department that is returning materials. Seon! copy is sent to the cost office for = ppPropriate entries and the thd copy is retained by the stores department for entry in the {ST __ XYZ C0. LTD | MATERIALS RETURN NOTE Creat JOB NO. nsesnonnsnnnsinns No, Department occur e oe Date .. Quantity Description “Code No. Cost Office Rate Amount = a BINNO. nse . Received by... Stores Ledger folio... Priced by Authorized by ... SS | Fig, 2.13: Materials Return Note | Materials Transfer Note _ Wiben such transfers are not permitted, the surplus materials are returned to the stores iret and then re-issued to another job, This results in extea transport costs. Thus, when materials sos(9) prema Such transport costs may be heavy, which can be svocae if direct transfers are I permitted. known as a Material Transfer Note (See Fig. 2.14) Failte to record transfer of costs would nepal reotar22212017 Ready Feaay Roady ites] sresi9) >ncpal t2ota7 Cost ed als in 231 avril Cs x2 60. LT9 | MATERIALS TRANSFER NOTE te. Dated ‘tno following materials have been Wanstrred | From jo2 No To jo No Guaniy | Bescon | Code No Cost Ofice coal c | P20 BY mn Received by . atone by Priced by Fig, 2.14: Material Transfer Note, eee INVENTORY SYSTEMS ‘There are mainly two inventory systems, viz, Periodic Inventory System and Perpetual Inventory System. Periodic Inventory System Under this system, stocktaking 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. This is because its rarely feasible to take stocks while production continues. Thus, the annual stock-taking should be ‘organized well in advance to minimize production hold-ups. Perpetual Inventory System “The periodic inventory system has certain serious disadvantages which the perpetual inventory system overcomes. A perpetual inventory system is defined as ‘the method of reconting stores balances after each receipt and issue to facilitate regular checking and obviate closing dow for stock-taking.”' Thus, under this system, current balance of stores is always shown, in records, any receipts being added to and any issues being deducted from the balance after each transaction. As stated earlier, the records used for perpetual inventory arc bin cand and stores ledger. The operation of the system is given in Illustration 2.6 where Bin Card is prepared on perpetual inventory system; i, balance in stock has been calculated after each entry, in receipts or issues columns, 1. Wheldon’s Cost Accounting and Costing Methods.220212017 Ready 1 Resay [Ready | | Ready | [Ready | >incpal molar be 232 ‘Material Cos Perpetual inventory system is operated by taking the following steps racer oncliation of bin cards and stores ledger accounts "As we have sen earlit, the redees nach tem of tore ae kept simultaneously at two places ie, bind ee in ent e the perpetual inventory records, The balance ofan tem of lore ooh those ra gtd shoul agree with that shown n the stores ledger Any difference barn Fy ee asttes may be duet: some arithmetic ettorin werking out the Soles eek ere ene esting o non-postng in bin card or stores ledger. The Balancer nan, records should be reconciled after passing rectifying entries ary perp nate | Main etre of Goinamss Sag ook balances as shovin by bin cards | () A few items are physically counter and stores ledger should agree with | daily or at frequent intervals. patval Physical balance in store. This is | (i) All items are checked ‘within a definite best done by continuous stock-taking. Period such as, one month or two which is an integral part of the per- | months, so that cach iton & checked a Petual inventory system. The primary specific number of times in each year. Objectives of continuous stock-taking | (ii) The checking is carried out by special are to confirm that the perpetual staff, having no other responsibility for inventory system is functioning ’ Physical stocks or stock records, Propedy and to bring records intoline | (a) ‘Ay, differences are recorded in appro- With the physical stocks. Under this Priate reports system, a few items of stores are Bo Te Saily oF at frequent intervals and compared with the bin cards and ome ledger by the stores auditor. Whenever there isa difference between the recorded balance and teens tocks, an enquiry is made and the difference is adjusted in the acotae ns make them correspond with the physical count, {f should be noted that perpetual inventory system is not the same as continuous stock- taking, Whereas, perpetual inventory is a system of keeping up-to-date records, the falang fe aenock taking is physical checking of records with actusl stock, Continence stock- taking is only a part of perpetual inventory system The difference between book balance and physical balance may arise due to: (0) Clerical errors in posting and working out balances in bin card and stony ledger (2) Pilferage and breakages (6) Over or underissues or wrong issues (@) Variations in weight caused by evaporation or absorption of moisture (©) Breaking the bulk, ie, issuing materials in smaller quantities (P Placing materials in the wrong bin advantages: 1. The system helps in avoiding the long and costly work of physical checking of all the stocks at the end of the year, 2. It also avoids dislocation in production which arises in the case of periodic stock taking at the end of the year 3. As stock figures are readily available at all times, the Profit and Lose Account and Balance Sheet can be easily prepared at interim periods22022017 Ready Rea | Ready Ready >encipal rotar rial Cost ier, the stores shown tween and/ etwo Material Cost 233 “4. The system acts as a moral check on part ofthe staff ofthe stores department, and sepals them fo work honestly and to maintain up-to-date records ‘{ aystem of intemal check remains in operation all the time. &. Discrepancies are readily discovered and rectified. This gives an opportunity for preventing a recurrence in future. 7, The system helps in Keeping the stocks within the limits decided upon by the Frehagement 50 that excessive working capital is not sunk in the stocks 4, A detailed and reliable check on stores is obtained. Materials Abstract (Materials Issue Analysis Sheet) ‘This is ‘a document which isa classified record of material issues, returns and transfers. In other are, all materials requisitions, materials return notes and material transfer notes are Wlysed periodically by the cost accounting department to ascertain the materia cost ar ach job. This is done on a document known as Materials Abstract which is shown in Fig. 215, Tt should be noted that the total of the amount column of the issues posted in the stores ledger must agree with the materials abstract. Postings in the job ledger for various Accounts of jobs, products, production orders, ete, are made on the basis of different columns of the materials abstract. aS XYZ CO. LTD MATERIALS ABSTRACT Month or week ending ‘Stores Job (No. ~] Total indirect, k Requisition for materials a | No | | jobs _ | (Overheads) © L _| Total TE | | Fig. 2.15: Materials Absiract MATERIAL HANDLING Material handling is the movement of materials from one place or position to another. Such movements of materials may be horizontal or vertical. It is mainly concerned with movements of materials from the time of their purchase upto and including delivery of finished goods to customers. However, it does not include material movements which constitute an operation or inspection. 2. CIMA terminology. a2an2r20t7 Ready [Ready | Ready [Ready] ites rest) y— —_] >rincipal ‘otar macro 234 ‘Material Cost Principles of Good Material Handling An efficient and good material han: ng a scientific layout of the factory futomatic equipment for material handling Equipment used for Material Handling The following are the main types of material handling equipment: 1. Unloading equipment —fork lift trucks, Power-pallet trucks, ete 2. Handling in stores—o rk lift trucks, towveyors, rotabins or overhead stacking and reaching crane. 5 : : a LE % Delivery at operational points in the fctory—Crane, Power-pulled trucks, conveyor, ete. 4 Movement betwocen operations —Crane, conveyor hoists, etc. Delivery to customers—Rail or road transports, the following stores ledger account, (Figures are assumed), Sores Ledger Account Dae eae Tie Tae | bo ae] ee | a] oe |e] am |e Tac Coe fn] "|e | ci] Se] “2 [04 |e] a am | co az] @ lace =| Sl = ers es fry | 0 smo} fam! =) =] =] = [ym [5 [aa so | ¢ | 328 20 [5 | tae Shy] 0 | eof eso fsa} — | | | _ fsa | 5 | tao 00 | és] Sau wey} =} | Jos] we] | [|] 52ar02i2017 Ready Ready | Ready “| Resy—] vincpal rota vial Cost and ‘or, 2s e uw eee eee Material Cost 235 ice. The question is whether it should be the Methods of ra the current market pri . ae original purchase price or SS eee eel Important Methods: onthe date of issue or should some other price be oor this purpose. The question is important | 1. Fist.n,Frst-out Price (FPO) teee ie the pricing directly affects the amount of | 2. Last-in, First-out Price (LIFO) Profit or lose reported for the accounting period. 3. Simple Average Price Prepe method chosen puts higher value to closing | 4. Weighted Average Price Tack it will result in higher profi, and vice versa, | 5, Replacement Price sectr valuation of closing stock will result in| 6, Standard Price Other Methods: () Highest-in, First-out (HIFO) (ii) Next-in, First-out (NIFO) (iil) Specific Price (je) Base Stock Method (2) Periodic Simple Average (vi) Moving Simple Average (vii) Periodic Weighted Average (viii) Moving Weighted Average (éx) Inflated Price lower profits. It should be noted that methods discussed below are methods of pricing the issue of materials and not the methods of physically issuing materials. These methods are discussed and illustrated below. First-in, First-out (FIFO) Method = ‘This method is based on the assumption that ‘materials which are purchased first are issued first. Truses the price ofthe first batch of materials purchased for all issues until all units from this batch have been issued. After the first batch is fully issued, the price of the next batch eceived becomes the issue price. Upon this batch also getting fully used, the price of the Stl next batch is used for pricing and so on. In other words, the materials are issued at the oldest cost price listed in the stores ledger account and thus, the materials in stock are valued at the price of the latest purchases. ‘Three important effects of using FIFO method are: (@) Materials are priced at the actual cost (6) Charge to production for material cost is at the oldest prices of materials in stock (©) Closing stock is valued at the latest price paid Illustration 2.7 From the following transactions, prepare a Stores Ledger Account using FIFO method: Year 2012 1July Opening stock 500 units @ %20 each “-a4july Purchased GRN 574400 units @ €21 each / july Issued SR 251 600 units Sjuly Purchased GRN 578800 units @ 224 each gJuly Issued sR 258 500 units 1B July Issued SR 262” 300 units 24July Purchased GRN 584 500 units @ £25 each 28 July Issued SR 269 400 units GRN = Goods Received Notes; SR = Stores Requisition (These transactions have also been used to illustrate other methods of pricing).2212/2017 [Rea] Ready Ready [Resa | iuee vros(9) ¥ >eincpal Weta be - 236 Material Cost Solution: FIFO Method Stores Ledger Account Di Recs ees [tale wm [alee] © ) ela pon Rae | an GaN J unts| ef Te [ism | me [P| “et | Ou) Re | Ae ey] — PPT Peete shay ma | aot ar | ago] — | S|] T [20] 2 | ram 400] a1 | sao ow} — | —]—] fos 10000 2100 | 300] 21 | 6300 Stuly | 578 | 900 | 24 | 1920} — | — | _ | “me a. | 6300 ‘800 | 24 | 19,200 sity! — | —f—] —Jose} rao! ar | 30 fo] a: | am | co] 20 | ean Bhiy| = P= }=] =| a2]. so] 2 | rao] so | oe |? 24 July | 584 | 500 | 25 | 12500] — = - — | {300} 24 | 7200 '500 | 25 | 12500 ary! — | —[— | _] 29 24 | 7200 | | 25 | 250 | wor] 25 | s000 * Closing stock is 400 units @ %25 = ®10,000 raed be noted that the assumption of FIFO is only for accounting purpose, ic, the physical flow of materials need not necessarily be in the oxdor ofthe he ‘of cost, though sake 2 materials would be expected to move out of tock on a FIFO basis oeccr ‘oldest stocks are usually used up first. Advantages The following advantages are claimed for FIFO method: 1 It's based on a realistic assumption that materials are issued in the onder of their receipts, 2. Materials are issued at actual cost and thus no unrealized Profit/loss arises from the operation of this method, 3. Valuation of closing inventory is at cost as well as at the latest prices paid. 4, This method is easy to understand and simple to operate. Disadvantages The main disadvantages of this method are: 1+ As materials are charged to production at the old prices, the cost of production may lag behind the current economic values 2. This method goes not permit comparison of the costs of similar jobs or cost units because simifar jobs simultaneously started may be charged materials at different prices, 5. When prices are subject to frequent changes, this method involves ‘cumbersome records and calculations. ra pancts of rising prices, the FIFO method produces higher profits and results in higher tax liability because lower cost is charged to production’ Conversely, in periods of faling price the FIFO method produces lower profits and results in lower ter because they are derived from a higher cost of goods sold2210212017 Ready Rey] Rea] Ready “[Reaay | iee | ses(9) inca rotar ~TReaay | ‘st r Material Cost 237 Lastiin, First-out (LIFO) Method ‘hismethod operates in just the reverse order of FIFO method. Iti base on the assumption Ta he lact materials purchased are the first materials tobe issued. Thus, the price ofthe tae ch of the materials purchased is used first for all issues until all units from this teeth have been issued, after which the price ofthe previous batch of materials purchased card. It should be noted that physical flow of materials may not conform to LIFO assumption “Three points should be noted regarding this method: (@) Material issues are priced at actual cost (}) Charge to production for material cost is at latest prices paid {© Closing stock valuation is at the oldest prices paid and is completely out of line with the current prices Ilustration 2.8 Prepare a Stores Ledger Account, showing pricing of materials on LIFO bass, from the data given in Mlustration 2.7. . Solution: LIFO Method Stores Ledger Account Date Receipts l sues Balance zor [Rep | ty [Rate] Amt | Ref | Qty | Rate | Amt | Oty | Rate | Amt Gen |unis| | * [RO | Unis | z |e | unis| & | 2% my!— |—/-[ -]-]| — |—] —|,2| % | 1900 ajuly | 57a | 40 | 2 | 8000] — | — | — | —| {500} 20 | 10,000 400} 21 | 8400 omy |— |—|—| -| 400] 21 | 8400 600 200| 20 | 4,000| 300] 20 | 6000 ajuly | 578 | 800 | 28 | 1920} — | — | — | —|{300] 20 | 6000 | 800 | 24 | 19,200 sjuly | — | —|—| —| 258] soo] 24 300 | 20 | 6.000 | 300 | 26 | 7.200 ajay | — | =| =| 22 | 300] 24 300 | 20 | 6.000 2ajuly | 584 | 500 | 25 | 12500] — | — | — | —|{300] 20 | 6,000 500 | 25 } 12,500 asjuly | — | — | —| —| 269 | 400] 25. | 10.000 300 | 20] 6,000 l i | roo | 25 | 2500 * Closing stock is 300 units @ £20 = %6,000 + 100 units @ 25 = %2,500. Total 400 units at 28,500. ‘Advantages The main advantages of this method are: 1. Materials are charged to production at the latest prices paid. In times of rising prices, ‘quotation of prices for company’s product will be safe and profitable. 2. This method, like FIFO, does not result in any unrealized profit or loss. 3. This method is also quite simple to operate, particularly when prices are fairly steady.238 ‘Material Cost 2210212017 RoaVersely, in periods of falling prices, closing stock ey valued at old prices which are at Figher level and thus, profit would also be higher resulting in higher tax liability, || Mlustration 2.9 = The following isthe record of receipts and issues ofa certain ‘material in the factory during a week: Aprit 1 Opening Balance --50 tonnes @ 210 per tonne a] Issued 30 tonnes | 2 Received 60 tonnes @ 810.20 per tonne 3 Issued “25 tonnes. (Stock verification reveals loss of 1 tonne) F eceved back from orders...10 tonnes (Previously iseued at Sore per tonne) 5 Issued 40 tonnes Ready 6 Received @ 410.30 per tonne 7 Issued At what prices will you issue the materials? Use FIFO and LIFO methods for this | I Purpose and show the comparative results. neaey Solution: FIFO Method Stores Ledger Account Date Receipts sues Balance Apt | Oly Rate Ami_-| Qty Rate Aa ty Rate Ami a SS z — =—_ 2 == 50 10.00 S000 1 a 3000 300 | 20 1000 20000 4 2 020 2 201000 200.00 @ 1020 6120 A - 200 eet) BI $5 1020 561.00 . 3 1020 [34 1020 550.0 ¢ 0, 9580 541020 550.80 Return) 10915 “9150 (Contd) >éncial . _ solar2202/2017 Reaay —] Ready Ready “| Reay— Pineal rotar rial Co terials, current s may >rices. & inde level reat ring rT Material Cost 239 5 - = 5 401020408 | 14 1020 142.80 1959150 é 103022660 | — = [3 yo 280 2 1030 22660 7 =f aajis 102014280 0 9159150 | 1030 11420 | 8__ 10308240 T Closing stock = 8 tonnes @ %10.30 = %82.40. See Received back from orders on 4 April has been treated as a new purchase. LIFO Method Stores Ledger Account Date Receipts Issues Balance apt | Qy Rate Amt [Qty Rate Amt | Oly Rate Amt Units e | Units ¢ z | units i == = = 5010.00 500.00 ai == 301000 300 | 20 1000 200.00 2 @ 1020~—«iz = a 6 10 52.00 3 => 3% 1020 255 | {20 1000 20000 3510.20 357.00 3 == — | 4(€esy 10201020 | [20 1000 "20000 341020 34680 4 7 95 91) — — — 20 10.00 20000 (Return) 3410.20 346.80 10959150 5 = Pf 885 stso | [2 1000 20900 301020 30600 | 14 1020 _40.80_ 6 Bm 1030 mem fo — — — 20 10.00 20000 4 1020 40.80 21030 226.60 7 a= = 2 1030 226.60 38] 4 1020 40.80 121000 12000 | 8 10.00 __80.00 * Closing stock 8 tonnes @ 10 each = %80. AVERAGE COST METHODS ‘These methods are based on the assumption that when materials purchased in different lots are stored together, their identity is lost, and therefore, issues should be charged at an average price. Basically, average prices are of two types—simple average and weighted average, Simple Average Method ‘Simple average price is calculated by adding 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22002017 “| Reaay Ready | Ready | Ready Ready ‘ire & 110s) ¥ taotar 2.40 ‘Material Cost that total. This method does not take into account the quantities of materials in stock while calculating the average. Suppose, the following three lots of materials are in stock when material is to be issued: 500 units purchased @ %20 200 units purchased @ @21 700 units purchased @ 22 2 Simple Average Price = While calculating the simple average, the price of lots of materials which are assumed to have been completely issued on FIFO basis are not taken into account. IMlustration 2.10 Prepare Stores Ledger Account by Simple Average Method from the transactions given. in Illustration 2.7, Solution: Simple Average Price Method Stores Ledger Account Date Receipts Issues Balance 2m | Ree Oty Rate Amt | Ro Qty Rate Amt | Qty Rate Ami GRN Units ¢ | SR Unis @ | Unis 7 tay | — — — fF 50020 10,000 4July | 574 400 2 8400 | — — — —| 90 — 13400 Stuy | — — = “— 1351 600 2050 12300] 300 — 6100 syuly | 578 900 24 20} — — — "| too — 25300 9fuly | — — — “=| 288 500 2250 11250} 600 — 14750 whuly | — ~ — — —| 262 300 2400 7200] 300 — 6850 2ayuly | 584 500 25 ss] — = — | a9 19,50, zejuly | = — = =] 269 4002450 9800] 400 — 9550 Working Notes: Various issue prices are computed as follows: On 6 July = @0+21)22 = 72050 On 9July = @i+24+2 = e250 On 13July = @4=1) 724.00 On 28July = 24425)+2 = ¥2450 Advantages and Disadvantages of Simple Average Method The only advantage that this method enjoys is its simplicity. No more can be said in favour of this method as it Pays no consideration to the relative quantities held at each price. For this reason, this method is considered unscientific and it usally produces unsatisfactory results. The value of closing stocks may be sometimes negative, which is quite absurd. For instance, if 100 units at 210 each and 1,000 units at ®2 each are held in stock at a total value of 73,000, when 600 units are issued at a simple average price of %6, i) (10 + 2) + 2, the closing stock of 400 units will be valued at a negative value of 8600, which s absurd. These figures have been exaggerated to illustrate the point. Another disdvantage of this method is that it does not charge materials at actual cost and thus, may result in unrealized profit or loss.222t2017 Reay Ready tures] sr0s(9) >fnepal rotat Tost ile en Material Cost 21 Weighted Average Method “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 rotal cost of material in stock, from which the material to be priced could have been drawn, by the fotal quantity cf material in that stock. The simple formula is that weighted average price at any time is the balance value figure divided by the balance units figure, IMlustration 2.11 From the transactions given in Illustration 2.7, prepare Stores Ledger Account assuming pricing according to Weighted Average Method. Solution: Weighted Average Method Stores Ledger Account Date Receipts Issues Balance zor | Rf Qty Rate Amt | Ref. * Qty Rate Amt | Qiy Rate Amt GRN_Units @ —@ | SR Units | mits @ in | === — = = =|] 500 20.000 10.000 ajuly | 574 400 21 sto | — — — — —| 900 20444 18400 éjly | — — — —| 251 600 244s 12267 | 300 20444 6133, Bjuly | 578 80 24 19200) — — —— “"_ |ar00 23030 25333, gyuly| — — — (—| 258 500 23.030 11,515 | 600 23030 13818, Bry | —- — — 262 300 23.030 6909 | 300 23.030 6909 2ajuly | 584 500 25 1250] — — — = —| Bod 24261 19409 july | — — — | 269 400242619705 | 400 24261 9704 Notes: The issue prices are calculated as follows: On July 18400 = 900units = €20.444 On 8July 25333 + 1100units = %23.000 On 24 July %19409 + 800 units = 24.261 The fresh issue rate is determined after each purchase and not atthe time of each issue. ‘Thus, as soon as fresh supply is received, a new price is calculated and all issues are then valued at that price until the next supply is received when a new issue price will be calculated. Advantages This method has the following advantages: 1. This method smoothens out the effect of fluctuations in purchase price. It is thus, particularly advantageous where price variations are wide so that extreme prices are ironed out. 2. The new issue price is calculated at the time of each new purchase and not at the time of each issue. Since receipts are much less frequent than issues, the work of making calculations is reduced. 3. No unrealized profit or loss arises by the use of this method. Disadvantages 1. Issue prices may not be at the current market prices. 2. The method calls for many calculations where purchases are made frequently.220212017 Feay Reaay ~]Ready | ‘tare & ros(9) y rotar 242 Material Cost 3 To avoid errors, the average price must be calculated toa sufficient numberof decimal Points. This makes the operation of the method somewhat tedious ‘4+ Excessively high or low prices paid in the past are reflected in the average for a considerable time after the expensive (or inexpensive) material has been cor aanea IMlustration 2.12 ‘The following transactions occur in the purchase and issue of a material: Jan, 2 Purchased 4,000 units @ 4.00 per unit Jan, 20 Purchased 500 units @ €5.00 per unit Feb. 5 Issued 2,000 units Feb. 10 Purchased 6,000 units @ %6,00 per unit Feb. 12 Issued 4000 units March 2 Issued 1,000 units March 5 Issued 2,000 units March 15 Purchased 4,500 units @ 5.50 per unit March 20 Issued 3000 units From the above, prepare the Stores Ledgtr Account using the Weighted Average Price, Solution: Weighted Average Price Stores Ledger Account Date Receipls Tues Balance Gy Rate Amt [Qty Rate Amt | Oly Rate Amr [Units ee Units ft | units ee Jan. 2 | 4000 400 1600 | — = | 4000 4.000 16,000 Jan. 20 | “500 500 2.500 — — | 4500 4.111 18500 Be elem ch wpe | 200 41 eam | Sep HE 10278, Feb. 10 | 6000 6.00 36,000 — — | 8500 5445 46.278 Fo fo = | #000 5445 21780 | 4500 5445 24/498 mee] = > = | yo sus ‘sus | 3am sae 248 Ma 5 | — = | 2000 5445 10890 | 1500 S445 ‘B63 Mar. 15 | 4500 550 24,750 — = | 6000 5486 32013 Mer | — =~ | 3000 sass_reasr | Samy 26 16456 ‘Closing stock: 3,000 units, value ®16A56, Working Notes: Weighted Average Price on Jan. 20 (On Feb. 10 On March 15 = Replacement Price Method Replacement price is the price at which materials would be replaced, ie, the market Price on the date of issue. This method is used when itis desired to reflect the eancnn prices in be passed on to the customer.