MATERIAL CONTROL AND COSTING

3.0 DEFINITION/CLASSIFICATION OF MATERIAL

Material is defined as all the tangible material assets of an organization other than its fixed assts. It is also called stocks,
stores, merchandise and inventory. Stock consists of:
 Raw materials
 Work-in-progress
 Finished goods
 Merchandise ready for sale
 Materials to be incorporated into a finished product (i.e. component parts)
 Consumables such as stationery
3.1 DESCRIPTION OF STORE DEPARTMENT
Store is the place where materials are kept for future use. Effective management of the store is very important to minimize
cost and maximize profit

i) The Store Functions;

1. Purchasing / Purchasing Procedures
 Identify material needed
 Locate the suppliers
 Negotiate with the suppliers
 Make contract and place orders for the materials
2. Operating The Store
 Receive and accept or reject the materials ordered
 Hold or keep the items for future use
 Issue the items out for use
3. Stock Control
 Recording stock
 Checking stock
 Placing replenishment / re-order of the stock
 Valuation of stock
ii) Objectives/Purposes/ of Storing Materials

i. To ensure sufficient goods are available to meet expected demand

ii. To provide a buffer storage or safety stock
iii. To meet any future shortages
iv. To take advantage of bulk purchasing discounts
v. To absorb seasonal fluctuations and any variations in usage and demand
vi. To allow production process to flow smoothly and efficiently
vii. As a deliberate investment policy, especially in terms of inflation or possible shortages

iii) Factors That Facilitate Effective Material Cost Control

i. Preparing budget of material usage and purchases
ii. Handling of purchases by competent and qualified personnel
iii. Availability of sufficient and effective storage facilities
iv. Classification of materials as direct or indirect with unique code and assignment of cost to cost units or cost
centres
v. Documentation and control at each stage
vi. Effective co-ordination among all department involved in material handling e.g. purchasing, receiving, storage
and usage
vii. Effective internal control system/audit
viii. Well organized stock taking and its reconciliation

1
3.2 FUNCTIONS OF PURCHASING DEPARTMENT
i. Selection of the supplier to use
ii. Preparation of purchase order
iii. Monitoring suppliers performance
iv. Re-negotiate / cancel purchase order when conditions change
v. Provide information to management and participate in management planning
vi. Review purchase specification
vii. Protect the organisation from unnecessary commitment resulting from inappropriate contracts with suppliers
viii. Dispose all obsolete material, equipment or scrap that is no longer needed
i) Methods of Purchasing
i. Verbal contract
ii. Standard purchase order form
iii. Cash purchase
iv. Spot contract for immediate delivery
v. Future contract for delivery at a stipulated future date
ii) Settlement Method
i. Cash with order
ii. Part-payment when contract is made
iii. Stage payment during the course of the contract
iv. Payment upon completion
3.3 RECEIPT AND STORAGE OF MATERIALS
Store operations include:
1. Receiving goods
2. Holding / storing stocks and
3. Issuing stocks
i) Receiving Goods
When goods are received, they are checked for quantity and description against the delivery note (DN) and purchase
order. If they are satisfactory, a Goods Received Note (GRN) is prepared. If the goods do not meet the specification or
purchase order, they are returned immediately to the supplier if possible. If not, they are stored separately and marked to
be returned. Rejected goods should be covered by a debit note.
ii) Holding / Storing Stocks
After acceptance, the goods are stored in the proper location in the store for issue when required. Frequently used items
should be nearest to the issue point, items used together should be stored together, isolate dangerous stock and change
location when demand change.
Recording of Stores
There are two main documents for recording the quantity of materials held in the store. They are:
1. The Bin Card or Stock Card Kept in the Store
A bin card shows the level of inventory of an item at a particular stores location. It is kept with the actual inventory and
it is updated by the storekeeper as inventories are received and issued. A typical bin card is shown below:

BIN CARD

Bin number -------------------- Location -----------------------

Material code --------------------- Store ledger number -----------------------
Description ---------------------
Receipts Issues
Date GRN No. Quantity Date Requisition Quantity Inventory Balance
No

Note: The bin card does not show the monetary value of materials. It is just the quantity received and issued.
2
2. The Stores Ledger Card or Account
The stores ledger card or account is kept in the accounting office and form part of the accounting system. This shows the
monetary value of materials received and issued.
A typical store ledger is shown below:

STORE LEDGER CARD / ACCOUNT

Material ---------------------- Re-order Level ------------------------------

Code ---------------------- Re-Order Quantity ------------------------------
Maximum Quantity ------------------------------
Minimum Quantity ------------------------------
Date Receipts Issues Inventory Balance
GRN Qty. Unit Amt. Requisition Qty Unit Amt. Qty. Unit Amt.
No. Price No. Price Price
N N N N N

iii) Issuing Stocks

i. Requisition note is issued by the department that needs the materials to the store indicating job no., number of
materials needed, date and authorized signature
ii. Store issues out the specified stock
iii. The completed requisition is passed to stock clerk who adjusts stock records to show new balance after issue and
copy price from stock record to requisition form
3.4 FACTORS THAT DETERMINE THE DESIGN OF OPERATING THE STORE
i. Volume of material handled
ii. Frequency of transaction
iii. Range and variety of stock items
iv. The kind of demand on the store
v. The type of store
vi. The value of the goods
Perpetual Inventory System
This is a system of stock control where records are kept as a perpetual record of receipts and issues of materials. This is
to say that the stock record is updated each time there is receipt or issue of material. This makes it possible to know the
stock level at any point in time
Stock Taking
This is the physical counting of materials in the store. There are two types of stock taking methods namely:
i. Annual / Periodic Stock Taking
This is a method of stock taking that counts and value stocks at the end of a given period usually quarterly, ½ yearly
or annually.
Advantages
i. It is less expensive
ii. The inconveniencies of regular or frequent stock count is avoided
Disadvantages
i. It may require a disruption of operation activities at the end of the year when stock take is to be taken
ii. The rate of inaccuracies may be high due to large no. of work involved
iii. It may increase theft and pilferages that ought to have been noted earlier and corrected.

ii. Continuous Stock Taking

This is the counting of physical quantity of materials in store s regularly, a few at a time, until all items are checked at
least once a year. Stock items are counted at frequent intervals on a random rotational basis and the results of the counts
are reconciled with the corresponding figure on the bin card. This stock take is usually carried out by an expert who is
not a member of the store department.

3
 Advantages
i. It is deterrent to pilferage and theft
ii. The closure of store for an annual stock count is avoided
iii. Discrepancies are discovered earlier and remedied more promptly
iv. The store system is kept constantly under review
v. It enhances effective stock control

Disadvantages
i. It is expensive to operate

Effective Stock Taking Procedures

The following can guide in having an effective stock take
i. Stock items should be arranged as to avoid omission and double counting
ii. Arrangement and counting should not be done simultaneously
iii. Counting should be done by at least two persons, one is counting and the other is recording
iv. Stock take should be well planned and organized to minimize or avoid production disruptions
v. The final stock sheet should be checked against the store records and discrepancies investigated immediately
Causes of Stock Discrepancies
i. Incomplete entries causes by non-completion of original document
ii. Casting errors on the stock records
iii. Over or under issue due to carelessness of the issuing officer
iv. Recording material in the wrong stock record
v. Movement of stock without proper documentations
vi. Pilferages and theft
vii. Loss due to breakage and evaporation
viii. Inaccuracies in the stock count caused by:
a) Omission
b) Double counting

The need for Stock Control / Objectives of Stock Control

i. Materials can be recorded on receipt in relation to both quantity received and price per unit
ii. Issues of materials to production can be recorded and the balance in store can be known both the quantity and value
iii. Check can be implemented on a regular or random basis to minimize losses due to pilferage or damages
iv. Records can be examined to highlight slow moving stock which may become obsolete
v. New stocks can be ordered when the re-order level is reached
vi. Signal is raised when the stock falls to minimum stock level which invariably guides against stock out
vii. Material costs are charged to the appropriate cost centre when materials are issued from store
viii. Return to store and supplier can be properly recorded
ix. The valuation of stock charged to production and the closing stock can be accurately measured.

Illustration 3.2
A wholesaler has 8,450 units outstanding for part X100 on existing customer’s order. There are 3,925 units in inventory
and the calculated free inventory is 5,525 units. How many units does the wholesaler have on order with his supplier?
SUGGESTED SOLUTION:
Outstanding units = 8,450
Units in Inventory = 3,925

3.5 MATERIAL ISSUES PRICING AND VALUATION OF STOCKS

When materials are needed from store, the user prepares a material requisition note to request for the material needed.
When these materials are issued, they should be priced. The price to use now constitutes a problem. This is because
materials of the same quality and identification may have been bought at different prices from time to time. To solve this
problem, there are different methods that could be used to price materials issued to production depending on the method
chosen by the organisation.

4
i) Objectives of Material Issues Pricing
i. To charge to production on a consistent and realistic basis the cost of materials used
ii. To provide a satisfactory basis of valuing stock at the end of each period
iii. To determine the selling price
iv. To determine the profitability on jobs

ii) Methods of Material Issues Pricing and Valuing Stocks:

1. First –in First- out (FIFO) Pricing Method

The FIFO method is based on the assumption that materials are issued out to production according to how they are
received i.e. the materials received earlier are issued out to production as they come to the store. This means that the
oldest costs of goods are assigned to the units that are transferred out of store first and the closing stock is measured by
the cost of units most recently acquired.
Advantages
i. It is simple to calculate
ii. Stock is valued using recent price
iii. It uses actual price
iv. It issues materials in order of receipt
v. It avoids materials becoming obsolete

Disadvantages
i. It is difficult to compare jobs because different prices of materials are used
ii. The issue price may not reflect current economic value
iii. Stock with low turnover will tend to be priced at old prices
iv. In times of inflation, product cost may be low while replacement cost is high, thus profit may be overstated

Illustration 3.3
The following materials are received into store as follows:
Date Units Price (N)
February 2010:
12 180 5.00
15 150 6.00
21 240 4.50
The store keeper issues out 350 units to production on the 24th of February. What is the cost of goods sold and value of
closing stock?

SUGGESTED SOLUTION FIFO Method

Total units received = 180 + 150 + 240 = 570 units

Cost of goods sold = Feb 12: 180 x ₦5 = ₦900

15: 150 x ₦6 = ₦900
21: 20 x ₦4.5 = ₦90
350 ₦1,890

Value of closing inventory = 220 units not issued X ₦4.50 = ₦990

2. Last-in First-out (LIFO) Pricing Method

This method assumes that the latest materials received are issue out to production first. This means that the latest cost of
materials are assigned to stock issued to production while closing stocks are valued using the oldest cost of materials
Advantages
i. It is fairly simple to calculate
ii. The issue price is near to the current economic value
Disadvantages
i. It is not realistic as it is contrary to normal issue procedures
ii. Stocks value may significantly be understated

5
Illustration 3.4
Use the same data as in illustration 3. What is the cost of goods sold and value of closing stock using LIFO method of
pricing issue?
SUGGESTED SOLUTION 3.4 LIFO Method
Total units received = 180 + 150 + 240 = 570 units

Cost of goods sold = Feb 21: 240 x ₦4.5 = ₦1,080

15: 110 x ₦6 = ₦660
350 ₦1,740

Value of closing inventory = 40 units X 6 = ₦240

180 units X 5 = ₦900
220 ₦1,140

3. Weighted Average Pricing Method

This method uses the average price of FIFO and LIFO. It averages prices after weighing different prices by their quantity
with each receipt of material. The weighted average price is calculated each time there is a fresh receipt of goods and
this price is used to value the issue of materials to production and closing stocks

Advantages
i. It smoothens out fluctuations in issue prices
ii. The comparison of different jobs is easier
iii. Stocks are valued at price reasonably related to the current conditions

Disadvantages
i. Calculations have to be made to approximated figures
ii. Issue of price may not reflect current economic values
Illustration 3.5
Using the same information in illustration 3, calculate the cost of goods sold and the value of closing stock

SUGGESTED SOLUTION 3.5 Weighted Average Method

Calculation of weighted price: Feb 12: 180 x ₦5 = ₦900
15: 150 x ₦6 = ₦900
21: 240 x ₦4.5 = ₦1,080
570 ₦2,880
Weighted price = 2,880/570 = ₦5.053

Cost of goods sold = 350 X ₦5.053 = ₦1,768.55

Value of closing inventory = 220 units not issued X ₦5.053 = ₦1,110

4. Standard Price
This is often part of a standard costing system. A pre-determined price is set after taking into consideration factors which
may influence the prices of materials in a future period. The pre-determined price is used in pricing out all issues of
materials to production

Advantages
i. Jobs can be compared since material are issued at standard cost
ii. It makes it possible to compare actual material price and standard price
iii. It is useful for control purposes

Disadvantages
i. Setting standard price may be time consuming
ii. Standard price may not be useful in an unstable economy

6
5. Replacement Cost
This method uses current market price to issue material to production and value closing stock regardless of how much
the stock were actually bought. It is mostly used for short term decision making.

Other Methods of Materials Issues Pricing Include:

6. Simple Average method
7. Base stock method

Illustration 3.6
The following data are supplied in respect of Maryam Limited:
Materials received
A B
Kg N kg N
Week: 1 600 1,200 1,200 1,560
2 500 1,050 750 1,050
3 300 660 1,600 2,800
4 400 760 750 1,470
Opening balance: 500 1,250 2,600 3,900

Materials issued to production

A B
Kg Kg
Week 1 350 1,100
2 450 700
3 250 1,300
4 300 600
Required:
a) What is the simple average price for the 4 weeks receipts of material A?
b) What is the weighted average price of the 4 weeks receipts of material B?
c) What is the value of balance of material B in stores at the close of the fourth week if issues are priced on LIFO
basis?
SUGGESTED SOLUTION:
a) Simple average (Material A) = 1,200 + 1,050 + 660 + 760 + 1,250 = ₦984
5

b) Weighted average price (Material B) = Units ₦/unit ₦

1 1,200 X 1,560 = 1,872,000
2 750 X 1,050 = 787,500
3 1,600 X 2,800 = 4,480,000
4 750 X 1,470 = 1,102,500
Opening balance: 2,600 X 3,900 = 10,140,000
6,900 18,382,000

Weighted price = ₦18,382,000/6,900 = ₦2,664.06

c) Value of closing inventory for material B = 600 units X ₦1,560 = ₦936,000

2,600 units X ₦3,900 = ₦10,140,000
3,200 units ₦11,076,000

3.6 STOCK CONTROL LEVEL

The level of stock held will depend on a number of variables which have cost implications. Management must make
decision about the control of stock level to minimize cost and also to avoid running out of stock so that profit can be
maximised. The following stock levels need to be considered:

7
 i. Re-order stock level
ii. Minimum stock level or buffer stock or safety stock level
iii. Maximum stock level
iv. Re-order stock quantity or Economic Order Quantity
v. Average stock
Illustration 3.7
The following data relates to Good work company Ltd. with respect to material AY4
 12,000 units of material will be used every day for a 360 days year
 It will cost ₦50,000 to place each order
 The cost of one unit of AY4 is ₦1,200 and it will cost 10% of this amount to hold each stock
 Daily usage will not exceed 12,500 units and not less than 11,500 unit
 It takes the supplier maximum period of 4 days to deliver but the shortest delivery period could be 2 days
 Economic Order Quantity is 60,000 units
Calculate the various stock levels
The above example will be used to illustrate and explain the various stock levels as follows:
i) Re-Order Level
This is the level at which an order will be placed for additional supply of materials to avoid stock out. When inventory
reach this level an order should be placed to replenish inventories. It is influence by:
 Rate of consumption and
 Delivery period
It is calculated as:
ROL = maximum usage X maximum lead time (lead time is the delivery period)

Using Illustration 3.7,

ROL = 12,500 x 4
= 50,000 units
ii) Minimum Stock Level
This is the lowest level at which stock may be allowed to fall. It is also called the safety stock and buffer stock. It is a
warning level to draw management attention to the fact that inventories are approaching a dangerously low level and that
stock outs are possible. It is influenced by the following factors:
 Rate of consumption
 Delivery period i.e. the lead time
 The re-order level

It is calculated as:
Minimum Stock level = ROL – [average usage x average lead time]

Using Illustration 3.7,

Minimum Stock level = 50,000 – [(12500 + 11,500)/2 x (4 + 2)/2]
= 50,000 – [12,000 x 3]
= 14,000 units
iii) Maximum Stock level
This is the maximum level of stock that can be held at any given time. It also acts as a warning level to management that
inventories are reaching a potentially wasteful level. It is influenced by the following factors:
 Storage facilities
 The nature of stock such as its Perishability and seasonability
 The cost of storage
 The rate of consumption
 The Re-order Quantity / EOQ
 The delivery period
 The Re-order level
It is calculated as:
Maximum Stock level = ROL + EOQ – [minimum usage x minimum lead time]

8
Using Illustration 3.7,
Maximum Stock level = 50,000 + 60,000 – [11500 x 2]
= 87,000 units

iv) Re-Order Quantity / Economic Order Quantity (EOQ)

This is the optimum quantity that should be ordered each time an order is placed. It is to optimize material cost. The cost
of material is made up of the following:
1. Holding / Carrying Cost: this comprises of:
 Forgone interest on capital
 Storage charges e.g. rent, light and heating
 Store administration cost i.e. staff salary, equipment maintenance and handling charges
 Insurance and security
 Pilferages and damages
 Stock taking
 Handling costs e.g. cost of packing and unpacking stock

2. Ordering Cost: This includes:

 Administrative cost associated with purchasing, accounting and receiving goods
 Transportation cost i.e. carriage inward
 Set-up and tooling costs of production run for goods manufactured internally
 The purchase price of stock

3. Stock out Cost: This includes:

 Loss of contribution
 Loss of future sales
 Loss of customer goodwill
 Loss of production stoppage i.e. idle time payment
 Labour frustration over stoppage which may lead to labour turnover
 Extra cost of urgent replenishment purchases

EOQ is calculated as: 2DCo

Cc
Where D = Annual demand or Demand in the period
Co = Ordering cost
Cc = Carrying cost per annum / per period

Using Illustration 3.7,

D = 12,000 x 360 = 4,320,000
Co = ₦50,000
Cc = 10% of N1,200 = ₦120

Therefore EOQ = 2 x 4,320,000 x 50,000

120

= 60,000 units

Assumption of EOQ
The following are the assumptions of EOQ:
i. No price discount is allowed
ii. Demand rate is constant
iii. Carrying cost is directly proportionate to the value of stock held
iv. No stock outs are allowed
v. Replenishment of stock is instantaneous

9
v) Average Stock Level
The formula for the average inventory level assumes that inventory levels fluctuate evenly between the minimum
inventory level and the highest possible inventory level (the amount of inventory immediately after an order is received,
i.e. safety stock + re-order quantity). It is calculated as:
Average inventory = safety inventory + ½ re-order quantity
Using Illustration 3.7
Average stock level = 14,000 + ½ x 60,000
= 47,000 units

Alternatively, average stock level can be calculated as:

Maximum stock level + Minimum stock level

2
= 87,000 + 14,000
2 = 50,500 units

3.7 PRACTICE QUESTIONS

6. From the information below which relates to component XYZ, prepare statements using each of the following methods
of stock accounting viz:
i. Weighted average method ii. Standard cost iii. Replacement cost
To show the following:
a) The amount to be charges to cost of production b) The value of closing stock

Date Receipts Unit Issues to Market

Cost (N) production unit price (N)
Feb. 1 100 41 41
10 75 42 42
15 50 43
20 65 44
23 40 45 45
30 50 46
You may assume the company had no opening stock of component XYZ and that in the case of method (ii) it is the
company practice to account for component XYZ in terms of standard unit cost of ₦40
7. On 1st January, Mr. Gorimapa started a small business buying and selling a special tool. He invested his savings of
₦35,000 in the business and during the next six months, the following transactions occurred:
Purchases Sales
Date of Receipt Quantity Total Cost Date of Quantity Total value
(Boxes) N Dispatch (Boxes) N
13th January
8th February 200 7,200
11th March 400 15,200 10th February 500 25,000
th
12 April 600 24,000
15th June 400 14,000 20th April 600 27,000
500 14,000 25th June 400 15,200

The tools are stored in premises Mr. Gorimapa has rented and the closing stock of the tools counted on 30 th June was
500 boxes. Other expenses incurred and paid in cash during the six month period amounted to ₦2,300.
Required:
a) Calculate the value of the materials issues during the six month period and the value of closing stock at the end of
June, using the following methods of pricing
i. First-in-First-out ii. Last-in-First-out iii. Weighted average (to two decimal places)

b) Calculate and discuss the effect each of the three methods of material pricing will have on the reported profit of the
business
10
8. For the six months ended 30th April 2010, Asese Ltd bought a particular product and sold to customers in Kaduna.
There is an opening stock of 500 units valued at ₦70 each. The following transactions took place:
Date Quantity purchased Unit cost N
January 500 74
March 450 77
May 750 79

Date Quantity sold Unit Price N

February 700 100
April 500 110
June 800 115

Required:
a) Record the above transaction on a store ledger card using each of the following methods:
i. FIFO ii. LIFO iii. Weighted average method
b) Determine the gross profit for the period using the average method of stock valuation
c) Without preparing any trading account for the period, state by how much gross profit under LIFO will be
different from that of FIFO method.
9. ABC Ltd purchases 20,000 units of material in a year. Ordering cost per order is ₦16 and unit purchase price is ₦10.
Annual holding cost per naira of stock is 40 kobo.

Required: Calculate:
i. EOQ
ii. Number of order in a year
iii. Carrying cost of inventory
iv. Total material cost for the year
10. A large retailer with multiple outlets maintains a central warehouse from which the outlets are supplied. The following
information is available for product K
Average usage 350 per day
Minimum usage 180 per day
Maximum usage 420 per day
Lead time for replenishment 11 – 15 days
Re-order quantity 6,500 units
Re-order level 6,300 units
Required:
a) Based on the information above, what is the maximum level of inventory?
b) What is the buffer stock?

11. A firm’s annual requirement is 10,000 units. Stock carrying cost per annum is ₦2 per unit. Ordering cost per order
is ₦100.
Required:
a) Calculate the EOQ
b) Assuming annual period of 50 weeks and a lead time of 3 weeks and constant usage of materials, calculate the
re-order level
12. A component has a safety inventory of 500 units, a re-order quantity of 3,000 units and a rate of demand which varies
between 200 and 700 per week. The average inventory is approximately?
13. The following data relate to a stock item component of a company.
Normal or average usage 50 units per week
Minimum usage 25 units per week
Maximum usage 75 units per week
EOQ 300 units
Lead time (re-order period) 4 – 6 weeks
Calculate:
i. Re-order level ii. Safety stock iii. Maximum level

11
14. Benue Links Motors Limited buys certain type of gear box for use in one of its Macopollo bus models. The
followings are summary of the receipts and issues of the gear box for the month of January.
Opening stock on 1st January 200 gear boxes at ₦145
April 4, 2017 Purchased 100 gear boxes at ₦185
April 8, 2017 Issued 50 gear boxes at ₦200
April 10, 2017 Purchased 300 gear boxes at ₦190
April 11, 2017 Issued 200 gear boxes at ₦195
April 12, 2017 Issued 200 gear boxes at ₦210
April 15, 2017 Purchased 150 gear boxes at ₦160
April 21, 2017 Issued 100 gear boxes at ₦220
April 25, 2017 Purchased 100 gear boxes at ₦135
April 30, 2017 Issued 50 gear boxes at ₦205

You are required to:

a) show the appropriate stores ledger using:
i. FIFO method
ii. LIFO method
iii. Weighted average method

b) determine the profit for the period under each method

15. King Jajay Solution Ventures produces a special “Recession Tonic” to combat Laziness Fever. The
following particulars were extracted from his records:
Monthly customers’ demand for Recession Tonic 500 pieces
Raw materials required to produce one piece of Recession Tonic 10 litres of Chloride
Ordering cost ₦30 per order
Storage cost per unit of raw material 20% of purchase price
Purchase price of raw material ₦50/ litres of Chloride
Maximum usage 6,700 litres/month
Minimum usage 2,300 litres/month
Re-order period 3 to 6 days

You are required to determine the following.

i) Annual demand of raw material
ii) Re-order quantity
iii) Re-order stock level
iv) Maximum stock level
v) Minimum stock level
v) Average stock level

12