Professional Documents
Culture Documents
SECTION B
Answer any three questions. Each correct answer carries five marks (3x5=15)
2.Write a note on inventory-related costs.
There are four main types of cost in inventory :
Purchase Cost : The actual cost of materials. The most basic type of inventory cost is
the purchase price. Some businesses, such as retailers, buy finished goods inventory that
is ready for resale as soon as they receive it. Alternatively you might purchase
component parts, and assemble them into new products for sale.
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Ordering costs: Ordering costs have to do with placing orders, receiving and storage.
Transportation and invoice processing are also included. Lowering these costs would be
accomplished by placing small number of orders, each for a large quantity. Unlike
carrying costs, ordering expenses are generally expressed as a monetary value per order.
If the business is in manufacturing, then to production set up costs are considered instead.
Holding\ carrying cost\Safety stock: This cost is measured as a percentage of the unit
cost of the item. This measure, gives a basis for estimating what it actually costs a firm to
carry stock. This cost includes: 1) Interest on capital. 2) Insurance and tax charges. 3)
Storage costs – any labour, the costs of provisions of storage area and facilities like bins,
racks, etc. 4) Allowance for deterioration or spoilage. 5) Salaries of stores staff. 6)
Obsolescence. These charges increase as inventory levels rise. To minimize carrying
costs, management makes frequent orders of small quantities.
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Holding costs are commonly assessed as a percentage of unit value, rather than
attempting to derive monetary value for each of these costs individually. This practice is
a reflection of the difficulty inherent in deriving a specific per unit cost, for example,
obsolescence or theft.
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Stock-out costs: Stock out or shortfall costs(Ks) represent lost sales due to lack of
supply for consumers. How these costs are calculated can be a matter of contention
between sales and logistics managers. Sales departments prefer these numbers be kept
low so that an ample stock will always be kept. Logistics managers prefer to err on the
side of caution to reduce warehousing costs. They include sales that are lost, both short
and long term, when a desired item is not available; the costs associated with back
ordering the missing item; or expenses related to stopping the production line because a
component part has not arrived. These charges are probably the most difficult to
compute, but arguably the most important because they represent the costs incurred by
customers when an inventory policy falters.
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Spoilage Costs
Perishable inventory stock can rot or spoil if not sold in time, so controlling inventory to
prevent spoilage is essential. Products that expire are a concern for many industries.
Industries such as the food and beverage, pharmaceutical, healthcare and cosmetic
industries, are affected by the expiration and use-by dates of their products. 1
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3) Write a note on vendor management.
Vendor management is a term that describes the processes organizations use to manage their
suppliers, who are also known as vendors. Vendor management includes activities such as
selecting vendors, negotiating contracts, controlling costs, reducing vendor-related risks and
ensuring service delivery.
The vendors used by a company will vary considerably depending on the nature of the
organization, and could include companies as diverse as seafood suppliers, IT vendors,
cleaners and marketing consultants. Vendors can also range in size from sole traders to large
organizations.
Vendor management is important for a number of reasons. For one thing, vendor
management plays a key role when it comes to selecting the right vendor for a particular
business need. In addition, companies can use vendor management to achieve business goals,
such as harnessing opportunities for cost savings, as well as taking steps to speed up the
onboarding process.
Vendors also need to be managed effectively in order to reduce the risk of supply chain
disruption and ensure the goods and services provided are delivered on time and to the
expected standard. Beyond this, an effective vendor management process can help companies
build stronger relationships with their vendors which may, in turn, lead to opportunities to
negotiate better rates.
The material manager can suggest the new alternatives to reduce the cost or dependence on
imports of materials. The import substitution also results in savings of valuable foreign
exchange, thereby helping in the growth of the economy.
(b) Material Management and Production department:
Material department helps in a long way in providing uninterrupted supply of materials.
Unless there is a close harmony and mutual trust between these two departments, the
unrestricted flow of production cannot be maintained.
The materials department advises the production department promptly of any change in
quality, quantity, increased rejection, thereby enabling any changes in scheduling to be
carried out with minimum delay.
For spare parts needed in the production department, a similar interrelationship exists
between the materials department and maintenance department.
Material cost is the major component of the cost of production. Any pricing or engineering or
development decision can be taken only after getting proper advice from the purchasing
department.
This provides an opportunity to the materials department to play an advisory role in its
relation to the production department. Thus the production and material department are
interrelated and interdependent.
It must be assured that the cash outflow in materials is properly planned by preparing a
materials budget fixing economic order quantity, maximum, minimum and danger levels, so
that, there is neither overstocking nor understocking.
Instead the employees should be expert in handling various activities such as inviting tenders,
preparing comparative statements, meeting the suppliers, drafting order for materials and
taking up the follow up action.
The manpower planning of materials department should be done well in advance, taking into
account the purchasing functions, import substitutions, vendor rating, cost reduction and
purchase intelligence.
The basic mantra of success of management lies in the principle that there should be right
man for the right job must be strictly followed while developing the organisational structure.
The success or failure of any department depends on the people working there.
The persons who are selected should be such who are ready to learn new skills and are
sincere and dedicated towards the organisation. An effort should be made to avoid
understaffing and overstaffing of personnel in the materials department as both adversely
affect the functioning of the department.
(e) Relationship between Material and Marketing department:
Consumer is the king in the modern marketing scenario. The consumer must feel that the
finished products purchased by him are of high quality and are durable. He expects that a
right quality product is being purchased by him at the right price and right time.
Purchasing Policy
Policy refers to the set of purpose, principles and rules of actions* that guide and
organization • Usually documented in writing *rules of actions – Standard
Operating Procedures along with rules and regulations .
Purchase Policy Category
I. The Role of Purchasing
• Addresses the objectives of the purchasing function • Defines the
responsibilities of the various buying levels
• Serves as general or broad statements which more detailed or specific
policies are involved
II. Policies Defining the Conduct of Purchasing Personnel
Procedures of purchasing :
The policy statements are guidelines and they should be difficult to understand. Lengthy and
too many policies have to be avoided. The purchasing policy provides the guidelines and
direction in the following categories.
The procedure describes the sequence of steps leading to the completion of an identified
specific task. The purchasing procedure comprises the following steps as indicated in Fig.
The initiation of procedure starts with the recognition of the need by the needy section. The
demand is lodged with the purchase department in the prescribed Purchase Requisition Form
forwarded by the authorised person either directly or through the Stores Department. The
purchase requisition clearly specifies the details, such as, specification of materials, quality
and quantity, suggested supplier, etc.
The process of selection of supplier involves two basic aspects: searching for all possible
sources and short listing out of the identified sources. The complete information about the
supplier is available from various sources, such as, trade directories, advertisement in trade
journals, direct mailing by the suppliers, interview with suppliers, salesmen, suggestions from
business associates, visit to trade fair, participation in industries convention, etc.
Once the supplier is selected the next step is to place the purchase order. Purchase order is a
letter sent to the supplier asking to supply the said material. At least six copies of purchase
order are prepared by the purchase section and each copy is separately signed by the purchase
officer. Out these copies, one copy each is sent to store-keeper, supplier, accounts section,
inspection department and to the department placing the requisition and one copy is retained
by the purchase department for record
Follow-up procedure should be employed wherever the costs and risks resulting from the
delayed deliveries of materials are greater than the cost of follow-up procedure, the follow-up
procedure tries to see that the purchase order is confirmed by the supplier and the delivery is
promised. It is also necessary to review the outstanding orders at regular intervals and to
communicate with the supplier in case of need.
The receiving department receives the materials supplied by the vendor. The quantity are
verified and tallied with the purchase order. The receipt of the materials is recorded on the
specially designed receiving slips or forms which also specify the name of the vendor and the
purchase order number. It also records any discrepancy, damaged condition of the
consignment or inferiority of the materials. The purchase department is informed
immediately about the receipt of the materials. Usually a copy of the receiving slip is sent to
the purchase department.
When the goods are received in satisfactory condition, the invoice is checked before it is
approved for the payment. The invoice is checked to see that the goods were duly authorised
to purchase, they were properly ordered, they are priced as per the agreed terms, the quantity
and quality confirm to the order, the calculations are arithmetically correct etc.
Maintenance of the records is an important part and parcel of the efficient purchase function.
In the industrial firms, most of the purchases are repeat orders and hence the past records
serve as a good guide for the future action. They are very useful for deciding the timings of
the purchases and in selecting the best source of the supply.
The quantum and frequency of the transactions with the same key suppliers provide a
platform for the purchase department to establish and maintain good relations with them.
Good relations develop mutual trust and confidence in the course of the time which is
beneficial to both the parties. The efficiency of the purchase department can be measured by
the amount of the goodwill it has with its suppliers.
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Stores accounting is important from the point of view of estimating the cost of the product for
pricing decisions. The costing of material has to be done both for the materials consumed in
the production and estimating the value of materials held in stock.
For the purpose of costing the receipt of materials, the factors that should be included are
material price, freight charges, insurance, duties, taxes, packaging charges etc. The prices
quoted and accepted in purchase order may often be stated in various ways such as net prices,
prices with discount terms, free on board, cost, insurance, freight, etc. All these factors should
be appropriately accounted while costing for the incoming materials.
Another important accounting is to be done for the issue to production and of the stocks held
at the end of accounting period. Let us discuss some of the important and frequently used
system for this purpose:
FIFO System: This system known as First in First Out System is based on the assumption
that the oldest stock is depleted first. Therefore, at the time of issue the rate pertaining to that
will be applied. There is no `profit’ or `loss’ in the pricing arrangements. The value of the
stocks held on hand is the money that has been paid for that amount of stock at latest price
levels. In case of too many changes in price levels the FIFO System becomes unwieldy.
Another limitation of this system is that it fails to provide a satisfactory answer to costing-
returns from stores.
LIFO System: This system known as `Last in First Out’ System is based on the assumption
that the most recent receipts are issued first. As the latest prices are charged in this system, it
leads to lower reported profits in the periods of rising prices and this offers savings in taxes.
In case of wide fluctuations in prices this system tends to immunize unrealized gains or losses
in inventory. It has almost the same limitations as that of FIFO System.
Average Cost System: This is based on the assumption that issues to production department
are equally made from different shipments in stock, i.e. an average cost of shipment in stores
is charged. It stabilizes the cost figures. The average is to be calculated by dividing the total
cost with the number of items and is to be updated with every new purchase.
Market Value System: This is also known as replacement rate costing, in which the
materials issued are charged the prevailing market rates. This system underestimates the
stock on hand in the case of price increase, whereas it overestimates the stock on hand in the
case of price decrease. This may in turn lead to writing off huge amount to make it realistic.
Moreover, a continuous monitoring of the market rates for all materials makes the system
cumbersome.
Standard Cost System: In this system a detailed analysis of market price and trends is
carried out to determine a standard rate for a fixed period, say six months or so. This standard
rate is charged to materials issued during this period irrespective of the actual rate. After the
period is over the standard rate is reviewed and updated.
This system reflects the efficient use of materials as the fluctuation in rates is not considered
in accounting. Moreover, it adds to clerical efficiency as the fresh rates are not to be obtained
every time. However, similar to Market Value Approach, this also leads to underestimating or
overestimating stocks on hand in case of rising and falling prices respectively.
System of Costing the Closing Stock: The general guideline for this purpose is to use
market price or stock at cost, whichever is less.: The cost of closing stock is governed mainly
by price units, obsolescence and deterioration. In rare cases the stock may appreciate with
time. Appropriate formulae to account for these factors should be developed keeping in view
the past experience. 7
Some discrepancies between the actual and the book balances of inventories are bound to
occur despite the diligent store keeping. The process of stock verification is carried out for
following purposes:
To reconcile the store records and documents for their accuracy and usefulness,
Identification of areas deserving tighter document control,
To back-up the balance sheet stock figures, and
To minimize the pilferage and fraudulent practices
Most companies keep an “inventory short and over” account to absorb such discrepancies,
which is eventually closed into the manufacturing overheads account. Some of the systems of
physical stock taking are as follows:
Annual or Periodic Physical Verification: In this system the entire inventory is physically
verified at the end of a period, usually the accounting period. That is, normally at the end of
fiscal year. Stocks are closed for a few days. This may necessitate the shutdown of
production operations;.’ the activities such as repair and overhaul of equipment and
machinery are resorted to. A special crew of store inspectors and stores verifying officers,
usually from the material audit, physically check each item and compare the entries on bin
card and stores ledger. This leads to the formation of a list of surplus or short items. Damaged
and obsolete items are traced and recorded. This needs to develop a detailed programme and
schedule to complete the verifications, store wise and item wise. Top management’s sanction
can then be sought for writing off deficiencies or valuing surplus.
As all the items are checked at one time there can be no confusion about any item being left
unchecked.
Perpetual Inventory and Continuous Stock Taking System: In case of large firms dealing
with a large number of items the final inventory system may take a lot of time and it may not
be possible to shut down the whole plant. The perpetual inventory system is a more
appropriate method for large plants. In this method the stock verification is done continuously
throughout the year. Different methods are adopted by different firms for continuous
verification.
Some firms divide the whole inventory into fifty-two equal parts. Each part is verified every
week. Some firms’ record store balances after every receipt and issue, and a number of items
are counted daily or at frequent intervals and checked with the bin cards and stores ledger.
Discrepancies found, if any, owing to incorrect entries, breakage pilferage, over-issue,
placing of items in wrong bins, etc., are investigated and corrected accordingly. The
significant advantages of this system are as follows:
The method is less costly, less tiring, less cumbersome and hence is more accurate.
Discrepancies and defects in stores are readily detected and are not carried over
throughout the year. This prevents damages and losses.
Slow moving stocks can be noted and proper action can be initiated in time. v) The
stock items are kept within the limits.
Low Point Inventory System: Some companies take the physical inventory, i.e. the stock
level of stores is checked generally when it reaches its minimum level. 8
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C VED Analysis: VED stands for Vital, Essential and Desirable. Highest control is
over vital items, medium control is exercised over essential items and least control is
inferred over desirable items. ABC analysis does not tell anything about the criticality
of the items. VED analysis is done to control a critical inventory situation. Through this
analysis, we identify the criticality of production situation and accordingly plan for the
inventory. Materials are classified into the three types as under:
V-Vital: items without which production will completely stop. i.e. non- availability
cannot be tolerated. Eg. Due to the absence of bearing, rolling machine cannot operate.
Airlines industry is bound to keep stand-by engines as its absence; at times, the
industry may require flight cancellation, which costs to the industry an enormous
revenue loss.
E-Essential: items whose cost of non availability can be tolerated for 2-3 days,
because similar or alternative items are available. For example, some paper mills,
bamboo is an important raw material. Availability of bamboo from the forests, at
times, becomes uncertain because of number of reasons due to climate, natural
calamities etc.,
D-Desirable: items whose non availability can be tolerated for a long period. Although
the proportion of vital, essential and desirable items varies from organisation to
organisation. Although not included in scientific VED analysis, in some public
organizations which are static or inefficiently managed, there is a peculiar category of
‘U’ items which can be grouped as unnecessary. These unnecessary items get
purchased due to the following reasons. 2
D SDE Analysis: SDE stands for Scarce, Difficult and Easy. Highest control is over
scarce items, medium control is exercised over difficult items and least control is
inferred over easily available items.
SDE ANALYSIS : This analysis is based spares availability of an
item – S-Scarce Items
D-Difficult Items
E-Easy Items
S - refers to Scarce Items, especially imported and those which are very much in
short supply. Due to their nature, these items are procured on yearly interval.
D - are Difficult items which are procurable in market but not easily available. For
example, items which have to come from far off cities or where there is not much
competition in market or where good quality supplies are difficult to get or to be
procured. E - refers to Easy items – Items are those which are easily available; mostly
local items. Due to their easy availability, organizations may not require to hold these
items in large volume in their stock. It is normally advantageous to consider A, V & S
items for selective controls. 2
E. FSN Analysis: FSN stands for Fast Moving (F), Slow Moving (S) and Non
Moving (N). Highest control is kept over fast moving items, medium control is
exercised over slow moving items and least control is inferred on non-moving
items.
This analysis is to help control obsolescence and is based on the consumption
pattern of the items. The items are analyzed to be classified as
Fast-moving (F),
Slow-moving (S) and
Non-moving (N) items.
The Non-moving items (usually not consumed over a period of two years) are of
great importance. Scrutiny of non-moving items is to be made to determine
whether they could be used or be disposed off. The fast and slow moving
classifications help in arrangement of stock in stores and their distribution and
handling methods. 2
F .GOLF ANALYSIS: It is similar to SDE analysis, and it is based on the
nature of market and suppliers. Suppliers or Vendors are classified as under:
G-Government O Ordinary or Non-government L-Local F-Foreign All these
suppliers have their own payment terms, own administrative procedure and
soon. For a materials Manager, therefore, it is important to keep in mind all
these issues to function efficiently and smoothly. 2
G .SOS ANALYSIS: SOS Analysis is done, keeping in view the
seasonality or non seasonality of the item.
S- Seasonal Items
OS – non-seasonal Items Depends on seasonality and non-seasonality of the
items, procurement actions vary. Example: in case of sugar mills whose
procurement is seasonal, these companies need to procure their requirement for a
longer duration so as to adjust their production plans. 2
H.. XYZ ANALYSIS :This analysis is made based on the value of left out stock
in the stores. ‘X’ items are those whose value of left out stock is very high. ‘Y’
items are those whose left-out stock value is moderate. ‘Z’ items are the residual
items, whose left-out stock value is neither high nor moderate. Materials
managers, based on such analysis, can plan not only for procurement but also for
secured storage of items. 2
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