MATERIALS CONTROL

Materials

The term “Materials”, generally used in manufacturing concerns, refers to raw materials used for
production, sub-assemblies and fabricated parts. The terms “Materials” and “stores” are
sometimes used interchangeably. However, both the terms differ. “Stores” is wider in meaning
and comprises many other items besides raw materials, such as tools, equipments, maintenance
and repair items, factory supplies, components, jigs, fixtures. Sometimes, finished goods and
partly finished goods are also included within the scope of this term.

CONCEPT AND OBJECTIVES OF MATERIALS CONTROL

Materials cost constitutes a prime part of the total cost of production of manufacturing firms.
Proper accounting, therefore, for and control over materials purchase, consumptions, and
inventories are important for effective management of a business firm. Materials control
basically aims at efficient purchasing of materials, their efficient storing and efficient use or
consumption.

Materials control consists of controls at two levels: (1) quantity controls, and (2) financial
controls. For instance, the production department in a manufacturing company aims at quantity
controls, i.e., lesser and lesser units should be used in the production department. Although lesser
units would result in lower investments on purchase of materials, yet the user (production)
department normally does not think in terms of expenditure. In contrast, the finance manager is
interested in keeping the investments on materials at the lowest point. In materials controls,
balance has to be maintained between two opposing needs, i.e., (1) maintenance of sufficient
inventory for efficient production and (2) maintenance of investment in inventory at the lowest
level. In details, the following are the objectives in a good system of materials control:

1. Materials of the desired quality will be available when needed for efficient and
uninterrupted production.
2. Materials will be purchased only when need exists and an economic quantities.
3. The investment in materials will be maintained at the lowest level consistent with
operating requirements.
4. Purchase of materials will be made at the most favorable prices under the best possible
terms.
5. Materials should be stored in such a way that they can provide minimum of handling
time and cost.
6. Materials are protected against loss by fire, theft, handling with the help of proper
physical controls.

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 7. Vouchers will be approved for payment only if the material has been received and is
available for issue.
8. Issue of materials are properly authorized and properly accounted for.
9. Materials are, at all times, charged as the responsibility of some individual.

 ORGANIZATION (Bhabatosh-100)

In order to exercise effective control on material, there should be proper co-operation and co-
ordination in the following departments:

a. Purchase
b. Receiving and Inspection
c. Stores
d. Production
e. Stock control
f. Sales
g. Accounts

PURCHASING AND RECEVING PROCEDURE

Purchasing procedures vary with different business firms, but all of them follow a general pattern
in the purchases and receipt of materials and payment of obligations. The important steps may be
listed as follows:

1. Purchase requisition: A form known as a purchase requisition is commonly used as a

formal request to the purchasing department to order goods or services. The purchase
requisition serves three general purposes:
(a) It automatically starts the purchasing process and informs the purchasing department
of the need for the purchase of materials.
(b) It fixes the responsibility of the department/personal making the purchase requisition.
(c) It can be used for future reference.

Usually, purchase requisitions are prepared by the storekeepers for regular store items which are
below or approaching the minimum level of stock or replace stock of materials and parts in
stores. The production control department can also requisitions for the purchase of specialized
materials. A typical purchase requisition contains details, such as number, date, department,
quantity, description, specification, signature of the person initiating the requisition, and
signature of one or more officers approving the purchase. Copies of the purchase requisition are
sent to the purchasing department and accounting department.

2. Purchase order: After the requisition is received duly approved the purchasing department
places and with a supplier, offering to buy certain materials at stated prices and terms.

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 The purchase order is a formal contract for the supply of materials. The order should
clearly state the materials required and the price; and provide information, such as
delivery period and the department for whom the materials are purchased. Copies of the
purchase order are sent to the department concerned, the sender of the purchase
requisition, and the stores department advising them to expect the materials as specified
and where to send them upon receipt. Copies of the purchase requisition and the purchase
order are sent to accounting department, to be used in checking the supplier’s invoice
when a voucher is being prepared for payment.
3. Receiving materials: The receiving department performs the function of unloading and
unpacking materials which are received by an organization. This will need an inspection
report which is sometimes incorporated in the receiving report, indicating the items
accepted and rejected, with reason.
4. Approval of invoices: Invoice approval indicates that goods according to the purchase
order have been received and payment can now be made. However, if the goods or
equipment received are not of the type ordered, or are not in accordance with
specifications, or are damaged, the purchasing department issues a return order indicating
that the goods are to be returned to the supplier.
5. Marking payment: After the purchase invoice total is approved, the process of making
payment beings. Payment depends on the terms agreed upon on any particular order, and
any terms which differ from normal practice should be considered individually. When it
is found that items written on the invoice qualify for payment, a remittance advice is
prepared after providing for deduction on discounts, if any.

Economic Order Quantity (EOQ) (Reorder Quantity):

The EOQ is the optimum or the most favorable quantity which should be purchased each time
the purchases are to be made. The EOQ is one where the cost of carrying inventory is equal or
almost equal to the cost of not carrying inventory. Also at EOQ level, total of these two costs is
minimum.

However, simultaneously the cost of carrying the inventory will go up because purchases have
been made in large quantities. It may be possible to have a point is known as the EOQ. This
equilibrium can be determined mathematically as follows:

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 EOQ =

Where U = Annual usage in units

O = Cost of placing an order

I = Percent cost of carrying inventory

C = Cost per unit of material

Assume

Annual usage units = 6000

Cost of placing an order = Rs 30

Carrying cost as a percent of inventory = 20%

Cost per unit of material = Rs 5

Then,

EOQ =

= 600 units

The EOQ formula is sometimes expressed in the following manner which is not in any way
different from the formula explained earlier.

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 EOQ =

Where, U =Annual demand or consumption or purchased quantity. (in units)

P = Cost of placing an order

S = Annual cost of carrying inventory per unit

When to Order (Reorder Level):

The EOQ determines how much to buy at a particular time. But the question “when to buy” is
equally important for business firms. This question is easy to answer only if we know the lead
time –the time interval between placing an order and receiving delivery-and know the EOQ, and
are certain of the consumption pattern during lead time. The order point or re-order level is a
point or quantity level at which if materials in stores reach, the order for supply of materials must
be placed. This point automatically initiates a new order. The order point is calculated from three
factors:

1. The expected usage.

2. The time interval between initiating an order and its receipt, referred to as the lead time.
3. The minimum inventory or safety stock.

For example, if daily usage is 400 units of material which have a lead time of 20 days and the
safety stock is 500 units, the order point will be calculated as follows:

Daily consumption * lead time = 400*20= 8000

Add safety stock = 500

Order point units = 8500

Minimum Stock Level:

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It is advisable to carry a reserve or safety stock to prevent stock-out. The safety stock should be
used only in abnormal circumstances, and the working stock in ideal or normal condition.
Therefore, for normal working conditions, the stock should not be allowed to fall below the
safety limit, kept only for emergencies. If the usage pattern is known with certainty, and the lead
time also known accurately, then no safety stock would be needed. However, if either usage or
lead time is subject to variation then it is necessary for a business firms to maximum usage over
lead time that the firms feels is necessary for cost minimization. The safety stock level can be
computed by using the following formula:

Safety stock level = Ordering level – (Average rate of consumption * Reorder period)

Or

Safety stock level = (Maximum rate of consumption – Average rate of consumption)*Lead time

That is, = (425-400)*20 days

= 500 units

Maximum Stock Level:

The maximum stock level ensures that the stocks will not exceed this limit although there may be
low demand for materials or quick delivery from the suppliers. Maximum stock level can be
computed as follows:

Maximum stock level = EOQ + Minimum stock

Or

Maximum stock level = Reorder level + EOQ – (Minimum consumption * Minimum reorder
period)

Danger Level:

Generally the danger level of stock is indicated below the safety or minimum stock level.
Sometimes, depending on the practices of the firms and circumstances prevailing, the danger
level is determined between reorder level and minimum level. In the second case, the firms can
only take steps to ensure that materials ordered will arrive in time.

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Average stock level is computed in following manner:

Or

 SCRAPS

Scraps may occur due to break down of machinery, wrong planning, bad production method,
inferior material, bad workmanship etc. Scraps have some values if sold either without further
processing or used as raw material for another process.

 SPOILAGE

Spoilage is the units of output which fail to reach the required standard of quality or
specification.

 DEFECTIVES

Defective goods are the materials which develop some imperfection in course of manufacturing
process. At some additional labor and material costs these can be made into perfect finished
goods. So, defectives are the same which are economically capable of being corrected into
perfect finished goods.

 WASTES

Wastes are the portion of the basic raw materials which is lost in processing and those have no
recovering value. Wastes may be normal and abnormal. Normal waste is a part of cost, while
abnormal wastes is excluded from cost and charged in profit loss account.

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 CALCULATIONS OF STOCK LEVELS

the stock levels can also be determined with the help of formulae

 Re-order level

Re-order level = Maximum period for require for delivery x Maximum

consumption rate

Or

Re-order level = Maximum Stock + (Average consumption rate x average lead time)

 Maximum Level

Maximum level = (Re-order level + Re-order quantity) – (Minimum consumption rate x

Minimum delivery time)

 Minimum Level

Minimum level = Re-order level - (Normal consumption rate x average delivery time)

 Average Stock

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

Example 3.2

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About 50 items are required every day for a machine. A fixed cost of Rs. 50 per order is incurred
for placing an order. The inventory carrying cost per items amount to Rs. 0.02 per day. The lead
period is 32 days. Compute:

i. Economic Order Quantity

ii. Re-order level

Solution

Annual Consumption (U) = 50 items * 365 days

= 18,250 units

Ordering Cost (P) = Rs. 50

Inventory Carrying cost per

items per annum (S) = Rs. 0.02 *365 = Rs. 7.30

i. Economic Order Quantity =

= 500 units
ii. Re-order Level = Maximum Usage per day *Maximum Lead Time
= 50 units per day * 32 days
= 1600 items

Example 3.3

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From the following information calculate Economic Order Quantity, and the number of orders to
be placed in one quarter of the year:

i. Quarterly consumption of materials 2,000 kg.

ii. Cost of placing one order Rs. 50
iii. Cost per unit Rs. 40
iv. Storage and carrying cost 8% on average inventory

Solution

EOQ =

Where;

U = Annual consumption

S = Storage cost per unit annum

Annual usage of materials = 2000 kg * 4 = 8000 kg

Cost of placing order = Rs.50

Annual storage or carrying cost of one unit = = 3.2

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 EOQ =

= 500 kg

No. of order per quarter =

=4

Example 3.5

From the details given below, calculate:

i. Re-ordering Level
ii. Maximum Level
iii. Minimum Level
iv. Danger Level

Cost of placing a purchase order is Rs. 20

Number of units to be purchased during the year is 5,000

Purchase price per unit inclusive of transportation cost is Rs. 50

Annual cost of storage per unit is Rs. 5

Details of lead time: Average 10 days, maximum 15 days, Minimum 6 days. For emergency
purchases 4 days.

Rate of Consumption: Average: 15 units per day, Maximum: 20 units

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Solution

i. Re-ordering Level (ROL) = Maximum Usage per day *Maximum Re-order period

= 20 units per day * 15 days

= 300 units

ii. Maximum Level = ROL + ROQ – (Min. rate of Consumption * Min. Re-order
period)

= 300 units+200 units – (10 units per day * 6 days)

= 440 units

iii. Minimum Level = ROL – (Average rate of Consumption * Average reorder

period)
= 300 units – (15 units per day *10 days)
= 150 units
iv. Danger Level = Average Consumption * Lead time for emergency purchases
= 15 units per day * 4 days
= 60 units

Working Notes:

1. ROQ = = = 200 units

Where; ROQ = Reorder Quantity

U = Annual consumption

P = Cost per order

S = Storage Cost per unit

2. Average Rate of Consumption

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 =

15 units per day = or x = 10 units per day.

Example 3.16

XYZ Company buys in lots of 500 boxes which is a 3 months’ supply. The cost per box is Rs 125
and the ordering cost is Rs 150. The inventory carrying cost is estimated at 20% of unit value.
What is the total annual cost of the existing inventory policy? How much could be saved by
employing the economic order quantity?

Solution

i. Ordering Cost Rs
4 Orders in a year @ Rs 150 each order 600
Carrying cost of average inventory

= 250 units * 20% * 125 = 6250

Total annual cost of existing inventory policy = 6850

ii. Economic Order Quantity (EOQ)

= 155 units
iii. Ordering Cost

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 = = 12.90 or 13 orders approx.

13 orders are to be placed at Rs 150 each 1950.00

Carrying cost of average inventory

= * * 125 1937.50

Total annual cost 3887.50

Saving in annual cost if EOQ is adopted
Rs 6850 – Rs 3887.50 = Rs 2962.50

Problem 2:

Shown below are the consumption figures forecast for BR Limited in respect of material 562.
You are required to calculate the estimated average stock level for the year.

Forecast Consumption

Material 562 Re- order Quantity: 8000 units

Month Consumption (units) Month Consumption (units)

January 2000 July 3000

February 2000 August 3000

March 2800 September 2200

April 2800 October 2200

May 3000 November 2000

June 3000 December 2000

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 Delivery period from supplies: minimum 2 months

Maximum 4 months

Solution:

Re- order level = Maximum usage * Maximum delivery period

=3000 * 4 = 12000 units

Maximum level = Re- order level + Re-order quantity - (Minimum usage * Minimum

delivery period)

= 12000+ 8000 – (2000 * 2)

=16000 units

Maximum level = Re- order level – (Normal usage * Average delivery period)

= 12000- (2500 * 3)

=4500 units

Average stock level = ½ (Maximum level + Minimum level)

= ½ (16000 +4500)

= 10250 units

Note: Normal usage is taken to be the average usage, if normal usage figure is not

Supplied.

Normal usage for the period = (minimum usage + maximum usage)

Or, 2000 + 3000

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 Or, 2500 units.

Problem 5;

A manufacturing company produces a special product `Sorbina` the monthly demand for which
is 500 units. The following particulars are available in respect of the material used for
manufacturing the product:

Cost of placing an order Rs. 120

Annual carrying cost- per unit Rs. 12

Normal usage- 60 units per week.

Minimum usage- 30 units per week.

Maximum usage- 90 units per week.

Delivery period- 4 to 6 week.

Compute from the above:

(a) Re- order quantity, (b) Re- order level, (c) Minimum level,

(d) Maximum level, (e) Average stock level.

Solution:

(a) Re- order quantity =

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 Where, Consumption pa
O= Cost of Placing 1 order

= Carrying cost of 1 unit for 1 year

Notes:

1. Re- order quantity represents the economic order quantity

2. Co = Annual consumption of producing of

Sorbina = 52 weeks * Normal usage of material per week .

(b)Re- order level =

(c) Minimum level=

=240 units

(d) Maximum level =

= 540 +250 – )

=670 units

(e) Average stock level = ½ (Minimum level + Maximum level)

= ½ (240 + 670)

= 455 units.

Problem 10:

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The annual requirement of an item is 12000 unites. Each costing Rs. 6. Every order costs Rs.200
at release and inventory carrying charges are 20% of the average inventory per annum.

Find out : (1) economic order quantity and corresponding total inventory cost (including item
costs), (2) Whether the item should be purchased in lost of 6000 units at a time, if the price per
unit is reduced by 5% for this quantity.

Solution:

(1)

Total inventory cost: Rs.

Ordering cost: 6 orders per year at Ps.200 per order 1200

Carrying cost of average inventory: 1200

Item costs: 1200 at Ps. 6 72000

74400

Note: 6 orders are to be placed in a year to meet the annual requirements of 1200 units.

(2)Total inventory cost when 6000 units are purchased at a time: Rs.

Ordering cost: 2 order per year at Rs. 200 per order

Carrying cost of average inventory:

3420

Item cost : 12000 at Rs. 5.70 68400

72220

Notes: 2 orders are to be placed in a year to meet the annual requirements of 12000 units.

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Cost per unit is Rs. 6 less 5% or Rs. 5.70.

There will be saving of Rs. (74400 – 72220) or Rs. 2180, if 6000 units are purchased at a time.

Problem 2:

Shown below are the consumption figures forecast for BR Limited in respect of material 562. You are
required to calculate the estimated average stock level for the year.

Forecast Consumption

Material 562 Re- order Quantity: 8000 units

Month Consumption (units) Month Consumption (units)

January 2000 July 3000

February 2000 August 3000

March 2800 September 2200

April 2800 October 2200

May 3000 November 2000

June 3000 December 2000

Delivery period from supplies: minimum 2 months

Maximum 4 months

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Solution:

Re- order level = Maximum usage * Maximum delivery period

=3000 * 4 = 12000 units

Maximum level = Re- order level + Re-order quantity - (Minimum usage * Minimum

delivery period)

= 12000+ 8000 – (2000 * 2)

=16000 units

Maximum level = Re- order level – (Normal usage * Average delivery period)

= 12000- (2500 * 3)

=4500 units

Average stock level = ½ (Maximum level + Minimum level)

= ½ (16000 +4500)

= 10250 units

Note: Normal usage is taken to be the average usage, if normal usage figure is not

Supplied.

Normal usage for the period = (minimum usage + maximum usage)

Or, 2000 + 3000

Or, 2500 units.

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Problem 5;

A manufacturing company produces a special product `Sorbina` the monthly demand for which is 500
units. The following particulars are available in respect of the material used for manufacturing the
product:

Cost of placing an order Rs. 120

Annual carrying cost- per unit Rs. 12

Normal usage- 60 units per week.

Minimum usage- 30 units per week.

Maximum usage- 90 units per week.

Delivery period- 4 to 6 week.

Compute from the above:

(a) Re- order quantity, (b) Re- order level, (c) Minimum level,

(d) Maximum level, (e) Average stock level.

Solution:

(d) Re- order quantity =

Where, Consumption pa
O= Cost of Placing 1 order

= Carrying cost of 1 unit for 1 year

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Notes:
1. Re- order quantity represents the economic order quantity

2. Co = Annual consumption of producing of

Sorbina = 52 weeks * Normal usage of material per week .

(e) Re- order level =

(f) Minimum level=

=240 units

(d) Maximum level =

= 540 +250 – )

=670 units

(e) Average stock level = ½ (Minimum level + Maximum level)

= ½ (240 + 670)

= 455 units.

Problem 10:

The annual requirement of an item is 12000 unites. Each costing Rs. 6. Every order costs Rs.200 at
release and inventory carrying charges are 20% of the average inventory per annum.

Find out : (1) economic order quantity and corresponding total inventory cost (including item costs), (2)
Whether the item should be purchased in lost of 6000 units at a time, if the price per unit is reduced by
5% for this quantity.

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Solution:

(2)

Total inventory cost: Rs.

Ordering cost: 6 orders per year at Ps.200 per order 1200

Carrying cost of average inventory: 1200

Item costs: 1200 at Ps. 6 72000

74400

Note: 6 orders are to be placed in a year to meet the annual requirements of 1200 units.

(2)Total inventory cost when 6000 units are purchased at a time: Rs.

Ordering cost: 2 order per year at Rs. 200 per order

Carrying cost of average inventory:

3420

Item cost : 12000 at Rs. 5.70 68400

72220

Notes: 2 orders are to be placed in a year to meet the annual requirements of 12000 units.

Cost per unit is Rs. 6 less 5% or Rs. 5.70.

There will be saving of Rs. (74400 – 72220) or Rs. 2180, if 6000 units are purchased at a time.

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