Material costing

Faculty: Zaira Anees

Areas to cover
• Documentation of materials

• Recording of material

• Inventory control
 Summary of documents
DOCUMENT PREPARED SENT TO DOCUMENT NAME CONTAINS
BY
PRODUCTION DEPT STORE DEPT MATERIAL REQUISITION Quantity, material code, sending dept
NOTE code, authorization
STORE DEPT PURCHASING DEPT MATERIAL PURCHASE Quantity, material code, sending dept
REQUISITION code, authorization
PURCHASING DEPT SUPPLIER PURCHASE ORDER Quantity, description, price,
authorization
SUPPLIER STORE DEPT INVOICE, DELIVERY NOTE INVOICE: price, quantity, cost
(DN)* DN: quantity
STORE DEPT GRN Quantity, material code, supplier name
Materials requisition note
• Materials can only be issued against a materials/stores requisition.
• This document must record not only the quantity of goods issued, but
also the cost centre or the job number (department) for which the
requisition is being made.
• It should be authorised by the cost centre sending material
requisition note
Purchase Requisition
• The stores department issues a purchase requisition which is sent to
the purchasing department, authorising the department to order
further inventory.
Purchase order
• The purchasing department draws up a purchase order which is sent
to the supplier. (The supplier may be asked to return an
acknowledgement copy as confirmation of his acceptance of the
order.)
• Copies of the purchase order must be sent to the accounts
department and the storekeeper (or receiving department).
Delivery Note

• The supplier delivers the consignment of materials, and the

storekeeper signs a delivery note for the carrier.
• The packages must then be checked against the copy of the
purchase order, to ensure that the supplier has delivered the types
and quantities of materials which were ordered. (Discrepancies
would be referred to the purchasing department.)
Goods received note
• If the delivery is acceptable, the storekeeper prepares a goods
received note (GRN), A copy of the GRN is sent to the accounts
department, where it is matched with the copy of the purchase order.
• The supplier's invoice is checked against the purchase order and GRN,
and the necessary steps are taken to pay the supplier
• Copies of GRN must be sent to the accounts department and the
purchasing department.
Materials transfer note
• Where materials, having been issued to one job or cost centre, are
later transferred to a different job or cost centre, without first being
returned to stores, a materials transfer note should be raised.
• Such a note must show not only the job receiving the transfer, but
also the job from which it is transferred. This enables the appropriate
charges to be made to jobs or cost centres.
Materials returned note
• Material returns must also be documented on a materials returned
note.
• This document is the 'reverse' of a requisition note, and must contain
similar information. In fact it will often be almost identical to a
requisition note.
• It will simply have a different title and perhaps be a distinctive colour,
such as red, to highlight the fact that materials are being returned.
• A bin card shows the level of inventory of an item at a particular
stores location. It is kept with the actual inventory and is updated by
the storekeeper (store department) as inventories are received and
issued. It mainly includes quantity of material

• Store ledger account is a document prepared by accounts

department which is used to record (FIFO/LIFO/weighted average)
material cost. It includes quantity of material, price and cost of raw
material
Recording of Material
• FIFO
• LIFO
• WEIGHTED AVERAGE METHOD

• In case of Manufacturing business we use issue cost

• In case of trading business we cost of sales
• Opening 400 units @ $2.20 per unit
• 5 September Issue 250 units
• 10 September Receipt 500 units @ $2.50 per unit
• 15 September Issue 340 units
• 18 September Receipt 400 units @ $2.70 per unit
• 27 September Issue 600 units
Date Purchase / Receipt Issue (production) based on FIFO Balance
opening 400 units @ $2.2 = $880
5 sept 250 units @ 2.20 = $550 150 units @ $2.2 = $330
10 sept 500 units @ 2.50 = $1,250 150 units @ $2.2 = $330
500 units @ 2.50 = $1,250
15 Sept 150 units @ $2.2 = $330 310 units @ 2.50 = $775
190 units @ $2.50 = $475
18th Sept 400 units @ $2.70 = 1,080 310 units @ 2.50 = $775
400 units @ $2.70 = $1080
27th Sept 310 units @ 2.50 = $775 110 units @ 2.7 = $297
290 units @ $2.70 = $783
• Opening 400 units @ $2.20 per unit
• 5 September Issue 250 units
• 10 September Receipt 500 units @ $2.50 per unit
• 15 September Issue 340 units
• 18 September Receipt 400 units @ $2.70 per unit
• 27 September Issue 600 units

Date Purchase / Receipt Issue (production) based on LIFO Balance

opening 400 units @ $2.2 = $880
5 sept 250 units @ 2.20 = $550 150 units @ $2.2 = $330
10 sept 500 units @ 2.50 = $1,250 150 units @ $2.2 = $330
500 units @ 2.50 = $1,250
15 Sept 340 units @ $2.5 = $850 150 units @ $2.2 = $330
160 units @ 2.50 = $400
18th Sept 400 units @ $2.70 = 1,080 150 units @ $2.2 = $330
160 units @ 2.50 = $400
400 units @ $2.70 = 1,080
27th Sept 400 units @ $2.70 = 1,080 110 units @$2.2 = $242
160 units @ $2.50 = $400
40 units @ $2.2 = 88
 • Opening 400 units @ $2.20 per unit
• 5 September Issue 250 units
• 10 September Receipt 500 units @ $2.50 per unit
• 15 September Issue 340 units
• 18 September Receipt 400 units @ $2.70 per unit
• 27 September Issue 600 units

Date Purchase / Receipt Issue (production) based on Balance

weighted average method
Opening 400 units @ $2.2 = $880
5 sept 250 units @ 2.20 = $550 150 units @ $2.2 = $330
10 sept 500 units @ 2.50 = $1,250 150 units @ $2.2 = $330
500 units @ 2.50 = $1,250
650 units 2.43 = $1,580
15 sept 340 units @ $2.43 = $826 310 units @ $2.43 = $753.3
18th sept 400 units @$2.70 = $1,080 310 units @ $2.43 = $753.3
400 units @$2.70 = $1,080
710 units @ $2.58 =$1,833
27th Sept 600 units @ $2.58 = $1,548 110 units @ $2.58 = $284
Conclusion
• In case of inflation
FIFO Weighted Avg LIFO

Issue cost Lowest Highest

Closing stock Highest Lowest

Profits Highest Lowest

FIFO, LIFO, WEIGHTED AVERAGE
METHOD
• A business has inventories of material A of 400 units valued at $2.20
per unit at 1 September.
• During the month of September the movements of material A were as
follows:
• 5 September Issue 250 units
• 10 September Receipt 500 units @ $2.50 per unit
• 15 September Issue 340 units
• 18 September Receipt 400 units @ $2.70 per unit
• 27 September Issue 600 units
Q2
• P Ltd uses the FIFO system for valuing material issues from stores to production.
• The Materials Account had an opening value of £12,000 on 1 April 2002:
• 1,000 units @ £5∙80 – Purchased 22 March 2002
• 1,000 units @ £6∙20 – Purchased 23 March 2002
• The following receipts and issues were recorded during April:
• 2 April 2002 Receipts 5,000 units £6∙30 per unit
• 15 April 2002 Receipts 8,000 units £6∙25 per unit
• 30 April 2002 Issues 9,000 units
• Using the FIFO method, what was the value of the closing stock on 30 April?
• A £37,200 B £37,400 C £37,500 D £37,600
• If P Ltd had used LIFO, instead of FIFO, the value of the material issued would have been
• A £100 lower B £100 higher C £300 lower D £300 higher
Q4
Q5
Q6
Q7.
Economic Order Quantity (EOQ)
Economic order quantity
• The economic order quantity (EOQ) is the order quantity which
minimises inventory costs. (sum of ordering cost and holding costs)

• It can be calculated by using following formula

Ordering cost
• (a) Clerical and administrative costs associated with purchasing,
accounting for and receiving goods
• (b) Transport costs
• (c) Production run costs, for inventory which is manufactured
internally rather than purchased from external sources
Holding costs
• (a) Costs of storage and stores operations. Larger inventories require more storage space and
• possibly extra staff and equipment to control and handle them.
• (b) Interest charges. Holding inventories involves the tying up of capital (cash) on which interest
must
• be paid.
• (c) Insurance costs. The larger the value of inventories held, the greater insurance premiums are
likely
• to be.
• (d) Risk of obsolescence. The longer a inventory item is held, the greater is the risk of
obsolescence.
• (e) Deterioration. When materials in store deteriorate to the extent that they are unusable, they
must
• be thrown away with the likelihood that disposal costs would be incurred.
• ORDERING COST
• Number of orders = Annual demand/Order size
• Ordering cost = number of orders * ordering cost per order

• HOLDING COST
• Average inventory = (order size / 2) + safety stock
• Holding cost = average inventory * holding cost per unit per annum
Q1 - EOQ
• Information regarding stocks is given below:
• Purchase price £15/unit
• Ordering cost per order £200
• Holding cost £1.5 per unit per annum
• Annual demand 15,000 units
• Required:
• (a) Calculate the Economic Order Quantity.
• (b) Calculate ordering cost and holding cost at following order sizes
• i) 1,000 units, ii) EOQ, iii) 2,500 units
• order size 1000 2000 2500
• ordering cost 3000 1500 1200
• holding cost 750 1500 1875
• total cost 3750 3000 3075
Q2 - EOQ
• Information regarding stocks is given below:
• Purchase price £20/unit
• Ordering cost per order £100
• Holding cost £0.75 per unit per annum
• Annual demand 60,000 units
• Required:
• (a) Calculate the Economic Order Quantity.
• (b) Calculate ordering cost and holding cost at following order sizes
• i) 2,000 units, ii) EOQ, iii) 5,000 units
• order size 2000 4000 5000
• ordering cost 3000 1500 1200
• holding cost 750 1500 1875
• total cost 3750 3000 3075
Q3.
• TNG Co expects annual demand for product X to be 255,380 units. Product X is
purchased for £11 per unit from a supplier. TNG places an order for 50,000
units of product X at regular intervals throughout the year. Because the
demand for product X is to some degree uncertain, TNG maintains a safety
(buffer) stock of product X which is sufficient to meet demand for 28 working
days. The cost of placing an order is £25 and the storage cost for Product X is
10 pence per unit per year. TNG Co uses a working year consisting of 365 days.
• Required:
• (a) Calculate the annual cost of the current ordering policy.
• (b) Calculate the annual saving if the economic order quantity model is used
to determine an optimal ordering policy.
Inventory control levels
• Inventory control levels can be calculated in order to maintain
inventories at the optimum level. The three critical control levels are
• 1. reorder inventory level
• 2. minimum inventory level
• 3. maximum inventory level.
Inventory levels
• Reorder level: When inventories reach this level, an order should be
placed to replenish inventories.

• Minimum inventory level: This 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.

• Maximum inventory level This also acts as a warning level to signal to

management that inventories are reaching a potentially wasteful level.
 Inventory levels
• Reorder level (without safety stock) = maximum consumption * maximum
lead time
• Reorder level (with safety stock) = (Average consumption * Average lead
time) + safety stock
• Maximum inventory level = reorder level + reorder quantity – (minimum
consumtion * minimum lead time)
• Minimum inventory level = Reorder level – (Average consumption * average
lead time)
• Note:
• lead time is time taken by supplier to deliver raw material
• Consumption is by production department
2.
• Data relating to a particular stores item are as follows:
• Average daily usage 400 units
• Maximum daily usage 520 units
• Minimum daily usage 180 units
• Lead time for replenishment of stock 10 to 15 days
• Reorder quantity 8,000 units
• Calculate all inventory levels.
Practice Questions
1
3.
• Jane plc purchases its requirements for component RB at a price of £80 per
unit. Its annual usage of component RB is 8,760 units. The annual holding
cost of one unit of component RB is 5% of its purchase price and the cost of
placing an order is £12·50.
• Required:
• (a) Calculate the economic order quantity (to the nearest unit) for
component RB.
• (b) Assuming that usage of component RB is constant throughout the year
(365 days) and that the lead time from placing an order to its receipt is 21
days, calculate the stock level (in units) at which an order should be
placed.
4.
• A manufacturing organisation uses 20,000 kilograms (kg) of a raw
material evenly over a period. The material is purchased for £2·50 per
kg, the cost of placing an order with the supplier is £60 and the cost
of holding one kg of the material in stock for the period is 15% of the
purchase price.
• Required:
• (a) Calculate the economic order quantity (EOQ) of the raw material
• (b) Calculate the total holding costs of the raw material in the period
if the ORDER QUANTITY is 3,000 kg and BUFFER STOCK is 1,000 kg. (5
marks)
5.
• The following data for the current year relate to a sterile pack purchased by the Goodheart
Hospital:
• Annual demand 90,000 units
• Annual holding cost per unit £8
• Cost of placing an order £25
• From the start of next year the cost of placing an order will rise by £11 but all the other data
will remain the same. The hospital bases its purchasing decisions on the Economic Order
Quantity (EOQ).
• Required:
• (a) Calculate the EOQ for:
• (i) the current year
• (ii) next year.
6
7

• Supplier offered 1% discount if order size is 2000 units or above

• Calculate total saving if company accept discount
Q8.
9.
• The total annual requirement for Material Y is 120,000 litres, used
evenly over each year. A safety stock of 2,500 litres of Material Y is
held and the average lead time (the interval between placing an order
for materials and having them delivered) is 1·5 weeks. (Assume 1 year
= 50 weeks);
• Reorder level will be ___________ kg
10.
• Material Y is also used in the manufacture of Product Z and in several other products. The total annual
requirement for Material Y is 120,000 litres, used evenly over each year.
• The costs of ordering stock and holding stock are as follows:
• Ordering £45 per order
• Holding £0·30 per litre per annum
• A safety stock of 2,500 litres of Material Y is held and the average lead time (the interval between
placing an order for materials and having them delivered) is 1·5 weeks.
• Required:
• Calculate for Material Y the:
• (i) Economic order quantity, using the formula
• (ii) Reorder level (assume 1 year = 50 weeks);
• (iii) Total annual cost of ordering stock;
• (iv) Total annual cost of holding stock.
True or False
• 1. Material requisition note is a document prepared by production
department and sent to store department requesting for material
issue.
• 2. Invoice is a document prepared by supplier and include price,
quantity and cost of material.
• 3. Goods received note and material requisition note are used to
update bin card.
True or False
• 4. A document prepared by store department and sent to purchase
department for purchasing goods is called purchase order.
• 5. Goods received note is prepared by store department.
• 6. Purchase order include date, quantity and material code.
True or False
• 7. Bin card is used to identify balance quantity of raw material in the
store department at any time during the year.
• 8. Stock count identifies any discrepancy (difference) between stock
of item held in the store department and amount of material shown
in bin card.
• 9. Theft and inaccurate recording can be reasons for discrepancy
between record of bin card and quantity of stock held.
True or False
• 10. Payment is made to supplier after matching invoice with purchase
order and GRN.
• 11. Bin card is maintained by store department and store ledger
account is maintained by accounts department.
• 12. Bin card include quantity of material however store ledger
account include quantity as well as price of material.
True or False
• 13. Bin card include date, material code, quantity issued, quantity
received and balance.
• 14. Production department is responsible maintain raw material.
• 15. Profit will be lower using FIFO rather than LIFO.
• 16. Production costs will be higher using weighted average pricing
rather than FIFO.
True or False
• 17. All documents which one division send to the other shall be
authorise by manager of receiving division.
• 18. Invoice should be matched with GRN and purchase order for
payment.
• 19. When invoice is matched with GRN, its purpose is to check
quantity of material in invoice and that which store department has
received.
True or False
• 20. When invoice is matched with purchase order, its purpose is to
check date so as to make sure that material has been received within
expected time period.