Cost Accounting

Chapter 03 (Part 04)

(Material Cost Management or Cost control of material)

Md. Monowar Uddin Talukdar

Lecturer
Department of Business Administration

Khwaja Yunus Ali University

Outlines:
• Material Cost and Control
• Importance of Material control
• Need for control of Materials
• Essentials of Material Control
• Purchase control
• Centralized and Decentralized purchase

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Outlines:
• Function of Purchasing Department
• Store Management
• Reorder Level
• Danger Level
• Economic Order Quantity
• Uncertainty and Safety stock

2021 Md. Monowar Uddin Talukdar

Outlines:
• Store Records
• Reconciliation of BIN cards and stores ledger
• Methods used in issuing Materials
• Stock Valuation
• Perpetual Inventory System
• Advantages of the perpetual inventory system

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Outlines:
• Periodic inventory
• The ABC analysis
• Stock Turnover
• Just in time systems

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Material Cost and Control:

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Importance of Material control:
• Material is a very important factor in production in a manufacturing
organisation. It is the first and the most important element of cost.
Materials account for nearly 60-70 percent of the cost of production in
most of the manufacturing concerns.

• Product cost is controlled by proper planning, purchasing, handling and

accounting are of great importance.

• Two levels of material control exist:

• (i) Quantity or unit control.
• (ii) Taka and financial control.

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Importance of Material control:
• For better understanding of material control, the entire
process of material control may better be divided into
three stages, namely;
(i) Purchase Control
(ii) Store control
(iii) Issue control

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Need for control of Materials:
1. Availability of materials
2. No excessive investment in materials
3. Reasonable Price
4. Minimum Wastage
5. Perpetual Inventory System
6. Risks Avoidance
7. Availability of information

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Purchase control:

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Centralized and Decentralized purchase:

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Function of Purchasing Department:
• The following are the functions of a purchase department:
1. What to purchase?
2. When to purchase?
3. Where to purchase ?
4. How much to purchase ?
5. At what price to purchase?

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To perform the functions of a purchase department follows the
following procedures:
(a) Receiving purchase requisitions
(b) Exploring the sources of supply and choosing the supplier
(c) Preparation and Execution of purchase order
(d) Receiving and inspecting materials
(e) Checking and passing of Bills for payment

2021 Md. Monowar Uddin Talukdar

• To perform these functions effectively, the purchasing department
follows the following procedures:
(a) Receiving purchase requisitions
(b) Exploring the sources of supply and choosing the supplier
(c) Preparation and execution of purchase order
(d) Receiving and inspecting Materials
(e) Checking and passing of bills for payment

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Store Management:
The important aspects of store management have discussed below:
• Minimum stock level
• Maximum stock level

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Store Management (Minimum stock level
):
• This is known as safety or buffer stock. In other words, stock beyond this
level should not be allowed to fall. In fixing this level, the following
factors are taken into consideration:
a) Lead-time i.e. time lag between indenting and receiving of the
materials.
b) Rate of consumption of the materials during the lead-time.
c) Re-ordering level, i.e. the level at which the storekeeper should initiate
the purchase requisition for fresh procurement of the materials.
d) Nature of the material. Minimum level is not required against
customer’s specific order.

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Store Management (Maximum stock level):
• It represents the maximum quantity of an item of material, which
can be held in stock at any time. Stock should not exceed this
quantity. The main purpose of this level is to ensure that capital is
not blocked up unnecessarily.

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Store Management (Maximum stock level):
• The maximum stock level is fixed keeping in view the following factors:
1. Amount of working capital that can be spared for maintaining stors.
2. Availability of storage space.
3. Maximum requirement of the stores for production purposes at any point of time.
4. Lead-time.
5. Rate of consumption of the stores by deterioration, evaporation, etc.
6. Cost of carrying the stores.
7. Possibility of loss in stores by deterioration, evaporation, etc.
8. Possibility of price fluctuation.
9. Economic order quantity.

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Reorder Level :
• It is the point fixed between maximum and minimum stock levels.
When stock of materials reach at this pint, the storekeeper will
initiate purchase requisition.

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Danger Level:
• Normally stock should not be lower than minimum or safety
levels. But if for any reason, stock comes down below the
minimum level, it is called danger level, which will necessitate
urgent action on the part of management for immediate
replacement of stock to prevent loss of stock outs. At this level,
normal issues of the materials are stopped and issues are made
only order specific instructions.

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Danger Level (Calculation of Stock
Level):
The following formula may be used for working out the above levels
• Maximum Stock Level = Reorder Level + Reorder Quantity – (Minimum usage X
minimum time required for delivery)
• Minimum Stock Level = Reorder level – (Normal consumption per unit of time X
minimum time required to obtain delivery)
• Average stock Level = ½ (minimum stock level + maximum stock level ) or
= Minimum stock level + ½ of Reorder quantity
Reorder Level = Maximum consumption per unit of time X Maximum period
required for delivery
• Or
Minimum stock + (Average consumption per unit of times X Average lead time)

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Illustration:
• In manufacturing its products, a company uses three raw materials A, B and C in respect of
which the following apply.
Raw material Usage per Reorder Price per Delivery Order Level Minimum
unit of Quantity (Kg) Period (Kg) Level (Kg)
product (Kg) (Kg) (week)
A 10 10,000 10 1 to 3 8,000 -
B 4 5,000 30 3 to 5 4,750 -
C 6 10,000 15 2 to 4 - 2,000

Weekly production varies form 175 to 225 units, averaging 200, what would you expect the
quantities of the following to be?
(a) Minimum stock of A
(b) Maximum stock of B
(c) Reorder level stock of C, and
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(d) Average stock of A
Economic Order Quantity (EOQ):
• In purchasing material one of the important problems to be faced
is how much to buy at a time. So, it represents the most favourable
(Optimum) quantity to be ordered each time fresh supplies are
required.

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Charring Cost:
It is the cost of holding the materials in the stores and includes-
• Cost of storage space, which could have utilized for some other
purpose.
• Cost of bins and racks that have to be provided for the storage of
materials.
• Cost of maintaining the materials to avoid deterioration.
• Amount of interest payable on the money locked up in the materials.
• Cost of spoilage in stores and handling.
• Insurance cost.
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Ordering Cost:
It is the cost of placing orders for the purchase of materials and includes-
• Cost of staff posted in the purchasing department, inspection section and
payment department.
• Cost of stationary, postage and telephone charges.

The quantity to be ordered should be such which minimizes the carrying and
ordering cost. If the price to be paid is stable, the quantity to be ordered each time
can be ascertained by the following formula:
EOQ = C = Consumption Cost
O = Ordering Cost
I = Interest payment
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Illustration:
• From the following information related to a type of raw material is a
available:
Annual Demand : 2,400 units
Unit Price : Tk. 2.40
Ordering Cost per order : Tk. 4.00
Storage cost : 2% p. a.
Interest rate : 10% p. a.
Lead time : Half month
Requirement: Calculate EOQ and total annual inventory cost in respect
of the particular raw material.
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Uncertainty and Safety stock:

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 • Thanks To All

2021 Md. Monowar Uddin Talukdar