MATERIAL

Introduction

One of the major objectives of cost accounting is cost control. Every element of cost
has to be effectively control out of the three elements i.e., material, labour and
expenses. Material forms a chunk of cost of production.

Meaning of Material Control

Material control is a system which ensures required quantity of material at the time
and place with minimum investment of capital. It may be defined as the regulation of
functions of an organization relating to procurement. The storage and usage of
material in such a way as to maintain even flow of production without excessive
investment in material stock.

An effective material control system can improve the input, output ratio. It is an
integration of the various aspects includes scheduling the requirements, purchasing,
receiving and inspecting, maintaining stock records and stock control.

Objectives of Material Control or Need for Material Control

1. It ensures supply of adequate quantity of material

2. To reach optimum investment in material
3. To attain favourable terms of purchase
4. To control wastage
5. To control of obsolesce and spoilage
6. To maintain proper reporting to management
7. To present any misappropriation of material
8. To make proper control system for settlement of invoice

Economic Ordering Quantity (EOQ)

Economic Ordering Quantity (EOQ) is an important element of inventory to be

decided in the day of inflationary control. The buying cost, carrying cost, and ordering
cost are very high. Such costs should be minimized by the firm in order to minimize
the cost to control and reduce material cost of production. Economic ordering quantity
depends on many factors like cost of purchasing and receiving, normal consumption,
interest on capital availability of storage accommodation, ordering and carrying cost.
EOQ is a recording quantity which is a quantity to be purchased each time the order is
placed.

An EOQ is aimed at minimizing both carrying cost and cost of ordering.

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1. Carrying Cost

Carriage costs are incurred on maintenance of material, materials in stores, and

including cost of material handling, interest on capital, obsolesce, pilferage, rent,
insurance and other storage cost.

2. Ordering cost

Ordering costs are incurred for acquiring material into store. This cost is incurred each
time materials are purchased. The ordering cost includes cost of processing, receiving,
inspecting, general administration overheads, and cost of purchase department. As
number of units per order is increased ordering cost are reduced that is a placement of
(less number of purchase order) but at the same time carriage cost increased than
quantity of material kept in the stores increases.

Formulae
2AB
EOQ = √
CS
Where, EOQ = Economic Ordering Quantity

A = Annual consumption or usage of materials in units

B = Buying cost per order

C = Cost per unit

S = Storage & carrying cost percentage per annum

Though the above formula is the most popular the following are some other variations
of the same formula with different abbreviations:

2UO
EOQ = √
C

Where, U = Usage in units per annum

O = Ordering costs

C = Cost of carrying one units to inventory during one year

2CO
EOQ = √
I

Where, C = Consumption of materials in units per year

O = Ordering costs

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 I = Interest & other carrying cost per units per annum

All the formulae provide the same result. However, the first formula which is the more
popular one usually used.

Sometimes, consumption of material may not be given in units but only in value. In
such cases, the formula for EOQ is slightly altered.

2AB
EOQ (in Rs.) = √
S

Where,

EOQ = Economic Ordering Quantity in rupees

A = Annual consumption of materials in rupees

B =Buying cost per order

S = Storage & carrying cost percentage

This formula is applicable only when consumption of materials is not given in units.

Inventory control and its techniques:

Inventory control is a system which ensures the maintenance of required

quantity of inventory of the required quality at the required time with minimum
amount of investment.
The term inventories include raw material, store, supplies, spare parts, tools,
components, assemblies, partly finished goods and finished goods.
The objective of inventory control is to achieve maximum possible inventory
turnover.
The quantity of inventory to be maintained is based on the following factors:
(a) Availability of finance.
(b) Quantity discounts allowed.
(c) Storage space available.
(d) Ordering cost.
(e) Receiving cost.
(f) Risk of loss due to price fluctuations
(g) Risk of loss due to evaporation, obsolescence, theft, deterioration, etc.
(h) Economic ordering quantity; and
(i) Time to obtain delivery or lead time.
The main objectives of Inventory control are as follows:
(1) Keeping required material of adequate quantity in order to avoid disruption of
production.

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(2) Optimising investment in inventory and reducing carrying cost.
(3) Following the policy of M.B.E. (Management by Exception) by relieving the top
management from involving in each and every decision relating to inventory.
The following are various inventory control techniques used in different
industries
1. Demand and supply method of stock control – Levels of stock and EOQ:
This method of material control utilizes the principles of planning the demand for and
supply of each item of material:
 At the lowest cost possible
 With the lowest possible inventory
 Consistent with operating requirements
Optimum quantity of purchasing and manufacturing lot sizes are determined by
economise the cost of procuring, storing and consuming each time of material.
The various levels of stock used in demand and supply method are explained in
detail below:
(a) Minimum stock level:
This is the minimum quantity of material to be maintained in stores throughout
the year. The following factors are essential for fixing minimum stock level:
1. Reorder level.
2. Normal consumption of material.
3. Time required to obtain material from the time of issuing purchase order to the
time of physical receipt of the material.
4. Nature of material.
(b) Maximum stock level:
It is that quantity above which stock of any item should not be allowed to exceed.
Fixation of this quantity depends on several factors as given below:
1. Rate of consumption required for production.
2. Availability of storage space.
3. Cost of storage.
4. Availability of finance.
5. Extent of price fluctuations.
6. Reorder level and time required to obtain delivery of supplies.
7. Availability of quality raw material.
8. Economic ordering quantities.
9. Risk of obsolescence, evaporation and natural waste.
10. Cost of insurance.
(c) Danger level:
This is the stock level below the minimum level. When stocks reach this level
action for immediate purchase is necessary. Issues are controlled by stopping normal
issues and issuing only on special instructions.

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 (d) Reorder level:
It is between maximum and minimum stock levels. Once the stock level reaches
reorder level, the store keeper initiates purchase requisition to obtain fresh stocks.
Reorder level depends on economic ordering quantity, lead time and rate of
consumption of material.
Various methods are used for calculation the levels of stock.
(a) Reorder Level = Maximum Consumption x Maximum Reorder Period

(b) Minimum Level = Reorder level – (Normal Consumption x Normal

Reorder Period)

(c) Maximum Stock Level = Reorder Level + Reorder Quantity – (Minimum

Consumption x Minimum Reorder Period)

1
(d) Average Level = Minimum Level + of reorder quantity
2
Or
1
= (Maximum level + Minimum level)
2

(e) Danger Level = Average Consumption x Maximum reorder period for

emergency purchases

METHODS OF PRICING MATERIAL ISSUES (OR) STORES LEDGER

Need for Pricing
Ascertainment of accurate cost is one of the main objectives of cost accounting.
For a manufacturing company material consumption and material cost are vital
aspects. Ascertainment of accurate cost depends on correct valuation of material used
in the product. The material cost consists of invoice price plus freight, carriage,
insurance, taxes, stores costs, etc.
Materials are issued to different departments, different orders and jobs from
stores. The jobs are to be correctly charged with material consumed. But the material
in stores will be different lots received at different prices on different occasions. This
makes it necessary to decide about the price to be charged to jobs which are issued
with materials from different lots.
The following are essential for ascertainment of accurate material cost:
1) Computation of total cost of material purchased.
2) Systematized material issue procedure.
3) Appropriate methods of pricing material issues.

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 Methods of Pricing Materials Issues
The purchase prices of materials fluctuate on account of changes in the product
prices, buying form different suppliers and on account of quantity discounts. Because
of price fluctuations, the stock may include several lots of the same material
purchased at different prices. When these materials are issued to production, it is
important to consider the correct price at which these materials are charged to
production.
There various methods in use such as;
1. Fist in First out (FIFO)
2. Last in First out (FIFO)
3. Simple Average
4. Weighted Average
1. First in First out Method (FIFO)
Different lots of the same material received are noted in order in which they
have entered into the stock. When an issue is made, the price of the earliest lot in the
stock is charged to the receiving department. When that lot is exhausted, the next lot is
issued at the respective price of that lot. This method resembles the ‘queue’ system
because the material which entered the store first goes out first.
Advantages of FIFO Method
1. Prices are based on actual costs. No profit or loss on stocks results from using
the method.
2. Stock balances are of fair commercial value representing the latest market
prices.
3. This method is suitable in case of slow moving materials.
4. It is appropriate in situations of falling prices to charge the jobs with higher
prices purchased earlier.
Disadvantages of FIFO Method
1. Possibility of more clerical errors due to more number of calculations.
2. The cost of similar jobs differs if the prices fluctuate.
3. In times of rising prices, the cost of jobs does not reflect current market prices.
This inflates the profits unnecessarily, resulting in higher taxes.
Pro forma of FIFO Method
Receipt Issued Balance
Date Particulars Qty Rate Amount Qty Rate Amount Qty Rate Amount
Units Rs. Rs. Units Rs. Rs. Units Rs. Rs.
Balance b/d

G.R.N. No.
M.R.N. No.
G.R.N. No. – Goods Received Note Number
M.R.N. No. – Material Requisition Note Number

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2. Last-in-First out method (LIFO)
Under this method, the price of material last purchased and kept in stores in
changed for the issues first and then the preceding lots purchased are issued.
This method is used to take advantage of rising prices.
Advantages of LIFO Method
1. This method is simple to operate when issues are not too many.
2. Prices are based on actual cost. Therefore there is no possibility of profit or loss
in stocks.
3. Production cost reflects latest market prices.
4. This method is suitable in case of rising prices because materials are issued at
current market prices. The jobs and production are charged at the latest prices.
Thus, profit on the jobs is not unnecessarily inflated.
Disadvantages of LIFO Method
1. This method also involves tedious clerical work which may lead to clerical
errors.
2. Comparison of jobs becomes difficult as they use same raw material but are
charged with different prices.
3. During the period of falling prices the stocks are at high prices, which may
necessitate writing off stock values to show the stocks at their market values.
3. Simple Average Price Method
When the variance between purchase prices is very little, this method is most
suitable one. Here the total of the prices of materials in the stock (from which the
material to be priced could have been drawn) is divided by the number of prices used
to ascertain the ‘simple average price’. Irrespective of the quantities, the average of
the prices is found. One lot may be 5 kgs., and another lot may 5,000 kgs., But the
prices per kg., of both the lots are taken for average purpose.
It should be noted that for the purpose of physical movement of materials,
FIFO (First in First Out) method is assumed which forms the basis of simple average
method. Thus, the prices of earlier lots are left out of simple average calculation, as
and when materials are issued and older lots are exhausted.
Advantages
1. It is simple and easy to calculate the issue price.
2. This method reduces the effect of fluctuation of prices by averaging the price.
Disadvantages
1. This method does not take into account the quantity purchased at each price.
This may lead to absurd results.
2. As the actual price is not used, profit or loss on material will usually arise.
3. The value of closing stock under this method is absurd. When price fluctuates
sharply, the closing stock shows credit balance, that is negative figure!

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