MATERIAL COST

MEANING OF MATERIAL
The term ‘material’ refers to all commodities that are consumed in the
process of manufacture. It is defined as ‘anything that can be stored, stacked or
stockpiled.’ Materials are classified into:
Direct materials are those whose Indirect materials are those
consumption may be identified which cannot be conveniently
with specific production units and
identified with individual cost
which usually become a part of the
units.
finished product.

The term ‘inventory’ is used to cover the stocks of raw materials, components,
work-
in-progress and finished goods. It has been defined by the Accounting
Principles Board as ‘the aggregate of those items of tangible personal
property which (i) are held for sale in the ordinary course of business; (ii)
are in the process of production for such sales; or (iii) are to be currently
MATERIAL
consumed CONTROL
in the (Inventory
production of Control)
goods or services to be available for sale.’
Material or inventory control may be defined as ‘systematic control
and regulation of purchase, storage and usage of materials in such a
way so as to maintain an even flow of production, at the same time
avoiding excessive investment in inventories. Efficient material
control cuts out losses and wastes of materials that otherwise pass
ESSENTIAL REQUIREMENTS OR PRINCIPLES OF
INVENTORY CONTROL
1. •There should be proper coordination and cooperation between various departments dealing in materials, viz., Purchasing Department, Stores Department, Receiving and Inspecting Department, Accounting Department, etc.

2. •There should be a central purchasing department under the control of a competent and expert purchase manager.

3. •There should be proper classification and codification of materials.

4. •Material requirements should be properly planned.

5. •The perpetual inventory system should be operated so that up-to-date information is available about the quantity of material in stock.
ESSENTIAL REQUIREMENTS OR PRINCIPLES OF
INVENTORY CONTROL
6. •Adequate records should be introduced to control materials during production and the quantities manufactured for stock.

7. •The storage of all materials should be well planned, subject to adequate safeguards and supervision.

8. •The various stock levels like minimum, maximum, etc., should be fixed for each item of material.

9. •Purchases of materials should be controlled through budgets.

10. •An efficient system of internal audit and internal check should be operated so that all transactions involving materials are checked by reliable and independent persons.

11. •There should be regular reporting to management regarding purchases, issues and stock of materials. Special reports should be prepared for obsolete items, spoilage, returns to suppliers, etc.
TECHNIQUES OF INVENTORY CONTRO
ABC technique

Stock levels-Minimum, maximum and reorder

levels

Economic order quantity (EOQ)

Proper purchase procedure

Proper storage of materials

TECHNIQUES OF INVENTORY CONTROL
Inventory turnover ratio to review slow and
non-moving materials

Perpetual inventory system

Fixation of material cost standards (Used

in Standard Costing)

Preparation of material budgets (Used in

Budgetary Control
 ABC TECHNIQUE
(Selective Control )
ABC technique is a value based system of material control. In this
technique, materials are analysed according to their value so that costly and
more valuable materials are given greater attention and care.

‘A’ Items: These are high value items which may consist of only a small
percentage
of the total items handled. On account of their high cost, these materials
should be under the tightest control and the responsibility of the most
experienced personnel.
‘B’ Items: These are medium value materials which should be under the
normal control procedures.
‘C’ Items: These are low value materials which may represent a very large
number of items. These materials should be under simple and economical
methods of control.

The point of classifying stock into A, B and C categories is to ensure

that material management focuses on A items where sophisticated controls
 STOCK LEVELS
In order to guard against under-stocking and over-stocking, most of the large
companies adopt a scientific approach of fixing stock levels. These levels
are: (i) maximum level; (ii) minimum level; (iii) reorder level; and (iv)
reorder quantity. By adhering to these levels, each item of material will
automatically be held within appropriate limits of control.
Maximum
Level

Minimum Level

Reorder Level or Ordering Level

Danger Level

Average Stock Level

 REORDER QUANTITY
(Economic Order Quantity Or EOQ)

Reorder quantity is the quantity for which order is placed when

stock reaches reorder level. By fixing this quantity, the purchaser
doesnít have to recalculate the quantity to be purchased each
time he orders for materials. Reorder quantity is known as Economic
Order Quantity because it is the quantity which is most economical
to order. While setting economic order quantity, two types of costs
should be taken into account:

1.Ordering cost This is the cost of placing an order with the

supplier.

2. Cost of carrying stock This is the cost of holding the stock in

storage.
 REORDER QUANTITY
(Economic Order Quantity or EOQ)
Mathematical Formulae of EOQ
 INVENTORY TURNOVER
Inventory or stock turnover ratio tells us how many times in a year stock is
used up and replaced. The greater the stock turnover, the more efficient is
the stock policy. Stock turnover rate is the ratio which the cost of materials
consumed per annum bears to the average stock of raw materials. Thus,

Stock turnover ratio is an indicator of the rate of consumption, i.e., whether

materials are moving fast or slowly. A high stock turnover ratio indicates fast
moving materials and a low ratio indicates slow moving materials. Stock
turnover rate may also be calculated in terms of days. This is done by
dividing 365 days by the inventory turnover ratio. Thus:
PURCHASE OF MATERIALS
Just-in-time (JIT) Purchasing Centralized and
Just-in-time purchasing is the purchase
of materials immediately before these
Decentralized Purchasing
are required for use in production. Broadly speaking, purchase
According to CIMA, London JIT function may be organized in
purchasing is ‘matching receipts of two ways, i.e., centralized
materials closely with usage so that
raw material inventory is reduced to purchasing and decentralized
near zero level.’ purchasing.

Centralization Decentralization
Centralization of purchasing In decentralized purchasing, each
branch or department makes its own
means that all purchases are
purchases. If the branches or plants
made by a single purchase are located at different places, the
department. Head of this decentralized purchasing can better
department is designated as meet the situation by making
Purchase Manager or Chief purchases in the local market by plant
Buyer. or branch managers
PURCHASE PROCEDURE
PURCHASE PROCEDURE( Contd.)
 PURCHASE PRICE
The invoice received from the supplier provides a base figure of
purchase price. The following adjustments have to be made in this figure to
arrive at the real material cost.
• This is an allowance made by the supplier to
Quantity discount
the purchaser to encourage large orders.
• This is an allowance made by the supplier to a
purchaser who has to re-sell the material, e.g.,
Trade discount
discount allowed by the manufacturer to the
wholesaler.
• This discount is allowed by the supplier to a
Cash discount purchaser to encourage prompt payment of
invoice.
• Items, like sales tax, excise duty, customs duty
Sales tax and other
and octroi, should be added to the purchase
levies
price.

• These include sea, land and air freight, dock

Transport charges
• charges, insurance,
If containers etc. on materials
are separately charged, purchased.
all such
costs should be included in the purchase price
i.e. (i) the cost of containers if these are not
Cost of containers returnable; and (ii) the difference between the
cost of container and the amount refunded when
 STOREKEEPING
Storekeeping is the function of receiving of materials, storing
them and issuing these to workshops or departments.

Stores Organization
There are mainly two types of stores organization, i.e., central
stores and departmental sub-stores. From control point of view, it
is ideal to have one central store for receiving and issuing all
materials. However, this is not always practicable because in large
factories, where there are many production departments, the
location of the central store may not be convenient to all such
departments. Thus, where it is not advantageous to keep central
stores, departmental sub-stores should be maintained.

Imprest System
Under this system, a number of sub-stores exist, each drawing
their supplies from the central store. Each sub-store is given,
as a commencing stock, sufficient supplies for a little more than the
re-stocking period. At the end of the period, the storekeeper of each
sub-store will requisition from the central stores the number of
articles required to bring the stock upto the predetermined quantity.
 CLASSIFICATION AND CODIFICA TION OF
MATERIALS
Classification of materials refers to grouping of materials according to their
nature in
suitable categories. Codification is the procedure of systematic assignment
of symbols for each item of store. Such codes may be either numeric,
alphabetic or a combination of numerical and alphabetical symbols.
Basic Principles of Coding: While assigning codes, the following principles
should be kept in mind:
1. Exclusive Each code number should relate to only one type of material.
2. Clear Code must be clear and should identify materials without any
ambiguity.
3. Brief Codes should be brief because long codes are prone to error.
4. Elastic Code should be such that new materials can be added easily.
5. Mnemonic As far as possible, codes should be easier to remember.

Systems of Coding
1. Numerical and Decimal
2. Alphabetical or Mnemonic In
this method, each item of store
3. Alpha-numerical
In this method, a number may be denoted by a combination This is a
of alphabets. As alphabets
is allotted to each item. represent the first sound of combination of
Sub-groups are indicated description of materials, it numerical and
by decimals. becomes easy to remember the
alphabetical methods.
codes.
 STORES RECORDS
The stores records are of two types:
1. Perpetual Inventory Records These records show the movement of
stores, i.e., the
receipt of materials, issues of materials to production department and also
balance in stock. Bin card and stores ledger are the two basic perpetual
inventory records.
2. Documents The documents are used to authorize movement of materials
into and
out of stores. These documents include Goods Received Note, Bill of
Materials, Materials Requisition Note, Materials Return Note and Material
Transfer Note.

Bin Card (Stock Card): A bin card is attached to the bin, drawer or any
other container in which material is stored. An entry is made at the time of
each receipt or issue and the new balance in stock is calculated. All these
entries of receipts and issues are supported by documents, such as Goods
Received Note, Materials Return Note, Stores Requisition Note, etc.

Stores Ledger: The stores ledger is maintained in the cost accounting

department and is one of the basic records for material accounting in a cost
system. This record gives the same information regarding stores as bin
 STORES RECORDS(Contd.)
Goods Received Note
• A copy of Goods Received Note is sent to the storekeeper along with the materials for his records. The storekeeper uses this document
for posting on the receipt side of the bin card.

Stores Requisition Note (or Materials Requisition Note)

• It is a document which is used to authorize and record the issue of materials from store.
• It is a key document in virtually all costing systems and serves the dual purpose of:
• (a) authorizing the storekeeper to issue material
• (b) providing a written record of usage of materials

Bill of Materials (Specification of Materials)

• It is a master requisition which lists all the materials required for the completion of a job. So, a bill of materials is a special form of stores
requisition note which is generally used by departments having standard materials requirements or a comparatively fixed list of materials.

Materials Return Note

• When materials issued are in excess of requirements, the unused materials are returned to stores together with a Materials Return
Note.

Materials Transfer Note

• Materials may have to be sometimes transferred from one job to another. Where such transfers are permitted, these should be
supported by a special document known as a Material Transfer Note.
 INVENTORY SYSTEMS
There are mainly two inventory systems, viz., Periodic Inventory System
and Perpetual Inventory System. There are mainly two inventory systems:
Periodic Inventory System: Under this system, stock-taking is undertaken
at the end of the accounting year.
Perpetual Inventory System: A perpetual inventory system is defined as
‘the method of recording stores balances after each receipt and issue to
facilitate regular checking and obviate closing down for stock-taking.’
Perpetual inventory system is operated by taking the following steps:

1. Reconciliation of bin cards and 2. Continuous stock-taking: In any

stores ledger accounts: The records perpetual inventory system, the book
of each item of store are kept balances as shown by bin cards and
simultaneously at two places i.e., bin stores ledger should agree with actual
card and stores ledger, which are the physical balance in store. Under this
perpetual inventory records. The system, a few items of stores are
balance of an item of store as shown counted daily or at frequent intervals
in the bin card should agree with that and compared with the bin cards and
shown in the stores ledger. stores ledger by the stores auditor.

Materials Abstract (Materials Issue Analysis Sheet ): This is ‘a

document which is a classified record of material issues, returns and
transfers.’ In other words, all materials requisitions, materials return
notes and material transfer notes are analysed periodically by the cost
accounting department to ascertain the material cost of each job.
METHODS OF PRICING MATERIAL ISSUES
 METHODS OF PRICING
First-in, First-out (FIFO) Method: This method is based on the
assumption that materials which are purchased first are issued first. It uses
the price of the first batch of materials purchased for all issues until all units
from this batch have been issued. After the first batch is fully issued, the
price of the next batch received becomes the issue price.
Three important effects of using FIFO method are:
(a) Materials are priced at the actual cost
(b) Charge to production for material cost is at the oldest prices of materials
in stock
(c) Closing stock is valued at the latest price paid

Last-in, First-out (LIFO) Method: It is based on the assumption that the

last materials purchased are the first materials to be issued. Thus, the price
of the last batch of the materials purchased is used first for all issues until all
units from this batch have been issued, after which the price of the previous
batch of materials purchased is used.
Three points should be noted regarding this method:
(a) Material issues are priced at actual cost
(b) Charge to production for material cost is at latest prices paid
(c) Closing stock valuation is at the oldest prices paid and is completely
out of line with the current prices
 METHODS OF PRICING
AVERAGE COST METHODS: These methods are based on the assumption
that when materials purchased in different lots are stored together, their
identity is lost, and therefore, issues should be charged at an average
price.
Simple Average Method
• Simple average price is calculated by adding all the different prices of materials in
stock, from which the materials to be priced could be drawn, by the number of prices
used in that total.

• Weighted
This Average
method gives Method
due weight age to the quantities held at each price when
calculating the average price. The weighted average price is calculated by dividing
the total cost of material in stock, from which the material to be priced could have
been drawn, by the total quantity of material in that stock. The simple formula is that
weighted average price at any time is the balance value figure divided by the balance
units figure.
Replacement Price Method

• Replacement price is the price at which materials would be replaced, i.e., the market
price on the date of issue. This method is used when it is desired to reflect the current
prices in cost.

Standard Price Method

• Standard price is a predetermined price which is fixed for a definite period, such as a
year. Under this method, all receipts are posted in the Stores Ledger Account at actual
cost and issues are priced at standard price. The difference between actual and
OTHER METHODS OF PRICING
• In this method, materials issued are charged at the
rate of the highest priced materials in stores. This
Highest-in, First-out (HIFO)
highest rate is continued to be used until material
Method
at that highest price is exhausted, after which the
next highest price is used.
• Here materials are not charged at a price which has
Next-in, First-out(NIFO) been paid, but rather at a price at which an order
Method has been placed, i.e., the price of materials that will
be next received.
• Special materials purchased exclusively for specific
jobs or work orders should be charged to those
Specific Price or Identifiable specific jobs at the specific (actual) price. This
Cost Method method can always be used where materials are
purchased and set aside for a particular job or work
• ordermethod
This until required
assumesfor production.
that minimum (base) stock is
always held in stock and is not issued. This is in the
nature of a fixed asset and is carried at original cost.
Base Stock Method
Any quantity in excess of base stock is valued
according to one of the other methods, i.e., FIFO,
LIFO, Average, etc.
• This method is similar to simple average method
Periodic Simple Average except that the issue price here is computed
Method periodically (normally at the month-end) and not at
the time of each issue of material.
OTHER METHODS OF PRICING(Contd.)
Periodic Simple Average Method: This method is similar to simple
average method except that the issue price here is computed periodically
(normally at the month-end) and not at the time of each issue of material.

Periodic Weighted Average Method: Like periodic simple average method,

in this method also average price is calculated at the end of a given period
(which is usually one month).

Moving Simple Average Method: In this method, the periodic simple average
is further averaged. For this purpose, a number of periods (or months) is
decided first and then the total of the periodic average prices of the given
periods is divided by the number of periods taken.
Moving Weighted Average Method: In this method, the moving average
price is calculated in exactly the same way as the moving simple average
price except that periodic weighted average prices are taken for averaging.
Inflated Price Method: This method is used where materials are subject to
some inevitable losses that may arise from evaporation, breaking the bulk, etc.
The issue price is slightly inflated to ensure that the loss is covered and the
 MATERIAL LOSSES
Losses of materials may arise during handling, storage or during process of
manufacture. Such losses or wastages are classified into two:
1.Normal Loss This is that loss which has necessarily to be incurred
and thus is unavoidable.
2.Abnormal Loss This is that loss which arises due to inefficiency in
operations, bad luck, mischief, etc.

Control of Material Losses

• Proper storage conditions should be provided, mainly for perishable
materials.
• Store room should be well guarded to avoid the risks of fire or theft, etc.
• To reduce obsolescence, materials should be issued on first-in, first-out basis.
• Accuracy of weighing instruments should be periodically checked.
• A systematic procedure should be developed regarding movement of
materials from one place to another.
• Specialized material handling equipment should be employed so as to
Accounting Treatment: In order to absorb normal material losses in cost,
minimize losses in materials handling.
the rates of usable materials in stock are inflated so that such losses are
covered. Alternatively, normal material loss is transferred to factory
overhead. Abnormal material losses, such as those due to breakage, theft,
fire, flood and abnormal evaporation, are charged to Costing Profit and Loss
Account.
WASTE, SCRAP, SPOILAGE AND DEFECTIVES
Waste: It is defined as ‘that portion of a basic raw material lost
in processing, having no recovery value.’ Waste has the effect of
reducing the quantity of output.. If waste is a part of the normal
process loss, the cost will be absorbed by the good production.
On the other hand, if it is a part of the abnormal process
loss, it is transferred to Costing Profit and Loss Account.

Scrap: As per Cost Accounting Standard-6 (CAS-6) ‘scrap is the

“discarded material having some value in a few cases and which
is usually either disposed of without further treatment (other than
reclamation and handling) or re-introduced into the process in
place of raw materials.” ’ Scrap is treated as (a) As other income
credited to Profit and Loss Account (b) Credit to overheads (c)
Credit to job or process
WASTE, SCRAP, SPOILAGE AND DEFECTIVES
Spoilage: Spoiled work results when materials are damaged in
manufacturing operations is such a way that they cannot be
rectified. For accounting purposes, spoiled work should be
divided into normal and abnormal. The cost of normal
spoilage should be borne by good production. Abnormal
spoilage, caused due to inefficiency and treated as controllable
should be transferred to Costing Profit and Loss Account.
Defectives: It is defined as ‘that production which is below
standard specifications or quality and can be rectified by
incurring additional expenditure (of material, labour, etc.)
known as rectification costs.’ Where defective work is easily
identifiable with specific jobs, the rectification costs should be
debited to the jobs concerned. Where, however, such work
cannot be conveniently identified with jobs, the rectification
costs may be debited to overheads.