MATERIAL COST

The term material refers to all commodities consumed in the process of

manufacturing.

Material represents an important asset and is the largest single item of cost in
almost every manufacturing unit.

Classification of material:

• Direct materials

It is that which can be conveniently identified with and allocated to cost

units. Direct materials generally become a part of the finished products. eg –
a cotton used in a textile mill is a direct material .

• Indirect materials

These are those materials which cannot be conveniently identified with

individual cost units. These are minor in importance. eg – pins, screws nuts
etc. . . These are those which do not physically become a part of finished
products. eg- coal , sand paper soap etc.

• Supplies

These are indirect materials used in production which do not become part of
finished products. eg – oil and grease used in keeping machines in running
conditions .

• Finished or component parts

In assembly type production like refrigerator radio TV car etc. .., component
parts may be purchased or produced within the organization. eg- tires and
tubes in car manufacturing .

• Stores

It is a very wide term and includes raw materials component parts tools
maintenance materials finished goods etc.

• Inventory
It covers stock of raw materials working progress and finished goods.

Inventory or material control:

Meaning and definition

It is defined as safe guarding of companies property in the form of materials

by a proper system of recording and also to maintain them at the optimum
level considering operating requirements and financial resources of the
business.

According to this material control embraces control over purchases storage

and consumption of materials and determine the optimum level for each item
of inventory.

Objectives

• No under stocking.

• No overstocking.

• Minimum wastage.

• Economy in purchasing.

• Proper quality of materials.

 • Information about materials.

• Material report to management.

Essential requirements or principle of inventory control

• Proper coordination and cooperation.

• Competent and expert purchase manager.

• Classification and codification of materials.

• Proper planning.

• Inventory system should be updated.

• Adequate records should be produced.

• Well planned supervision.

• Stock levels should be fixed for each item of materials.

• Budget controlled.

• Internal audit and internal check.

• Reporting.

TECHNIQUES OF INVENTORY CONTROL

1. ABC technique
2. Stock levels
3. Economic Order Quantity
4. Purchase of materials
5. Storage of materials
6. Documents authorizing movements of materials
7. Inventory systems
8. Methods of pricing material issues

1. ABC TECHNIQUE

ABC technique is a value based system of material control. In this technique

of selective control, materials are analyzed according to their value so that
costly and more valuable materials are given greater attention and care. All
items of materials are classified according to their value i.e.

‘A’ Items – these are high value items which may consist of only in small
percentage of the total items handled. On account of their highest 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 the simple and economic
methods of control.

Category % of total value % of total Type of control

quantity
A 70 10 Strict control
B 25 30 Moderate control
C 5 60 Loose control
Total 100% 100% 100%

EXPLANATION

In the given table it is shown that 10 % of total quantity accounts for as

much as 70% of the total value. These are a category items which need very
strict control because of their high cost significance.

The second type of items represents 30% of the total quantity but account for
25% of the total value. These are B items which need routine type of control.

The items representing 60% of the total quantity account for 5% of the total
value. These C items are kept under simple physical controls.

The rules regarding purchasing, storing and issuing of various categories of

items should be framed according to their value and importance.

2. STOCK LEVELS

One of the major objectives of a system of material control is to ensure that

there is no ‘under stocking and overstocking’. A scientific approach to
achieve these objectives to adopt a system of stock levels is:

1. maximum level
2. minimum level
3. re-order level
4. danger level
5. average stock level

1. Maximum level: the maximum stock level is the level above which stocks
should not normally be allowed to rise. It is the maximum quantity of a
material that may be held in store.
The following factors are considered while fixing this level

1. Rate of consumption of the material

2. Storage space available
3. Amount of capital needed and available
4. Risk of obsolescence and deterioration
5. Cost of storage
6. Insurance costs
7. Bulk purchases of seasonal materials
8. Re-order quantity for the material.

Formula

Maximum level= re-order level + re-order quantity –

(Minimum consumption * minimum re-order period)

2. Minimum level: minimum level is that level below which stock should
not normally be allowed to fall. In case any item of material falls below
this level, there is a danger of stoppage in production and top priority
should be given to the purchase of new materials.
 Factors to be considered

1. Rate of consumption of material

2. Time required to obtain delivery of the new materials

3. Re-order level

Formula

Minimum level= re-order level-(normal consumption * normal re-order

period)

3. Re-order Level: this is that level of material at which a new order for
material is placed. It is at this level that purchase requisition is made out. This level
is above minimum level but below maximum level.

Factors to be considered

1. Rate of consumption of material

2. Minimum level
3. Lead time or delivery time i.e., the time normally taken from the time of
raising purchase requisition to receipt of materials.

Formula

Re-order level = (maximum consumption * maximum re- order period)

4. Danger level: this is a level at which normal issues of materials are

stopped and urgent action is taken for purchase of materials so that
production is not interrupted due to shortage of materials
 Formula

Danger level = average or normal consumption * maximum re-order

period for emergency purchases.

5. Average stock level

Formula

Average stock level = minimum level + maximum level

3. ECONOMIC ORDER QUANTITY

Re-order quantity is the quantity to be ordered whenever materials are

to be purchased. By setting this quantity the buyer is saved the task of re-
calculating how much he should buy each time he orders.

Re-order quantity is sometimes known as Economic Order Quantity

because it is the quantity which is most economical to order. In other words, EOQ
is the size of the order which gives maximum economy in purchasing any material
and ultimately contributes towards maintaining the material at the optimum level at
the maximum cost. It equates the ordering cost with the cost of storage of
materials.

Ordering cost: it mainly includes cost of stationery, salaries of those engaged in

receiving and inspecting, salaries of those engaged in preparing the purchase
orders etc...
Cost of storage or cost of carrying inventory: this includes cost of storekeeping,
risk of obsolescence, deterioration and wastage of materials, evaporation etc...

Formula

EOQ = √2.A.O/C

A= annual consumption

O= ordering cost per order

C= carrying cost of one unit i.e. carrying cost % * cost of one unit

4. PURCHASE OF MATERIALS

1. Just In Time (JIT) purchases

JIT is a philosophy when to do something. When applying JIT to purchasing, it

means the purchase of materials at such a time that delivery of materials is
received immediately before its demand or use. It should be recognized that lowest
purchase price does not necessarily result in low cost. Cost may be reduced by
keeping stock of materials at nearly zero level and purchasing just at the time of
requirement. For this purpose long term contracts may be entered into with reliable
suppliers to deliver materials just in time to be used in production. JIT purchasing
reduces stock levels considerably and helps in cost control.

2. Centralized and decentralized purchasing

Organization of purchase function will vary according to particular conditions and

ideas.

Purchases may be centralized or decentralized.

In centralized purchasing, there is a separate purchasing department entrusted with

the task of making all purchases of all types of materials. The head of this
department is usually designated as purchase Manager or chief buyer.

In decentralized purchasing, each branch o department makes its own purchases. If

the branches or plans are located at different places, it may not be possible to
centralize all purchases. In such cases, the decentralized purchasing can better meet
the situation by making purchases in the local market by plant or branch managers.
Advantages of centralized purchasing

1. Concentration in one department

2. Initiation of Firm policy
3. Standardization
4. Better control
Disadvantages

1. Higher administration costs

2. Suitability

Procedure

The procedure of purchasing materials varies from one business to another,

depending upon its size, conditions and ideas.

1. Purchase requisition
2. Selection of supplier
3. Purchase order
4. Receipt of materials
5. Inspection of materials
6. Returns to supplier
7. Approval of invoices and payment

1. Purchase requisition
Purchasing starts when someone in the organization decides that a
particular material is needed and to satisfy this purpose a form known as
Purchase Requisition is used as a formal request to the purchasing
department for the purchase of the material.
 Purchase requisition may be received from:

1. Storekeeper
2. A departmental head
3. Plant engineer
Purchase requisition should be received only from certain authorized
persons in the organization. Everybody cannot be allowed to requisition
purchases...

Specimen

PURCHASE REQUISITION NOTE

Date …….. No …………

Date required …….. Dept ……….

Purpose ………………….
Quantity Description Code Purchase supplier
order No.

Requisition by Approved by

………………….. ………………….
2. Selection of supplier
The purchase department analyses each of the purchase requisitions
received before making arrangements for the purpose. It usually
maintains a suitable record of the different sources of supply and of
 various quotations. Various sources are examined for the purpose of
securing the best quality materials at the lowest possible price.

Factors considered

a. Terms of payment
b. Dates of delivery and reliability of various suppliers in the past
c. Invitation of tenders
3. Purchase order
Orders are placed by the purchasing department with the suppliers who
provide goods at competitive rates.

Purchase order is a written authorization to the supplier to supply the

specified materials at a price and terms mentioned therein.

Purchase order is a legal contract between the parties concerned, the

authority to sign purchase orders should be restricted to selected
responsible officers.

Specimen

PURCHASE ORDER

Supplier …………… Order No ……………….

Date required…………… Date …………................

Requisition No…………..

Quantity Description Code No. Rate Rs.

 To be delivered at …… (place) For ABZ co.ltd

On……………………. (Date) ………………

Terms of payment ………….. Purchase manager

5 copies of purchase order are prepared by large concerns. They are

supplied to:

a. The supplier
b. The receiving department
c. The accounts department
d. The department which initiated Purchase Requisition
e. Retained in the Purchasing Department for reference purpose.

4. Receipt of materials
In large concerns, there is a separate Receiving Department.
All incoming materials are received by the Receiving Department. This
department unpacks the goods and verifies their quantity and condition.
The quantity is checked against the copy of the purchase order and the
supplier’s advice note. Thereafter a Goods Received Note is prepared.

Goods Received Note is prepared in triplicate and sent as follows

i. First copy to purchasing department

ii. Second copy accompanying the goods to the department or
stores to which goods are sent
 iii. Third copy retained in receiving department.

Specimen

GOODS RECEIVED NOTE

Supplier……….. No………..

……….. Date received………….

……….. Purchases order No………

Quantity Description No. of packages gross weight
 Received by

………….
Inspection
Quantity Quantity rejected Reasons for
passed rejection

Date ………..

Inspector Date

……………. ………….

5. Inspection of materials
Large manufacturing companies may also have separate Inspection and
Testing Departments to test the quality of materials purchased. Samples
may be subjected to laboratory tests before the goods are finally
approved. The results of the tests are intimated to the authorities by
means of Testing Reports. Necessary columns are also provided in the
Goods Received Note about the goods passed and rejected on the basis of
tests conducted.
6. Returns to supplier
Where goods received are not of the type ordered or are damaged or are
not satisfactory, these may be returned to the supplier immediately.
A debit note is forwarded to the supplier. If the supplier accepts the
claim, he signifies his acceptance by the issue of a credit note.

7. Approval of invoices and payment

The supplier’s invoice should be checked before payment is made. When
the invoice is being vouched, the various docs like copies of purchase
requisition, purchase order, GRN, inspection report should be checked
against each other to ensure that the quantity, price, carriage, packing and
discounts have been charged correctly.
 If everything in the invoice is found to be correct, a voucher authorizing
payment is prepared and payment is made accordingly.

Valuation of Materials Purchased

1. Quantity discount
2. Trade discount
3. Cash discount
4. Sales tax and other levels
5. Transport charges
6. Cost of containers

5. PROPER STORAGE OF MATERIALS

• Store keeping.

• Stores records.

Store keeping

In large manufacturing companies major part of investment is represented

by stocks. Hence it is necessary for a good store keeping running the
business.

Trained and experienced personnel should be in charge of stores department.

The stores function involves both safeguarding the materials as well as

maintaining up to date stores records.
Objectives

• Economic al usage of storage space.

• Protection of materials against fire and theft.

• Protection of materials against detritions.

• Immediate location of materials required.

• Up to date stores records.

• Facilitating perpetual inventory.

• Speedy receipts and issue of materials.

• Avoiding overstocking and under stocking.

Functions and duties of store keeper

• Maintaining materials.

• Record maintenance.

• Counter checking the deliveries.

• Issuing against authorized store requisitions.

• Prohibiting unauthorized persons.

• Advising management.

Stores organization

There are two types –

1. Central stores – ideal to receive and issue all materials.

2. Departmental sub stores – in large factories and organizations

there are various departments where central stores do not play a
role.

Codification of material
In order to avoid length and ambiguity in description and names of
materials, a symbol may be assigned to each item of material which is
known as code. The codes can be either numerical or alphabetical
symbols.

Advantages:

• Ambiguity in description is avoided.

• Clerical effort is reduced.

• Secrecy is maintained.

• Coding is essential.

• Each item is identified.

Stores record

They are of 2 types

1. Perpetual inventory records – these records show movement of

stores that is receipt of materials, issue of materials to production
department and also current balance in stock.

Bin card and stores ledgers are two types of inventory records.

2. Documents – they are used to authorize movement of materials

into and out of stores .these documents include received note, bill
of materials, materials requisition note, materials return note etc.

BIN CARD: (STOCK CARD)

• A bin is a container in which material is kept. Separate bins are

maintained by the store keeper for each item of material in store.
The bincard shows the details of receipts and issues of materials
and the balance in stock at any time. This record is of immense
help to the store people in controlling the stock position.
• A bin card is attached to the bin, drawer or another container in
which material is stored. An entry is made at the time of each
receipt or issue and the new balance in the stock is calculated. All
these entries of receipts and issues are supported by documents
such as goods received note, materials received note etc.
alternatively bincards are kept on the table in trays.

• A bincard is a quantitative record of receipts, issues and closing

balances of material items in store but it does not contain
information about the prices of the material. A specimen of bincard
is give below.

General purpose bins

 ABZ co. Ltd

BIN CARD

Bin no……….. Minimum level………

Description……….. Re- order level………

Code no …………….. Re- order

quantity………

Stores ledger folio ………….

Date Receipts Issues Balance Stock
verification
Ref. Quantit Ref. Quantit Quantity Date Initials
NO y NO y

Two bin system:-

• In this system two bins are maintained for each item of store. One
bin constitutes the main or the regular bin form which materials are
issued and the other bin contains the maximum stock from which
issues are made in stock in the regular bin is exhausted.

• The idea of two bin system is to provide automatic information

about reaching minimum stock level so that issue materials for
regular production are stopped.
 Stores ledger

This ledger is maintained in the cost accounting department. The stores

ledger records all receipts and issue transactions in respect of materials.

Separate ledger folios are maintained in the stores ledger for each item of
material.

STORES LEDGER ACCOUNT

Date Receipts Issues Balance

Ref Qty Rate amt Ref Qty Rate amt Ref Qty Rate amt

6. DOCUMENTS AUTHORISING MOVEMENT OF MATERIALS

Goods received note

The store keeper uses this document for posting on the receipt side of the
bincard.

Stores requisition note

It is a document which is used to authorize and record the issue of

materials from stores. The store keeper should issue materials on the
presentation of duly authorized stores requisition note. It should be
appreciated that this is a key document. It is used for the purpose of –

a) Authorizing the store keeper to issue the material.

b) Providing a written record of usage of materials.

A separate requisition may be prepared for each item of material or a

single requisition may be prepared to cover the issuance of a number of
items.

The stores requisition note may be prepared in duplicate or triplicate.

The original copy is passed to the stores department while the duplicate
is retained by the department requisitioning materials.

The stores requisition note is used for making entries in bincard, stores
ledgers etc...

STORES REQUISITION NOTE

Materials required for job No……….. No…………

Department………….. Date………..

Quantity Description Code No. Cost office

Rate Amount

Rs Rs

Bin No…………………. Issued by………..

Stores ledger folio……………. Received by………..

Priced by…………..

Bill of materials

It is a special form of stores requisition note which is generally used by

departments having standard material requirements or a comparatively
fixed list of materials

BILLS OF MATERIAL

No…………

Job orders No………… Date…………….

Item No Quantity Description Code For Cost office

No.
Rate Amount

Rs Rs

Prepared by………….. Date Issued ………..

Checked by……………. Storekeeper……….

Advantages of using bill of materials are

• Saves time and promotes efficiency.

 • Avoids delay in production.

• Risk of errors is reduced.

• Costing of jobs become easier and speedier.

Material return note

When materials issued are in excess of requirements, the unused

materials are returned to stores together with a material return note.

When materials are received back in the store, these should be placed in
appropriate bins and entries made in the bincard.

MATERIALS RETURN NOTE

Department……… No…………

Credit Job No………… Date…………….

Quantity Unit Description Code For Cost office

Rate Amount

Rs Rs

Bin No……………… Date Issued ………..

Stores ledger folio……… Storekeeper……….

Authorized by…………
Materials transfer note

Materials may have to be sometimes transferred from one job to another.

This may be either because excess materials were issued to a job or
surplus materials are directly transferred to another job or because
materials issued to a less urgent job are transferred to a more urgent job.

When such transfers are not permitted, the surplus materials are returned
to the stores and then reissued to another job. This results in extra
transport costs. Thus when materials are bulky such transport costs may
be heavy which can be avoided if direct transfers are permitted. For a
transfer of materials a material transfer note is used.

MATERIALS TRANSFER NOTE

From job No…………. No…………

To Job No………… Date…………….

From department To Department………

Quantity Unit Description Code For Cost office
Rate Amount

Rs Rs

Bin No……………… Date Issued ………..

Stores ledger folio……… Storekeeper……….

Authorized by…………
Materials abstract (materials issued analysis sheet)

All material requisitions, material written notes and material transfer

notes are analyzed periodically by the cost accounting department to
ascertain the material cost of each job. This is done on a document
known as material abstract.

MATERIALS ABSTRACT

Month or week ending………

Stores requisition Job No. Tota Indirect
No. l for overheads
jobs

Total

7. INVENTORY SYSTEM
There are mainly 2 inventory systems –

1. Periodic inventory system

Under this system stocking is undertaken at the end of the

accounting year. As the stock taking involves verifying the
physical quantities of stores in hand, some stores temporarily
suspend plant operations when this is done. This is because it is
rarely feasible to take stocks while production continues. Thus the
annual stock taking should be organized well in advance to
minimize production holdups.

2. Perpetual inventory system

The periodic inventory system has certain serious disadvantages

which perpetual inventory system overcomes. Under this system
current balance of stores is always shown in records, any receipt
being added to an issues being deducted from the balance after
each transaction. The records used for perpetual inventory are
bincard and stores ledger.

Steps in perpetual inventory system

1. Reconciliation of bincard and stores ledger account

2. Continuous stock taking

Advantages of perpetual inventory system

• Avoids long and costly work

• Avoids dislocation and production.

• Profit and loss account and balance sheet can be easily

prepared.

• Moral check on staff.

• Continuous internal check.

• Early detection of errors.

 • Manages working capital.

• Detailed and reliable.

Material losses

Losses are classified into 2 categories:

1. Normal loss

a) Loss by evaporation in case of liquid materials.

b) Loss due to breaking the bulk.

c) Loss due to loading and unloading of materials.

2. Abnormal loss

a) Theft or pilferage.

b) Breakage.

c) Fire accident, flood etc.

d) Use of inaccurate weighing instruments.

e) Improper storage of materials.

Control of material losses

Steps to be taken to control losses of materials

1. Proper storage condition

2. Materials should be issued on FIFO basis.

3. Periodic checking of weighing machines.

4. Systematic procedure to be developed.

 5. Specialized equipment should be employed.

Waste and scrap are forms of material losses.

STOCK TURNOVER RATIO

STR= cost of materials consumed during the period

Average stock of materials during the period

STR is an indicator of the rate of consumption. A high STR

indicates fast moving materials and low ratio indicates slow
moving materials.

This will enable the management to avoid keeping capital

locked up in undesirable items of materials.

8. METHODS OF PRICING MATERIAL ISSUES

Important methods of pricing material

1. FIFO

This method is based on the assumption that

materials which are purchased first are used first. It
uses the price of the first batch of materials
purchased for all units from this batch have been
issued. After the first batch is fully issued, the price
of the next batch received becomes the issued price.
Upon this batch also fully used, the price of the still
next batch is used for pricing and so on.

Advantages:

a. Realistic assumption

b. Actual cost

c. Closing stock valuation

d. Simple and easy

 Disadvantages

a. Materials are not charged at the current market

prices.

b. Unfair results

c. Increased possibility of errors

2. LIFO:

This method is just reverse of FIFO. It is based on

the assumption that last purchases of materials are
issued first and earlier receipts are issued last. LIFO
method uses the price of the last batch received for
all issues until all units from this batch have been
issued.

Advantages

i. Materials are charged at current market prices.

ii. Actual cost

iii. Income-tax saving

Disadvantages

i. Stock value does not represent its

current value.

ii. Not realistic

iii. Complicated calculations and increase

of clerical errors.

3. Simple average price

It is calculated by adding all the different prices and

dividing by the number of such prices. It does not
take into account quantities of materials while
computing average price.
 Advantages

a. Simple to understand a

b. Easy to operate.

Disadvantages

a. Materials are not charged out at actual

cost.

b. Unscientific method and unsatisfactory

results.

4. Weighted average price

This method gives due weight to the qualities 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 that total
quantity of material in that stock.

Advantages

a. Evens out the effect of widely varying prices of

different purchases.

b. Reduces the work of making calculations.

c. No unrealized profit or loss arises.

Disadvantages

a. More calculation is required when the receipts

are numerous

b. Materials are not issued at the current market

prices

c. Issue prices generally run to a number of

decimal points.