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INTRODUCTION Materials constitutes an important part of the cost of a product. A significant proportion of companys funds are invested in materials/inventory.

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Presentation on theme: "INTRODUCTION Materials constitutes an important part of the cost of a product. A significant proportion of companys funds are invested in materials/inventory."— Presentation transcript:

1 INTRODUCTION Materials constitutes an important part of the cost of a product. A significant proportion of companys funds are invested in materials/inventory. A proper control over materials, therefore, becomes necessary to keep the cost of production to the minimum. There must be a proper control of materials from time orders are placed with suppliers (i.e. from the stage of procurement) until they have been effectively utilized in production (i.e. to the stage of their ultimate consumption). So, an efficient system of material control will be that which ensures availability of the right quantity of material of right quality at the right time so as to maintain an even flow of production and at the same time avoiding excessive investment in inventories. Materials may be classified as follows :

2 Raw materials are the basic materials supplied in crude form to be used for production e.g., jute, cotton, steel, timber, rubber, coal, etc. Components are not raw in nature rather are finished parts made out of raw materials which are assembled to make the finished products, e.g., tyres and tubes in cycle industry, stabilisers in A.C. and fridge manufacturing, batteries in car manufacturing, monitors in computer manufacturing, etc. Tools are the appliances used in the manufacturing operations, e.g., hammers, screw-drivers, drills, milling cutters, etc. Spare parts are used for the maintenance of plant, machinery and buildings and for smooth running of production schedule. Consumable stores are the items used for smooth running of the machines, e.g., lubricants, oil, cotton waste,rags,brooms, etc. Materials include both direct and indirect materials.

3 Meaning of material control Material control is a system which ensures that right quality of material is available in the right quantity at the right time and right place with the right amount of investment.In simple words material control is a systematic control over the purchasing, storing and using of materials so as to have the minimum possible cost of materials. Matz, Curry, Frank state in their book Cost Accounting as follows: Because materials constitute such a significant part of product cost and since this cost is controllable, proper planning, purchasing, handling and accounting are of great importance.

4 ASPECTS OF MATERIAL CONTROL There are two aspects of material control as given below (a) Accounting Aspect: This aspect of material control is concerned with maintaining documentary evidence of movement of materials at every stage right from the time sales and production budgets are approved to the point when materials are purchased and actually used in production operations. (b) Operational Aspect: This aspect of material control is concerned with the maintenance of material supplies at a level so as to ensure that material is available for use in production and production services as and when required by minimising investment in materials.

5 ESSENTIALS OF MATERIAL CONTROL 1. Purchases of materials should be centralised i.e., one purchasing department should be authorised to make all purchases of materials to avoid reckless buying by all departments and to ensure that all purchases are made at the most reasonable prices. 2. There should be proper scheduling of materials. 3. There should be proper co-operation and co-ordination among the departments involved in purchasing, receiving and inspection so that there may be no inadequate availability of materials which may disrupt production and lose sales.

6 4. The storage of materials should be well-planned to avoid losses from theft, carelessness, damage, evaporation and pilferage. 5. A good method of issue of materials to various jobs, orders or processes should be followed so that there is delivery of right type of materials in the right quantity at the they are needed. 6. Perpetual inventory system of materials should be operated to facilitate regular checking and avoiding closing down factory for stock-taking. 7. Minimum, maximum and re-ordering levels for each type of material should be fixed to ensure that there is no shortage of materials and there is no over-stocking.

7 METHODS OF VALUING MATERIAL ISSUES OR MATERIAL COSTING (A.) COST PRICE METHODS (i) First in first out (ii) Last in first out (iii) Average cost (iv) Inflated price (v) Specific price (vi) Base stock (vii) Highest in first out. (B.) MARKET PRICE METHODS (i) Replacement price (ii) Realisable value (C.) STANDARD PRICE METHODS (i) Current standard price (ii) Basic standard price FIRST IN FIRST OUT (FIFO): Under this method material is first issued from the consignment on hand and priced at the cost at which that consignment was placed in the stores. In simple words, materials received first are issued first.

8 Example: The received side of the stores ledger account shows the following particulars: Jan. 1 Opening balance: 500 units @ Rs. 4 Jan. 5 Received from vendor 200 units @ Rs. 4.25 Jan. 12 Received from vendor 150 units @ Rs. 4.10 Jan. 20 Received from vendor 300 units @ Rs. 4.50 Jan. 25 Received from vendor 400 units @ Rs. 4 Issues of material were as follows : Jan. 4 -- 200 units; Jan. 10 -- 400 units; Jan. 15 – 100 units; Jan. 19 – 100 units; Jan. 30 – 250 units Write out the store ledger Account in respect of the materials for the month of January.

9 DateParticulars Receipts Issues Balance Qty. (unit) Rate (Rs) Amt. (Rs) Qty. (unit) Rate (Rs) Amt. (Rs) Qty. (unit) Rate (Rs) Amt. (Rs) Jan 1Balance b/d - - - - - - 500 42000 Jan 4 Requisition slip no… - - - 200 4 800 300 41200 Jan 5 Goods Rec. Note no…. 200 4.25 850 - - - 300 200 4 4.25 1200 850 Jan10 Requisition slip no….. - - - 300 100 4 4.25 1200 425 100 4.25 425 Jan12 Goods Rec. note no….. 150 4.10 615 - - - 100 150 4.25 4.10 425 615 Jan15Req. slip no - - -100 4.25 425 150 4.10 615 Jan19Req. slip no - - -100 4.10 410 50 4.10 205 Jan20Goods rec. note no…. 300 4.50 1350 - - - 50 300 4.10 4.50 205 1350 Jan25Goods rec. note no…. 400 4.001600 - - - 50 300 400 4.10 4.50 4.00 205 1350 1600 Jan30Req. slip no - - - 50 200 4.10 4.50 205 900 100 400 4.50 4.00 450 1600 FIFO METHOD;

10 MERITS: 1. The main advantage of FIFO is that it is simple to understand and easy to operate. 2. It is logical method because it takes into consideration the normal procedure of utilising first those materials which are received first. 3. In this method, materials are issued at the purchase price ; so the cost of jobs or work orders is correctly ascertained so far as cost of materials is concerned. Thus, the method recovers the cost price of the materials. 4. This method is useful when prices are falling. 5. Closing stock of materials will be valued at the market price. 6. This method is also useful when transactions are not too many and prices of materials are fairly steady.

11 DEMERITS: 1. This method increases the possibility clerical errors, if consignments are received frequently at fluctuating prices as every time an issue of materials is made. 2. For pricing one requisition more than one price has often to be taken. 3.When prices rise, the issue price does not reflect the market price as materials are issued from the earliest consignment. Therefore, the charge to production is low because the cost of replacing the material consume will be higher than the price of issue. LAST IN FIRST OUT (LIFO): This method is sometimes known as the replacement cost method because materials are issued at the current cost to jobs or work orders except when purchases were made long ago. Valuing material issues at the price of the latest available consignment will help the management in fixing the competitive selling prices of the products.

12 MERITS: 1.This is simple to operate and is useful when transactions are not too many and the prices are fairly steady. 2. This method recovers cost from production because actual cost of material is charged to production. 3.In times of rising prices, LIFO method of pricing issues is suitable because materials are issued at the current market prices which are high. DEMERITS: 1.This method may lead to clerical errors as every time an issue is made, the store ledger clerk will have to go through the record to ascertain the price to be charged. 2.For pricing a single requisition, more than one price has often to be adopted. 3. The stock in hand is valued at price which doesn't reflect current market price. Consequently, closing stock will be understated or overstated in balance sheet.

13 TECHNIQUES OF MATERIAL CONTROL The following techniques are commonly used by firms for material control: 1. Level Setting 2. Economic Order Quantity 3. Just -in -Time Inventory System 4. ABC Analysis 5. VED Analysis 6. Perpetual Inventory System 7. Double Bin System 8. Input - Output Ratio 9. Material (or Inventory )Turnover Ratio 10. FNSD Analysis 11. Material (or Inventory) Cost Report

14 DETERMINATION OF VARIOUS STOCK LEVELS LEVEL SETTING:- This technique of material control is helpful in avoiding overstocking and understocking of material in store room. The stock levels are fixed by the management and it is the duty of store keeper to observe item. The various stock levels commonly fixed are as follows: (1.) Re- order Level : Re- Order Level is a level of stock fixed between minimum and maximum stock level will be sufficient to meet requirements of production during lead time i.e. time from placing of order to receiving of order. At reorder level the storekeeper fills up a purchase requisition slip and sends it to the purchase department. After that, the purchase department takes prompt action to purchase and replenish the stock so that the production can be continued without any interruption.

15 Formula for computing Re- order Level Re-order Level = i) Minimum Level + Consumption during lead time ii) Minimum Level + (Average rate of consumption x Average time required to get fresh supplies) iii) Another formula given by Wheldon, Maximum Consumption x Maximum Re-order period (or Maximum Lead Time) (2.) Minimum Stock Level or Safety Level : It represents the minimum which should always be maintained in stores so as to avoid the risk of stoppage of production due to shortage of materials. In other words, this is the level below which stock should not allow to fall except under abnormal conditions or in emergencies.

16 The main factors which should be taken into considerations in fixing the minimum Level are: a) The average rate of consumption of material. b) Lead time i.e. time to get fresh delivery. c) Re- order level. d) Production requirements of the material. e) Nature of material. Formula for computing Minimum Level Minimum Level= Reordering Level – (Normal Consumption x Normal Re-order Period Or = Reordering Level – ( Average Rate of Consumption x Average Re-order Period)

17 (3.) Maximum level : Maximum level represents the maximum quantity of material which can be held in stock at any time. In other words, it is the point beyond which the stock of raw materials should not be allowed to exceed. The main advantage of fixing maximum level is to avoid overstocking which in turn avoids unnecessary blocking up of companys funds in stores and at the same time the storage space. Maximum stock level is determined by taking into consideration the following factors: a) Normal Consumption rate of material b) Lead time c) Economic Order quantity (EOQ) d) Storage space available e) Carrying cost of inventory f) Government policies i.e. any restriction imposed by government to stop more than particular level. g) Seasonal condition of material.

18 Formula for computing Maximum Level Re-order Level – (Minimum Consumption x Minimum Reorder Period ) + Re- order quantity Note : In case re-ordering quantity is not given the EOQ (Economic Order Quantity ) is taken as reordering quantity. (4.) Danger level :Danger Level is fixed below the minimum stock level which represents the quantity of stock at which special step must be taken to obtain emergent supply of material in order to carry out production. Formula for computing Danger Level Danger Level = Average or Normal Consumption x Maximum Re- order Period for Emergency purchases

19 (5.) Average stock level :Some industries also determine average stock level in addition to above levels. Average stock level indicates the average quantity of materials held by a firm during the year. Formula for computing Average Stock Level Average Stock Level = ½(Minimum Stock Level + Maximum Stock Level ) = Minimum Stock Level + ½ of Reorder Quantity PERPETUAL INVENTORY SYSTEM:- Perpetual Inventory is a system of records maintained by the controlling department, which reflects the physical movements of stocks and their current balance. Thus, it is a system of ascertaining balance after every receipt and issue of materials to facilitate regular checking and to avoid closing down the firm for stocktaking.

20 ECONOMIC ORDER QUANTITY INTODUCTION The total cost of material purchased can be ascertained as follows: Total cost of materials purchased = Material acquisition cost + Material carrying cost + Material Ordering cost Generally, purchase cost or acquisition cost remain same irrespective of quantity purchased unless there is any discount policy available so the purchase manager should take care of carrying cost and ordering cost to minimize material cost. MEANING Quantity to be ordered at each time which will give maximum economies is known as Economic Order Quantity or in other words quantity to be ordered each time at which carrying cost and ordering cost are minimum.

21 So in a manufacturing concern, the purchase manager is usually faced with the problem of deciding the quantity of various items which should be ordered and purchased at a time. On the other hand, if purchases are made in small quantities then the ordering cost will be high as more number of orders will have to be placed. Thus it becomes necessary to determine the quantity that should be ordered each time to minimize these two costs which is known as Economic Order Quantity (EOQ). METHODS FOR DETERMINING OF ECONOMIC ORDER QUANTITY Method I: Mathematical Formula Method Under this method, the following formula is used for computing EOQ EOQ = 2co/i

22 Method II: Tabulation method: The computation Of EOQ method is shown with the help of following table : Annual usage No. of Orders per year Units per order (Annual usage + no. of orders) Value per order @ Rs…. Per unit Average inventor y value (value per order/2) Carrying cost Ordering cost @Rs… per order Total cost

23 Ques: Two components A and B are used as follows: Average consumption 40 units Normal usage 50 units per week each Minimum usage 25 units per week each Maximum usage 75 units per week each Re-order quantity A : 300 units B : 500 units Re-order period A : 4 to 6 weeks B : 2 to 4 weeks Maximum lead time for emergency purchases A : 1 week B : 2 weeks Calculate for each component : (a) Re-order Level, (b) Minimum Level, (c) Maximum Level, (d) Average Stock Level, (e) and Danger Level.

24 SOLVATION : (a) Re-order level For component A:- For component B:- = Max. usage x Max. time = Max. usage x Max. time = 75 x 6 = 75 x 4 = 450 units = 300 units (b) Minimum Level For component A:- = Reordering Level - (Normal cons. X normal time) = 450 – (50 x 5) = 200 units For component B:- = Reordering Level – (Normal cons. X normal time) = 300 – ( 50 x 3) = 150 units

25 (c) Maximum Level For component A: - = Reordering level – ( Min. cons. x Min. time)+ Reorder qty. = 450 – (25 x 4 ) + 300 = 650 units For component B:- = Reordering level – ( Min. cons. x Min. time) + Reorder qty. = 300 – (25 x 2 ) + 500 = 750 units (d) Average stock level For component A:- = Minimum stock level + ½ Reorder qty. = 200 + ½ (300) = 350 units For component B;- = Minimum stock level + ½ Reorder qty. = 150+ ½ (500) = 400 units

26 (e) Danger level For component A: = Max. time for emergency purchased x average cons. = 1 x 40 = 40 units For component B:- = Max. time for emergency purchased x average cons. = 2 x 40 = 80 units

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