Material Cost -

Accounting and Control

.Chapter:·9u~line
' • ' • • • '. • ' • ' • ' • w • • • - • •
.·.
Introduction; Inventory Control; ABC Technique; Stock Levels; Purchase of Materials;
Store-Keeping; Stores Records; Periodic and Perpetual Inventory Systems; Material
Losses; Methods of Pricing Material Issues; Problems and Solutions; Examination
Questions.

Introduction
The term material refers to all commodities consumed in the process of manufacturing . According
to CIMA of UK, material cost is "'the cost of commodities supplied to an undertaking."
Material represents an important asset and is the largest single item of cos!:,_in almost every
manufacturing business. The 1IUportant role playeo by this element in tli'e fotal cost structure can be
realism! by the fact that usually more than fifty percent of the total product cost is material cost.
=-
Classification of Materials
Materials may be classified as follows:
Direct materials. Direct material cost is that which can be conveniently identified with and
allocated to cost units. Direct materials generally become a part of the finished product. For example,
cott:Qn used in a textile mill is a direct material. Other examples of direct materials are leather in shoes,
timber used in furnih ue, steet" useff' in ma k i n ~es, etc.
Indirect materials. These are tnose7natenals'""'W!uch.., cannot be conveniently identified with
individual cost units. These are generally minor in importance, such as (i) small and relatively
inexpensive items which may become a part of finished product, e.g., pins, screws, nuts and bolts,
thtead, etc., and (ii) those items which do not physically become a part of the finished products, e.g. ,
coal, lubricating oil and grease, sand paper used in polishing, soap, etc.
Supplies. Supplies are indirect materials used in production which do not become part of the
finished product. Oil and grease used in keeping machines in running condition. soaps and towels used
by workmen, sand paper used in polishing, etc., are examples of supplies.
Finished or component parts. In assembly type production like refrigerator, radio, TV, car, etc.,
component parts may be purchased or produced within the organisation. For example, tyres and tubes
in car manufacturing, picture tube in TV manufacturing are component parts.

2.1
 I
Cost Accountiti
::2.2=------------------------------ ~

Stores. The term Stores' is a very wide term and includes raw materials, component parts, too~
maintenance materials consumable stores, work-in-progress, finished goods and pattern, etc.
Inventory. The te~ inventory covers stock of raw materials, work-in-progress and finished stoc~

INVENTORY OR MATERIAL CONTROL

Significance
· w1thout
No cost accounting system can become effective · proper an d effi c1en
· t control of mate.~al.l,
· 1.
This is so because quite often material is the largest single element of cost and as s~ch an efficient
system of material control leads to a significant economy in the total cost of production,

Meaning and Definition

Inventory or material control is defined as "safeguarding of company's property in the form of
maten"als by a proper system of recording and also to maintain them at the optimum level con:i_d~ring
operating requirements and financial resources of the business." This wide de~tion ~!!1brac:! .~ ~tro\
ov~ purc~ ses, sj ora9e and consumption of materials and determinin<fthe OJ!.t!wp m levelfgrgch item
of inventory. The system ~f ~ontrol should be comp~ensive enough to cover the tTow of materiah
stainhgfrom the point when someone makes a request for the purchase up to the stage when materiah
are consumed and their costs compiled and assemble·d in cost sheets.

Objectives of Inventory Control

The main objectives of inventory control are listed below :
· l J- ~ c.1-,-Ko understocking. Understocking leads to materials running out of stock at som~ tim~ or the
) b ~ -- ~- ~ ~
, • ~ other. Shortages -~ of materials may arise at the time when they are urgently needed and production then
" ~ n.,.(( be delayed. Delay or stoppage in production due to non-availability of materials is v~ruostly as it may
,r- 1.,-' result in loss of profits. Material control system ensures that th~1snoslfortage of rnaterials.-
rfai"11,v- ~ ov- ki~g. Invest~ als rnustbe k:PJ~~ ~ w as possibl; , consi~ t he
~\JW ...,..P-roduction requirements and..!_he financia_L resources of the business. Overstocking of materials
\-.~» unnecessaril ylocks up capital and cau5es high storage costs, thus, adversely affecting the fronts.
'r-+-~ · ~mum Wfill!Q!!• Pro~er stora~~;- ~ns rn~ provided to different types of rnA_erials.
~\..>J Losses of materials may occur ue to deterioration, obsolescence, theft, evaporation, etc. All efforts
shoufcT'oemacfeto keep these losses at the-""':rrliiumurn. ·~- -A -- - • - " CE

~ ~ :n.;;;¥ in purchasing. The purchasing of material is a highly specialised function. By

r purchasing materials at the most favourable prices, the et£cient ILurcltaser is able to make a valuable
contribution to the success of a business. - -
t;;;'. _... - ..........,-----.

~ r quali!Y of matepals.__,.}Vhile pur~ ~rn1,teJials, due consideration should also be

given to the quality. It is no~u~,Rurchas~g rnaterials-9f inferior quality or of very superior quality. For
each .!,YIJe of proauct t~~r~ ~ particular. quality of_pE-!e~als which is n;_e'dedandt hat quality alone
shouffil:ie purchased.
6. Intormati«m, about materials. Not only that materials should be available as and when
required, but also there should be a system to give complete and up-to-date accounting information
ab0!,1_! ! he S!C~.c~ .ofm at~:ls. Sometimes inadequatei nformation- aboutthe a=raB1lity'of materials
may cause new purchases be made of materials already in stock.

6
 ,- ,. f .

·a/ Cost-Acco1111ti11g a11d Control 2.3

Mater'

1. Material rep~!!!..!.o ni.anagement . The material control system

should be so designed so as to
and
serve the purpo~e of accurate and up-to-date re~orts to management about purchase , consumption
stock ~ls.

Essential Requirements or Principles of Inventory Control

Ideally, inventory control must ensure that the following requirements are fully met:
~rdin ation and. Coo!eration_. Ther_e should be proper coordination and cooperation bet:"':en
vanous departments d~ ling--.!!l matenals; VIZ. , Purchasing Department, Sto1es Department, Rece1vmg
and Inspecting Department, Accounting Department, etc. -
cJiiifral Purchasing. There sfioutd be · central purchasing department under the control of a
competent and expert purchase manager. · •
~ ~!
ijication. There should be proper classification and co~ atio_!; materials.
~lanni ng. Material requirements should be properly planned.
5. Perpetual inventory. The perpetual inventory system should be operated so that up-to-date
infonnation is available about the quantity of material in stock. -
~ oper records. Adequate records should be introduced to control materials during production
and the quantities manufactured for stock. =- ,. - 1
_, - '

7 Proper storage. 'The storage -of all materials should be well-planned subject to adequate
i, d .. - .
safeguards an supems~
ock levels. The various stock levels like ~
matenal.
. ~ .. .
minimum, maximum, etc., should be fixed for each
, ..
ite
~--
.........
~ dgWJJl1-Purchases of materials should be controlled through ~n,al b,lldg~ts.
10. Internal control. An efficient system of internal audit and internal check should be operated
so that all tr~ acti~ involving m~'ats are checkedb y'Teuaole and ind ependent persons.- - '
..,_eet ern:-Jr - - □ f I - .., _ ..1-
- - ---
11. Regular reporting. There should be regular reporting to management regarding
purchases ,
to
issues and stock ~riiatqa""ls. Special reports~nould be prepared Woosolete items, spoilage, returns
suppliei's, abnorrn~li;;ss~ , slow moving materials, etc. -
w n a
Tech~~s of Inventory Control
Various techniques commonly used for inventory control are listed below :
~ BC technique.
..,J..Minimum, maximum and re-order levels.
~ onomic order quantity. t (> 'f ? 1 dJ
4. Proper purchase procedure.
5. Proper storage of materials.
ise:a:» = ....,,.
6. Inventory turnover ratio to review slow and non-moving materials .
n ~
.,,,_ f Yb □ ft iC
7. Perpetual inventory system.
8. Material budgets.
 ■
2.4 Cost Account;~

~
Q ABC TECHNIQUE _).,.1
ABC techni . a value-based system of material control In this technique of selective cont:r1111
IS
que - -' • T - e.ria1s ~ "°'
materials are analysed according to th.,~ value_ s ~ t ~ mo1: ~ uab: ~ ttl · -~~
--

grea~ tten_!ion an~ All items of matenals dare~ . ~rdinlgABCc ..;g__va u Le., ~
7
m edium .
anul low values wruch are known as A, B an C items respective y.
- ,
t euuuque JS som ~
_.,. -
catfed Always Better Control m~ d..
~- Items-These a.:°high value items w h i c h ~ of only a small percentage of the tot:i1
items haifaled. On account of their IJ!gh cost, these materials s~ould be under 'the tigfitest contr,21 airj
the responsibility of the most experienced personnel ----~ = "' ❖-

matena1s· '"' '

0

should ..
~- ·-
be uni:ler •
the Simple • -
and economic methods
--
'B 'Jtem?..'.. These are m~um value materials which should be under the normal control Procedmes.
'C' lems - These are low value materials which may represent a very. large number of items. ~
of - control.
- - 'Si;!..,
- __, --~

TheepUIJ>o;"e of cl~ sifying stock~ o A, Band C categories is to ensure that material managemem
focusses on A items where sophisticated controls should be installed. B items may be given ~
attention an~ ems least attemion. bo il - - - .. - - -

'-n\us ABC technique is a selective control which aims at concentrating efforts on those materials
where attention is needed most":" rrus IS ~6 because it is unwise· to giv e e ~ttention toallitems in
stock. The'\ t ~ are &ted and-ranked in the order of their d~dfug uiportan ce-showing quantity
ancfvalue of each item. This is illustrated below with amitrary percentage figures:
Category % of total value % of total quantity Type of control
A 70 10 Strict control
B 25 30 Moderate control
C 5 60 Loose control
Total 100% 100% ~

In this table it is shown that 10% of the total quantity accounts for as much as 700/o 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 represent 30'3/o of the total quantity but account for 25% of the total value.
These are B items which need routine type of control. Finally, the items representing 600/o of the total
quantity account only for 5% of"the totaTvalue. These C items are kept under simple physical CC}Jltrols.
The rules regarding purchasing, storing and issuing of various categories of itelnSShould be framed
according 1 o th;.1£ ~asue and-lIDportance.Tlle '1nfonnation given m the abovet ableis presented in the
following Fig. 2.1. ' - -
Advantages. The advantages of ABC technique are ii§- follQws:
F
~ ~l,. and s~ cter control can be exercised on those item~ which ,represent large amoll!lts of
capital invested.
~ ves~ ent)-U in~~tmy_is regul~SSr & d funds can ~ utilised ~ e best possible way.
"'• =- -----
---
- ~ L6'1orn_y in stock carrying costs is achieved.
'-----
·· \,. in maintaining enough safety stock for 'C' category ·
~4. !!Jl.elps
items.
- qelective conqol helps ~ taming \high t tocf turnover rate.
--- -- - .
 -
,\f1.1t.-rti1I CoM - A ccount int"''•' Cm,trvl 2.5

100,--------=======--i
9'-t-·---- ---,..,-

70

z
.
•
►

• 30
...!
0

••

0 _ _ _ _ _ _ _.._______ ____
10 40 .50 100

% of total quantity
FIG. 2.1. ABC categories of stock (cumulative percentages).

Illustration 2.1.
A fact ory uses 4, 000 varieties of inventory. In terms of inventory holding and inventory usage, the
fo llowing information is compiled :
No. of varieties % % value of inventory % of inventory usage
of inventory holding (average) (in end-product)
3,875 96.875 20 5
110 2.750 30 10
15 0.375 50 85

4, 000 100.00 100 100

Classify the items of inventory as per ABC analysis with reasons.

Solution
ABC Classification
Category No. of items % of value % of usage

A 15 50 85
110 30 10
B
3,875 20 5
C
 2.6 Cost Acco11nti11i
•
Reasons
'K items : 15 items constituting 0.375% of the total number of items represent 50% of the to~
inventory value and 85% of the total usage in the final product. These are classified as 'K items beca~
of their highest value in the total material cost.
'B' items: 110 items representing 2.75'3/o of the total number of items represent 30% of the totai
inventory value and only 10'3/o of the total usage. These are thus classified as 'B' items because of their
moderate value.
'C' Items : These are 3,875 items which constitute 96.875% of the total items. These represent 20Csi
of the total value but only 5% of the usage in final product. These are classified as 'C' items because of
their low value.

STOCK LMLS
One of the major objectives of a system of material control is to ensure that there is no ~eking'
and 'overstocking'. A scientific approach to achieve ~ v e is to adopt a system of stock leyels,
These leveisare maximum level, minimum level, re-order leve). and re-order quantity. By adhering to
these levels, material stocksv&l be at the optimum levi. In other words, by taking action 9n tj).e...hasis
of th~els, each item of m~terial will automatically be held within ap:Qropriate limits of co~ ol
These levels are not fixed permanently bµt can be chapged as~d when39uired
(a) Maximum Level. The maximum stock level is the level above which stocks should not normally
be allowed t!Lrise. It is the maximum quantity of~terial that may beheidin~. The following
factors are considered while fixing this level.
(i) Rate of consumption of the material, (v) Cost of storage.
(ii) Storage space available. (vi) Insurance costs.
(iii) Amount of capital needed and available. (vii) Bulk purchases of seasonal materials.
(iv) Risk of obsolescence and deterioration. (viii) Re-order quantity for the material.
---.._
Formula :

Maximum = Re - order + Re - order _ ( Minimum x Minimum )

level level quantity consumption re - order period
(b) Minimum Level. Minimum level is that level below which stock should not normally be allowed
to fall. In case any item of ma~erial falls below this level, there ) s a danger of stoppage ~ ction
andl op priority should be given to the yurchase of new materials. In setting this level, the following
factors must be taken into account. --=- -
(i) Rate of consumptionofmaterial.
(ii) Time r~guired to obtain delivery of the new materials.
(iii) Re-order level.
Formula:
Minimum level .. Re-order level - (Nonnal consumption x Nonnal re-order period)
(c) Re-order Level. This is that level of material at which a new order for material is placed. It is
at this level tb_at pufchase reg~ sition is made _Qfil. This ~vel is abo~ min.imun1 level but below
m~imum level, It is set after a consideration of the following factors:
(i) Rate of consumption of material.
(ii) Minimun_!Jevel.
 . 1cost -Accounting and Control 2. 7
~ --------------------------
(•'i) 1,ead time or delivery time, i.e., the time normally taken from the time of raising purchase
u requisition to receipt of materials.
forTTIUla :
----
- - - - - - - - - - - - x-Maximum ---
- - -re-order
Re-order level = Maximum consumptjon
-~
period

nanger Level
This is a ~ at which normal issues of materials are s ~ and urgent action is taken for
se of materials so that production is not interrupted due to shortage of ·materials ·
pure ha::...:--- -
formula:
Average or normal x Maximum re-order period for
Danger Level = consumption emergency purchases

Average Stock Level

Average stock level is calculated by the following formula :
Minimum Level + Maximum Level
Average stock level = 2
Alternatively, average stock level may also be-computed by the following formula ·:
Average stock level = Minimum level + ½ (Re-order quantity)

Illustration~
In a manufacturing company, a material is used as follows:
Re-order quantity = 3,600 units
Maximum consumption 900 units per week
- Minimum consumption 300 units per week
Normal consumption 600 units per week
Re-order period 3 to 5 weeks
Calculate : (a) Re-order level ; (b) Minimum stock level; (c) Maximum stock level.
(B. Com., Bharathidasan)

Solution:
Re-order Level ~ Maximum consumption x Maximum re-order period
- 900 x 5 = 4,500 units ,...
Minimum Stock Level Re-order level - (Normal consumption x Normal re-order period)
4,500 - (600 x 4 ) = 2,100 units
Note. Normal re-order period is the average period.
Maximum Stock Level
= Re-order level + Re-order quantity - (Minimum consumption x Minimum re-order period)
= (4,500 + 3,600) - (300 x 3) = 7,200 units.
 1ll li
1.a Cos t A cco 11rit i11g

ntut tntic m ~
ln minu f.u:t\ lrirtq comp any. a material is used
.i
as follows:
~'\ltn conr urnp uon - 12,0 00 units pe.1 ~ k
~JJn um con.sump-lion - 4,00 0 units pet week
Norm.ii co ns ump tion - 8,00 0 units pe_r week
Rt orde r quan l1ty - 48,0 00 units
T1rnt required tor deliv · ery
- urLU..
:-:m
, .. um : 4 ~ ks , Maximum· ·· 6 weeks
CalC'IJl.ltr : (a) Re-o rder level ; (b) Mini (d) Danger level; and
mum level ; (c) Maximum level
(,) Avernqe stock ll?vel. (B. Com ., Bangalore)

Solution :
Re-order Level • Maximum consumption ,c Maximum re-order period
... 12,0 00 - 6 - 72,0 00 unit s
Mini mum Level • Re-order level - (Normal consumption x Normal
re-order period)
.. 72,0 00 - (8,00 0 ,c 5 ) - 32,0 00 unit
s
Re - order Re - order
Max imum Level • level
( Minimum Minimum
+ quan tity .,.. ~ consumption x re - orde
l
r perio d)
... 72,0 00 + 48, 000 - (4,00 0 - 4) = 1,04 ,000 unit s
Danger Leve\ - Average cons umption x Maximum re-order period for emergency purc
hases.
8,00 0 x 2 weeks (~ d) = 16,0 00 unit s
Average Stock Leve\
= Minimum Level + 1/ 2 of Re-order Quan
tity
= 32 ,000 + 1/ 2 (48,0 00) = 56,0 00 unit s

Re-order Qua ntit y ~co nom ic Order Qua

..____ . . .
ntity or EOQ)
Re-order quan tity is the quan tity to be orde . .
red whenever matenals are to be purchased.
By setting
.
this qum fity, the" buyer issaved thet asl<
of re-calcutating ho!Y much he shou labu y
orders. This quan tity ·may, of cour se,o erev each time he
ised if circumstances warrant it. •
- Re-o rder quantl'ty is sometimes known as Eco; ~-
omic Order Quantity beca use it is the quan tity
is mon economic to orde r-{In othe r words, ec~ which
mi corder q; anti ty is the size of til:e orde r
maximum economy in purchasing any mate whic h gives
rial and ultimately cont ribu tes towards main
material at the optimum level and at the mini taini ng the
mum cosh fu equa tes the cost of ordering
of st_orage of materials) with the cost
J
I Ord~ ~- cost. It mainly includes cost. 2f stationer
y, salari~ of thos e enga ged in receiving
insp t,cti~g, salaries of those enga ged in prep and
aring the purch~se orders, etc.
/ 2:. ~ost of sto~age or cost ~f carr ~ng inve ntor
y. This incl udes the cost of store keep
(stat ionery, salaries, rent, matenal handling ing
cost, etc.) , inte rest on capi tal lock ed up
incidence of insurance cost, risk of obsolesce in store s, the
nce, deterioration and wastage of materials
0 , evap orat ion, etc.
Economic order quan tity may be determined
by the following foµn ula :
Jn Ve,,,, toJ (a r,-yi"';f '-<J, f-
 . I cost-Ac countin g and Control
~ - - - - - - - - -- - - - - - - - - - - - - - - - -----=2~.9

forrnu/a: _ _ _ _ _ _ _-==- - - - - - - - - - - - - - - - - - - - - .
EOQ = J2.A.B
where EOQ = Economic order quantity
c.s
A = Annual consumption
B = Buying or ordering cost per order
C = Cost per unit of material
S = Stora~ and carryir19 cost% of cost

Alternatively, EOQ = where S = Storage cost per unit P.er annum

s
Illustration 2.v
Calculate the economic order quantity for material M. The following details are furnished:
Annual usage 90,000 units
Buying cost per order t 10
Cost of carrying inventory 10% of cost
Cost per unit t 50 (B. Com., Calicut)

- --
Solution :

-t·li.B
EOQ - C.S.
2 X 90,QQQ
50 X 10%
X 10
= 600 units

Alternatively, if the question states that storage cost is t 5 per unit per annum (instead of 10% of
~-50 )-:ihen

2 X 90,QQQ X 10
EOQ = = = 600 units
- _ 5

~
From the following informati on, calculate Economic Order Quantity and the number of orders to be
pl~ in one quarter of the year.
(i) Quarterly ~onsumptio~ 9f
materials 2,000 kg
(ii) Cost of placing one order t 50
(iii) Cost per unit t 40
(iv) Storage and carrying cost 8% of average inventory
(B.Com. Hons., Delhi)
Solution :

EOQ -vc.s:-
- [2.A.B
where A = Annual consumption (2,000 x 4) = 8,000 kg.
B = Cost of placing one order (t 50)
 2. 10
-
Co~ t Ac-count •
,,,~
C • Cost pu urul ( f 40)
S - 'it OIJgt' COS! (8 ... )

Z ~ 8.<XXJ • 50
£00 •\ - 500 kg
40 ,.. 8"lo
~ "' 01 o rdr n l)"r qu.uter - 2, 000 kg ~ 500 kg = 4 orders

Ohutnllo ~
A ,om r.my manufacture$ 5,000 units of a product per mon th. Cost of placing an order is f 10,
Tho· pu, h.u,· pnce of raw m.it enal is f 10 per kg . The re- o rder period is 4 to 8 ?;eeks. The consump~~
o l 1.iw m.i t1•1ldl.5 Vd.Il (' $ h o rn 100 kg to 450 kg pe r week, the average consumptio n being 275 kg. I};
,.lJ t Vl!lq ,o~ t o f mve nt o ry u 20"4 per annum.
Yo u J.1 1' rcquu 1·d to ca ll'."llla t e·
(r) Rr o rde r qu an tity; (11) Re o rder level. (B.Com. De;;; 1

Solution :

2AB
Re-order Ouantlly (E:00) - \ CS

whe re A - Annual consump tion (275 x 52 weeks) = 14,300

B - Cost of ordering = f 100
C - Cost per unit - f 10
S - Storage cost • 20"/o
2 '< 14 ,300 X 100
- \ 10 X 20%
- ..,'14 . 30,000 = 1, 196 kg (approx.)
Re-order level - Max. consumption " Max. re- order period
= 450 kg " 8 weeks = 3600 kg