School of Commerce

Cost Accounting
Unit-2- Material and Cost Control
Material and Cost Control:
Meaning – Types: Direct Material, Indirect Material. Material Control –
Purchasing Procedure – Store Keeping – Techniques of Inventory Control –
levels settings – EOQ – ABC Analysis – VED Analysis- Just in Time –
Perpetual Inventory System- Documents used in Material Accounting –
methods of Pricing Material Issues: FIFO, LIFO, Weighted Average Price
Method and Simple Average Price Method – Problems.
Meaning:

The term 'materials' refers to all commodities or components which are

consumed in the process of manufacture

Definition:

According to CIMA of UK, material cost is “the cost of commodities supplied

to an undertaking”.

Types of materials

Materials can be classified into 2 i.e., direct and indirect materials

1) Direct Materials

Direct Materials are those materials which can be conveniently

identified with and can be directly allocated to a particular product, job or
process. examples: timber in Furniture, cloth in Garments, Milk and Cream
in ice cream, Paper in Books, Gold/silver in Jewellery, Bricks and Cement in
building construction

2. Indirect Materials

Indirect Materials are those materials which cannot be conveniently

identified with and cannot directly allocated to a particular product, job or
process.

Examples:

1. Stores used for maintaining machines such as lubricant oil and

grease, cotton waste, consumable stores etc.

2. Stores used by service departments like power house, boiler house.

 3. Materials of small value which can not be conveniently identified with
a particular product, job or process. For example: nails used in
furniture, thread used in stitching garments.

INVENTORY /MATERIAL COST CONTROL

Meaning:

Material control involves the planning, organizing and controlling the

procurement, storage and usage of materials so as so to achieve the
objectives of efficiency and economy.

OBJECTIVES OF MATERIAL CONTROL

The following are the objectives of stores control:

1. To enable uninterrupted production:

The main object of material control is to ensure smooth and unrestricted
production. Production stoppages and production delays cause substantial
loss to a concern.
2. To minimize wastage:
The loss of material may occur on account of rust, dust, dirt or moisture,
bad and careless handling of materials, poor packing and many other
reasons. The causes responsible for such losses must be brought to light
and utmost efforts should be made to minimise the wastage of raw
materials. This is possible only by introducing an efficient materials control
system.

3. To fix responsibility:
A proper system of materials control also aims at fixing responsibility of
operating units and individuals connected with the purchase, storage and
handling of materials.
4. No Under Stocking:
Under stocking leads to materials running out of stock at sometime or the
other, shortage of materials may arise at the time when they are urgently
needed and production then be delayed.
5. No overstocking:
Investments in materials must be kept as low as possible, considering the
production requirements and the financial resources of the business. Over
stocking of materials unnecessarily locks up capital and causes high storage
costs, thus, adversely affecting the profits.
6. Economy in purchasing:
The purchasing of materials is highly specialized function. By purchasing
materials at the most favorable prices, the efficient purchaser is able to
make a valuable contribution to the success of a business.
7. Materials Reports to Management:
The materials control system should be so designed so as to serve the
purpose of accurate and up-to-date reports to management about purchase,
consumption and stocks of materials.

ESSENTIAL REQUIREMENT OR PRINCIPLES OF MATERIAL CONTROL

1. Proper co-ordination:

There should be proper co-ordination of all departments involved viz.

purchasing, receiving, inspection, storage, production, cost and finance.

2. Proper Purchase System:

There should be proper purchase system to ensure the procurement of

materials and stores of the required quality at minimum cost from a reliable
source.

3. Proper Storage System:

There should be proper storage system to ensure a place for

everything and everything in its place and avoidance of losses during storage
and minimum storage cost.

4. Proper issue System:

There should be proper system for the issue of materials to ensure the
delivery of materials of the required quality in the required time upon
requisition to the department making requisition.

5. Perpetual inventory System:

There should be perpetual inventory system so as to determine the

quantity and value of each item of materials in stock at any point of time.

6. Proper Forms:

There should be use of proper forms with regard to purchase

requisition, Purchase Order, Material Received Note, Material Requisition,
Bill of Material, Bin Card, Stores Card etc.
7. Proper Accounting System

There should be proper accounting system so as to determine the cost

of materials at time of receipt and consumption.

8. Proper Reporting System

There should be proper reporting system to ensure regular reporting

to the management regarding

a) Materials purchased

b) Materials issued

c) Materials in hand

d) Slow-moving and obsolete stock etc.

STEPS IN MATERIAL CONTROL

A material control is ensured by laying down by considering following steps

1. Purchasing and Receiving:

Purchase procedure differs from business to business, but all of them

follow a general pattern or procedure. There should be proper purchase
procedure to ensure that right time, in right quantity, at right price and
right place. All these things require a well-defined procedure of purchasing.

2. Purchase Requisition:

A form known as ‘purchase Requisition’ is commonly used as a format

requesting the purchase department to purchase the required material.
Normally the purchase requisition is issued by the stores department when
the quantity of the concerned material reaches the minimum level.

3. Purchase order:

After the receipt of purchase requisition, the purchase department

places an order with a supplier, offering to buy certain material at stated
price and terms. However before issuing the purchase order, quotations may
be invited from various suppliers for arriving at the best deal. The purchase
department usually keeps a list of suppliers from whom the quotations are
invited. It is a legal document and it results into a contract between the
company and the supplier. Hence the terms and conditions in purchase
order should be drafted clearly without any ambiguity.

4. Receiving the materials:

The receiving department performs the function of unloading and
unpacking materials which are received by an organization. This will need
an inspection report which is sometimes incorporated in the receiving
report, indicating the items accepted and rejected with reasons. It is sent to
various departments like purchase, stores, concerned department, accounts
department and costing departments.
5. Approval of invoice:
Approval of invoice indicates that goods according to the purchase
order have been received and payments can be made for the same. However
if the goods are not according to the quantity, quality, payments can be with
held.

6. Making the Payment:

After the invoice is approved the payment is made to the supplier. The
purchase procedure is completed with the payment released.

TECHNIQUES OF (INVENTORY) MATERIAL CONTROL

Stock Levels

Setting of various stock levels is one of the techniques of inventory

control. The main purpose of setting various stock levels is to avoid the
situation of under stocking and over stocking. These levels are not
permanent but need revision according to the changes in the factors which
determine these levels.

a) Maximum Stock Level

Maximum stock level is that level of stock above which the stock in
hand should not normally be allowed to exceed. It the largest quantity of a
particular material which may be held in the stores at any time.

Objectives of Maximum Stock Level

 The objective of fixing the maximum stock level is to avoid to costs of
over stocking such as cost of storage, cost of investment in stock, cost of
insurance, risk of obsolescence etc.

Formula

Maximum Level =ROL + ROQ – (Min consumption X Min ROP)

Re-Order Re-Order Minimum Minimum Re-Order

+ - X
Level Quantity Consumption Period

b) Minimum Stock Level

Minimum Stock level is that level of stock below which the stock in
hand should not normally be allowed to fall. It is the lowest quantity of a
particular material which must be held in the store at all times.

Objectives:

The objective of fixing the minimum stock level is to avoid the cost of
under-stocking such as cost of stoppage of production due to shortage of
materials like cost of idle labour, cost of idle plant and machinery etc.

Formula

Minimum Level = ROL – (Normal Consumption X Normal Re-order

Re-Order Normal Normal Re-Order

- X
Level Consumption Period

c) Re-order Level

Re-order level is that level of stock at which fresh order should be

placed for replenishment (replacement or refill) of stock. It is fixed
somewhere between maximum and minimum levels in such a way that fresh
supplies are received in such a way that fresh supplies are received just
before the minimum level is reached. It is the level at which purchase
requisition should be made out for fresh supplies.

Formula

Re-Order Maximum Maximum Re-Order Level =

X
Consumption Period

d) Danger Level
 Danger level is the level at which normal issues of the raw material
inventory are stopped and emergency issues are only made on special
requisition approved by the competent authority.

When stock reaches this level an urgent action is required for the
fresh supplies of materials. It is generally below the minimum level.

Formula: Danger Level =

Average or Normal Maximum Re-Order Period for

X
Consumption emergency purchases

e) Average Stock Level

Average stock level indicates the average stock held by the

organisation.

Formula

Minimum Level + Maximum Level

Re-Order Quantity (EOQ)

Re-order quantity is the quantity to be ordered when ever materials
are to be purchased. By setting this quantity, the buyer is saved the task of
recalculating. How much he should buy each time he orders.

The company has to incur certain cost at the time of order , these
costs include costs like handling and transportation costs, stationery cost,
cost of inviting quotations and tenders etc. it is known as order cost
Cost of carrying Inventory: This includes the cost of store keeping
(stationery, salaries, rent) interest on capital locked up in stores, insurance
cost as the like.
2.A.B
C.S 2.A.B
Or
S A=Annual Consumption B=
Buying Cost per order C= Cost per unit of material
S= Storage and carrying cost

 ABC Analysis
ABC Analysis is one of the important techniques which is based on grading
the items according to the importance of materials. This method is popularly
known as Always Better Control. This is also termed as Proportional Value
Analysis - In inventory control, this technique helps to analyze the
distribution of any characteristic / material by money value of importance in
order to determine its importance.

Accordingly, materials are grouped into three categories on the basis

of the money value of importance of materials.

(1) High Value Materials - A

(2) Medium Value Materials - B

(3) Low Value Materials – C

Category % to total inventory % to total inventory cost

A Less than 10 70 to 80

B 10 to 20 15 to 25

C 70 to 80 Less than 10

2. VED Analysis

Under this, materials are classified into 3 broad categories, namely

V stands for vital items in the sense that when these are out of stock
or when not readily available, the production activity comes to a complete
halt or is drastically affected.

E is for Essential items without which temporary losses of production

or dislocation of production work occurs. Their stock-out is very high.

D denotes Desirable items i.e., all other items of materials which are
necessary but do not cause any immediate effect on production.

Just in time (JIT)

Just in time purchasing means purchase when required only or
purchase immediately before use.
This principle imagines that there should not be any intermediate
stage like storekeeping.
 Material purchased from supplier should directly go the assembly line,
i.e. to the production department. There should not be any need of storing
the material. The storing cost can be saved to a great extent by using this
technique.

STORES RECORDS

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 current balance in
stock. Bin cards and store ledgers are two basic perpetual inventory records

BIN CARD:

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

by the store keepers for each items of material in store. The bin cards are
attached to every bins which shows the detail of receipts and issues of
materials and the balance in stock at any time.

STORES LEDGER:

This is another document maintained in cost accounting section. It contains

not only for quantity but also for rate and value with respect to receipt,
issue and balance of each kind of material. On the basis of Goods Received
Note and Material Requisition Note, entries are made in respective columns
and balance is ascertained. The entries are made in the chronological order
of receipts and issues.