Coa B1
Coa B1
Coa B1
Costing of Costing of
Overhead Labor
Classification of Materials
Direct
Traceability/ Materials
Purpose Indirect High value
Materials items
Based on Medium
Material value/costs value items
Low value
Control items
purpose
Vital
Based on
Essential
utility
Desirable
Material
• Material costs include the cost of obtaining the materials and receiving
them within the organization.
• Materials (and stores/supplies) are the basic ingredients that are
transformed into finished goods through the use of labor and factory
overhead in the production process.
• Direct materials are the major costs of a finished product that can be
economically and conveniently traced to that specific product. For example,
wood used in making a furniture, steel used in the manufacture of a car.
• Indirect materials comprise all the other materials or supplies involved in
the production of a product that can not be identified with a specific
product (necessary but relatively insignificant costs). For example, glue used
in the manufacture of furniture and rivets used in the manufacture of a car.
Objectives of Material Management and Controls
Assure/ensure uninterrupted supply of required materials as per
requisitions/demands of various work stations.
Maintain inventory at the optimum level (at the lowest level possible) to
minimize the total costs of carrying and holding materials.
Procurement of quality materials at the lowest possible prices.
Facilitate/allow effective control over the use (from handling to put into
machine) of materials to minimize the level of waste.
Prevent materials from being obsolete, theft etc.
Objectives of Inventory Management
Liquidity
inventory is held so that it does
not run out and disrupt
business
Profitability
lowest possible amount to
minimize the level of capital
employed to be funded
Dangers of holding low or high inventories
Costs of high inventory levels Costs of low inventory levels
Incur additional interest cost on the funds tied Stock outs costs for:
up in inventory or the foregone interest that is o Lost contribution
lost from tying up capital in inventory o Production stoppage
o Emergency orders
Extra holding costs for storage High setup/re-order costs
• A stock control system (also known as inventory control system) incorporates all the functions
associated with inventory management and maintenance in a manufacturing environment. It
should encompass everything from purchasing, product tracking to storage inputs, shipping and
receiving and re-ordering materials. The purpose of inventory/stock control is to reduce the costs
of holding stock, while ensuring to meet customer demand and making sure that there's enough
material for production. Advanced manufacturing environment should always have a 'safe' amount
of stock so that they're able to react and cover any unforeseen issues.
• Major inventory control methods include the followings:
EOQ
Reorder level
Maximum level
Minimum level
Regular usage/normal usage
Safety stock
Economic Order Quantity (EOQ)
• Businesses not using JIT inventory management systems rely on EOQ [a
technique used to determine an optimum order quantity for inventory
items] to minimize the total cost of holding and ordering inventory.
• EOQ balances the relevant costs of holding and ordering inventory which
involves:
1. The variable costs of holding/carrying the inventory
2. The fixed costs of placing the order
Holding costs: EOQ model assumes that it costs a certain amount to hold or
carry a unit of inventory for a year [CC ] which is expected to go up with an
increase in the average level of inventory hold.
Ordering costs: A fixed cost incurred every time an order is placed [O],
which is expected to go down with an increase in the quantity ordered each
time.
Economic Order Quantity (EOQ)
2AO
• EOQ = ; Where, EOQ = Economic Ordering Quantity
CC
A = Annual consumption (units)/usage of materials (or RU= Annual requirements computed as normal
use per day × Working days per year)
O = Cost of placing an order (or CO)
CC= Carrying cost or holding cost of material
(inventory) per unit per annum
(cost per unit × carrying cost percentage)
• EOQ can be calculated using formula or table.
• Tabular method is useful when quantity discounts
are available for bulk purchase.
• Assumptions of EOQ:
1. Demand and lead time are known and constant,
2. Purchase price is constant
3. No buffer inventory is held as it is assumed that
it is not needed since demand and lead time are known with certainty.
Illustration 1
• A company requires 1,000 units of material X per month, the cost per order
is BDT 30 regardless of the size of the order. The annual carrying (or holding)
costs are BDT 2.88 per unit.
Required:
I. Compute EOQ using formula method.
II. Investigate the total cost of buying the material in quantities of 400, 500, 600, or
800 units at one time. Identify the cheapest option and comment on the
acceptability of result produced by the EOQ model in (I) above.
Sample Answer:
Req (I): Computation of economic order quantity (EOQ):
Annual requirement (A) = 1,000 × 12 = 12,000 units
Carrying cost per unit per annum (CC) = BDT 2.88
Cost per order (O) = BDT 30
2 × 12,000 ×30
EOQ = = 500 units.
2.88
Req (II) Tabular Method:
Order quantity
Annual order cost = (number of orders per 900 720 600 450
annum × cost per order)
Comment: EOQ
Illustration 2: [Quantity discounts]
ABC Ltd has annual demand of 30,000 kg of material A @ BDT 12 per kg. Ordering cost including transportation
costs are BDT 200 per order, while annual cost of holding one kg of material in stock is estimated to be BDT 1.20
per kg. A 2% discount is available on orders of at least 5,000 kg and 2.5% discount is available if the order
quantity is 7,500 kg or above. It now takes two weeks for an order to be delivered.
Required:
i. Calculate EOQ ignoring quantity discounts
ii. Calculate EOQ assuming that quantity discounts are available.
iii. Calculate how frequently will the company place an order.
iv. Calculate how much inventory will it have on hand when the order is placed.
Sample Answer:
Req (i): Computation of economic order quantity (EOQ):
Annual requirement (A) = 30,000 kg
Carrying cost per unit per annum (CC) = BDT 1.22
Cost per order (O) = BDT 200
2 × 30,000 ×200
EOQ = = 3,162 units.
1.20
Req (ii)
Order quantity
3,162 5,000 7,500 10,000
Average inventory (units) 1581 2,500 3,750 5,000
Number of orders per annum = 30,000 ÷ 9.48 or 10 6 4 3
order quantity
Annual holding cost = 1,897 3,000 4,500 6,000
(average inventory × CC)
Annual order cost = (number of orders per 2,000 1,200 800 600
annum × cost per order)
Total cost 3,897 4,200 5,300 6,600
Savings on quantity discount 0000 30,000×12×2%= 30,000×12×2.5%= 30,000×12×2.5%=
(7,200) (9,000) (9,000)
Net savings 4,200-3,897= 303 - 5,300-3,897= 6,600-3,897= 2,703 -
7,200= 6,897 1,403 -9,000= 9,000= 6,297
7,597
COMMENT: A further cost savings can be made on 7,500 kg purchased on each order.
Req (ii) Alternative Approach
Compare the total costs at each level and choose the lowest total costs as the best order level. The total cost will be
made up of the total purchasing costs (net of discounts), the holding or carrying costs and the ordering costs.
Req (iii):
Number of orders if adopts EOQ policy = 30,000 ÷ 3,162 = 9.487 or 10
Number of days between two consecutive orders = 365 days ÷ 9.487 = 38 days 365 ÷ 10 = 37 days
Number of orders if adopts discount policy = 30,000 ÷ 7,500 = 4; Number of days between two orders = 365 ÷ 4 = 91 days
Req (iv):
Inventory should have on hand when the order is placed = 30,000 ÷ 52 × 2 = 1,154 kg
Other formulas to monitor and control inventory levels
• Safety stock = (Maximum use per day – Normal use per day) × lead time
• Reorder point or level= Normal Lead time usage + Safety Stock
• Normal Maximum Inventory= Safety stock+ Economic order Quantity
• Absolute maximum Inventory = Normal maximum inventory + [(Normal use per day - Minimum
use per day) × lead time]
• Minimum level = Re-order level - (Normal consumption x Normal re-order period).
• Safety stock level = Ordering level – (Average rate of consumption × Re-order period) OR
• (Maximum rate of consumption - Average rate of consumption) × Lead time
• Ordering level = Minimum level + Consumption during time lag period. OR
• Maximum consumption x Maximum re-order period. OR
• Maximum consumption x Lead time + Safety Stock
December 2020
ABC Manufacturing Co. Ltd. provides you with the following information pertaining to one of
its raw materials:
Normal use per day.............................................................. 400 units
Maximum use per day.......................................................... 600 units
Minimum use per day .......................................................... 100 units
Working days per year........................................................... 250 days
Lead time............................................................................... 8 days
Cost of placing one order........................................................ Tk.20.00
Cost per unit of material......................................................... Tk.2.50
Carrying cost percentage......................................................... 10%
Required:
Calculate the following: (i) Economic order quantity; (ii) Safety stock; (iii) Reorder point; (iv)
Normal Maximum inventory; (v) Absolute maximum inventory; (vi) Average normal
inventory.
Model solution
(i) Economic order quantity:
=√(2 𝑋 𝑅𝑈 𝑋 𝐶𝑂) ÷ ( 𝐶𝑈 𝑋 𝐶𝐶%) =√{2 𝑋 (400 𝑋 250)𝑋 𝑇𝐾 20} ÷ (𝑇𝑘 2.50 𝑋 10%)= √40,00,000÷ 0.25=
√160,00,000= 4,000
(ii) Safety Stock= Maximum use per day-Normal use per day= 600 units-400 units = 200 units x 8 days lead
time = 1,600
(iii) Reorder Point= Normal Lead time usage (400 units x 8 days)+ Safety Stock (1,600 units)= 4,800 units
(iv) Normal Maximum Inventory= Safety stock+ Economic order Quantity= 1,600 units+ 4,000 units= 5,600
units
(v) Absolute maximum Inventory:
Normal maximum inventory [Req.(4)] ………........................................ 5,600
Normal use per day...........................................400
Minimum use per day.......................................100
300 x 8 days= 2,400
8,000
(vi) Average normal inventory:
Safety stock......................................................................................1,600
Economic order quantity÷2=4,000÷2...............................................2,000
3,600
June 2020
• From the following particulars determine the EOQ.
Ordering Quantities (Tons) Price per ton (Tk.)
Less than 100 ……………..……………………….=10.00
Between 100 and 199 ………………………….=9.90
Between 200 and 499 ………………………….=9.80
Between 500 and 999…………………………..= 9.70
Between 1,000 and 1,999 …………………….=9.60
Between 2,000 and above ……………………=9.50
• Additional Information:
(i) Annual Consumption of materials = 2,000 tons
(ii) Carrying Cost 10%
(iii) Ordering Cost Tk. 5 per order
June 2021
ABC Company sells a number of products to many restaurants in the area. One product is a
special meat cutter with a disposable blade. Blades are sold in a package of 12 at Tk. 20 per
package. It has been determined that the demand for the replacement blades is at a
constant rate of 2,000 packages per month. The packages cost the company Tk. 10 each
from the manufacturer and require a three-day lead time from date of order to date of
delivery. The ordering cost is Tk. 1.20 per order, and the carrying cost is 10% per annum.
The company uses the economic order quantity formula.
Required:
(i) Compute the economic order quantity.
(ii) Compute the number of orders needed per year.
(iii) Compute the cost of ordering and of carrying blades for the year.
(iv) Determine the date on which the next order should be placed, assuming that there is
no reserve (safety stock) and that the present inventory level is 200 packages. (360 days = 1
year)
(v) Discuss the difficulties that most firms would have in attempting to apply the EOQ
formula to their inventory problems.
Inventory System-Periodic vs. Perpetual System
A periodic inventory system is a form of inventory valuation where the inventory account is updated at the end of an
accounting period rather than after every sale and purchase.
The method allows a business to track its beginning inventory and ending inventory within an accounting period.
This system visualizes physical stock verification at a fixed date/period during the year. Generally, under this system the activity takes
place at the end of the accounting period or a date close to such date. Usually the system is opened in the following manner: -
1. A period of 5/7 days, depending on the magnitude of the work is chosen during which all the items under stock are verified
physically and such period is known as ‘cut-off’ period. During this period there are no movements of stock items and neither
‘receipts’ nor are ‘issues permitted.
2. The items are physically counted/measured depending on their nature and are noted down in records which are signed by the
auditors if they are present in stock verification.
3. The bin cards balances are also checked and initiated. Generally, the physical balances and bin card balances of various items
should be same unless shortage/excesses are there or the recording/ balancing in the cards are incorrect.
4. After the physical verification is completed work sheets are countersigned by the go down supervisors and the stock verified.
5. Thereafter reconciliation statement is prepared item wise where the physical balances and bin card balances are different.
6. Then the balance as per bin cards and as per stores ledger is also compared and necessary adjustments are made to show the
correct position of stock at the year end.
7. Finally the shortages/excess statement is prepared by the concerned departments and are placed before the higher management
for their approval for adjustments.
The periodic inventory system is ideal for smaller businesses that maintain minimum amounts of inventory. The physical inventory
count is easy to complete, small businesses can estimate the cost of goods sold figures for temporary periods.
Perpetual Inventory
• It represents a system of records maintained by the stores in department. It in fact comprises of: Bin Cards, and
Stores Ledger.
• Bin Card maintains a quantitative record of receipts, issues and closing balances of each item of stores. Separate
bin cards are maintained for each item. Each card is filled up with the physical movement of goods i.e. on its receipt
and issue. Like bin cards, the Stores Ledger is maintained to record all receipt and issue transactions in respect of
materials. It is filled up with the help of goods received note and material requisitions.
• A perpetual inventory is usually checked by a programme of continuous stock taking. Continuous stock taking
means the physical checking of those records (which are maintained under perpetual inventory) with actual stock.
Perpetual inventory is essentially necessary for material control. It incidentally helps continuous stock taking.
• The main advantages of perpetual inventory are as follows:
(1) Fixation of the various levels and check of actual balances in hand with these levels assist the Storekeeper in
maintaining stocks within limits and in initiating purchase requisitions for correct quantity at the proper time.
(2) A systematic review of the perpetual inventory reveals the existence of surplus, dormant, obsolete and slow-
moving materials, so that remedial measures may be taken in time.
(3) Physical stocks can be counted and book balances adjusted as and when desired without waiting for the entire
stock-taking to be done.
(4) Discrepancies are easily located and thus corrective action can be promptly taken to avoid their recurrence.
(5) Quick compilation of Profit and Loss Accounts (for interim period) due to prompt availability of stock figures.
Maintenance of General Ledger and Subsidiary Ledger
Methods of Pricing Issues FIFO, LIFO, Average
The important operation of the inventory management is inventory valuation through stores register.
Inventory valuation under-pricing is being executed through the following various methodologies:
1. First in First out (FIFO)
2. Last in First out (LIFO)
3. Weighted Average Method (WAM)
Note
• If the question does not require you to prepare a stores ledger account, you are recommended for the FIFO
method to follow the approach shown in this answer. First calculate the closing stock in units. With the FIFO
method the closing stock will be valued at the latest purchase prices. You can calculate the cost of sales as
follows:
• Cost of sales = Opening stock + Purchases – Closing stock
Req iii)
The purchase cost per box is TK 36 (Jan.), TK 38 (Feb.), TK 40 (March), TK 35 (April) and TK 28 (June).
• The use of FIFO results in the lowest profit because prices are falling and the higher earlier prices are charged
to production, whereas with LIFO the later and lower prices are charged to production. The use of the weighted
average method results in a profit calculation between these two extremes. There are two items of concern
regarding the performance of the business:
• There was a large purchase at the highest purchase price in March. This purchase could have been delayed
until April so as to take advantage of the lower price. The stock loss has cost over TK 3000. This should be
investigated. A materials control procedure should be implemented.
Recording Materials as per BCAS-24
BCAS: 24-Material costs deal with the principles and methods of classification, measurement and assignment of material cost, for
determination of the cost of product or service, and the presentation and disclosure in cost statements. The objective of this standard is
to bring uniformity and consistency in the principles and methods of determining the material cost with reasonable accuracy.
Principle of valuation of receipt of materials:
The material receipt should be valued at purchase price including duties and taxes, freight inwards, insurance, and other expenditure
directly attributable to procurement (net of trade discounts, rebates, taxes and duties refundable or to be credited by the taxing
authorities) that can be quantified with reasonable accuracy at the time of acquisition.
Finance costs incurred in connection with the acquisition of materials shall not form part of material cost.
Self-manufactured materials shall be valued including direct material cost, direct employee cost, direct expenses, factory overheads,
share of administrative overheads relating to production but excluding share of other administrative overheads, finance cost and
marketing overheads. In case of captive consumption, the valuation shall be in accordance with Cost Accounting Standard 27.
Spares which are specific to an item of equipment shall not be taken to inventory, but shall be capitalized with the cost of the specific
equipment. Cost of capital spares and/or insurance spares, whether procured with the equipment or subsequently, shall be amortized
over a period, not exceeding the useful life of the equipment.
Principle of valuation of issue of material
Issues shall be valued using appropriate assumptions on cost flow e.g. First In First Out, Last In First Out, Weighted Average Rate. The
method of valuation shall be followed on a consistent basis.
Where materials are accounted at standard cost, the price variances related to materials shall be treated as part of material cost.
Any abnormal cost shall be excluded from the material cost.
Material cost may include imputed costs not considered in financial accounts. Such costs which are not recognized in financial
accounts may be determined by imputing a cost to the usage or by measuring the benefit from an alternate use of the resource.
The material cost of normal scrap/ defectives which are rejects shall be included in the material cost of goods manufactured. The
material cost of actual scrap / defectives, not exceeding the normal shall be adjusted in the material cost of good production. Material
Cost of abnormal scrap /defectives should not be included in material cost but treated as loss after giving credit to the realizable value
of such scrap / defectives.
Indirect materials may be grouped under major heads like tools, stores and spares, machinery spares, jigs and fixtures, consumable
stores, etc., if they are significant.
Assignment of costs – Materials
Assignment of material costs to cost objects: Material costs shall be directly traced to a Cost object to the extent
it is economically feasible and /or shall be assigned to the cost object on the basis of material quantity consumed
or similar identifiable measure and valued.
Where the material costs are not directly traceable to the cost object, these may be assigned on a suitable basis
like technical estimates.
Assignment of costs – Direct Expenses
Where a material is processed or part manufactured by a third party according to specifications provided by
the buyer, the processing/ manufacturing charges payable to the third party shall be treated as part of the
material cost.
Wherever part of the manufacturing operations / activity is subcontracted, the subcontract charges related to
materials shall be treated as direct expenses and assigned directly to the cost object.
Assignment of costs– Indirect materials
The cost of indirect materials shall be assigned to the various Cost objects based on a suitable basis such as
actual usage or technical norms or a similar identifiable measure.