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Cost Accounting - Material cost control.pdf

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Cost Accounting - Material cost control.pdf

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MATERIAL CONTROL
The cost associated with inventories
Techniques Of Material Control
MATERIAL CONTROL PROCESS
ISSUE OF MATERIAL - LIFO, FIFO, Average method, Replacement cost method, NIFO, Base stock method
STORES LEDGER ACCOUNT

MATERIAL CONTROL
The cost associated with inventories
Techniques Of Material Control
MATERIAL CONTROL PROCESS
ISSUE OF MATERIAL - LIFO, FIFO, Average method, Replacement cost method, NIFO, Base stock method
STORES LEDGER ACCOUNT

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Cost Accounting - Material cost control.pdf

  1. 1. Material Cost Control John Pradeep Kumar Department of Management Kristu Jayanti College
  2. 2. Material Material or material cost is the cost of materials used to manufacture a product or provide a service. Definition “Cost of commodities supplied to an undertaking” - CIMA, UK – Forms a major part of the product cost. – Raw materials and consumables used as a part of production. – Material can be raw material, work in progress and finished goods. – Raw material can be direct material or indirect material. Mr. John Pradeep K, KJSOM 2
  3. 3. MATERIAL CONTROL Definition “Safeguarding of company's property in the form of material by a proper system and maintain them at the optimum level considering operating requirements and financial resources of the business.” Scope and need of Material Control: • Systematic control over purchasing, storing and consumption of materials. • Helps to maintain a regular and timely supply of materials by ensuring right quantity. Mr. John Pradeep K, KJSOM 3
  4. 4. MATERIAL CONTROL • Ensures that the right quality and quantity of materials is available to the company at the right time • Helps to reduce the losses and wastage of materials. • Maintains efficient purchase, storage and use or consumption in the factory. • Helps in reducing the cost of production and increasing the profitability of the company. Mr. John Pradeep K, KJSOM 4
  5. 5. MATERIAL CONTROL The objectives of Material Control: 1. Economy of purchase • Effective in negotiating of purchase price. • Economy of scale 2. Maintaining appropriate stocks • Understocking and overstocking a concern • Maintain EOQ of material Mr. John Pradeep K, KJSOM 5
  6. 6. MATERIAL CONTROL The objectives of Material Control: 3. Minimized wastage • Better techniques and arrangements for storage 4. Minimize associated costs • Reduction is costs linked with material – transportation, security, insurance cost, carrying cost, etc. 5. Reporting on material management • Maintain records and reporting is easier. Mr. John Pradeep K, KJSOM 6
  7. 7. Cost associated with inventories 1. ORDERING OR ACQUISITION COSTS  It is the fixed cost of placing and receiving an inventory order  Ordering costs are costs involved in: a) Preparing a purchase order or requisition form. b) Receiving, inspecting, and recording the goods received to ensure both quantity and quality.  The acquisition costs are inversely related to the size of inventory: they decline with the level of inventory.  Ordering Cost can be minimised by placing fewer orders for a larger amount. 7 Mr. John Pradeep K, KJSOM
  8. 8. Cost associated with inventories 2. CARRYING COSTS  Carrying costs are the variable costs per unit of holding an item in inventory for a specified time period.  The cost of holding inventory may be divided into two categories: a) Those that arise due to the storing of inventory (insurance, utilities, pilferage, service costs, such as labour for handling inventory, clerical and accounting costs). b) The opportunity cost of funds (if funds were not locked up in inventory, they would have earned a return). 8 Mr. John Pradeep K, KJSOM
  9. 9. Total cost  The carrying costs and the inventory size are positively related and move in the same direction.  Total cost is the sum of the ordering costs and carrying costs of inventory. Total Cost = OC + CC 9 Mr. John Pradeep K, KJSOM
  10. 10. TECHNIQUES OF MATERIAL CONTROL Mr. John Pradeep K, KJSOM 10
  11. 11. Techniques Of Material Control Material Control techniques helps in: – Scientific management of materials. – Helps in eliminating and minimizing all kinds of wastes and losses. – Helps in effectively managing material during purchase, storing, handling, issued or consumption. Mr. John Pradeep K, KJSOM 11
  12. 12. Inventory Management techniques I. ABC analysis II. Economic order quantity (EOQ) III. Order point problem IV. Two-bin technique V. VED classification VI. HML classification VII. SDE VIII. FSN IX. Order cycling system X. Just in time (JIT) Mr. John Pradeep K, KJSOM 12
  13. 13. ABC Technique ABC Technique is a technique used for control of materials. – Technique is value-based system of material control. – Materials are analyzed or evaluated for its value. – Items are classified into 3 based on the value: • ‘A’ item : high value, smaller in percentage of total value. Highest responsibility and control procedures. • ‘B’ item : medium value, normal control techniques. • ‘C’ item : low value, large quantities. Simple techniques. – Selectively attention and control given based on the value of material. Mr. John Pradeep K, KJSOM 13
  14. 14. I. ABC analysis  Inventory control tool that categories inventory into three groups –A, B, and C, in descending order of importance of control.  Categorisation of inventory  Category No. of Items (%) Item value (%) A 15 70 B 30 20 C 55 10 TOTAL 100 100 14 Mr. John Pradeep K, KJSOM
  15. 15.  A firm has 7 different items in its inventory.The average number of each of these items held, along with their units costs, is listed below. The firm wishes to introduce an ABC inventory system. Suggest a breakdown of the items into A, B, and C classifications. Item numbers Average number of units in inventory Average cost per unit (Rs.) 1 20,000 60.80 2 10,000 102.40 3 32,000 11.00 4 28,000 10.28 5 60,000 3.40 6 30,000 3.00 7 20,000 1.3 15 Mr. John Pradeep K, KJSOM
  16. 16. ABC ANALYSIS Item Units Per Cent of Total Unit Cost Total Cost Per Cent of Total 1 20,000 10 60.8 1216000 38.00 2 10,000 5 102.4 1024000 32.00 3 32,000 16 11 352000 11.00 4 28,000 14 10.28 287840 9.00 5 60,000 30 3.4 204000 6.38 6 30,000 15 3 90000 2.81 7 20,000 10 1.3 26000 0.81 Total 2,00,000 100 3199840 100.00 15 30 55 70 20 10 16 Mr. John Pradeep K, KJSOM
  17. 17. EOQ (ECONOMIC ORDER QUANTITY) EOQ is the inventory management technique for determining optimum order quantity which is the one that minimises the total of its order and carrying costs. EOQ = √2AB/C  A = annual usage of inventory (units)  B = buying cost per order  C= carrying cost per unit  C = C * i (i = carrying cost (%) c = cost per unit) Mr. John Pradeep K, KJSOM 17
  18. 18. EOQ Q1.  A firm’s inventory planning period is one year. Its inventory requirement for this period is 1,600 units. Assume that its acquisition costs are Rs. 50 per order. The carrying costs are expected to be Re.1 per unit per year for an item. Find out the EOQ.  Solution: EOQ = √2AB/C 1,600*50/1 0 units 18 Mr. John Pradeep K, KJSOM
  19. 19. EOQ Q2. Mr. John Pradeep K, KJSOM 19 From the following particulars, calculate the Economic Order Quantity (EOQ): Annual requirements: 1,600 units, Cost of materials per units: Rs. 40, Cost of placing and receiving one order: Rs. 50; Annual carrying cost for inventoryValue: 10%.
  20. 20. III. Order point problem  EOQ provides answer to the question: how much inventory should be ordered in one lot?  Another important question pertaining to efficient inventory management is: when should the order to procure inventory be placed?  This aspect of inventory management is covered under the reorder point problem.  “Reorder point is the level of inventory when fresh order should be placed with the suppliers for procuring additional inventory equal to the economic order quantity”. 20 Mr. John Pradeep K, KJSOM
  21. 21. IV. Two-bin technique  According to this technique, stock of each item is separated into two bins or groups.  First bin contains stock, just enough to last from the date a new order is placed until it is received in inventory.  The second bin contains stock, which is enough to meet current demand over the period of replenishment.  First stock is issued when the first bin stock is completed, then an order for replenishment is placed, and the stock in the second is utilised until the ordered material is received.  Generally, this method is used to control ‘C’ category inventories. 21 Mr. John Pradeep K, KJSOM
  22. 22. V. VED Classification  According to this classification inventories are grouped based on the effect on production.  Inventories are grouped into three groups-Vital, Essential and Desirable (not so essential) inventories.  It is specially used for classification of spare parts.  ‘V’ category item are stocked high and category ‘D’ items are maintained at minimum level. 22 Mr. John Pradeep K, KJSOM
  23. 23. VI. HML Classification : It classifies materials into three groups – High (H), Medium (M) and Low (L) in descending order of unit value.  This classification is useful for keeping control over consumption at department levels, for deciding the frequency of physical verification and for controlling purchases. VII. SDE classification: it is based on availability of inventory. Here ‘S’ refers to ‘scarce’,‘D’ refers to ‘difficult’ and ‘E’ refers to ‘easy’. VIII. FSN classification: it is based on movement of inventory from stores. FSN stands for Fast moving (F), Slow moving (S) and Non-moving (N). 23 Mr. John Pradeep K, KJSOM
  24. 24. IX. Order cycling system: in this system, periodic reviews are made of each item of inventory and orders are placed to restore stock to a prescribed supply level. X. Just-in-time (JIT): No inventories are held at any stage of production and the exact requirement is bought in each and every successive stage of production at the right time. 24 Mr. John Pradeep K, KJSOM
  25. 25. Minimum, maximum and reorder levels Material control needs certain inventory levels to be maintained. – Helps in overcoming problems of overstocking and understocking. – Actions are taken by the management based on these levels. – Levels maybe modified from time to time based on review. – Some important levels set are: • Maximum level • Minimum level • Re-order level • Danger level • Safety stock Mr. John Pradeep K, KJSOM 25
  26. 26. Minimum, maximum and reorder levels Maximum Level: – Refers to the maximum capacity of the firm. – Measure of the maximum quantity that can be accommodated by the management. – Increase in levels may lead to problems relating to storage, logistics, etc. Maximum stock level = Re-order level + Re-order Quantity – (Minimum Usage * Minimum Delivery Time) Mr. John Pradeep K, KJSOM 26
  27. 27. Minimum, maximum and reorder levels Minimum Level: – Refers to the least stock capacity of the firm. – Management should not allow the stock levels to fall below minimum level. – Drop in stock level beyond this would stop the production process. Minimum stock level = Re-order level –[Normal usage * Avg. delivery time] Mr. John Pradeep K, KJSOM 27
  28. 28. Minimum, maximum and reorder levels Reorder Level: • Refers to level of inventory at which new order of purchase/ procurement needs to be made. • It is in-between max and min level. • Reorder level is fixed based on following parameters: 1. Nature of material 2. Rate of consumption 3. Lead time -number of days required to receive the inventory from the date of placing order Re-order level = Maximum Usage * Maximum DeliveryTime Mr. John Pradeep K, KJSOM 28
  29. 29. Minimum, maximum and reorder levels Danger Level: • Refers to level of inventory at which production will be halted. • Needs immediate attention of management. Danger level = Average Usage * Minimum DeliveryTime [for emergency purchase] Mr. John Pradeep K, KJSOM 29
  30. 30. Minimum, maximum and reorder levels Average Stock Level: • Gives an average level of the inventory. • Helps in managerial decisions. Average stock level = Minimum level + [Reorder Quantity ÷ 2] Mr. John Pradeep K, KJSOM 30
  31. 31. Minimum, maximum and reorder levels Safety Stock Level: • Additional quantity of an item held by a company in inventory. • Helps in reducing the risk of the item running out of stock. Mr. John Pradeep K, KJSOM 31
  32. 32. ISSUE OF MATERIAL Mr. John Pradeep K, KJSOM 32
  33. 33. MATERIAL CONTROL PROCESS Mr. John Pradeep K, KJSOM 33
  34. 34. ISSUE OF MATERIAL Issue of Material refers to the process followed for the release of the material from storage to the point of consumption. • Materials purchased stored in inventory. • Needs to be issued based on the need. • Requisition process needs to followed for the issue. Store manager responsible for: – Pricing of material – Preparation and treatment of requisite form. Mr. John Pradeep K, KJSOM 34
  35. 35. ISSUE OF MATERIAL The some of the methods followed for the material issue are as follows: • LIFO • FIFO • Average method • Replacement cost method • NIFO • Base stock method Mr. John Pradeep K, KJSOM 35
  36. 36. FIFO First in, first out (FIFO) is a method used to account for inventory. The feature of FIFO are as follows: • Method of pricing the issue of material using, the purchase price of the oldest unit in the stock. • Materials are issued out of stock in the order in which they were first received into stock • Easy to understand and simple to price the issues of material. • Material leave the stores in a chronological order based on age. • Inventory is valued at the most recent market prices. Mr. John Pradeep K, KJSOM 36
  37. 37. LIFO Last in, first out (LIFO) is a method used to account for inventory. The feature of LIFO are as follows: • Most recent purchase will be the first to be issued. • Issues are priced out at the most recent batch received. • Stocks issued at more recent price represent the current market price. Mr. John Pradeep K, KJSOM 37
  38. 38. AVERAGE METHOD Under the ‘Average Cost Method', the cost of inventory is based on the average cost of the goods available The feature of Average Method are as follows: • Based on the assumption material purchased at different intervals are stored together. • Hence should be charged at average price. • Two types: Simple Average & Weighted Average Mr. John Pradeep K, KJSOM 38
  39. 39. SIMPLE AVERAGE METHOD Simple Average Method is a technique of Issue of Material under the Average Method: The features are as follows: • Taking average of the prices at which materials were purchased. • Does not consider the quantities. • Easy to prepare. • Simple to understand. Mr. John Pradeep K, KJSOM 39
  40. 40. WEIGHTED AVERAGE METHOD Weighted Average Method is a technique of Issue of Material under the Average Method: The features are as follows: • Based on weighted average price of the material. • Considers the quantity and the price of the material. • Evens out the price variation at different intervals of purchase. Mr. John Pradeep K, KJSOM 40
  41. 41. STORES LEDGER ACCOUNT Stores Ledger Account is a document prepared to maintain the issue of material. The features are as follows: • Used for recording raw materials and production supplies. • Helps in systematic maintenance of record. • Maintained by the stores personnel. • Helpful for auditors to carry out stock keeping of company's inventory records. Mr. John Pradeep K, KJSOM 41
  42. 42. STORES LEDGER ACCOUNT Format of Stores Ledger Account DATE RECEIPTS ISSUES BALANCE Quantity Rate Amount Quantity Rate Amount Quantity Rate Amount Mr. John Pradeep K, KJSOM 42

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