UNIT 3 PROCUREMENT, STORAGE AND

ISSUE
Structure
3.0 Objectives
3.1 Introduction
3.2 Direct and Indirect Materials
3.3 Material Control
3.3.1 Definition
3.3.2 Objectives
3.3.3 Advantages
3.3.4 Basic Requirements
3.4 Purchase Procedure
3.4.1 Centralised Purchasing
3.4.2 Decentralised Purchasing
3.4.3 Steps Involved in Purchase
3.5 Storage of Materials
3.5.1 Functions of Storekeeping
3.5.2 Location and Lay-out of Stores
3.5.3 Issue of Materials
3.5.4 Treatment of Surplus Materials
3.6 Let Us Sum Up
3.7 Key Words
3.8 Answers To Check Your Progress
3.9 Terminal Questions

3.0 OBJECTIVES
After studying this unit you should be able to:
●● define and distinguish between direct and indirect materials;
●● define material control and state its objectives;
●● explain the steps involved in connection with the purchase of materials;
●● explain the objectives and functions of storekeeping; and
●● explain the procedure involved in connection with the issue of material.

3.1 INTRODUCTION
Material constitutes an important part of the cost of production of an article.
It is, therefore, necessary to exercise proper control over the procurement,
storage and issue of materials. In this unit, you will study the procedure
and documents involved regarding the purchase of materials, its storage and
issue to the various production orders.

3.2 DIRECT AND INDIRECT MATERIALS

If you analyse the cost of production of any articles, you will find that
materials constitute an important component of the cost of production. They
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 Material and Labour account for nearly 60 per cent of the cost of production of a large number
of private and public sector organisations. The materials can be divided into
two categories: (1) Direct materials; and (2) Indirect materials.
The materials which can easily be identified and attributed to the individual
units are known as ‘direct materials’. These materials form part of the
finished product. Leather used in the manufacture of shoes and yarn required
for the production of cloth are examples of direct materials. All costs which
are incurred to obtain direct materials are known as ‘direct material cost’.
Indirect materials, on the other hand, do not form part of the finished product
and cannot be conveniently and accurately allocated to a particular unit of
product. Examples of such materials are: consumable stores, cotton waste
and lubricating oils, required for the maintenance of machines, etc. Costs
associated with indirect materials are known as indirect material costs.’
The grouping of materials into direct and indirect sometimes become a
matter of convenience. Materials of small value which should actually be
termed as direct may be treated as indirect for the sake of simplicity. For
instance, in the manufacture of shirts, the thread forms part of the shirts
and hence should he classified as direct materials. But, considering the
time and expense involved in measuring the thread required for each shirt,
it is desirable that the cost of thread be treated as indirect material cost.
Similarly in the manufacture of shoes, the cost of nails used is treated as
indirect material cost.

3.3 MATERIAL CONTROL

As stated earlier, materials constitute an important part of the cost of
production of a product. It is, therefore, important to keep a strict control
over the cost of materials. Any savings made in the cost of material will go a
long way in reducing the cost of production and improving the profitability
of the concern. It is essential to keep a proper control over materials and
supplies from the time orders for materials are placed with the suppliers
until they have been consumed. Proper control of material can make a
substantial contribution to the efficiency of a business.
3.3.1 Definition
Material control may be defined as the regulation of the functions of an
organisation relating to procurement, storage and usage of materials in
such a way as to maintain an even flow of production without excessive
investment in material stock. Thus, materials control involves control of
three important function viz., procurement, storage and usage. It has been
rightly pointed out that just as the handling of cash is of utmost important in
the case of a non-manufacturing business, an efficient handling of materials
is of vital importance in the case of a manufacturing business.
3.3.2 Objectives
The following are the main objectives of material control.
1) There should be a continuous availability of all types of materials in the
factory so that production may not be held up for want of any material.
2) Over stocking of materials should be avoided. By doing so the various
losses caused by overstocking can be avoided.
3) Materials should be purchased on the most favourable terms. This helps
in effecting maximum economy in the cost of buying of course, the
quality should not be sacrificed at the cost of lower price.
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 4) Purchase of materials should be of the right quality consistent with the Procurement, Storage and
standards prescribed in respect of the finished product. Issue
5) Materials should be properly stored so as to prevent losses during storage.
6) The management should be frequently provided with information
regarding the cost of materials and the availability of stock.
3.3.3 Advantages
The main advantages of a good system of material control are as follows:
1) It ensures unrestricted and continuous supply of materials and may be
greatly helpful in preventing production delays.
2) It minimises capital investment in the stock of materials.
3) It considerably reduces the cost of storage and issuing of materials.
4) It eliminates wastage and loss of materials arising on account of
spoilage, pilferage, theft, etc.
5) It is immensely helpful in introducing the system of perpetual inventory
control by which accurate ascertainment and valuation of closing stock
are facilitated.
6) It ensures the purchase of materials at reasonable prices.
7) It aids management in initiating and formulating proper purchase
policies regarding materials.
3.3.4 Basic Requirements
Materials control extends to all spheres of materials management viz.,
buying, receiving, inspection, storage consumption and accounting. The
following are the basic requirements of a good system of materials control:
1) There should be proper co-ordination of all departments which are
involved in the purchasing, receiving, testing, approving, storage of
materials and payment of price.
2) The purchase of materials should be centralised.
3) Proper forms should be used with regard to receipt, issue and transfer
of materials from one job to another.
4) There should be a budget for materials and supplies so that economy in
purchasing and use of materials is realised.
5) A system of internal check should be introduced in order to have proper
check on the purchases of materials, and supplies.
6) A well organised system of storage of materials should be undertaken
in order to avoid deterioration, pilferage, wastage and evaporation of
materials.
7) There should be a system of perpetual inventory so that it is possible
to find out the quantity and value of materials in stock at any point of
time.
8) Minimum limit for each item of material should be fixed below which
the stock is not allowed to drop. Similarly, the maximum limit should
be fixed above which the stock should not be kept.
9) There should be a proper system for the issue of materials so that there
will be delivery of materials on requisition to the department, processes
or jobs in the right quantity and at the moment they are needed.

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 Material and Labour 10) Information about availability of materials should be made continuously
available to the management so that planning of production may be
done keeping in view the inventory balances instores. Information about
obsolete and defective stock should also be given to the management
from time to time so that steps may be taken for the disposal of such
stock.
Check Your Progress A
1) Select the correct answer in each of the following cases:
i) In most of the industries, the most important element of cost is:
a) Material b) Labour c) Overheads
ii) Direct material is a:
a) Fixed cost b) Variable cost c) Semi-variable cost
iii) Direct material is a:
a) Manufacturing cost b) Administration cost
c) Selling and distribution cost d) Any of the above
iv) Which of the following items of cost should not be treated as
direct material:
a) Electricity representing 90% of the total cost
b) Sand paper used in production
c) Thread used in stitching garments
d) All of the above
2) Define materials control.

3.4 PURCHASE PROCEDURE

You should know that purchasing is the most significant step in the process of
material control. In order to ensure that the required materials are available
at the right time, in the right quantity and at the right price, there should be
a separate purchase department under the control of a purchase manager.
Keeping in view the size and the requirements of an organisation. The function
of purchasing can be either centralised or decentralised. Let us study these
two systems in detail.
3.4.1 Centralised Purchasing
Under centralised purchasing purchases are made at one central point for
the whole organisation and from that central point materials are issued
to respective departments or jobs as and when required. In other words,
centralisation of purchasing refers to the placement of authority for the
whole purchasing function in the purchasing department headed by
the purchase manager. In medium sized and big companies purchasing
function is generally centralised.
Advantages
1) Centralised purchasing brings about economies in purchasing. Higher
trade discount or economies in transport can be obtained because the
quantity involved will be large.
2) The buying staff concentrates on purchases alone and develops specialised
knowledge and skill leading to expert and economical buying.
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 3) It ensures consistent policy with regard to purchases. It avoids haphazard Procurement, Storage and
buying and the consequent effect on the finances of the concern. Issue
4) Centralised purchasing facilitates the maintenance of one complete set
if records for purchase transactions which enables the management to
exercise a better and effective control over purchases.
5) It relieves the departmental heads of the responsibility of procuring
variety of materials. They can thus concentrate on the functions
assigned to them.
6) Centralisation of purchasing is helpful to the vendors. Their selling
costs are reduced as they can easily co-ordinate and supply goods to a
single buyer instead of large number of buyers.
Disadvantages
1) The procedure adopted for the purchase of materials s less flexible
which may cause undue delays in obtaining supplies.
2) The administrative cost of setting up a separate purchase department is
likely to be quite high.
3) There are chances of misunderstanding between the department which
requires the material and purchasing department with the result that
wrong purchase of material can be made.
3.4.2 Decentralised Purchasing
Decentralised purchasing is the reverse of centralised purchasing. Each
department makes its own purchases. Decentralised purchasing is also
known as ‘localised purchasing’.
Advantages
1) It is quite flexible and can be quickly adjusted in accordance with the
changed requirements of a particular plant.
2) In case of emergency, localised purchasing is best suited and purchases
can be procured more quickly.
3) Technical requirements of each plant can be ascertained.
Disadvantages
1) As compared to centralised buying, it offers lesser economy in
purchasing.
2) There are problems of co-ordination among various departments of the
organisation and it usually leads to unplanned buying.
3) Uniformity in prices may not be ensured because every departmental
head may not posses the calibre of an expert buyer.
After analysing the merits and demerits of both the systems, it can be said
that centralised purchasing is decidedly better than decentralised purchasing.
However, neither of them is considered wholly satisfactory in the case of all
types of concerns.
Centralised purchasing is eminently suited to a concern operating only one
plant. It is also suitable for a concern operating two or more plants located
not far away from one another and producing more or less homogeneous
products. However, a manufacturing concern which operates several branches
or factories at different places and manufactures different products requiring
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 Material and Labour different types of materials, can have decentralised purchasing and different
factories can meet their requirements by making purchases in the local
markets.
3.4.3 Steps Involved in Purchase
Although the details of the purchase procedure may very with individual
concerns, the following are the various steps which are usually followed in
connection with the purchase of materials.
1. Purchase Requisition
A form known as ‘purchase requisition’ is commonly used as a formal
request to the purchase department to order goods or services. The purchase
requisition serves thedual purpose of authorising the purchasing department
to make a purchase and provides a record of the description and quantity of
materials required.
The purchase requisition is prepared by the storekeeper for regular stock
materials and by the departmental head for special materials not stocked as
regular items.
Regular purchase requisitions are prepared when stock is reduced to re-order
level, i.e., the level when the order for replenishment should be placed. The
requisition is approved by an executive.
Purchase requisitions are generally prepared in triplicate. The original copy
is sent to the purchase department, the record is retained by the storekeeper
or the executive initiating the purchase requisition and the third copy is sent
to the costing department.
The purchase requisition contains the requisition number, date, department,
code number, description and quantity of materials required, signature of
the person initiating the requisition and signature of one or more executives
approving the purchase requisition.
Specimen form of purchase requisition is given in Figure 3.1
Figure 3.1: Specimen of Purchase Requisition
PURCHASE REQUISITION
No……………….. Date :……………
Date by which material are
Required…………………..
Serial No. Description Code No. Quantity Remarks

Requested Checked Approved

by…… by………. by………

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 2. Selecting the Supplier Procurement, Storage and
Issue
Having decided to purchase the material, the purchase department invites
tenders or quotations for the supply of materials. On receipt of the
quotations from the suppliers, a comparative statement known as ‘schedule
of quotations’ should be prepared so that a suitable supplier may be selected.
While making the selection, the purchase manager should not mechanically
identify the supplier whose quotation is the lowest. He should judiciously
decide with whom he has to place the order and in doing so he must consider
such factors as price, quality, time of delivery, dependability of the supplier,
discount, credit facility, terms of payment, etc.
The specimen of the comparative statement of quotations is given in Figure 3.2
Figure 3.2: Specimen of Schedule of Quotations
COMPARATIVE STATEMFNT OF QUOTATIONS
Tender No………………..
Material …………………
Date:…………………..
Serial Name Quantity Rate Terms of Time of delivery Remarks
of the delivery
No. supplier

Purchasing clerk_________ Purchasing Officer__________

3. Purchase Order
After choosing the supplier, the purchase department prepares a purchase
order for the supply of stores. The order is the written authorisation to the
supplier to supply the particular material or materials. The purchase order
is an important document not only from the legal point of view, but from
the accounting point of view also. It is the evidence of the contract between
the buyer and the supplier that binds both the buyer and the supplier to
the terms under. which the order is placed. It also gives authority to the
receiving department to receive the materials, ordered for and to the account
department to accept the bill from the supplier for payment.
The purchase order should contain such particulars as date, name and
address of the supplier, description and specification of the material, quantity
ordered, date, time and place of delivery, price, terms of payment, transport
charges, packing and shipping instructions, the name and address of the
buyer, and the signature of the purchase manager.
The number of copies of the purchase order depends upon the size of the
organisation. A large concern usually issues five copies. Of these the original
copy is sent to the supplier, the second to the receiving department, third to
the department initiating the purchase requisition, the fourth to the accounts
department and the fifth copy is retained in the purchase department. The
copy retained in the purchase department is used to check the progress of
the order and to ensure that the delivery promises are adhered to.
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 Material and Labour Figure 3.3: Specimen of Purchase Order
PURCHASE ORDER
To
(Name and Address of Supplier) Date :……………
Requisition No…………...
Please supply the following items in accordance with the terms and
conditions mentioned herein.
Item No. Description Quantity Code No. Price Total Remarks

Packing and dispatching instructions ………………

Discount………………
Terms of payment………………
Condition regard empties…………….
Excise duty and sales tax………………..
For X Y Z Co. Ltd
(Signature )
Chief Purchasing Officer

4. Receiving and Inspection of Materials

The receiving department is responsible for taking delivery of packages and
to get a physical verification of the contents. When the packages are received,
the receiving official gets them opened and makes detailed verification of the
contents. After the contents of the packages have been checked, the details
of the materials received are entered in a Goods Received Note. Five copies
of the note are prepared. One copy is kept by the receiving department while
the remaining copies are routed to the purchase department, the department
originating the purchase requisition, the stores department, and the accounts
department.
The form of the Goods Received Note is given in Figure 3.4.
Figure 3.4: Specimen of Goods Received Note
GOODS RECEIVED NOTE

Supplier’s name…………… G. R. No…….............

Purchase order No……………….. Date…………...........
Item No. Description Code No. Quantity Quantity Amount Remarks
ordered received

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 Received by………………….. Inspected by…………….. Procurement, Storage and
Issue
Storekeeper ………………….
Stores ledger posted by………………..
Where the factory has a separate inspection department, its main function is
confined to testing the material received, for quality and specifications. The
engineer or the chemist may be called to check the quality of the materials.
He is to ensure that the quality is according to the purchase order. After
checking the quality of the materials, the department will submit a report as
to the quality and if some of materials are rejected, the reasons therefore. An
unfavourable inspection report is utilised by the purchasing department in
obtaining, adjustments or an authority for the return of goods to the vendor.
This forms the basis for the issue of a debit note.
5. Checking and Passing of Bills for Payment
Invoice is the document giving details of goods supplied and the amount to
be paid. Invoice received by the purchase department is forwarded to the
Accounting Department to check the authenticity as well as the arithmetical
accuracy. The quantity and the price mentioned in the invoice are checked
with reference to goods received note and the purchase order respectively.
For Adjustment of discrepancies. the inspection report and goods returned
note should be compared with the invoice. It is equally necessary to check
extensions and totals.
If the contents of the invoice are found to be correct, an endorsement to that
effect is made on it with a rubber stamp. With the signature of the purchase
manager, the invoice is passed on to the accounts department for payment.
Check Your Progress B
1) Indicate whether the following statements are True or False and
justify your answer.
i) Purchase requisition note is prepared by the purchasing
department.
ii) Purchase order is prepared by the stores department.
iii) Original copy of the purchase order is sent to the supplier.
iv) Goods received note is prepared by goods receiving department.
v) Payment of the invoice is made by the purchase department.
2) List the steps involved in purchase of materials.
3) What do you mean by centralised purchasing?

3.5 STORAGE OF MATERIALS

After the purchase, receipt and inspection of materials, the next most
important step in the process of material control is concerned with’ the
storage of materials which is termed as ‘storekeeping’. Storekeeping is that
aspect of material control which is concerned with the physical storage of
goods. For carrying the task of storekeeping, a separate stores department
under the charge of a storekeeper is set up. The storekeeper should have
the technical knowledge and experience in stores routine and the ability of
organising various activities relating to the storage of goods, An efficient
system of storekeeping should:
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 Material and Labour 1) Ensure uninterrupted supply of materials and stores without delay to
various production and service departments of the organisation.
2) Prevent overstocking and under stocking of materials.
3) Minimise the cost of storage.
4) Prevent all kids of stores from theft, deterioration, evaporation and
pilferage.
5) Ensure an effective utilisation of available storage space and
workers engaged in the process of storekeeping.
6) Develop a system of providing necessary information about the
material items in the stores as and when required.
3.5.1 Functions of Storekeeping
The following functions are performed by the stores department:
1) Receipt of material from the goods receiving department and ensuring
that every Item of stores received by a storekeeper is duly supported
by a indent, a purchase order, an inspection note and a goods received
note.
2) Issue purchase requisition to the purchase department when the stock
of material reaches the re-order level.
3) Maintain proper record of receipt, issue and balance of all items of
materials, and check the bin card balances with the physical quantities
in the bins.
4) Placing and arranging materials received at proper and appropriate
places and adhering to the golden principle of storekeeping, i.e.,
a-place for everything and everything in its place.
5) Issue stores, against proper authorisation, in right quantity of right
specification, and at the right time.
6) Minimising the storage handling and maintaining costs.
7) Ensuring that the stocks neither exceed the maximum leve1 nor go
below the minimum level at any point of time.
8) Preventing the entry of unauthorised persons into the stores.
9) Co-ordination and supervision of staff in the stores department.
10) Carrying out a regular review of the items of stores in hand for locating
slow moving and non-moving items so that the necessary steps may
be taken for their disposal before they become obsolete.
3.5.2 Location and Lay-out of Stores
The location of stores department should be undertaken very carefully.
The management should keep in mind various important considerations
before selecting proper site for locating the stores department. It should
be close to the receiving department so that the transportation charges can
be minimised. At the same time, there should be an easy access to all other
departments of the factory, roads, railways siding and wharf.
Proper lay-out of stores is also of vital importance. Lay-out refers to the
internal arrangement or placement of materials inside the stores. It aims at
effective utilisation of space available for storage of materials. The stores
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 should be divided into racks which should be sub-divided into small spaces. Procurement, Storage and
All these spaces are known as bins. For every kind of material a bin is Issue
allotted. All bins should be serially numbered.
The stores department should be equipped with racks, shelves, boxes crates,
barrels, drums, cylinders and other receptacles for storing the different
items. The receptacles should be arranged in such a way as to make the
fullest utilisation of available space. At the same time, they should be easily
accessible. Enough space should be provided for the movement of trucks,
conveyors, lifts and other mechanical devices.
A proper location and lay-out would ensure economy in materials handling,
transportation costs, minimise wastage, ensure effective supervision and
control.
3.5.3 Issue of Materials
All items in stores are meant issuance to various production departments.
The procedure for the issue of material is normally laid down by the
management.
The storekeeper should not issue the materials unless a properly authourised
material requisition is presented to him. The requisition is prepared by the
foreman or the head of the department. It is prepared in triplicate, two
copies are sent to the stores department and the third copy is retained
by the requisitioning department for its own reference. On receipt of the
materials requisition, the storekeeper issues the necessary materials against
the signatures of the person receiving the materials. One of the copies of the
materials requisition is used by the storekeeper for making the necessary
entries in the bin card. The other copy is sent to the costing office for pricing
the issues and making the necessary entries in the stores ledger.
A specimen of the materials requisition is given in Figure 3.5
Figure 3.5: Specimen of Materials Requisition
MATERIALS REQUISITION

Department …………… Serial No ……...

Job No……………….... Date…………....
Quantity Description Code Bin Card Store Rate Amount
No. no ledger
Folio no.

Authorised by………………….. Received by…………..…..

Storekeeper’s signature …………………. Checked by…………….…
You will notice in the above specimen of materials requisition that it contains
information regarding the date, requisition number, description, quantity of
the material, name or job order number or work order number or process on
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 Material and Labour which material is to be used, and the signatures of the person receiving the
materials. The entries in the rate’ and amount columns of the requisition slip
are made by the costing office.
Bill of materials
Material requisition slip considerably increases the work-load, both in
the production department and the stores department. Production may be
delayed if requirements are not submitted in time or if the materials are
not available in stock. The use of the bill of materials overcomes all these
difficulties.
A bill of materials is a standard list (also called specification list) of all
materials required for a particular work order, job or process. It is prepared
by the production department on receiving the order. It can be used as a
substitute for materials requisition. It provides advance intimation to the
storekeeper about the requirements of different jobs or work orders.
The bill of materials serves the following purposes:
1) The clerical work involved in preparing a number of requisitions is
considerabably reduced and there is economy in the use of stationery.
2) The cost of transportation involved in receiving the required quantity
of every type of material is also proportionately reduced since all
the materials required for a particular job can be transported to the
receiving department only once.
3) It serves an advance intimation to the storekeeper and constitutes an
authorisation for the issue of materials.
4) It may also be used as an authorisation for procurement of materials
if these not available in stock. Thus it eliminates the need for the
issue of purchase requisitions for procuring materials not available in
stock.
5) It may be used as a basis for passing accounting entries in the stores
ledger.
6) The procurement and issue of materials can be planned in advance to
avoid delays in production and deliveries.
3.5.4 Treatment of Surplus Materials
Sometimes materials may be issued in excess of the requirement for
a particular job or work order. This may be done either to facilitate
convenient handling or sometimes it may not be possible always to
ascertain exactly the quantity of material that will be required. This would
result in a surplus of material at the work site. We can dispose of the
surplus in two days. We can either return the surplus material to the stores
or transfer the material to some other job or jobs where those materials
have been requisitioned.
Return of Materials: The document used for return of excess materials to
the stores is known as ‘materials returned note’ or ‘shop credit note’. The
form of the materials returned note is similar to that of material requisition
slip. But to distinguish between the two, forms of different colours are
generally used. The materials returned note is prepared in duplicate. One
copy is retained by the department returning the material and the other
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 copy is kept by the storekeeper who gets it along with the material returned. Procurement, Storage and
The materials returned note is forwarded to the costing office where the Issue
necessary credit for value of materials returned is given to the particular job.
Transfer of materials: Sometimes excess materials in relation to a job or
work order may become useful to another job. In such a case, a material
transfer note should be prepared transferring the material from one job to
another. This obviates the need to return the excess materials to stores and
draw the same again.
You should note that the direct transfer of material from one job to another
is undesirable and should be discouraged as far as possible. It is, however,
justified when an urgent job has to be completed and it is necessary to
appropriate the surplus materials in order to avoid the delay which may
be caused if the normal routine of returning the material to stores and then
getting them reissued is followed. But, all such transfer of materials must be
accompanied by a Materials Transfer Note which is signed by the foreman
of the sending and receiving departments and forwarded to the costing office
where the necessary adjustments shall be made in the respective job accounts.
If a transfer of the material is made without the knowledge of the costing office,
it will result in excess debit to one job and lower debit to another. As such the
true costs of jobs cannot be ascertained and cost comparison would be
misleading.
Check Your Progress C
1) Fill in the blanks in the following.
i) ………….items should be stored as near as possible to the
department requiring them.
ii) Materials should be issued by the storekeeper against ……….
iii) A list of all materials and parts required for a particular job is
called……..
iv) ……………….is a document which records the return of unused
materials.
v) …………..is a document on which is recorded the transfer of
materials from one job or department to another.
2) List any three functions of store keeping.

3.6 LET US SUM UP

Materials are divided into two broad categories: direct and indirect. Direct
materials can be easily identified with the finished product whereas indirect
materials cannot be so identified. However, sometimes materials of small
value, though forming part of the finished product are treated as indirect for
the sake of simplicity.
Since materials constitute an important part of the cost of production, it is
important to keep a proper control over them from the time orders for materials
are placed with the suppliers initial they have been consumed.Proper control
over material can make a significant contribution to the efficiency of business.
Materials control involves the control over the procurement, storage and usage
of materials.
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 Material and Labour The responsibility for the purchase of materials is entrusted to a separate
purchase department under the chargé of a purchase manager. The purchase
function may be centralised or decentralised. Centralised buying is
decidedly better than the decentralised buying due to relative merits of the
former over the latter. However, neither of them can be considered as wholly
satisfactory in the case of all types of concerns. The purchase department
adopts a standard procedure for the purchase of materials. It involves: (i)
receiving purchase requisition (ii) inviting quotations (iii) (iii) selecting the
supplier, (iv) placing the order, (v) receiving the materials and transferring
them to stores, and (vi) passing bills for payment.
Storage is the art of preserving raw materials and finished goods in the stores
in the best possible manner. The stores department should be located as near
as possible to the goods receiving department. It should have facilities for the
storage of all types of goods in such a manner so as to avoid the possibility
of loss in storage. The issue of materials from stores should be on the basis
of properly authorised materials requisition slip. Surplus materials issued
to a job may either be returned to stores or transferred to some other job
where the same materials are required. Accordingly, the shop will prepare
the materials returned note or the materials transfer note.

3.7 KEY WORDS

Bill of Materials : A standard list, of materials and components required for
a particular work order.
Centralised Purchasing: Purchase of materials by a specialised department.
Decentralised Purchasing: Purchases to be made by individual departments.
Goods Received Note: A document prepared by the receiving department
on receipt of materials.
Goods Received Note : A document prepared by the receiving department
on receipt of materials.
Lay-out of Stores: Internal arrangement or placement of materials inside
the stores.
Material Control: Regulating the functions of procurement, storage and
usage of materials in such a way as to maintain an even flow of materials to
production and avoid excessive investment in stock of materials.
Materials Returned Note: A document used for the return of excess
materials to the stores.
Materials Requisition Slip: A document on the basis of which materials
are issued by the storekeeper.
Materials Transfer Note: A document used for the transfer of materials
from one job to another.
Purchase Order: A request made by the purchaser to a supplier to deliver
certain goods of requisite quality and quantity at the terms and conditions
agreed upon.
Purchase Requisition Slip: A document requesting, the purchasing
department to purchase certain materials.
Storekeeping: Function of maintaining stores.
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 Procurement, Storage and
3.8 ANSWERS TO CHECK YOUR PROGRESS Issue

A) 1. i) a ii) b iii) a iv) d

B) 1. i) False ii) False iii) True iv) True v) False
C) 1. i) Bulky ii) Materials Requisition iii) Bill of Materials
iv) Materials Returned Note v) Materials Transfer Note

3.9 TERMINAL QUESTIONS

1) What do you understand by direct material and indirect mtena1?
Give examples.
2) What do you understand by materials control? Give its main objectives.
3) What are the important requirements of an efficient system of material
control?
4) Distinguish between centralised purchasing and decentralised
purchasing.
5) Outline the routine for the purchase and receipt of stores noting the
important documents involved.
6) What is a Goods Received Note? Give its specimen form and state the
purpose it serves.
7) Describe the functions of the stores department.
8) State the procedure for the issue of materials.
9) State the documents used in connection with receipt, issue, transfer
and return of materials from production to stores.
10) Under what circumstances should surplus material be transferred to
another job?

Note: These questions will help you to understand the unit better. Try to
write answers for them and verify with the content. But do not submit
your answers to the University. These are for your practice only

SOME USEFUL BOOKS

Arora M.N. 2003. A Text Book of Cost Accountancy, Vikas Publishing
House Pvt. Ltd.: New Delhi. (Chapter 3-8).
Bhar, B.K. 2018. Cost Accounting: Methods and Problems, Academic
Publishers: Calcutta. (Chapter 5-9).
Iyenger, S.P., Cost Accounting, Sultan Chand and Sons.
Maheshwari, S.N. and SN. Mittal, 2018. Cost Accounting: Theory and
Problems,
Shree Mahavir Book Depot: Delhi. (Chapter 2-3).
Nigam,B.M.L. and G.L. Sharma, 2018. Theory and Techniques of Cost
Accounting,
Himalaya Publishing House: Bombay. (Chapter 4-7).
Rajiv Goel, Cost Accounting, International Book House.

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 UNIT 4 INVENTORY CONTROL
Structure
4.0 Objectives
4.1 Introduction
4.2 Meaning and Objectives of Inventory Control
4.2.1 Meaning
4.2.2 Objectives
4.3 Techniques of Inventory Control
4.3.1 ABC Analysis
4.3.2 Stock Levels
4.3.3 Re-Order Quantity
4.3.4 Stores Records
4.3.5 Perpetual Inventory System
4.3.6 Inventory Turnover Ratio
4.4 Let Us Sum Up
4.5 Key Words
4.6 Answers To Check Your Progress
4.7 Terminal Questions/Exercises

4.0 OBJECTIVES
After studying this unit, you should be able to:
●● define the term inventory control and list its objectives;
●● enumerate the various techniques of inventory control;
●● explain the various stock levels, and the methods of their calculation;
●● define the term ordering quantity and list the factors on which it
depends;
●● explain the record maintained by the store keeper and the costing
department;
●● define perpetual inventory system and explain its advantages; and
●● determine the stock turnover ratio to determine the fast and slow
moving stocks.

4.1 INTRODUCTION
You have learnt that inventories constitute a significant part of the total
production cost of a product. An inadequate stock of inventory leads to
holding up of production thereby leading to customer dissatisfaction, loss of
revenue etc. Excessive investment in inventory, on the other hand, leads to
locking up of capital results in losses due to deterioration and obsolescence
of products. Thus, control of inventory will go a long way in reducing the
cost of production and improving the profitability of a concern. In this
unit, you will study the various methods by which a firm exercises proper
control over inventories and avoids losses arising from under stocking and
overstocking of materials.
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 4.2 MEANING AND OBJECTIVES OF INVENTORY Inventory Control
CONTROL

4.2.1 Meaning
Inventory control includes control over raw materials, stores supplies, space
parts, partly finished goods and finished goods. It is a system which ensures
the required quantity of inventories of the required quality, at the required
time and with the minimum amount of capital. The function of inventory
turnover is to obtain maximum inventory turnover with sufficient stock to
meet all requirements. The quantum of inventory to be kept is decided after
taking into consideration the availability of finance, the quantum of discount
allowed, the cost of storage and storage space available etc.
4.2.2 Objectives Inventory Control
The main objectives of inventory control are as follows:
i) To provide continuous flow of inventory for efficient and uninterrupted
flow of production.
ii) To avoid excessive investment in inventory and consequently reducing
carrying costs.
iii) To keep surplus and obsolete items to the minimum.
iv) To relieve the management in taking inventory decisions for various
items of inventory from time to time.

4.3 TECHNIQUES OF INVENTORY CONTROL

The following are the common techniques of inventory control:
1) ABC analysis
2) Setting of various stock levels
3) Economic order quantity
4) Use of perpetual inventory records and continuous stock verification
5) Use of control ratios and review of slow and non-moving items.
4.3.1 ABC Analysis
For the purpose of exercising selective control over materials, manufacturing
concerns find it useful to divide materials into three categories. An analysis
of the annual consumption of materials of any organisation would indicate
that a handful to top high value items (less than 10 per cent of the total
number) will account for a substantial portion of about 70 per cent of total
consumption value. Similarly, a large number bottom items (over 70 per
cent of the total number of items) account for only about 10 per cent of
the consumption value. Between these two extremes will fall those items
the percentage number of which is more or less equal to their consumption
value. Items in the top category are treated as ‘A’ items, items in the bottom
category are called as ‘C’ category items and the items that lie between
the top and the bottom are called ‘B’ category items. Such an analysis of
materials is known as ‘ABC analysis’ or ‘Proportional parts value analysis.

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 Material and Labour The logic behind this kind of analysis is that the management should study
each item of stock in terms of its usage, lead time, technical or other problems
and its relative money value in the total investment in inventories. Critical i.e.,
high value items deserve very close attention and low value items need to be
devoted minimum expense and effort in the task of controlling inventories.
The material manager by concentrating on ‘A’ class items is able to control
inventories and show visible results in a short span of time. By controlling
‘A’ items and doing a proper inventory analysis, obsolete stocks are
automatically pinpointed. ABC analysis also helps in reducing the clerical
costs and results in better planning and improved inventory turnover. ABC
analysis has to be resorted to because equal attention to A, B and C items
will not be worthwhile and would be very expensive.
The following steps will explain to you the classification of the items into
A, B and C categories.
1) Calculate the unit cost and the usage of each material over a given
period.
2) Multiply the unit cost by the estimated usage to obtain the net value.
3) List out all the items by rupee annual issues and arrange them in the
descending value.
4) Accumulate value and add up number of items and calculate percentage
on total inventory in value and in number.
5) Draw curve of percentage items and percentage value.
6) Mark off from the curve the rational limits of A, B and C categories
The graphical representation of ABC analysis is shown in Figure 4.1.
Figure 4.1: ABC Analysis

Check Your Progress A

1) Indicate whether the following statements are True or False:
i) In ABC analysis ‘A’ group of items consist of those materials
the value of which is not high but which are used in large
quantities.
ii) ABC analysis is based on the principle of management by
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 exception. Inventory Control
2) Define Inventory Control.
3) List the main objects of inventory control.
4.3.2 Stock Levels
You know that the maintenance of proper stock of each item of stores is
one of the main functions of stores department. If large quantity of stores is
maintained it would lead to huge investment, large space coverage, dangers
of deterioration in quality, etc. On the other hand, less stock will result in
frequent purchases, higher costs, lo of production etc. It implies that there
is always a limit to the minimum and maximum quantity of materials in
stores.
In order to ensure that the optimum quantity of material is purchased and
stored, neither more nor less, the storekeeper applies scientific technique of
material management. Fixation of certain levels for each item of materials
is one of such techniques. The following levels are generally fixed:
1) Minimum stock level, 2) Maximum stock level, 3) Re-ordering level, 4)
Danger level, and 5) Average Stock level
Re-ordering level
You should know the level at which the storekeeper will initiate the requisition
for the purchase of materials for fresh supplies. This level is referred to as
‘re-order level’ or ‘ordering level’. This level normally lies between the
maximum and minimum stock level. This level will usually be higher than
the minimum stock level to cover for emergencies as abnormal usage of
material or unexpected delay in delivery of fresh supplies. The fixation of
this level normally takes into consideration the lead time (period of supply
or re-order period), rate of consumption and the economic ordering quantity.
Re-ordering level can be calculated according to any one of the following
formulas:
Re-order level = Maximum consumption × Maximum
re-order period
OR
Re-order level = Minimum level + consumption during
the time required to get fresh deliveries
The following illustrations 1 and 2 will explain to you the calculation of the
re-order level.
Illustration 1 :
Calculate the re-order level from the following information:
Maximum consumption = 400 units per week
Minimum consumption = 250 units per week
Re-order period = 4 to 6 weeks
Solution :
Re-order level = Maximum consumption ×
Maximum re-order period

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 Material and Labour = 400×6 = 2,400 units
Illustration 2:
Find out the order level from the following information:
Maximum stock = 2,500 units
Minimum stock = 1,000 units
Time required for receiving the material = 10 days
Daily consumption, of material = 50 units
Solution :
Re-order level = Minimum stock level +
consumption during the
period required for fresh
delivery
= 1,000+ 50 ×10
= 1,000 + 500 = 1,500 units
Minimum Stock level
Minimum stock level points to the level of an item of material below which
the stock in hand is not normally allowed to fall. In other words, it refers to
the minimum quantity of a particular item of materials which must be kept
in stores at all times.
This limit is fixed so as to avoid the possibility of suspension of production
due to shortage of material. In fixing this level the following important
factors, among others are taken into consideration:
i) Lead time i.e., time lag between indenting and receiving of material
ii) Rate of consumption of material during the lead time
iii) Re-order level
Minimum stock level can be determined by applying the following formula:
Minimum stock level = Re-order level – (Normal consumption × Normal
re-order period)
Illustration 3 will explain to you the calculation of the minimum stock level.
Illustration 3:
Calculate the minimum stock level from the following data:
Net normal consumption = 400 units per week
Normal re-order period = 5 weeks
Re-order level = 3,500 units
Solution:
Minimum stock level = Re-order level – (Normal
consumption × Normal re-order period)
= 3,500 – (400×5)
= 3,500 – 2,000 = 1,500 units
Maximum stock level
It is that quantity of material above which the stock of any item should not
be allowed to exceed. The main object of fixing the maximum stock level
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 is to avoid undue investment in stock and to use the working capital in a Inventory Control
proper way.
Maximum stock level is fixed by taking into consideration the following
factors:
1) Amount of working capital available
2) Normal rate of consumption of materials during the lead time
3) Time necessary to obtain deliveries
4) Availability of storage space
5) Economic ordering quantity
6) Cost of carrying the inventory
7) Possibility of loss due to evaporation, deterioration etc.
8) Extent to which price fluctuations may be important.
9) Possibility of change in fashion, habit etc., which may necessitate the
change in the specification of materials
10) Incidence of insurance costs which may be important for some
materials.
The following formula is generally used for the calculation of maximum
stock level.
Maximum stock level = Re-order level + Re-order
quantity – (Minimum consumption)
Minimum re-order period)
Danger level
This is generally a level below the minimum level. When stock reaches this
level, urgent action is needed for replenishment of stock. If no emergency
steps are taken to restock the materials, the stores will be completely
exhausted and normal production stopped. At this level no further issues are
made by the storekeeper except on special requisition approved by the works
manager. The level is generally calculated by taking into account the time
required to get the materials by the quickest possible means of transport i.e.,
minimum time required for obtaining supplies from any possible source. It
is calculated as follows:
Danger level = Average consumption × Maximum
re-order period for emergency
purchases
Average stock level
Average stock level is usually calculated with the help of the following
formula:
1
(Minimum stock level + Maximum stock level)
2
Depending upon the availability of information average stock level can also
be calculated as follows:
1
Average stock level = Minimum stock level + Re-order
2
quantity
Illustration 4 will explain to you the calculation of the various stock level is.
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 Material and Labour Illustration 4 :
From the following information, calculate:
a) Re-ordering level
b) Minimum stock level
c) Maximum stock level
Re-order quantity = 30,000 units
Time required for delivery = 2 – 4 months
Maximum consumption = 8,000 units per month
Normal consumption = 5,000 units per month
Minimum consumption = 3,000 units per month
Solution:
a) Re-ordering level
= Maximum consumption × Maximum re-order period
= 8,000 × 4= 32,000 units
b) Minimum stock level
= Re-order level- (Normal consumption × Normal re-order period)
= 32,000 - (5,000 × 3)
= 32,000 - 15,000 = 17,000 units
2+4
NOTE: Normal re-order period = 3 months
2
c) Maximum stock level
= Re-order level + Re-order quantity - (Minimum consumption
× Minimum re-order period)
= 32,000 + 30,000 - (3,000 × 2)
= 32,000 + 30,000 - 6,000
= 62,000 - 6,000 = 56,000 units
4.3.3 Re-Order Quantity
It is helpful to determine in advance to how much should the storekeeper
buy when the stock reaches the re-order level. This quantity is known as
‘re-order quantity’ (ROQ). The quantity ordered must be such that when
the same is received the stock level will not exceed the maximum stock
to be carried at any point of time. The re-order quantity is also referred
to as the economic order quantity. It is called ‘economic order quantity’
(EOQ) because the purchase of this size of materials is most economical.
Purchase of material larger than the economic order quantity of material
will result in increase in the carrying cost. If on the other hand small
quantities of materials are purchased at frequent intervals the ordering
cost will increase and will lead to disruption in the production due to
inadequate inventory. The economic order quantity is fixed at such a
level as to minimise the cost of ordering and carrying the stock. It is
the size of the order which produces the low cost of material ordered.
Carrying cost includes the interest on investment, obsolescence losses,
space costs, storage charges such as warehouse rent, insurance, heating
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 and lighting expenses on stores staff, pilferage, breakage etc. The cost Inventory Control
of ordering is independent of the size of the order and includes costs due
to extra purchasing, handling and transportation costs, higher price due
to small order quantities, frequent stock outs, resulting in disruption of
production schedules, overtime and extra set up time, loss of sales and
customer goodwill etc.
The economic order quantity can be calculated by making use of the
2UO
following formula: EOQ
I
where EOQ = Economic order quantity
U = Annual usage in units
O = Cost of placing one order including the cost of
receiving the goods
I = Cost of carrying one unit of inventory for one year
Diagram representing the Economic Order Quantity is shown in Figure 4.2
Figure 4.2: Economic Order Quantity

Assumptions in the calculation of economic order quantity

The calculation of economic order quantity is subject to the following
conditions:
1) The quantity of the item to be consumed during a particular period is
known.
2) Cost per unit is known and is constant. Further quantity discounts are
not involved.
3) Ordering cost and carrying cost are known. They are fixed per unit
and will remain the same throughout.
4) Quantity ordered is delivered immediately. The following illustration
will explain to you the calculation of economic order quantity.
Illustration 5 :
From the following particulars calculate the economic order quantity
Annual usage = 6,000 units
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 Material and Labour Cost of the material per unit = Rs. 2.50
Cost of placing and receiving one order = Rs. 15.00
Annul carrying cost of one unit = 20% of inventory value
Solution :
2UO
Economic order quantity =
I
U = 6,000 units
O = Rs.15.00 per unit
1 = 20% of Rs. 2.50 to Rs. 0.50
Substituting the values in the above formula

2 × 6, 000 ×15
EOQ =
0.50

1,80, 000
= = 3, 60, 000
0.50
= 600 units
Check Your Progress B
1) Indicate whether the following statements are True or False and
justify your answer .
i) When maximum stock level is fixed, the stock in hand should
never exceed this level.
ii) Re-ordering level is always fixed somewhere between maximum
and minimum stock levels.
iii) Minimum stock level is the level of materials at which a new
order for material is to be placed.
iv) Economic order quantity is the re-order quantity.
2) How do you compute average stock level?
3) List the assumptions made while fixing the re-order quantity.
4.3.4 Stores Records
In order to exercise proper control over materials, it is necessary to record
the physical movement of every item of materials. One of the main functions
of the storekeeper is to maintain records for receipts, issues and balances of
various items of materials. Bin card and stores ledger are the two important
stores records that are generally kept for making a record of the various
items of stores.
Bin Card
A bin card provides a quantitative record of the receipts issues and balance
of material. A bin is a place where the goods are stored. A bin may be a shelf,
an almirah, open space etc. depending upon the nature of the commodity.
These cards are usually attached to or place near the bin so that receipts and
the issues may be entered therein as soon as they take place. Separate bin
cards are prepared for each item of stores and if two different materials
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 are kept in one almirah, two bin cards one for each item are prepared, Inventory Control
treating the almirah as two bins.
The bin card provides a continuous record of the stock in each bin
and assist the frrekeever to control the stock. For each material the
maximum stocks to be held an ordering level is also indicated therein
so that fresh supplies may be ordered before the minimum is reached.
These cards also provide an independent check on the stores ledger.
In large organisations, the storekeeper also maintains ‘store control cards’
which are similar to bin cards and are kept by him close at hand. This obviates
the difficulty of going to bins for obtaining the necessary information as and
when required.
A specimen of the bin card is given in Figure 4.3.
Figure 4.3 : Specimen of Bin Card
BIN CARD
Name ……………......... Maximum level………….....
Description …………… Minimum level………….....
Bin No ………….......... Ordering level……...............
Location code ………… Re-order quantity…………..
Stores ledger folio……. Unit………….......................
Receipts Issues Balance Audit
Quan-
Date G.R.No Qty Date Req. Qty tity Date Initials
No

Stores Ledger
This ledger is kept in the costing department and is identical with the bin
card except that the receipts, issues and balances are shown along with
their money values. Stores ledger contains an account for each class of
material and facilitates ascertainment of all details relating to the material
in minimum time. It provides a continuous record of stores received and
issued and discloses the balance in hand at any time both in quantity and
value. It thus furnishes management with a perpetual inventory.
Stores ledger is generally maintained in the form of loose leaf cards. These
cards should be serially numbered to obviate the risk of removal or loss.
A specimen of the stores ledger is given in Figure 4.4.
Figure 4.4: Specimen of Stores Ledger
STORES LEDGER
ABC Co. Ltd.

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 Material and Labour Name. …………........... Maximum level……………...........
Description …………. . Minimum level……………............
Location code ………… Ordering level………….................
Re-order quantity ......……….........

Unit ………………………...........
Receipts Issues Balance Remarks

Reqn No.
Quantity

Quantity

Quantity
Amount

Amount

Amount
G.R.No
Date

Rate

Rate

Rate
Difference between Bin Card and Stores Ledger
Bin Card Stores Ledger
1. Bin Card is not an accounting 1. Stores ledger is the basic
record accounting record
2. It is a record of quantity only 2 . It is a record of both quantity
and value
3. It is kept inside the stores 3. It is kept outside the stores
4. It is maintained by the 4. It is maintained by the costing
storekeeper department
5. Each transaction is individually 5. Transaction may be posted
posted periodically and in total.
It should be noted that documents like goods received note, materials
requisition slip, materials returned note, etc. also form part of stores records.
Check Your Progress C
1) Fill in the blanks.
i) Stores ledger is maintained in the …………………………
ii) Bin Card is a record of …………………………only.
iii) Bin Card is maintained by …………………………
iv) Quantities of materials on hand as shown by bin cards should
agree with quantities actually on …………………………
2) Indicate whether the following statements are True or False and
justify your answer.
i) Bin Card shows the quantity and value of material at any
moment of time
ii) Bin cards are not a part of accounting, records.
iii) The bin card and stores ledger are written up with the help of
same basic documents
iv) Stores control card is used as an alternative to bin card.
v) Documents like materials requisition and goods received note
also form part of stores records

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 4.3.5 Perpetual Inventory System Inventory Control

In order to facilitate regular checking and to obviate closing down of work

for stock taking, a method of recording stores balances after each receipt and
issues, is adopted. This method is known as perpetual inventory system. Bin
cards and the stores ledger help the management in maintaining this system
as they make a record of the physical movements of the stock on the receipts
and issues of materials and also reflect the balance in the stores. To ensure
the accuracy of perpetual inventory records, physical verification of
stores is made by a programme of continuous stock taking.
It is advisable that a number of items should be counted and checked daily
or at frequent intervals and compared with the bin cards or stores ledger.
The actual stock of material should not differ from the recorded stock under
normal circumstances. However, differences do arise on account of the
following reasons which may be classified as unavoidable and avoidable
causes.
The usual unavoidable causes are:
i) Shrinkage and evaporation
ii) Climatic conditions causing deterioration e.g., absorption of moisture, etc.
iii) Losses arising cut of breaking up bulk material as in case of sawing wood.
iv) Losses due to accident, fire, etc.
The avoidable causes are:
i) Errors in posting or calculation of receipts, issues or balances on bin
cards c stores ledger.
ii) Pilferages and breakages.
iii) Entering transactions in the wrong bin card or in wrong stores ledger.
Advantages :
The following are the advantages of the perpetual inventory method:
1) It is possible to prepare monthly and quarterly profit and loss statements
and balance sheet without physical inventory being taken for all the
items. This is possible because the figure of the closing stock can be
taken from the bin care or the stores ledger.
2) It obviates the necessity for physical checking of all items of stores at
the end the year and thereby avoids dislocation of production.
3) Actual stock can be compared with the authorised maximum and
minimum levels, thus keeping the stock within the prescribed limits.
The disadvantages o excess stock are avoided and capital tied up in
stores material cannot exceed target.
4) The method has a moral effect on the staff, makes them disciplined and
careful and acts as a check against dishonest actions.
5) As the work or recording and continuous stock taking is carried out
systematically and without undue haste, the figures are more reliable.
6) Discrepancies and errors are promptly discovered and remedial action
can be taken to prevent their reoccurrence in the future.
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 Material and Labour 7) A detailed and more reliable check on the stores is obtained.
8) Stock figures are available for insurance purposes.
9) It reveals the existence of surplus, obsolete and slow moving material
and hence remedial action can be taken.
10) A system of internal check remains in operation. Bin card and stores
ledger act as a cross check on each other. As such the errors are detected
as and when they are committed.
4.3.6 Inventory Turnover Ratio
It is one of the techniques for exercising control over inventory. The ratio
expresses the relationship between the cost of the material consumed to the
average inventors held during that period. The ratio is calculated as follows:

Cost of material consumed during the period

Inventory Control ratio =
Cost of average stock held during the period
Average stock can be calculated by adding opening and closing stocks and
then dividing it by two.
Opening Stock + Closing Stock
Average Stock =
2

The inventory turnover ratio indicates the index of the efficiency or

inefficiency with which inventories are maintained. It is in the best
interest of the organisation to compare the turnover of different types and
grades of material as a measure of detecting stock which does not move
regularly thereby minimising capital or investment in undesirable stock. A
low ratio indicates bad buying, accumulation of obsolete stock, carrying
of too much stock etc. On the other hand a high ratio is an indicator of fast
moving stock and less investment in stock.
Illustration 6 will explain to you the calculation of inventory turnover ratio
and 28 indicate the period for which the average inventory is held.
Illustration 6 :
Calculate the inventory turnover ratio for the year 2018 from the following
information and express the same in number of days the average inventory
is consumed for each material and comment on the purchasing procedure.
Material X Rs. Material Y Rs.

Opening Stock 40,000 60,000

Purchases during the period 2,80,000 80,000
Closing Stock 20,000 40,000

Solution:

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 Material X Material Y Inventory Control

Cost of Material Consumed Opening Stock 40,000 60,000

Add Purchases 2,80,000 80,000
3,20,000 1,40,000
Less : Closing Stock 20,000 40,000
3,00,000 1,00,000

Average Stock
Opening Stock 40,000 60,000
Closing Stock 20,000 40,000
60, 000 1, 00, 000
Average Stock = 2 = Rs.30,000 = = 50,000
2
Inventory turnover ratio

Cost of goods sold 3, 00, 000 1, 00, 000

Average inventory = 30, 000 = 10 times = 50, 000
= 10 times
Thus material X is fast moving and material Y is slow moving.Stock level
of material Y may be refixed considering the turnover ratio and purchases
of this time may be reduced.
Check Your Progress D
1) Fill in the blanks.
i) A method of recording stores balances after every receipt and
issue to facilitate regular checking and to obviate the closing
down for stock taking is know as ………………
ii) The two perpetual inventory records are ………………
iii) Perpetual inventory system acts a on staff in the stores.
……………
iv) Physical verification of stores under perpetual inventory system is
called ………………
v) Difference in actual stock and recorded stock arises on account of
some……………… causes and ………………causes.
2) What is the purpose of calculating inventory turnover rate?

4.4 LET US SUM UP

Inventory control is a system which ensures the required quantities of
inventories stores so that materials are available at the required time and with
the minimum amount of investment. A proper control over inventory goes
a long way in reduce the cost of production and improving the profitability
of concern.
Some of the common techniques of inventory control are: (i) ABC analysis
(ii) Setting of various stock levels, (iii) Economic order quantity (iv) Use
of perpetual inventory records and continuous stock verification (v) Use of
control ratios and review of slow and non-moving stock.
Under the ABC analysis, the material manager by concentrating on ‘A’ class
items able to control inventories and show visible results in a short span
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 Material and Labour of time. ABC analysis helps in reducing clerical cost and results in better
planning and improved inventory turnover.
Fixation of various stock levels for each item of material is one of the
scientific techniques of material management, and helps to ensure that
optimum quantity of material is purchased, and stored neither more nor less.
The fixation of economic order quantity helps in the determination of the
quantity of material for which order should be placed when the stock reaches
the re-order level. The economic order quantity is fixed at a level which
minimises the cost of ordering and carrying the stock.
The perpetual inventory control system is a method of recording
stores balances after each receipt and issue, to facilitate regular
checking and to obviate closing down of work for stock taking.
Inventory turnover ratio expresses the relationship between the cost of the
material consumed to the average inventory held during that period. The
number of times an inventory is used within a particular period is a good
measure of the efficiency of material control and material utilisation. Thus
knowing the turnover of different items it is possible to avoid keeping capital
locked up in undesirable stocks.

4.5 KEY WORDS

Inventory control: A system which ensures the provision of the required
quantity of inventories of the required quality at the required time with the
minimum amount of investment.
ABC analysis: A system of stock control based on the annual consumption
value.
Maximum level: It represents the maximum quantity above which stock
should not be held at any time.
Minimum level: It represents the minimum quantity of stock that should be
held at all times.
Danger level: Normal issues of stock are usually stopped at this level and
made only under specific instructions.
Ordering level: The level of stock at which indents should be placed for
replenishing stocks.
Re-order quantity: It is the quantity to be ordered when the stock reach the
re-order level. It is also called economic order quantity.
Lead time: Time lag between the indenting and receipt of material. It is also
called re-order period.
Carrying cost: Cost of holding the material in the stores.
Ordering cost: Cost of placing an order for the purchase of materials.
Bin card: Is a card which provides a continuous record of the receipt, issues
and balance of each item of materials.
Stores ledger: A record kept in the costing department which contains
information regarding receipts, issues and balance of each item of material
along with their money values.
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 Perpetual Inventory system: A system of ascertaining current balance Inventory Control
after recording every receipt and issues of materials through stock records.
Stock turnover ratio: Ratio of the value of material consumed during a
period to the average value of inventory during the period.

4.6 ANSWERS TO CHECK YOUR PROGRESS

A) 1. i) False ii) True
B) 1. i) True ii) True iii) False iv) True
C) 1. i) Cost Accounting Department ii) quantities
iii) storekeeper iv) hand
2. i) False ii) True iii) True iv) False v) True
D) 1. i) perpetual inventory system ii) bin card and stores ledger
ii) moral check iv) continuous stock taking
v) avoidable, unavoidable

4.7 TERMINAL QUESTIONS/EXERCISES

Questions
1) What do you understand by inventory control? What are its objectives?
2) What do you understand by ABC analysis? How is the control of
stores items effected through ABC analysis?
3) Explain the terms minimum level, maximum level, and ordering level
of stock. What are the factors that govern the fixation of these levels.
4) What is economic order quantity? How is it calculated?
5) What is a bin card? Give its specimen form and discuss its utility.
6) What is meant by perpetual inventory control system. Describe its
advantages.
7) What is meant by inventory turnover? Discuss the importance of
inventory turnover ratio in the control of inventory.
Exercises
1) Two components A and B are used as follows:
Normal usage 50 per week each
Minimum usage 25 per week each
Maximum usage 75 per week each
Re-order quantity A 300 B 500
Re-order period A 4 to 6 weeks, B 2 to 4 weeks
Calculate for each component
a) Re-order level b) Minimum level c) Maximum level.
Answer: A. a) 450 units b) 200 units c) 650 units
B. a) 300 units b) 150 units c) 750 units

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 Material and Labour 2) Calculate economic ordering quantity from the following particulars:
Annual usage 6,000 units
Cost of material per unit Rs. 20.00
Cost of placing and receiving one order Rs. 60.00
Annual carrying cost of one unit 10 per cent of inventory value
(Answer 600 units)
3) From the following data for an accounting year calculate the inventory
turnover and express the same in number of days the average inventory
is consumed for each material
Material X Rs. Material X Rs.
Opening stock 1,000 1,200
Purchases during the year 5,200 4,600
Closing stock 600 1,600
(Answer: Inventory turnover ratio X = 7 times Y = 3 times
Number of days average inventory is consumed X = 52 days, Y= 122 days)

Note: These questions will help you to understand the unit better. Try to
write answers for them and verify with the content. But do not submit
your answers to the University. These are for your practice only.

SOME USEFUL BOOKS

Arora M.N. 2003. A Text Book of Cost Accountancy, Vikas Publishing
House Pvt. Ltd.: New Delhi. (Chapter 3-8).
Bhar, B.K. 2018. Cost Accounting: Methods and Problems, Academic
Publishers: Calcutta. (Chapter 5-9).
Iyenger, S.P., Cost Accounting, Sultan Chand and Sons.
Maheshwari, S.N. and SN. Mittal, 2018. Cost Accounting: Theory and
Problems,
Shree Mahavir Book Depot: Delhi. (Chapter 2-3).
Nigam,B.M.L. and G.L. Sharma, 2018. Theory and Techniques of Cost
Accounting,
Himalaya Publishing House: Bombay. (Chapter 4-7).
Rajiv Goel, Cost Accounting, International Book House.

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 UNIT 5 PRICING THE ISSUE OF MATERIALS
Structure
5.0 Objectives
5.1 Introduction
5.2 Ascertaining the Cost of Materials
5.3 Problem in Pricing the Issue of Materials
5.4 Methods of Pricing
5.4.1 First in First Out Method
5.4.2 Last in First Out Method
5.4.3 Weighted Average Price Method
5.4.4 Replacement Price Method
5.4.5 Standard Price Method
5.4.6 Pricing of Materials Returned to Vendors
5.4.7 Pricing of Materials Returned to Stores
5.4.8 Treatment of Shortage of Materials
5.4.9 Treatment of Material Losses
5.5 Let Us Sum Up
5.6 Key Words
5.7 Answers to Check Your Progress
5.8 Terminal Questions/Exercises

5.0 OBJECTIVES
After studying this unit, you should be able to:
●● ascertain the cost of materials issued for production;
●● identify the problems associated with pricing the issue of materials;
●● list the various methods of pricing;
●● assess the pros and cons of FIFO, LIFO and weighted average methods
of pricing; and
●● prepare the stores ledger under FIFO, LIFO and weighted average
methods.

5.1 INTRODUCTION
You have learnt that the stores ledger is one of the important store records
which is maintained by the costing department and that in addition to
quantities it also records the prices at which the materials have been received
and issued. As for the receipts of materials, they may be recorded at prices at
which they are purchased after making necessary adjustment for discounts,
transportation charges, cost of containers, etc. But, when it comes to the
issues of materials, the problem arises with regard to the price at which
each issue should be recorded because different consignments of materials
might have been purchased at different prices. For this purpose, accountants
have developed a number of methods based on various materials flow
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 Material and Labour assumptions. In this unit, you will learn about these methods of pricing
the issue of materials and also the preparation of stores ledger account
according to some of the prominent methods.

5.2 ASCERTAINING THE COST OF MATERIALS

The basic document used for ascertaining the cost of materials received is
invoice. It contains the basic price as well as the items like discount, freight,
insurance, sales tax, cost of containers, etc. The organisation also incurs
some expenditure of cartage, receiving, inspecting and storage of materials.
Now the question arises as to which of these items should be taken into
account in arriving at the cost of materials. Let us discuss them one by one.
Cash Discount: Cash discount represents an allowance made by the supplier
if the payments of bills are made within the specified period. Opinions
differ as regards as method of treatment of such discount in cost accounts.
One view is that cash discount, being in the nature of purely a financial
transaction, should be completely excluded from cost accounts. The other
view is that if cash discount is always earned for prompt payments, it may
be considered in finding out the final rate for materials in cost accounts.
Trade Discount: Trade discount is shown in the invoice as a deduction
from the purchase price. If the consignment consists of one item only, the
entire trade discount is deducted from purchase price. Hence, no difficulty
arises with regard to its treatment. If, however, the consignment consists of
a number of items, the amount discount should be apportioned among all
the items covered by the consignment on the basis of the purchase price of
each item. In any case, the net amount after deduction of trade discount
is taken as the purchase price.
Quantity Discount: Quantity discount is allowed as an incentive for bulk
purchasing. The rate of discount varies with the quantity purchased. From
the point of view of the supplier, an order for a large quantity reduces
his selling and distribution cost. Thus, a part of the savings enjoyed by a
supplier out of the large orders is passed on the purchaser by means of
quantity discount. From the point of view of the buyer, quantity discount
is in the nature of a price reduction. Hence, the amount of discount may be
adjusted in the same manner as the trade discount.
Transportation Charges: Sometimes, the terms of supply provide for
free delivery at the premises of the purchaser. In that case, the price is
inclusive of the transportation charges. But, in most cases, the transport
costs are paid by the purchaser. These should be added to the invoice price
in order to arrive at the cost of materials. But, for the sake of convenience,
the transportation charges may be regarded as an item of factory overheads
and absorbed accordingly.
Custom, excise duty, sales tax, etc.: As stipulated in the contracts, the
supplier add several items such as sales tax, excise duty, custom duty,
octroi, etc. to the invoice price. These expenses should be added to the cost
of purchases, if they can be directly allocated to the particular materials.
Receiving, inspection, storage, material accounting and purchase
department expenses: These expenses cannot be easily allocated to the
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 materials. Hence, they are treated as factory overheads and recovered on Pricing the issue of Materials
the basis of the value of direct materials issued or as general overheads
to be apportioned to the various cost-centre on the basis of the value of
materials issued.
Cost of Containers
Materials are normally supplied by the suppliers in containers. They may
or may not make a separate charge for them. Then, these containers may be
either returnable or non-returnable. The cost of the containers can be treated
in any of the following ways:
a) If the supplier has not charged the cost of containers in which materials
have been supplied, there is no need to add any amount in this regard
to the cost of materials. But, if the containers have some realisable
value, the same should be estimated and deducted from the cost of
materials. Alternatively, it may be deducted from factory overheads.
b) If the supplier has charged the cost of containers and these containers
are non-returnable, their cost (minus realisable value, if any, should
be included in the cost by materials.
c) Where the cost of the containers has been charged by the supplier and
these containers can be returned to the supplier, the difference between
the cost of the containers and the amount credited by the supplier on
the return, will be added to the purchase price of the materials.
d) Where the supplier agrees to give full credit for the cost of the containers
charge by him on their return, the cost of these containers will not be
added to the purchase price of the materials on the assumption that the
containers will be returned to the supplier and their amount recovered
fully.
Illustration 1will explain to you the calculation of purchase price of materials.
Illustration 1:
From the following invoice received from a supplier, calculate the material
cost per unit:
Quantity Particulars Rate (Rs.) Amount (Rs.)
150 kgs Material x 10.00 per kg 1,500
100 kgs Material y 12.00 per kg 1,200
2,700
Less trade discount 90
Add: 2,610
Cost of containers (capacity of each 50 kgs) 60
Cartage and carriage 75
Octroi duty @ 1%
27
2,772
Terms
i) 5% cash discount for payment within a week
ii) Return value of containers Rs. 9 each

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 Material and Labour Solution :
Statement showing the calculation of material cost:
Material X Rs. Material Y Rs.

Invoice price 1,500 1,200

Less : Trade Discount (divided in the ratio
of invoice price i.e., 5:4) 50 40
1,450 1,160
Add : i) Cost of containers
(divided in the ratio of quantity i.e., 150:100) 9 6
Actual Cost 60
Return Cost 45
15
ii) Cartage and carriage
(in the ratio of quantity i.e.; 150:100) 45 30
iii) Octroi duty
(in the ratio of invoice price) 15 12
1,519 1,208
Cost per kg 1,519 1,208
150 kgs 100 kgs
= Rs.10.13 =Rs.12.08

Notes:
i) Cash discount being a financial item, has been ignored.
ii) It has been assumed that containers have been returned.

5.3 PROBLEM IN PRICING THE ISSUE OF MATERIALS

The fixation of the price at which issues of materials are to be charged to
production is important from the point of view of cost accounting. If prices
remain constant for a long time, there is little difficulty in pricing the issue
of materials. But, in practice, we find that the prices of materials continue
to fluctuate on account of changes in the value of money, changes in the
world commodity prices, buying from different sources, and differences
in the quantity discounts. Hence, different consignments of materials may
be bought at different prices during an accounting period. The problem,
therefore, is that which of these prices should be used for pricing the
materials issued to production from time to time. Is it the price of the first,
or the second consignment or the average of the two?
For example, 200 kg. of materials K was bought at Rs. 30 per kg. On January
10 and 300 kg. was bought at Rs. 32 per kg., on January 16; On January 18,
250 kg. was issued to production. Now the question arises as to whether the
250 kg. of material K be charged to production at Rs,30 or Rs.32 or Rs.31,
the average price. To solve this problem, a number of methods based on
certain materials flow assumptions, have been developed. You will study

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 these methods in detail in Section 5.4 of this unit. However, a good method Pricing the issue of Materials
of valuing material issues should satisfy the following conditions:
a) The issue price should recover the cost of materials.
b) The issue price must reflect the current market price.
c) The issue price should not cause any significant variation in cost from
period to period and from job to job.
d) The issue price should not necessitate heavy adjustments at the time
of valuation of closing stock.
e) It should be simple and easy to operate.

5.4 METHODS OF PRICING

The various methods used for the pricing of the material issues can be
classified as follows:
I) Actual Cost Methods
a) First in First out (FIFO)
b) Last in First out (LIFO)
c) Specific price
d) Highest in First out (HIFO)
e) Base stock method
II) Average Cost Methods
a) Simple average
b) Weighted average
c) Periodic simple average
d) Periodic weighted average
e) Moving simple average
f) Moving weighted average
III) Notional Cost Methods
a) Standard price
b) Inflated price
IV) Market Price Methods
a) Replacement price
b) Net Realisable price
Of the methods listed above, FIFO, LIFO, Weighted average, Replacement
price and Standard price are the most common methods. Hence we shall
discuss them here in detail.
5.4.1 First in First Out Method
This method assumes that materials received first are to be issued first.
Under this method the price of the earliest consignment is taken first and
when that consignment is exhausted, the price of the next consignment is
adopted, and so on. In other words, when a requisition for a certain type
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 Material and Labour of materials is presented to the storekeeper, he will apply the cost price of
the first lot of materials received, provide the same is still on hand. If the
quantity required is more than the units remaining from the first lot, he
uses the cost price of the second lot, then the third and fourth until the total
quantity requisitioned is issued. This method is based on the principle that
materials should be issued in the order of receipts and at the actual cost.
It should be noted that the physical issue of stores need not be in the above
order, generally it is neither possible nor necessary to do so. This arrangement
is only for the purpose of accounting. As the materials purchased first are
charged off first, the value of closing stock conforms, more or less, to the
current market price.
Illustration 2 will explain to you as to how the issue of the materials are
priced under this method.
Illustration 2 :
In a factory, the following purchase and issues were made during the month
Account January, 2018. Prepare the stores Ledger Account under FIFO
method.
Date Purchases Issues
Units
Rate (Rs) —
Jan. 1 500 5.00 —
Jan. 8 300 5.10
Jan. 13 — 600
Jan. 18 400 5.20 —
Jan . 23 — — 300
Jan. 25 500 5.10 —
Jan. 31 — — 200
Solution:
STORES LEDGER ACCOUNT (Under FIFO Method)

Name…………………......... Maximum Level……………………

Description………………… Minimum Level………………….…
Location Code……………… Ordering Level………………...……
Re-order quantity………………......
Date Receipt Issues Balance
G.R.N. Qty Rate Amount R.S. Qty Rate Amount Qty Rate Amount
No. Rs. Rs. NO Rs. Rs. Rs. Rs.
Jan. 1 _ 500 5.00 2,500 _ _ _ _ 500 5.00 2,500
Jan.8 _ 300 5.10 1,530 _ _ _ _ 5.00
5.10 4,030
500
800 
300

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 Jan. _ _ _ _ _ 5.10 1,000 Pricing the issue of Materials
600 300
13 
300 5.00 3,030 200 5.00
Jan. _ 400 5.20 2,080 _ _ _ - 600 200 5.00 3,080

18 400
5.20
Jan. _ _ _ _ _ 300 5.20 1,560 300 200 5.00 1,520

23 100
5.20

Jan. _ 500 5.10 2,550 _ _ _ 800 200 5.00 4,070


25 100
500
5.20
5.10

Jan. _ _ _ _ 200 5.10 1,020 600 200 5.00


31 100
5.20 3,050
300
5.10
1,700 8,660 1,100 5,610 600 3,050

Closing stock is 100 units @ Rs. 5.20 and 500 units @ Rs.5.10
This method is suitable in times of falling prices because the materials
charge to production will be high while the cost of stock replacement will
be low. But in case of rising prices, if this method is followed, the charge
to production will be to higher profits and higher tax liability.
Advantages
The following are the advantages of FIFO Method:
1) It is simple to understand and easy to operate.
2) Since materials are charged to production at actual cost, no profit or
loss by reason of adopting this method.
3) It is a good inventory management system since the oldest units are
used and inventory consists of latest stock.
4) Closing stock generally represents fair valuation of stock, as it would
consider recent purchases of materials.
Disadvantages
This method suffers from the following disadvantages:
1) The number of calculations complicates the accounts if the prices
of material purchased fluctuate considerably and increases the
possibilities of errors.
2) Usually more than one price has to be adopted for each issue.
3) Comparison of one job with another may be difficult because issues to
one may be charged at prices different from the other.
4) In a fluctuating market, the effect of the current market price is not
recent the cost of issues.
5.4.2 Last in First Out Method
Under this method, the price of the latest consignment is taken into
consideration for pricing theissues of materials. This method is based on
the assumption that materials received last are issued first. Thus, when a
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 Material and Labour requisition is received for certain materials, the storekeeper will charge
the cost price of the latest consignment. quantity required is more than the
units remaining from the latest consignment will apply the cost price of the
consignment immediately preceding the last lot so on.
This method is suitable in times of rising prices because the materials
charged to production will be higher leading to lower profits and lower tax
liability. The cost of production will also be closer to-current prices.
Illustration 3:
By taking the data of Illustration 2, prepare the Stores Ledger Account
under LIFO method.
Solution:
STORES LEDGER ACCOUNT (Under LIFO Method)

Name……………………….. Maximum Level…………………..

Description…………………. Minimum Level….…....…………..
Location Code………………. Ordering Level……….........………
Re-order quantity…….……………
Date Receipt Issues Balance
G.R.N. Qty Rate Amount R.S. Qty Rate Amount Qty Rate Amount
No. Units Rs. Rs. NO Units Rs. Rs. Units Rs. Rs,
Jan. 1 _ 500 5.00 2,500 _ _ _ 500 5.00 2,500
Jan.8 _ 300 5.10 1,530 _ _ _ 5.00 4,030

500 5.10
800 
300

Jan. 13 _ _ _ _ _ 600 300 5.10 3,030 200 5.00 1,000


300 5.00

Jan. 18 _ 400 5.20 2,080 _ _ _ _ 5.00 3,080

600 200
 5.20
400

Jan. 23 _ _ _ _ _ 300 5.20 1,560 5.00 1,520

300 200
 5.20
100
Jan. 25 _ 500 5.10 2,550 _ _ _ _ 5.00 4,070
800 200 5.20

100
5.10
500

Jan. 31 _ _ _ _ 200 5.10 1.020 5.00 3,050

600 200

100 5.20
300 5.10

1,700 8,660 5,610 600 3,050

Closing stock is 200 units @ Rs. 5.00, 100 units @ 5.20 and 300 units @
Rs. 5.10.
Advantages
The following are the advantages of pricing the material issues under LIFO:
1) It is simple and useful when transactions are few.
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 2) Since issues are based on the actual cost, no profit nor loss arises by Pricing the issue of Materials
using this method.
3) Production is charged at most recent prices so that cost of production
reflects current price levels.
4) During the period of rising prices, profits are lowered down since
production charged at current prices. The tax liability is thus reduced.
5) This method will iron out fluctuations in profits over a period of
changing price levels.
Disadvantages
1) Sometimes more than one price has to be adopted for pricing a
single requisition.
2) As in the case of FIFO method, calculations become complicated
and cumbersome when rates of receipts are highly fluctuating.
3) When prices are falling, it will lead to low charge to production.
4) As in the case of FIFO method, a substantial difference is likely to
be shown in the cost of two jobs, solely because the stock of one
happened to be drawn a few minutes before those for the other. Thus
it makes the comparison between different jobs very difficult.
5) Closing stock is valued at a cost which does not represent current
conditions.
5.4.3 Weighted Average Price Method
Under actual cost methods whether it is FIFO or LIFO, you have to assume
certain order of the outflow of materials which may or may not be observed
in actual practice. Hence, it is advocated that the issue of materials should be
valued average price. This average may be a simple average or a weighted
average. The weighted average considered more desirable as it also takes
into account quantities bought at each price. The weighted average price
is calculated by dividing the total cost of materials in stock by the total
quantity in stock prior to each issue. Thus
Value of material in stock
Weighted average price =
Quantity in stock

It is important to note the average price under weighted average method has
to be calculated each time materials are received in stores and not when they
are issued. Thus, under this method, as soon as a fresh lot is received, a new
price is calculated and all the issues are then taken at this price until the next
lot of material is received.
In periods of heavy fluctuations in prices, the weighted average method
results because it tends to smooth out the fluctuations in prices by taking
the average of the prices of various lots in stock, This method of pricing of
material the cost price of materials from production.
Illustration 4 should help you to understand the pricing of issues of materials
at weighted average price.

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 Material and Labour Illustration 4 :
Based on the data given in Illustration 2, prepare the stores Ledger Account
on weighted average price method.
Solution:
STORES LEDGER ACCOUNT (Under Weighted Average Method)
Name………………………… Maximum Level…………………….
Description…………………. . Minimum Level……………………..
Location Code……………… . Ordering Level………………...........
Re-order quantity……………………
Date Receipt Issues Balance

G.R.N. Qty Rate Amount R.S. Qty Rate Amount Qty Rate Amount

No. Units Rs. Rs. NO Units Rs. Rs. Units Rs. Rs.
Jan. 1 _ 500 5.00 2,500 _ _ _ 500 5.000 2,500

Jan.8 _ 300 5.10 1,530 _ _ _ 800 5.0375 4,030

Jan. _ _ _ _ _ 600 5.0375 3,023 200 5.1458 1,007

13

Jan. _ 400 5.20 2,080 _ _ _ 600 5.1458 3,087

18

Jan. _ _ _ _ _ 300 5.1458 1,544 300 5.143 1,543

23

Jan. _ 500 5.10 2,550 _ _ _ 800 5.1167 4,093

25

Jan. _ _ _ _ 200 5,1172 1,023 600 5.1167 3,070

31

1,700 8,660 1,100 5,990 600 5.1167 3,070

Closing Stock is 600 units @ Rs. 5.1167 per unit

Advantages
1) It is logical and consistent.
2) Cost comparisons are rendered easier.
3) When prices fluctuate considerably, it will smooth out fluctuations.
4) Calculation of the new price arises only with the new receipt in
stock, all subsequent issues are then charged at this price until the
next lot is received
Disadvantages
1) This method requires tedious calculations. For instance to get the
benefit of the method, average prices are to be calculated upto four or
five decimal points which is very much laborious.
2) Material cost does not represent the current prices.
3) Closing stock also may not represent current market prices.
4) Fresh calculations will have to be made every time fresh purchases
are made This will mean much of arithmetical work and is likely to
cause error.
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 It is the weighted average cost method which is mostly used by different or Pricing the issue of Materials
organisation becauseit satisfies most of the conditions of a good method of
valuing material issues.
5.4.4 Replacement Price Method
Under this method, market price on the date of issue of material will be
taken into account that is the price of replacement (procurement) on the
date of issue. This method is used to reflect the current prices in cost. The
manufacturing concerns, generally, purchase large quantity of raw material
and after few months it is common that price of such procurement increase.
Under this method the benefit is to be taken by the manufacturing concern.
The advantage of this method is that it is very simple to prepare the Stores
Ledger Account as there is no need to do calculations of different prices as
in case of LIFO, FIFO, Weighted Average. Under this method, rate is not
stated in the Balance column as it is not having reliability. Balance amount is
calculated by deducting issue amount from the previous amount of balance.
However, there are few limitations such as it involves additional work of
getting the current market price on the day of every time of material issue.
Same time replacement price may not be available hence market price as on
that date is estimated or if available it is the question of reliability. Stock is
not valued at replacement price and it may lead to unrealized profit or loss.
Following illustration 5 help you to understand the pricing of issue of
material under replacement price method.
Illustration 5 :
From the data given in Illustration 2, prepare the Stores Ledger Account
under Replacement Price Method. The replacement prices on the day of
issue are as below:
January, 13 Rs. 5.30 per unit
January, 23 Rs. 5.50 per unit
January, 31 Rs. 5.40 per unit
Solution:
STORES LEDGER ACCOUNT (Under Replacement Price Method)
Name……………………… Maximum Level…………………....
Description………………… Minimum Level…………………....
Location Code……………… Ordering Level…………………......
Re-order quantity………………......
Date Receipt Issues Balance

G.R.N. Qty Rate Amount R.S. Qty Rate Amount Qty Amount

No. Rs. Rs. NO Rs. Rs. Rs.

Jan.1 - 500 5.00 2,500 - - - - 500 2,500
Jan 8 - 300 5.10 1,530 - - - - 800 4,030
Jan 13 - - - - - 600 5.30 3,180 200 850
Jan 18 - 400 5.20 2,080 - - - - 600 2,930
Jan 23 - - - - - 300 5.50 1,650 300 1,280
Jan 25 - 500 5.10 2,550 - - - - 800 3,830
Jan 31 - - - - - 200 5.40 1,080 600 2,750

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 Material and Labour Under this method, you may notice that actual value of the costing stock is
600 units @ Rs. 4.5833 (2,750 600) where as the actual cost of purchase
is Rs. 5.70 and Rs. 5.10 under FIFO method and Rs. 5.00 Rs. 5.20 and Rs.
5.10 under LIFO method of different lots. It is clear that the manufacturing/
business firms takes the advantage of cheap price (price at the time of
procurement) by not extending the benefit to customer. If the balance of
quantity is valued @ Rs. 5.40 (Replacement Price) it would be Rs. 3,240 but
the closing value of stock shows Rs. 2,750. Here the favourable difference
is (3,240 – 2,750) Rs. 490 as it was under valued and the benefit to this
extent goes to the business concern.
5.4.5 Standard Price Method
Under this method, a standard price is decided for issue of material by taking
the previous price trend, discounts, supply and demand, market conditions
etc. It is a pre-determined price. This standard price is fixed for a particular
period, normally, half year or one year. Thereafter this price is revised
periodically or as and when required. In this method, receipts are recorded
at actual cost and issue are priced at standard price as decided.
Following illustration 6 help you to understand the posting of transactions
in Stores Ledger Account under Standard Price Method.
Illustration 6 :
By considering the transaction given in illustration 2, prepare Store Ledger
Account under Standard Price Method. The Standard price was fixed at Rs.
5.30 per unit.
Solution:
STORES LEDGER ACCOUNT (Under Standard Price Method)
Name…………………… Maximum Level……………….……
Description……………. Minimum Level……………….……
Location Code………….. Ordering Level………..……….……
Re-order quantity…………...….……
Date Receipt Issues Balance
G.R.N. Qty Rate Amount R.S. Qty Rate Amount Qty Amount
No. units Rs. Rs. NO Rs. Rs. units Rs.
Jan.1 - 500 5.00 2,500 - - - - 500 2,500
Jan 8 - 300 5.10 1,530 - - - - 800 4,030
Jan 13 - - - - - 600 5.30 3,180 200 850
Jan 18 - 400 5.20 2,080 - - - - 600 2,930
Jan 23 - - - - - 300 5.30 1,590 300 1,340
Jan 25 - 500 5.10 2,550 - - - - 800 3,890
Jan 31 - - - - - 200 5.30 1,060 600 2,830

Now, by comparing this method of calculation with the Replacement Price

Method, you will find that except the pricing for issues of material the
calculation is same. In Replacement Price Method issue prices variates as
the current market price on the date of issue. Where as fixed price will be
charged to the issues for specific time duration as decided by the business
concern.
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 Considering the standard price, the value of the closing stock is Rs. 3,180 Pricing the issue of Materials
(600 5.30). Here, the actual stock value is Rs. 2,830. The difference of
value Rs. 350 (3,180 – 2,830) is under valued and it is a favourable price
variance.
5.4.6 Pricing of Materials Returned to Vendors
Materials which are not according to specifications or are found to be of
substandard quality, are returned to the vendor. If such materials are not sent
to the stores and are returned to the vendor by the receiving section itself, a
debit note sent to the vendor after making the necessary adjustments in the
invoice value of the goods. However, if such goods have been included in
stock, the returns have to be recorded in the issue column of the stores ledger
account and valued at the price which they were received. Alternatively,
they may be treated as a normal issue of materials and valued according to
the method of pricing used. Thus,
i) If FIFO method is followed, the price will be that of the oldest stock
on the of return.
ii) If LIFO method is followed, the materials will be valued at the price
of the latest receipt.
iii) If the average price is followed, the returns should be valued at the
average price.
iv) If the replacement price or standard price is followed, the price of
returned material is valued as per the price charged at the time of issue
of such material.
5.4.7 Pricing of Materials Returned to Stores
Some materials issued to a job may become surplus. These should be returned
to the stores. The materials so returned to the are recorded in the bin card
as well as in the stores ledger. The general rule for recording such returns
in stores ledger account is to value them at the price at which they were
originally issued and then they should be included in the next requisition and
issued at the same price, unless given otherwise, However, if the company is
following the weighted average price method, the returned materials should
be recorded at the price at which they were originally issued and then a
new average cost should be worked out as if the materials returned were a
new purchase. Sometimes, the rate of original issue is not given. In such a
situation, it should be taken as belonging to the latest issue of materials and
recorded accordingly.
5.4.8 Treatment of Shortage of Materials
If any shortage of materials is noted on making a physical verification of
stock of materials, it should be entered in the issue column of stores ledger
and valued in accordance with the method adopted for pricing material
issues.
The following Illustration 7 shows the materials returned to stores and
shortage of materials are recorded in the stores Ledger Account.
Illustration 7:
The particulars of receipts and issues of materials in a factory in August
2018 are as under:
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 Material and Labour August 01 Opening balance 1,500 kgs. @ Rs. 12 per kg.
” 02 Issued 100 kgs.
” 03 Issued 250 kgs.
” 04 Issued 300 kgs.
” 05 Purchased 400 kgs. @ Rs 12.50 per kg.
” 09 Issued 300 kgs.
” 10 Purchased 200 kgs @ Rs. 12.50 per kg.
” 11 Issued 300 kgs.
” 12 Returned from workshop issued on 3rd August 20 kgs.
” 13 Issued 450 kgs.
” 16 Purchased 500 kgs. Rs. 13.00 per kg.
” 18 Issued 400 kgs.
” 20 Returned from workshop issued on 9th August 60 kgs.
” 22 Issued 300 kgs.
” 26 Purchased 400 kgs. @ Rs. 12.00 per kg.
” 29 Issued 200 kgs.
Pricing of issues is to be done on FIFO basis.Ashortage of 10 kgs. was noticed on
16th August. Prepare the Stores Ledger Account for the month of August,
2018.
Solution:
STORES LEDGER ACCOUNT (Under FIFO Method)
Name……………………. Maximum Level……..……………..
Description……………… Minimum Level…………………....
Location Code…………… Ordering Level…………………......
Re-order quantity…………………...
Date Receipt Issues Balance
G.R.N. Qty Rate Amount R.S. Qty Rate Amount Qty Rate Amount
No. Kgs Rs. Rs. NO Kgs Rs. Rs. Kgs Rs. Rs.

August 1 _ 1,500 12.00 18,000 _ _ _ _ 1500 12.00 18,000

August 2 _ _ _ _ _ 100 12.00 1,200 1400 12.00 16,800
August 3 _ _ _ _ _ 250 12.00 3,000 1150 12.00 13,800

August 4 _ _ _ _ _ 300 12.00 3,600 850 12.00 10,200

{
August 5 _ 400 12.50 5,000 _ _ _ _ 1250 12.00 15,200
850 12.50

400
August 9 _ _ _ _ _ 300 12.00 3,600 950 550 12.00 11,600
 12.50
400
400
August 10 _ 200 12.50 2,500 _ _ _ _ 12.00
1150 550 12.50 14,100

400 12.50
200
August 11 _ _ _ _ _ 300 12.00 3,600 12.00
850 250 12.50 10,500
 12.50
400
200

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 August 12 _ 20 12.00 240 _ _ _ _ 12.00 Pricing the issue of Materials
870 20 12.00 10,740
 12.50
250
12.50
400
200

August 13 _ _ _ _ _ 12.00
450 20 12.00 240 5490 12.50 5,250
 
250 12.50 300  220 13.00
420 
180 2250 200

August 16 _ 500 13.00 6,500 _ _ _ _

12.50
520 220 12.50 11,750

200 13.00
500

August 18 _ _ _ _ _
400 220 12.50 2750 5, 000 6,750
 
180 12.50 2250 520 20 12.50
 13.00
500

August 20 _ 60 12.00 720 _ _ _ _ 12.00

580 60 12.50 7,470
 13.00
20
500
August 22 _ _ _ _ _ 12.00 720 3830
12.50  360 13.00 4.680
300 60 250
 13.00
20 2860
220
August 26 _ 400 12.00 4,800 _ _ _ _ 360 13.00 9,480
400 12.00
August 29 _ _ 200 13.00 2,600 160 13.00 6,880
400 12.00

Closing Stock is 160 kgs @ Rs.13.00 per kg and 400 kgs @ Rs. 12.00 per kg.
NOTES: Returned from Workshop: The returns from workshop are
entered in the receipt column and valued at the rare at which they were
originally issued. In this illustration, there are two returns from workshop
on 12th and 20th August respectively. These are to be valued at the rates at
which they were originally issued. that is, rates charged (Rs. 12) on 3rd and
9th August respectively. Further, the 20 units returned on 12th August have
been included in the issue made on 13th August; and 60 units returned on
20th August have been included in the issue made on 22nd August.
2) Shortage: Shortage has been entered in the issue column and has been
treated just like other issues. It is to be valued at the rate as per the method
adopted, the FIFO, LIFO etc. treating the shortage as one of the issues.
Illustration 8:
From the following record of the receipt and issues of coal and stores
verification report, calculate the prices of issues charged out under
weighted average method.
2020
April 1 Opening balance: 100 tons Rs. 50 per ton
” 5 Issued 60 tons
” 6 Received 120 tons Rs. 50.50 per ton
” 7 Issued 50 tons (the stock verification report reveals a loss of 1 ton)
” 8 Received back from completed job 2 tons previously issued
Rs. 50.25 per ton,
” 9 Issued 80 tonnes.
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 Material and Labour Solution :
STORES LEDGER ACCOUNT (Under Weighted average Method)
Name…………………… Maximum Level…………………...
Description……………… Minimum Level…………………...
Location Code…………… Ordering Level……………….........
Re-order quantity……………….....
Date Receipt Issues Balance
G.R.N. Qty Rate Amount R.S. Qty Rate Amount Qty Rate Amount
1990 No. Tons Rs. Rs. NO Tons Rs. Rs. Tons Rs. Rs.

April 1 _ 100 50.00 5,000.00 _ _ _ _ 100 50.00 5,000.00

April 5 _ _ _ _ _ 60 50.0000 3,000.00 40 50,00 2,000.00
April 6 _ 120 50.50 6,060.00 _ _ _ _ 160 50.3750 8,060.00
April 7 _ _ _ _ _ 50 50.3750 2,518.75 110 50.3750 5,541.25

April 7 _ _ _ _ _ 1 50.3750 50.38 109 50.3750 5,490.87

(loss)
April 8 _ 2 50.25 100.50 _ _ _ _ 111 50.3727 5,591.37
April 9 _ _ _ _ _ 80 50.3727 4029.82 31 50.3727 1,561.55
222 11,160.50 191 9,598.94 31 1,561.56

Closing Stock is 31 tons @ Rs. 50.3727 per ton.

Check Your Progress A
1) State whether the following statements are True or False and justify
your answer.
i) First in First Out method of valuing materials issues is suitable
in times of rising prices.
ii) According to LIFO method of pricing, issues are close to current
economic values.
iii) Weighted average method of pricing stores involves adding all
the different prices and dividing by the number of such prices
2) Fill in the blanks.
i) First in First Out method of valuing material issues is suitable
in times of ……………………prices.
ii) Last in First Out method is suitable in times of prices………..
iii) Weighted average method of valuing material issues is suitable
when prices…………….
3) From the transactions given in the illustration – 6, you are advised to
prepare the Store Ledger Account under :
i) LIFO method,
ii) Weighted Average Method,
iii) Replacement Price Method (Replacement Prices are : August
2, 3 & 4 – Rs. 12; August 9 – Rs. 13; August 11 – Rs. 13.50;
August 13 & 18 – Rs.13; August 27 & 29 – Rs. 14
iv) Standard Price Method assuming that the standard price is Rs.
13 per kg.

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 5.4.9 Treatment of Material Losses Pricing the issue of Materials
In course of handling the materials at different stages i.e., receiving, storage,
issue, processing etc. there are possibilities of loss of material may arise.
Losses are classified into two categories. They are 1) Normal Loss and 2)
Abnormal Loss
Normal Losses : The losses which occur even after taken enough care
due to natural features of the material or situations. Such as evaporation
of liquid/gases for instance chemicals, petrol, CNG, PNG etc. Loss in
loading and unloading. For example, cement bags, coal etc. Loss due to
purchase of large quantity and making small parts for issuance to production
departments. For instance cutting of wood in furniture manufacturing.
These losses cannot be completely eliminated.
Abnormal Losses : The losses which may occur due to mishandling, poor
storage facility, breakage, theft, fire accident, earthquakes, floods, thefts,
long period storage, etc.
Accounting Treatment of Losses
Normal losses are treated as a part of the cost. In order to absorb normal
material loss the amount of loss is adjusted by inflated rate of the usable
material to cover the loss. This loss is included in the cost of transferring to
the factory overheads.
Abnormal Losses cannot be included in the cost and charged to costing
Profit and Loss Account. It is clear that this type of loss should not be
absorbed on usable material in stock.

5.5 LET US SUM UP

For ascertaining the cost of materials, the purchase price of materials
needs certain adjustments like cash discount, cost of transportation, cost of
containers, etc.
Materials may be purchased at different rates from time to time. Hence,
when they are issued to production a problem arises with regard to the
price at which they should be recorded. This can be done at actual cost, at
average cost, at notional cost or at market price. Accordingly, a number of
methods of pricing the issues have been developed. of these, FIFO, LIFO,
and weighted average price are the three prominent methods.
Under FIFO (First in First Out) method of pricing the materials, the cost
of the earliest consignment is taken first and when that consignment is
exhausted, the price of the next consignment is adopted and so on. This
method of pricing is suitable in times of failing prices.
Under LIFO (Last in First Out) method, the cost of the latest consignment
is taken first and when that consignment is exhausted, the price of previous
consignment is adopted. Materials cost under this method is closer to
current price level.
Under weighted average method, the price is calculated by dividing the total
cost of the materials in stock by the total quantity. This method of pricing of
materials gives better results because it tends to smooth out fluctuations in
prices by taking the average of prices of various lots in stock. This method
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 Material and Labour is mostly used by several organisations because it satisfies most of the
conditions of a good method of valuing material issues.
Under Replacement Price method, the current market price on the date
of issue will be taken into account. Under Standard Price method, pre-
determined price is decided for a specific period and charged to issues.
This price will be revised after the specific period or as and when required.
Normal losses are absorbed in the cost of usable material and abnormal loss
should be transferred to Costing Profit and Loss Account.

5.6 KEY WORDS

FIFO (First in First out): A method of pricing the issue of materials at
actual cost in the chronological order of the purchases.
LIFO (Last in First Out): A method of pricing the issue of materials at
actual cost in of the latest purchase and when that lot is exhausted, the price
of the previous consignment is adopted, and so on.
Weighted Average Price: The price which is calculated by dividing the
total cost of materials in stock from which the materials are issued by the
total quantity of materials in that stock.
Replacement Price Method : A method of pricing and the issue of material
the price at which material would be replaced on the date of issue.
Standard Price Method : A method of pricing the issue of material with a
pre-determined price which is fixed for specific period.

5.7 ANSWERS TO CHECK YOUR PROGRESS /

EXERCISES
A) 1. (i) False (ii) True (iii) False
2. (i) falling prices (ii) rising prices (iii) fluctuate considerably

5.8 TERMINAL QUESTIONS/EXERCISES

Questions
1) Discuss how you would treat discount, transportation costs, and the
cost of containers for ascertaining the cost of materials
2) Indicate the different methods used for pricing the issue of materials.
3) Explain with examples the following methods of pricing the issues of
materials:
a) LIFO and b) FIFO
Under conditions of rising prices, which of these two methods would
you recommend and why?
4) What is meant by weighted average method of valuing stores issues?
What are its advantages?
5) Explain the concept of Replacement Price and Standard Price methods
of pricing to material issues.
6) What are the Material Losses and how would you treat the material
losses in Cost Accounting ?
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 Exercises Pricing the issue of Materials
1) The following quotation is received from a supplier in respect of
material X.
Rate per kg.
Rs.
Lot price 100 kg. 5.00
500 kg. 4.50
1,000 kg. 4.00
Trade discount is 20%. Cash discount of 5% is allowed if payment is made
within 15 days. One container is required for every 100 kg of material and
containers are charged at Rs. 10,00 each but credited at R. 9.00 if returned
within three months.
Rs.
Transport charges for any order 50
Storage charges 15
Calculate the total material cost for 500 kgs. and ascertain the rate per kg
of the material when the purchaser decides to purchase 500 kgs. of the
material.
(Answer: Total cost Rs. 1,870; Cost per kg Rs. 3.74)
2) From the following transactions, prepare separately the stores ledger
accounts using the following pricing methods:
i) FIFO and ii) LIFO
January 1 Opening balance 100 units @ Rs. 5 each
5 Received 500 units @ Rs. 6 each
30 Issued 300 units
February 5 Issued 200 units
“ 6 Received 500 units @ Rs. 5 each
March 10 Issued 300 units
12 Issued 250 units
(Answer: Closing balance under both methods 50 units @ Rs. 5 each. Total
cost Rs 250).
3) Following transactions are recorded in respect of a store item.
Date Receipts Rate per unit Issues
kg. kg. kg.
December 3 400 1.00 --
December 11 600 1.20 --
December 16 -- -- 500
December 19 500 1.30 --
December 30 -- -- 400
Prepare a stores ledger account pricing the issues at weighted average
method.
(Answer : Balance qty. 600 units, Rate Rs. 1.21 per unit Total Rs. 726)
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 Material and Labour 1) The following receipts and issues were made of a new item of stores:
Receipts Issues
(units) Cost (Rs.) (units)
1st January 1,000 15,000 --
1st February 1,000 12,000 --
28th February -- -- 1,200
1st March 1,000 18,000 --
31st March -- -- 1,200
Tabulate the values of:
i) Issue made on 28 February
ii) Resulting stock on 28 February
iii) Issue made on 31st March
iv) Resulting stock on 31st March
according to:
a) LIFO basis
b) FIFO basis
c) Weighted average cost basis
Answers:
(a) (b) (c)

Rs. Rs. Rs.

i) 15,000 17,400 16,200
ii) 12,000 9,600 10,800
iii) 21,000 16,800 19,200
iv) 9,000 10,800 9,600
5) The following information is available from the records of oil
company for the month of June 2018.
Opening stock of oil 1,00,000 litres at Rs. 3 per litre. Purchases
(Including freight etc.) made
June 01 2,00,000 litres @ Rs. 2.85 per litre
June 30 1,00,000 litres @ Rs. 3.03 per litre
Closing stock June 30 1,30,000 litres
Sales Rs. 9,45,000
Administration cost 25,000
Compute the following under FIFO Method
a) Value of inventory on June 30;
b) Cost of goods sold for the month of June;
c) Profit or loss for the month
(Answer: (a) Rs, 3,88,500 (b) Rs. 7,84,500 (c) Rs. 1,35,500
6) The following is an extract of the record of receipts and issues of a
chemical coded as chemical A3 during the month.
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 February 01 Opening balance 500 tonnes Rs. 200 Pricing the issue of Materials
” 03 Issue 70 tonnes
” 04 Issue 100 tonnes
” 08 Issue 80 tonnes
” 13 Received from supplier 200 tonnes Rs. 190
” 14 Returned from works 15 tonnes
” 16 Issue 180 tonnes
” 20 Received from supplier 240 tonnes Rs. 210
” 24 Issue 300 tonnes
” 25 Received from supplier 320 tonnes Rs. 220
” 26 Issue 115 tonnes
” 27 Returned from works: 35 tonnes
” 28 Received from supplier 100 tonnes Rs. 230
Issues are to be priced on FIFO, LIFO, Weighted average, Replacement
Price Method (Replacement Prices are : Feb 3 & 4 – Rs. 210; Feb 8 –Rs.
205, Feb 16 – Rs. 210; Feb 24 – Rs.225 Feb 26 – Rs. 230) and standard
price method assuming the price is fixed at Rs. 220 per ton. Stock verifier
found shortage of 10 tonnes on 22nd. Draw up priced stores ledger card.
7) From the following data, prepare Store Ledger Account. Under
the methods of i) FIFO; ii) LIFO; iii) Weighted Average, iv)
Replacement Price, and v) Standard price.
July, 1 Opening Stock 500 units @ Rs. 40 each
July, 4 Received 400 units @ Rs. 42 each
July, 6 Issued 600 units
July, 8 Received 800 units @ Rs. 48 each
July, 9 Issued 500 units
July, 13 Issued 300 units
July, 24 Received 500 units @ Rs. 50 each
July, 28 Issued 400 units
Additional Information:
1) Replacement prices per unit are as under:
2) July 6 - Rs. 44; July, 9 – Rs. 46; July 13 – Rs.48 and July 28 – Rs. 52
3) The Standard Price is fixed at Rs. 48 per unit
(Ans: Closing Balances are:
i) 400 units @ Rs. 50 = Rs. 20,000
ii) 300 units @ Rs. 40 + 100 units @ Rs. 50 = Rs.17,000
iii) 400 units @Rs. 48.52 total amount Rs. 19,408
iii) 400 units total amount Rs. 15,600
iv) 400 units total amount Rs. 13,800.

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 Material and Labour
Note: These questions will help you to understand the unit better. Try to
write answers for them and verify with the content. But do not submit
your answers to the University. These are for your practice only.

SOME USEFUL BOOKS

Arora M.N. 2003. A Text Book of Cost Accountancy, Vikas Publishing
House Pvt. Ltd.: New Delhi. (Chapter 3-8).
Bhar, B.K. 2018. Cost Accounting: Methods and Problems, Academic
Publishers: Calcutta. (Chapter 5-9).
Iyenger, S.P., Cost Accounting, Sultan Chand and Sons.
Maheshwari, S.N. and SN. Mittal, 2018. Cost Accounting: Theory and
Problems,
Shree Mahavir Book Depot: Delhi. (Chapter 2-3).
Nigam,B.M.L. and G.L. Sharma, 2018. Theory and Techniques of Cost
Accounting,
Himalaya Publishing House: Bombay. (Chapter 4-7).
Rajiv Goel, Cost Accounting, International Book House.

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 UNIT 6 LABOUR – BASIC CONCEPTS
Structure
6.0 Objectives
6.1 Introduction
6.2 Direct and Indirect Labour
6.2.1 Direct Labour
6.2.2 Indirect Labour
6.3 Time Keeping
6.3.1 Forms of Time Keeping
6.3.2 Purpose of Time Keeping
6.3.3 Methods of Time Keeping
6.3.4 Importance of Time Keeping
6.4 Time Booking
6.4.1 Purpose of Time Booking
6.4.2 Methods of Time Booking
6.5 Payroll Accounting
6.5.1 Computation of Wages
6.5.2 Preparation of Wages Sheet
6.5.3 Purposes of Payroll Accounting
6.6 Idle Time
6.6.1 Causes of Idle Time
6.6.2 Control of Idle Time
6.6.3 Treatment of Idle Time Cost
6.7 Overtime
6.8 Labour Turnover
6.8.1 Causes of Labour Turnover
6.8.2 Effects of Labour Turnover
6.8.3 Control of Labour Turnover
6.9 Let Us Sum Up
6.10 Key Words
6.11 Answers to Check Your Progress
6.12 Terminal Questions

6.0 OBJECTIVES
After studying this unit you should be able to:
●● explain the meaning of direct and indirect labour;
●● explain the concepts of time keeping and time booking;
●● describe the system of payroll accounting ;
●● explain the concepts of idle time and overtime and describe their
treatment in cost accounts;
●● discuss the implications of labour turnover;
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 Material and Labour
6.1 INTRODUCTION
Labour is an essential factor of production. They make contribution to
the organisation through their time and energy. This needs adequate
compensation to labour by way of wages for the work done by them which
constitutes another important element of cost. In this unit you will learn
about the concept of direct and indirect labour, the method of their time
keeping and time booking, the methods of wage payment and payroll
accounting, and the treatment of idle time and overtime in cost accounts.

6.2 DIRECT AND INDIRECT LABOUR

Labour is an essential factor of production. It is a human resource and
participates in process of production. The remuneration paid to labour is a
significant item of cost. For costing purposes, labour may be classified into
two broad categories (i) direct labour, and (ii) indirect labour.
6.2.1 Direct Labour
Direct labour refers to labour engaged directly in the manufacture of a
product or in a particular job. Some examples of direct labour are:
a) Labour engaged in converting raw materials into manufactured
articles
b) Labour employed on a construction job
c) Helper attending a machine operator
d) Compositors working in a printing press
The main features of direct labour are as follows:
1) It can be easily identified and allocated to cost units.
2) It varies directly with the volume of output.
3) It can be easily ascertained and controlled because of its close
proximity to the output.
Wages paid to direct labour are termed as ‘direct labour cost’ and forms
part of prime cost.
6.2.2 Indirect Labour
There are a number of workers who are not engaged directly in the
manufacture of a product or in a particular job. They may be employed as
supervisors, repair workmen, inspectors, security men, foreman, cleaners,
messengers, timekeepers, etc. or engaged in purchasing, stores, factory
office or maintenance job. Wages and salaries paid to such staff are treated
as. ‘indirect labour cost’ which is included in overheads.
The importance of distinction between direct labour and indirect labour
lies in the fact that whereas direct labour can be identified with, and charged
directly to, the product or a job, the indirect labour is not o identifiable
and is, therefore, included in overheads which may be allocated to different
products on some suitable basis.

6.3 TIME KEEPING

Time Keeping is a system of recording the time of arrival and departure of
workers. This provides a record of total time spent by the workers in the
factory. It is on the basis of this record that their total entitlement for
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 work under time rate system is determined. Labour – Basic Concepts
The process of time keeping is to maintain an accurate record of time of
every worker when he is in and out of the factory i.e., a record of when he
reports for duty and when he leaves his duty. This also provides a basis for
distinction between regular time and overtime.
6.3.1 Forms of Time Keeping
Normally, two sets of time records are maintained in a factory:
i) Attendance Time: showing the total number of hours spent by each
work the factory. This record is used for determining the amount of
wages payable to the workers.
ii) Job Time: showing the number of hours spent on the jobs. This record
he computing the labour cost for each job, product or process.
6.3.2 Purpose of Time Keeping
The purpose of time keeping is to provide information for
1) Preparation of pay rolls;
2) Calculation of labour cost per unit of operation, production or service;
3) Allocation of overhead cost based on wages or labour hours;
4) Attendance record of workers to meet statutory requirements;
5) Control of labour cost;
6) Determination of productivity of labour in the factory; and
7) Promotion of punctuality and discipline among the workers.
6.3.3 Methods of Time Keeping
Attendance of workers in a factory on the basis of the time of their arrival
and departure may be recorded through either, or a combination, of the
following three methods:
Method of Time Main Features
Keeping
1. HANDWRITFEN a) Names of the workers are entered in an
METHOD attendance register maintained for the
purpose of time keeping.
b) They are required to sign the register at
the time of their arrival for duties in the
factory and at the time they leave.
c) Some time after the actual time
scheduled for reporting for duties,
workers are marked ‘late’ or ‘absent’ as
the case may be.

d) Though this is a simple and common

method, the possibilities of fake
attendance or fraudulent marking of
attendance may not be ruled out under
this method.
2. CHECK, TOKEN a) Each worker is allotted an identification
OR DISC or token number
METHOD

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 Material and Labour
b) At the time of arrival, the worker
collects his token from the board and
drops it in a box kept for the purpose at
the factory gate.
c) After 10 or 15 minutes of the normal
arrival time, the box is removed by
the Time Keeper or it is substituted by
another box.
d) The late corners are required to report
directly to the Time Keeper
e) On the basis of the tokens dropped in
the box, necessary entries regarding
attendance of the workers are made in
the Time Book which is passed on to the
Wages Section for payroll accounting.
f) The method needs proper supervision to
ensure that a worker does not put in the
box more than one token.
3. MECHANICAL a) Each worker is given a Clock Card
OR CLOCK hich is placed in racks the factory gate.
METHOD
b) The time of arrival and departure of a
worker is recorded the help of clock
recorders.
c) When workers report for duties, they
take out their cards from rack one, get
them punched by the Time Recording
Clock maintained at the factory gate,
and place them in rack two.
d) When they leave, they again get
their cards punched with the time of
departure and put them back in rack
one.
e) It is a quick, safe scientific, reliable and
accurate method of time keeping
6.4.3 Importance of Time Keeping
Time keeping is a significant aspect of labour accounting. The process of
time keeping
1) Ensures punctuality of workers and Identifies late-corners;
2) Improve discipline among workers;
3) Boosts morale of personnel;
4) Promotes a productive environment in the organisation;
5) Checks idle time and increases output by adherence to production
schedules;
6) Helps recording of time for statistical purposes;
7) Maintains a record of work performed by the people; and
8) Assists computation of labour cost per unit or per process of
production.
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 Check Your Progress A Labour – Basic Concepts
1) What is Direct Labour?
2) What is Indirect Labour?
3) What are the objects of Time Keeping?
4) State whether each of the following statements is True or False B and
justify your answer.
i) A fast worker is more profitable than a quality conscious worker
ii) A good system of wage payment is one which ensures maximum
possible payment to workers.
iii) Commission to salesmen is a direct labour cost.
iv) Labour cost control must be such which can ensure efficiency
and satisfaction.
v) There is no need for keeping a record of time for those who get
monthly salary.

6.4 TIME BOOKING

Under time keeping methods we simply record the time spent by a worker
in the factory. Such record does not show how that time was utilized by
him i.e., how much time he spent on the jobs entrusted to him and for how
much time he remained idle. Hence, in addition to recording his time of
arrival and departure, it is also necessary to record the time he spent on each
job, order or process. The system of maintaining such record is termed as
‘time booking’. In other words, time booking is a method of recording time
devoted by a worker on a job, order or process.
6.4.1 Purpose of Time Booking
The major purposes of time booking are:
1) To assist in ascertaining the cost of a job, order or process
performed;
2) To check wastage of time by the worker after he enters the factory;
3) To assess the cost of idle time, and
4) To ensure that the time spent by the worker in the factory has been
properly utilised.
6.4.2 Methods of Time Booking
The system of time booking may be maintained either manually or
mechanically. In relatively bigger organisations, where a large number of
labourers work, or where there is a wide variety of jobs being performed
every day, Time Recording Clocks may be used to enter the time of starting
and finishing each job separately on the Job Cards.
The other methods of booking the time taken on separate jobs are:
1) Daily Time Sheets: This is a record for each worker separately in
respect of time spent by him on each job during the day. Daily Time
Sheet (also known as time cards) include details relating to:
a) Name of the worker,
b) Work Order Number,

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 Material and Labour c) Description of Work,
d) Quantity Produced,
e) Time of starting and finishing the job,
f) Total hours consumed on the job,
g) Rate of Wages per hour, and
h) Amount of wages.
2) Weekly Time Sheets: It contains similar details of the record of time
for all jobs done by the workers during a complete week.
3) Job Cards: It is prepared for each operation to be carried out on every
order. This helps in computing the exact time taken by a worker on a
particular job, operation or service. A job card authorises a worker to
carry out the specified assignment. It also assists in having a correct
allocation of wages to jobs, operations or processes.
As a matter of fact, time card (daily time sheet) and job card are similar in
nature and content. Both help in ascertaining how each worker utilised his
time while he was in the factory and enable the organisation to reconcile the
time spent by the worker on each job with the time paid as per the attendance
record. Another advantage of these cards is that they provide complete
record as to the labour content of each job so that the computation of
labour cost is greatly facilitated. The difference between these two types
of cards lies only in the form in which the analysis of worker’s time is
recorded. In time card the analysis of time is made with reference to each
worker whereas in job card, the analysis of time is made with reference to
each job. Figures 6.1 and 6.2 should help you to understand this difference.
Figure 6.1: Daily Time Sheet
DAVAR CO. LTD.
Daily Time Sheet

Name of worker …………………… No ………………….

Token No. of worker ………………. Date………………...
Department………….....
Job or Work Description Time Total Hours Cost
work done of work
order done
No.
On Off Ordinary Overtime Rate Amount

Total Worker……………
hours……………………
Foreman……………
Total Cost
……………………

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 Figure 6.2: Job Card Labour – Basic Concepts
DAVAR CO. LTD.
Job Card for each Job
Job Order No ……………………
Job Description …………………… Completed on …………at
Started on …………at …………
Token no of Name Deptt Work Time Total Wage Amt.
worker of done Time Rate
Worker
On Off

Checked and Verified Total time Total Amount

for the job For the job

Deptt Foremen

6.5 PAYROLL ACCOUNTING

Each organisation has to maintain a system of payroll accounting for the
purpose of commutating wages payable to workers. This involves (i) the
calculation of gross wages and net amount payable to the employees after
making all deductions, and (ii) the preparation of wages sheet (also known
as payroll) according to the specified method of wage payment.
6.5.1 Computation of Wages
The gross wages payable to each worker are computed with the help of
Time Sheets, Job Cards, or Piece Work Cards. Under the time wage system,
the amount of gross wages is calculated by taking into account the total
number of hours worked multiplied by the hourly rate of wage payment,
plus overtime premium. Under the piece wage system, the amount of gross
wages is calculated by taking into account the number of units produced
multiplied by the rate per unit. For calculating the net wages payable to
each worker, following deductions are usually made from the gross wages:
i) Fines and deductions for absence from duty
ii) Damages or loss of goods or money
iii) House rent and cost of other amenities or services
iv) Recovery of loans or advances
v) Income tax
vi) Provident fund
vii) Welfare fund
viii) Co-operative society dues
ix) Life insurance premium
x) Contribution to employees’ state insurance
xi) Deductions on the basis of court order or the directive of some other
authority.
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 Material and Labour 6.5.2 Preparation of Wages Sheet
The wages sheet (payroll) is a consolidated statement showing the gross
wages, deductions and net wages payable to workers. It is prepared at
periodical intervals according to the time of wage payment. Large concerns,
these days make use of computers for preparing the wages sheets.
A wages sheet should generally contain the following information:
1) Name of the Department, 2) Period—Month/Week, 3) Worker’s Number,
4) Name of the Worker, 5) Number of Hours worked, 6) Normal Hours of
Duty 7) Overtime Hours , 8) Bonus Earned, 9) Rate of Payment , 10) Gross
Wages plus Allowances, 11) Deductions , 12) Net Wages Payable
Normally, payrolls or wages sheets are prepared separately for each
department. But they must be checked properly to minimise the possibilities
of wrong payments either deliberately or inadvertently. Detection and
prevention of both errors and frauds, including the checking for dummy
workers in wages sheets, need attention to ensure accuracy in wage
payments.
6.5.3 Purposes of Payroll Accounting
Payroll Accounting system helps the organisation in
1) Providing relevant data for cost control;
2) Determining the net amount of wages payable to each employee
individually;
3) Knowing the total amount of wages payable by the organisation
weekly, fortnightly or monthly for the different departments of the
unit;
4) Minimising the possibilities of errors and frauds in wage payments;
and
5) Issuing pay slips to everyworker showing in detail the amount of
gross wages and the deductions made there from for ascertaining the
net amount payable for the period.

6.6 IDLE TIME

When workers are paid on the basis of time, there may be some difference
between the time paid for and the time actually spent on production. This
difference is known as ‘idle time’. In other words, idle time is a period
or duration for which workers have been paid but they have not worked
towards production in the factory. This is a wastage which needs some
effective control so that payment of wages without actual work may be
minimised.
Idle time may be of two categories: (i) normal idle time due to
unavoidable factors in the factory, and (ii) abnormal idle time caused by
avoidable factors.
6.6.1 Causes of Idle Time
The reasons for idle time may be multiple. Some of the examples of
situations which cause idle time are prescribed in figure 6.3.
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 Figure 6.3: Causes of Idle Time Labour – Basic Concepts

6.6.2 Control of Idle Time

In order to reduce losses owing to idle time, the following measures may be
adopted:
1) Fix responsibilities for various activities associated with production
and for the control of idle time occurring at different stages in the
organisation.
2) Introduce a preventive maintenance system for machines with
periodical check-ups.
3) Maintain adequate stock of raw materials and a proper system of
stores control to ensure continuity of production.
4) Use planning, give clear instructions in advance, define job participation
by workers and apply proper supervision at every stage of performance.
5) Obtain periodical reports on idle time, identify the causes of time loss
and exercise quick corrective action.
6.6.3 Treatment of Idle Time Cost
Cost of idle time should be treated in the following manner:
Item Charged to
1) Cost of Normal and Controllable Idle FACTORY OVERHEAD
Time
2) Cost of Normal but JOBS (by inflating the rates
Uncontrollable Idle Time of wages)
3) Cost of Abnormal and Uncontrollable COSTING PROFIT AND
or Unavoidable Idle time LOSS ACCOUNT

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 Material and Labour Check Your Progress B
1) State the purpose of Time Booking.
2) What do you mean by Payroll Accounting?
3) Give four examples of items determining the wages payable to a
worker.
4) Distinguish between Active Time and Idle Time.
5) Give five major causes of Idle Time.
6) State whether each of the following statements is True or False and
justify your answer.
i) Wages Sheet containing dummy names on the payroll, but fully
passed for payment, form part of labour cost.
ii) Idle time is a deliberate wastage of time.
iii) One of the techniques of minimising idle time is to keep the
tools and materials ready for use.
iv) The difference between gross wages and net wages represents
deductions.
v) Job Cards can be used for the purpose of time booking.

6.7 OVERTIME
When workers have to work beyond their normal duty hours, the additional
period us treated as ‘Overtime’. Over time is an extra time over and above
the schedule hours of work or beyond the usual working hours. When
workers are detained for overtime, they are normally paid at double the
usual rate for extra hours.
Overtime may be considered useful under the following circumstances:
1) When the urgency of work demands an immediate completion of the
job for the customer.
2) When the organisation desires to make up any shortfall in production;
3) When the company needs extra production to meet additional market
demand or seasonal rush; or
4) When the number of workers is less than the requirement.
Since overtime involves an extra cost, it needs proper authorisation and
control. One to ensure that the system is not put to misuse. This will expect
a careful scrutiny i) the justification for overtime; and (ii) the workers who
are required to be tamed for this purpose.
Treatment of Overtime Cost: Additional payment for overtime should be
charged as follows:
Nature of Overtime Charged to
1) Due to customers’ request to complete a JOB directly
job within a specified period
2) Due to general pressure of work GENERAL OVERHEAD
3) Due to delayed schedule DEPARTMENT
4) Due to loss of time for unavoidable COSTING PROFIT AND
reasons LOSS ACCOUNT
5) Due to seasonal rush and peak load PRIME COST

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 Labour – Basic Concepts
6.8 LABOUR TURNOVER
Workers often change their jobs for better prospects and better environment.
In any organisation, therefore, there is a continuous flow of labour—some
old ones are leaving and new ones are joining. Though it is a normal
process, the frequent changes in the composition of labour affect the
continuity as well as the productivity of the organisation. This, in turn,
affects the labour cost. Hence, every effort is made to reduce the labour
turnover, which is defined as the rate of change in the labour force of
an organisation during a particular period. It can be measured by the
following two methods:.
Number of Workers Left
Sepa
aration Method
Average Number of workers on Roll
OR
Number of Workers Replaced
Replacement Method
Average Number of workers on Rolll

6.8.1 Causes of Labour Turnover

Factors which cause labour turnover can be grouped into two categories:
(i) avoidable causes, and (ii) unavoidable causes
Examples of avoidable causes of labour turnover are as follows:
1) Workers and jobs not matching with each other
2) Low wages
3) Bad working conditions
4) Poor treatment by employers
5) Lack of job satisfaction
6) Absence of planning and foresight in management
7) Psychological reasons like nature, behaviour, habit of change, jumping
preferences, militant attitude, etc.
8) Poor relationship with fellow workers
9) Unfavourable or odd hours of work
10) Bad relationship with supervisors
11) Poor promotion policy
12) Inadequate protection against accidents
13) Discrimination between one worker and another
14) Lack of proper incentives
15) Absence of a sound recruitment and training policy
16) Lack of recreational and medical facilities
Among the unavoidable causes of labour turnover are the following:
1) Opportunities of better prospects
2) Sickness
3) Accident or disability
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 Material and Labour 4) Change of place of stay
5) Marriage
6) Death
7) Retirement
8) Problems of accommodation and transport.
9) Resignation
10) Retrenchment
11) Domestic problems and family responsibilities
12) Seasonal nature of the business
13) Shortage of raw materials, power supply, market demand, etc.
6.8.2 Effects of Labour Turnover
A high rate of labour turnover means that workers often leave and do
not stay long. Old workers generally possess more experience than new
workers. Replacement of workers, therefore, declines the overall efficiency.
Moreover engagement of new workers needs recruitment and training
which involves a cost. This gap between the old and the new labour often
brings down both the and quantity of output. Undue labour turnover, thus,
involves an addition the organisation owing to:
1) Cost of recruitment of substitute workers;
2) Cost of training new workers;
3) Cost of decline in production due to reduced efficiency and disturber
schedule;
4) Loss on Account of defective work and increased wastage in
production;
5) Breakage of tools and equipment due to mishandling by new workers; and
6) Wastage of materials in handling by new workers.
The overall effect of labour turnover, therefore, is a higher cost of production
and lower profitability.
6.8.3 Control of Labour Turnover
Since labour turnover is a loss to the organisation, every effort is required to
minimise its frequency. Some of the measures to minimise labour turnover are:
1) Institute proper machinery to attend promptly to the grievances of
workers;
2) Create congenial working conditions in the factory;
3) Provide adequate welfare facilities to the workers;
4) Improve employees’ morale;
5) Give opportunities for workers’ participation in management;
6) Follow a suitable policy of promotion and transfers; and
7) Develop a sound system of recruitment and training.
Control of labour turnover, therefore, needs proper job satisfaction to
workers so that they continue to serve the organisation instead of taking a
decision to change.
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 Check Your Progress C Labour – Basic Concepts
1) What is Overtime?
2) Why do we need to control overtime?
3) What do you ‘mean by Labour Turnover?
4) Judge whether the following are GOOD or BAD as a trend in a
manufacturing enterprise and justify your answer.
i) Rising Wages with stable output.
ii) High labour turnover.
iii) Declining market prices but without any change in labour cost.
iv) Workers’ decision to work extra for compensating the loss due
to strike.
v) Workers work independently without any supervision.
vi) Substantial bonus is declared .by the company to the workers.

6.9 LET US SUM UP

Labour is an important element of cost. For costing purposes, labour
may be classified into direct and indirect. Direct labour cost forms
part of the prime cost while indirect labour is included in overheads.
Recording of time of arrival and departure of Recording the workers
is termed as ‘time keeping’ for which various methods like attendance
register, token or disc method, or clocks cards are used, Such record does
not show how each worker’s time was utilised. For this purpose a system
of time booking is maintained with the help of time cards or job cards. Job
cards help in ascertaining how each worker utilised his time while he was in
the factory and also in computing the labour cost of each job or operation.
Payroll accounting refers to the system of computing net wages
payable to each worker and preparing the wages sheet according to
the specified method of wage payment. It helps in providing relevant
data for cost control and minimising the possibilities errors and frauds.
Idle time refers to the time during which workers were not engaged on
production and for which they have been paid. For costing purposes
such time may be classified into normal idle time and abnormal idle tithe.
Wages paid for normal idle time are Labour charged to jobs by inflating
the hourly wage rates. But, the wages paid for abnormal idle time carried
by un-controllable factors like machine break-down, power failure,
strike etc. are charged to the Costing Profit and Loss Account. Overtime
involves an extra cost because the workers are paid higher wages for such
time. The additional payment for overtime should be charged to general
overheads if it is done due to general pressure of work or to the job
directly if it is done for completing a specific job within a specified period.
Labour turnover refers to the rate of change in the labour force during a
particular period. It may be caused by some unavoidable factors like
retirement, marriage, disability, etc. or by avoidable factors like poor work
environment, poor labour policies, low wages, etc. Undue labour turnover
involves additional cost and low profitability and should, therefore, be
avoided.
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 Material and Labour
6.10 KEY WORDS
Clock Card: A card given to each worker on which his time of arrival and
departure is recorded with the help of clock records.
Direct Labour: Labour directly engaged in the manufacture of a product
or in a particular job.
Idle Time: Wages paid for unproductive time due to circumstances beyond
the control of the workers..
Indirect Labour: Labour employed as supervisors, repair workmen,
security men, etc.
Job Card: A card maintained for each Job on which the time spent by
different workers on that job is recorded.
Labour Turnover: Rate of change in the labour force of an organisation
during a particular period.
Overtime: Extra time spent in the factory over and above the scheduled
hours of work.
Payroll: Wages sheet recording gross wages and net wages payable to each
worker.
Payroll Accounting: A system of computing net wages payable to each worker.
Standard time: Pre-determined time allowed for completing a particular task.
Time Booking: Recording utilisation of worker’s time on various jobs,
operations etc.
Time Card: A card maintained for each worker on which the time spent by
him on different jobs is recorded.
Time Keeping: Recording the time of arrival and departure of workers.

6.11 ANSWERS TO CHECK YOUR PROGRESS

A) 4. i) False ii) False iii) False iv) True v) False
B) 6. i) False ii) False iii) True iv) True v) True
C) 4. i) Bad ii) Bad iii) Bad iv) Good v) Bad vi) Good

6.12 TERMINAL QUESTIONS

1) Distinguish between Direct Labour and Indirect Labour.
2) Bring out the salient features of Time Keeping and Time Booking.
3) What do you mean by idle time? How are wages paid for idle time
treated in cost accounts?
4) ‘Overtime is an evil’. Do you agree? Give reasons and explain extra
wages paid for overtime treated in cost accounts.
5) What is Labour Turnover? State the major causes of Labour turnover.

Note: These questions will help you to understand the unit better. Try to
write answers for them and verify with the content. But do not submit
your answers to the University. These are for your practice only.
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 Labour – Basic Concepts
SOME USEFUL BOOKS
Arora M.N. 2003. A Text Book of Cost Accountancy, Vikas Publishing
ouse Pvt. Ltd.: New Delhi. (Chapter 3-8).
Bhar, B.K. 2018. Cost Accounting: Methods and Problems, Academic
Publishers: Calcutta. (Chapter 5-9).
Iyenger, S.P., Cost Accounting, Sultan Chand and Sons.
Maheshwari, S.N. and SN. Mittal, 2018. Cost Accounting: Theory and
Problems,
Shree Mahavir Book Depot: Delhi. (Chapter 2-3).
Nigam,B.M.L. and G.L. Sharma, 2018. Theory and Techniques of Cost
Accounting,
Himalaya Publishing House: Bombay. (Chapter 4-7).
Rajiv Goel, Cost Accounting, International Book House.

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 UNIT 7 ACCOUNTING FOR LABOUR
Structure
7.0 Objectives
7.1 Introduction
7.2 Methods of Wage Payment
7.2.1 Time Wage System
7.2.2 Piece Wage System
7.2.3 Balance of Debt System
7.3 Incentive Plans
7.3.1 Halsey Premium Plan
7.3.2 Rowan Premium Plan
7.3.3 Differential Piece Rate System
7.3.4 Group Bonus Scheme
7.4 Let Us Sum Up
7.5 Key Words
7.6 Answers to Check Your Progress
7.7 Terminal Questions

7.0 OBJECTIVES
After studying this unit, you should be able to:
●● understand time wage system; and
●● understand piece wage system;
●● explain balance of wage system; and
●● explain various incentive plans used to reward labour efficiency.

7.1 INTRODUCTION
In the previous unit, you learnt various aspects of labour and how their
wages are computed. In this unit, you will learn another important aspect
of labour that is payment of wages.
There are three important methods of wage payment namely time wage
system, piece wage system and balance of debt system. Besides there are
some incentives plans by which the more productive labour is motivated
and rewarded. Incentive plans are used to compensate the efficiency of
labour for the extra efforts used in minimising the time and cost.

7.2 METHODS OF WAGE PAYMENT

One of the basic incentives to job satisfaction and labour efficiency is
adequate wages.
Unless people get proper remuneration for their services, they are not
encouraged to participate actively in discharging their duties or in completing
the assignment effectively.
There are various methods of remunerating labour. Each method has its
merits and demerits. However, a good method of wage payment should
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 1) Guarantee a minimum wage for the time devoted by the worker, Accounting for Labour
2) Easy to understand and simple to operate,
3) Balance the interests of both the employers and the employee,
4) Allow proper supervision and control over the quality of output,
5) Maintain a reasonable distinction between efficient workers and
inefficient workers in terms of their wages,
6) Reward efficiency by additional payment for time saved or target
exceeded,
7) Avoid disparity of pay in similar nature and level of operations, and
8) Incorporate flexibility to adjust with the changing circumstances of
the business
It is to incorporate all such considerations that two main methods of wage
payment have been developed. These are:
1) Time Wage System
2) Piece Wage System
Let us now discuss the characteristics, merits and demerits of these two
systems separately.
7.2.1 Time Wage System
This is the most popular method of payment to workers. Under this system,
wages are based on the amount of time spent by a worker inside the factory.
He is paid at a specified rate per unit of time (for example, per hour, per
day, per week or per month) for his services rendered to the organisation.
Calculation of wages under this method of remuneration takes into account:
(i) the time for which the workers are engaged on the job and, (ii) the rate
per unit of time fixed for payment. For example, if a worker gets Rs. 5 per
hour, he works for 8 how per day and has been present for duties on 25 days
during the month, his wage for the month on the basis of Time Rate will be:
Rs. 5 × 8 × 25 = Rs. 1,000.
The main advantages of Time Rate method of wage payment are:
1) It offers a fixed minimum wage to the worker for a defined period of time.
2) It simplifies calculation of the payable amount of wages.
3) It makes a stable and secure return to the workers.
4) It encourages the workers to do their jobs with utmost quality, care
and efficiency and in the best possible manner.
5) It promotes a sense of equality and unity among the workers.
6) It is an economical system to the organisation in respect of wage
administration material use, plant operation and quality control.
The major disadvantages or limitations of Time method of wage payment are:
1) It ignores the individual quality and quantity of output.
2) It reduces personal initiative to work faster.
3) It treats both efficient and inefficient workers at par.
4) It increases the cost of labour per unit because of the tendency to
consume more time in finishing a job.
5) It needs a close supervision to ensure continuity of operations.
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 Material and Labour 7.2.2 Piece Wage System
When workers are paid on the basis of their output, irrespective of the time
consumed in completing the work, it is termed as Piece Wage. The rate of
payment under this method is related to the quantity of work done i.e. per
unit of output, per article per job or per commodity. Under this system, the
total units produced or manufactured by the worker during a given period
form the basis of computation of his wages for the period. For example, if
the rate of labour per chair is Rs.50 and the worker has completed 10 chairs
during a week, his wages for the week on the basis of piece rate will be:
Rs. 50×10 = Rs. 500
The major advantages of Piece Wages system are that it
1) Places greater reliance on the merit and efficiency of workers;
2) induces workers to be efficient, produce more and earn higher wages;
3) facilitates prompt computation of cost for quotations; and
4) maintains plant and equipment properly so as to avoid disruption in
work.
The main demerits or disadvantages of the piece wage system of wage
payment are at it:
1) ignores quality of products in an effort to maximise output;
2) kills a long-term interest and continuity of engagement in the
organisation of the workers;
3) treats workers as unsecure and uncertain in terms of wages payable
during different periods;
4) creates dissatisfaction among workers owing to disparity in wages;
5) needs a continuous supervision over the quality of operations;
6) enhances wastage of materials, wear and tear of machines and
absenteeism of workers; and
7) declines the level of labour discipline.
7.2.3 Balance of Debt System
In order to retain the merits of both Time Wage and Piece Wage systems,
as also to minimise their demerits, a balanced system of wage payment
is recommended in developing units. This is known as ‘Balance of Debt
system’ which is a compromise between the Time Wage and Piece Wage.
The two main features of Balance of Debt system are:
i) Minimum Payment: The worker is paid on the basis of a piece rate
per unit of output. In case, due to some unavoidable factors, the
earnings of a worker at piece rate are less than his earnings at time
rate, he is paid on time basis.
ii) Recoupment: The difference between the time rate and piece wage
paid to the worker is treated as an extra payment to be recouped from
his subsequent earnings when his piece rate wages are more than time
rate wages. This grants protection to workers to earn a minimum wage
on the basis of time rate even if he completes a job in longer hours due
to some unavoidable reasons. The recovery of extra payment too may
not be felt inconvenient by the worker when his piece wage earnings
exceed the time rate wages.
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 Under the Balance of Debt System, therefore, a worker gets fixed wages for Accounting for Labour
the time he works, plus extra payment for his performance beyond a certain
prescribed limit of output.

7.3 INCENTIVE PLANS

You have learnt that wages are paid to labour on time rate or piece rate
basis. But individual performance must also receive attention in a structure
of wages so that an appreciable difference is maintained between a good
worker, an average worker and a bad worker. Not only that, efficiency of
labour usually saves time and cost. Hence, it would be justified that a portion
of the benefit which goes to the organisation through labour efficiency is
also shared by those who generate this benefit. Incentive plans are used
to compensate the efficiency of labour for his extra efforts used in
minimizing the time or cost. It may be in the form of a bonus or premium.
Incentive plans are devised to compensate the worker through an additional
payment over and above their guaranteed wages. The plans also aim at
keeping efficient workers satisfied with their employment. The standard
time and standard performance are determined in advance so as to judge
individual contribution. In case there is a gain on time saved, it is distributed
between the employers and workers.
The main features of most incentive plans are:
1) The standard time and standard performance are determined in
advance.
2) Time wages are guaranteed to all workers.
3) Efficient workers are given incentive by way of bonus for the time
saved.
4) Wages per hour increase but not in the same proportion as the output.
5) Labour cost per unit of output decreases. The employer also shares
the benefit of efficiency which induces him to improve the methods
and equipment.
Some of the prominent plans are discussed here in detail.
7.3.1 Halsey Premium Plan
The main features of Halsey Premium Plan as a method of incentive to
efficient workers are as follows:
1) Standard time and standard work are prescribed in advance.
2) Workers are paid for the actual time they take to complete the job as
per the time rate.
3) If a worker completes the job in less than the pre-determined standard
time, he is given a bonus for the time saved. This is in addition to his
wages for the actual time spent on the job.
4) A bonus equal to 50 per cent of the wages of time saved is paid to the
worker as a reward to his good work.
5) Workers who fail to reach the prescribed standard get the time wage
The rate of bonus under the Halsey Premium Plan may vary according to the
policiesof the organisation. In some cases, it may be 1/3 of the wages of time saved.

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 Material and Labour It is a simple system to operate. It guarantees the hourly wages to workers for
the actual time. But fixation of standard time is a difficult process. Workers
however, fee that they do not get the full benefit for the time saved under
this system.
Method of Computation
Total Earnings of the worker = (Time Rate × Time Taken) +
1
Time Saved Time Rate
2
1
or, (T × R) + (S —T) × R
2
Where S = Standard Time
T = Actual Time Taken
R = Rate of Wages per Hour
Now, if the Standard Time for a Job = 8 hours
Actual Time = 6 hours
Rate per hour = Rs. 7
Then, Total Earning of the worker are
= (6 × 7) + 1 2 × 7
2
= Rs. 49
This includes times wages of Rs. 42 and Rs. 7 as bonus for time saved. It
is to be noted here that the worker gets Rs. 49 for 6 hours, which comes to
Rs. 8.16 per hour.
7.3.2 Rowan Premium Plan
Rowan Premium Plan is similar to Halsey Plan. The main features of Rowan
Plan are:
1) Workers are paid for the actual time taken by them in completing the
job on the basis of time rate.
2) They are paid a bonus for the time saved i.e., for the difference
between the standard time and actual time.
3) Bonus under this method is calculated as a proportion of the time
wages as time saved bears to the standard time.
Method of Computation
Time saved
Time Saved
Bonus = T × R ×
S
S−T
Total Earnings = (T × R) + (T × R × )
S
8−6
In the above example, it will be = (6 × 7) + (6 × 7) ×
8
= Rs. 52.50
This includes time wages of Rs. 42 and Rs. 10.50 as bonus for time saved.
Since the worker gets Rs. 52.50 for 6 hours, it amounts to Rs.8.75 per hour.
The merits and demerits of Rowan Plan are similar to those of Halsey Plan.
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 An additional advantage under Rowan Plan is that the worker is not induced Accounting for Labour
to rush through the work because if time saved is more than 50 per cent
of the standard time, the bonus will decrease. However, the calculation of
bonus is complicated.
Look at Illustration 1 and study how total wages of a worker are calculated
under different plans.
Illustration 1 :
The standard time allowed to complete a job is 100 hours and the hourly rate
of wage payment is Rs. 5. The actual time taken by the worker to complete
the job is 80 hours.
Calculate the total wages of the worker on the basis of :
i) Time Rate ii) Piece Rate iii) Halsey Plan iv) Rowan Plan
Also compare the effective earnings per hour under the above methods.
Solution:
i) Time Rate
Total Wages = 80 × 5 = Rs. 400
ii) Piece Wage
Total Wages = 100 × 5 = Rs. 500
iii) Halsey Plan
Basic Wages for 80 hours at Rs. 5 per hour = Rs. 400
1
Bonus (of Basic Wages for Time Saved) = 20 × 5 × = Rs. 50
2
Total Wages = Rs. 450
iv) Rowan Plan
Basic Wages for 80 hours @ Rs. 5 per hour = Rs. 400
20
Bonus for Time Saved = × 80 × 5 = Rs.80
100
Total Wages = Rs. 480
Commutative Earnings Per Hour
Time Rate = Rs. 400 ÷ 80 = Rs. 5
Piece Wage = Rs. 500 ÷ 80 = Rs. 6.25
Halsey Plan = Rs 450 ÷ 80 Rs. 5.62
Rowan Plan = Rs 480 ÷ 80 = Rs. 6
7.3.3 Differential Piece Rate System
Besides Halsey and Rowan Premium Plans, there is yet another line of
thought in respect of incentive methods. This system believes in payment
of wages to labour on the basis of piece rates varying with the level of
efficiency of workers.
Some of the exponents of differential piece rate system are:
i) Taylor ii) Gantt iii) Merrick
Let us now study the main features of their suggestions regarding the exact
basis on which the rates of payment should be distinguished between one
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 Material and Labour worker and another.
i) Taylor System
The main features of this system are:
a) It offers a higher piece rate to workers beyond a defined level of
output;
b) It distinguishes between workers through two types of piece rates: (i)
a lower rate for sub-standard performance (e.g. 80% of piece rate),
and (ii) a higher rate for standard and above standard performance,
which is much more than time wages (e.g. 120% of piece rate)
c) It acts as an additional incentive to expert workers towards maximisation
of production; and
d) It ignores any form of guaranteed day wages.
Illustration 2:
Standard Time allowed 10 units per hour
Normal Piece Rate Rs. 5
Differential Piece Rate:
80% of Piece Rate for Output below standard
120% of Piece Rate for output at or above standard
A produces 75 units in a day of 8 hours
B produces 100 units in a day of 8 hours
Compute wages of A and B under Taylor Differential Piece Rate System.
Solution :
Piece Rate will be 5 ÷ 10 = Rs. 0.50 per unit
Standard Output in 8 hours is 8 × 10 = 80 units
So A’s performance is below standard and B’s above standard
80
Earnings of A = 75 × 0.50 × = Rs. 30
100
120
Earnings of B = 100 × 0.50 × = Rs. 60
100
Labour Cost per unit
A = 30 ÷ 75 = 0.40 per unit
B = 60 ÷ 100 = 0.60 per unit
ii) Gantt Task Bonus Plan
This system combines the (a) Time Wage, (b) Piece Wage, and (c) Bonus
Plan. It mainly follows a differential piece rate basis of remuneration with
the following method of computation:
a) Output below standard to be paid at guaranteed Time Rate
b) Output at standard to be paid with 20 per cent of Time Rate as Bonus
c) Output above standard to be paid at high piece rate on the entire output
of the worker.
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 Gantt System, therefore, offers an incentive to efficient workers for increased Accounting for Labour
production. It means lesser the time consumed in completing the job,
higher the earnings per hour. The standard output within a specified period
is pre-determined. Bonus is paid at the rate of 20% for 100% efficiency.
Those workers who complete their job in the standard time are treated as
100 per cent efficient. They get wages for time taken plus bonus at a fixed
percentage of wages. If a worker completes his job in less than the standard
time, he gets wages for standard time plus bonus at a fixed percentage of
wages earned (which is usually 20%). Slow workers, howeve4 still get the
guaranteed wage for the day.
Illustration 3 :
Standard Rate = Rs 5 per hour
Standard Hours for the Job = 8 hours
Bonus = 20% of Standard Time
Worker A completes the work in 10 hours
Worker B completes the work in 8 hours
Worker C completes the work in 6 hours
Compute the earnings of A, B and C under Gantt Task Bonus Plan.
Solution:
The comparative earnings per hour of the three workers will be computed
as follows:
A: Wages for 10 hours at Rs. 5 per hour Rs. 50
B: Wages for 8 hours at Rs. 5 per hour = Rs. 40 + 20% of 8 hours
= 40 + 8 = Rs. 48
C: Wages for 6 hours =
Wages for 8 hours at Rs. 5 per hour = Rs. 40 + 20% of 8 hours = Rs. 48
A’s earnings per hour = Rs. 5
B’s earnings per hour = Rs. 6
C’s earnings per hour = Rs. 8
iii) Merrick Differential Piece Rate System
The man features of this system are as follows:
a) It is a multiple piece rate system.
b) All workers under this scheme are paid only on the basis of their
output.
c) Time Rate wages are not guaranteed to the workers; they are paid on
the basis of their efficiency.
d) The rates of payment under this system are:
Level of Efficiency Payment
Up to 83% of the standard Normal Piece Rate
83% to 100% 110% of Normal Piece Rate
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 Material and Labour Above 100% 120% of Normal Piece Rate
Illustration 4:
Piece Rate—Rs 20 per unit
Standard Output—24 units per day of 8 hours
Output of A – 16 units
Output of B – 21 units
Output of C – 25 units
Compute wages for A, B and C under Merrick Differential Rate System.
Solution:
A: Efficiency = 16 ÷ 24 × 100 = 67%
As this level is below 83%, wages = 16 × 20 = Rs.320
1
B: Efficiency = 21 ÷24 × 100 = 87 %
2
Efficiency level is above 83% but below 100%
Wages = 21 × 22=Rs. 462
C: Efficiency = 25 ÷ 24 × 100 = 104%
Efficiency level is above 100%. Rate per unit will be Rs. 24
Wages = Rs.600 (25 × 24)
A gets Rs. 20 per unit, B Rs. 22 per unit and C Rs. 24 per unit.
7.3.4 Group Bonus Scheme
This system rewards a group associated with production rather than the
individual workers.
The main characteristics of this system are:
a) Bonus is paid for collective efficiency in production.
b) Bonus is payable to a group of workers for their joint output over and
above the given target.
c) Distribution of bonus to the individual members of the group is made
on some agreed basis or in specified proportions.
d) Production is considered o be a team effort governing the efficiency
of performance.
e) It is a method of payment by results based on group productivity
being shared by the workers either equally or in different specified
proportions between workers of different skills.
f) The aim is to create a team spirit for increased production and lower cost
per unit through healthy competition between different groups.
g) The system gives an opportunity also to foremen and supervisors to
share the deals of efficiency in output and to take adequate initiative
in this area.
Check Your Progress A
1) How can you determine wages under the time rate system?
2) Why do we pay labour on piece wage basis?
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 3) State the need for labour incentives through bonus and premium. Accounting for Labour
4) Which one of the following alternatives should be the most advantageous
choice of objective in a company?
i) Increased production
ii) Minimum wages
iii) Effective supervision
iv) Extended hours of duty
v) Uniform rates of payment to all staff
vi) Fully mechanised operations
vii) Labour satisfaction -
viii) Industrial peace
ix) Optimum efficiency
x) Tight control over punctuality of workers.
5) State whether each of the following statements in True or False and
justify your answer.
i) A good method of wage payment should guarantee a minimum
wage to all workers.
ii) Time wage system motivates the worker to work faster.
iii) Under piece wage system, the worker maintains the plant and
equipment properly.
iv) Balancedebt system is a compromise between time wages and
piece wages systems.
v) Under incentive plans wages per hour increase in the same
proportion as the output.
vi) Rowan premium plan is more complicated than the Halsey
premium plan.
vii) Taylor differential piece rate does not ignore guaranteed day
wages.
viii) Gantt task bonus plan combines time wage system, piece wage
system and bonus plan.

7.4 LET US SUM UP

One of the basic incentives to job satisfaction and labour efficiency is
adequate wages. This has two aspects – proper remuneration for the services
rendered by the labour but control over the non performing labour as well.
There are basically three methods of wage payment system. These methods
are time wage system, piece wage system and balance of debt system.
Each method has certain merits and demerits. For example, time wage
system offers a fixed minimum wage for a defined period of time, but
the disadvantages is that it ignores the individual quality and quantity of
output. Similarly, piece wage system has the advantage that it places greater
reliance on the merit and efficiency of workers. But its disadvantage is that
it ignores quality of the products in an effort to maximize output. These are
other advantages and disadvantages also.
It has been realized that besides paying wages on time rate or piece rate
basis, there must be some plan to differentiate between a good worker, an
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 Material and Labour average worker and a bad worker. Thus some incentive plans are used to
compensate efficiency of labour for the extra efforts used in minimising
the time and cost. There are three incentives plans - Halsey Premium Plan,
Rowan Premium plan, and Group Bonus Scheme.

7.5 KEY WORDS

Balance of Debt System: A system of wage payment under which a worker
is paid on the basis of piece rate subject to a minimum wage based on the
time spent by him in the factory. The extra payment is recouped from his
subsequent extra earnings.
Differential Piece Rate System: A system under which piece rate varies
according to the efficiency of workers.
Piece Wage System: A system under which wages payable to workers are
based on their output.
Time Wage System: A system under which wages payable to workers are
based on the time spent by workers in the factory.

7.6 ANSWERS TO CHECK YOUR PROGRESS

A) 1. 4 (ix)

7.7 TERMINAL QUESTIONS

1) Name the various methods of remunerating labour and explain any
one of them in detail.
2) What are the different methods of incentives? Discuss any one of the
systems of bonus or premium which you consider as effective.
3) Comment on the relative utility of:
a) Halsey premium Plan
b) Rowan Premium Plan
c) Differential Piece Rate System
d) Group Bonus Scheme.
4) Compare merits and demerits of Time Wage System and Piece Wage
system.
5) How balance of debt system retains merits of time wage and piece
wage systems and minimizes their de-merits.
Exercise
6) Guaranteed wage of a skilled workers for 44 hours per week is Rs.
150 per hour. The Standard time to produce one item is 30 minutes.
Under incentive scheme the time allowed is increased by 20%.
During one week, the worker manufactured 100 items. Calculate his
wage under (i) Time wage, (ii) Piece wage, with a guaranteed weekly
rate of wage (iii) Rowan Plan, and (iv) Halsey Plan.
(Answer: (i) Rs. 6,600; (ii) Rs. 9,000 (iii) Rs. 8,359.56 (iv) Rs. 7,800
7) Calculate the earnings of a worker from the data given below:
(i) Time wage (ii) Piece Wage (iii) Halsey Method (iv) Rowan
Standard time for completion of job is 30 hrs. Time taken is 20
hours.
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 Hourly rate is Rs. 100 and Dearness allowance @ Rs. 50 per hour Accounting for Labour
worked.
(i) Rs. 3,000 (ii) Rs. 4,000 (iii) Rs. 3,500 (iv) Rs. 3,667
8) From the following information, Calculate the earnings of A and B
workers under (i) Strait Piece Rate and (ii) Differential Piece Rate
Systems.
Normal rate per hour Rs. 100, standard time per unit – 30 seconds.
Worker A and B produced 800 units and 1,000 units respectively per
day of 8 hours.
Worker A Worker B
1. Rs. 664 Rs. 830
2. Rs.528 Rs. 990
9) Calculate the earnings of workers A, B and C under Strait Piece Rate
and Merrick’s Differential Piece Rate Systems.
Normal Rate per hour Rs. 75
Standard time per unit 1minute
Workers output per day of 8 working hours as follows:
A= 390 units, B = 450 units and C = 600 units
(Answer: Strait Piece Rate : a) Rs. 487.50 b) Rs. 562.50 c) Rs. 750
Merrick Piece Rate : a) Rs. 487.50 b) Rs. 616.50 c) Rs. 900
10) In a day of 8 working hours, the output of X, Y and Z workers is 75
units, 80 units and 85 units respectively. Guaranteed time rate is Rs.
150 per hour. Standard output is 10 units per hour. High piece rate is
fixed at Rs. 20. You are required to calculate the earnings of X, Y and
Z workers under Gantt Task Bonus Plan.
X) Rs. 1,200 Y) Rs. 1,440 Z) Rs. 1,700

Note: These questions will help you to understand the unit better. Try to
write answers for them and verify with the content. But do not submit
your answers to the University. These are for your practice only.

SOME USEFUL BOOKS

Arora M.N. 2003. A Text Book of Cost Accountancy, Vikas Publishing
House Pvt. Ltd.: New Delhi. (Chapter 3-8).
Bhar, B.K. 2018. Cost Accounting: Methods and Problems, Academic
Publishers:
Calcutta. (Chapter 5-9).
Iyenger, S.P., Cost Accounting, Sultan Chand and Sons.
Maheshwari, S.N. and SN. Mittal, 2018. Cost Accounting: Theory and
Problems,
Shree Mahavir Book Depot: Delhi. (Chapter 2-3).
Nigam,B.M.L. and G.L. Sharma, 2018. Theory and Techniques of Cost
Accounting,
Himalaya Publishing House: Bombay. (Chapter 4-7).
Rajiv Goel, Cost Accounting, International Book House.
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