MODULE II

ACCOUNTING AND CONTROL OF MATERIAL COST

SYLLABUS
Material Purchase Procedure-Inventory Control-Material Stock Level-EOQ-ABC-VED and
FSN Analysis-JIT-Stock Turnover-Material Issue control-Stores records – Bincard and Stores
ledger-Documents authorizing movements of materials-Inventory System:Perpetualand
Periodic Inventory System-Continuous Stock Taking-Material Losses-Wastage-Scrap-
Spoilage-Defectives-Pricing of Issue of Materials-FIFO-LIFO-Simple Average-Weighted
Average.

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ACCOUNTING AND CONTROL OF MATERIAL COST

The basic input from which a product is manufactured is termed as material. In the
production of any finished goods materials plays an extremely significant role. It is the first
and most important element of cost of a product. The quality of finished goods is also
governed by the quality of raw material which is used in production process. Hence, control
over material is very essential to meet the objectives of cost control and cost reduction and to
assure a steady supply of each item of material.

Material Cost

The cost of material used at the basic input in a process of production of any good is known
as the Material Cost. Material cost involves Direct material cost and Indirect material cost.

Material Cost Accounting (MGU OCT. 2019)

Material cost accounting is the technique of accounting for materials which are acquired and
issued to production.

Material Cost Control – Definition and Meaning (MGU OCT. 2019)

Material Control may be defined as “the systematic control over the purchasing, storing and
using of materials so as to have the minimum possible cost of materials”- CIMA England

Material cost control is the control of the cost of materials by eliminating wastage in
purchasing, storing and pricing the issue of materials to the departments or cost centres. It is a
management activity that administers how the inventory employed in the production process
is procured, acquired, handled and utilized. It aims at keeping the material cost within
reasonable limits, budgets or standards.Materials include both Direct materials and Indirect
materials.

According to CIMA, London, Direct Material Cost is “the cost of materials entering into
and becoming constituent elements of a product or saleable service and which can be
identified separately in product cost”.

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Direct Material Cost is the cost of material which can be clearly traced and identified to a job,
product, process, cost centre or cost unit. It is the cost of materials used for a specific product
or service.

Indirect Materials are those materials which cannot be traced or identified to a job, product,
process, cost centre or cost unit.

Objectives/Advantages/ Need of Material Control and Accounting (MGU OCT. 2019)

Materials constitute a major portion of cost of production. Following are the important
objectives material control:

1. Ensuring un-interrupted production: The main objective of material control is to

ensure the un-interrupted supply of materials for smooth flow of production. Material
control helps in making available the right type of material at right time.
2. Availability of quality of materials: Material control helps to make available right
type of material of required quality without any interruption. Material control
department ensures the supply of quality material from the supplier which is to be
used in the production process. If the quality of material is not proper, it will
ultimately affect the goodwill of the concern.
3. Prevent overstocking: Material control helps to reduce overstocking of materials and
consequent blocking up of working capital.
4. Purchase of quality materials: Purchase of material of required quality according to
the standard fixed.
5. Purchase at lowest cost: Material control helps to purchase of material at reasonably
low cost or at maximum economy without affecting quality.
6. Reduces storage cost: purchase only the required quantity of materials helps to
reduce loss of obsolescence of materials.
7. Provides information to the management: a good system of material cost control
helps to provide information to the management regarding the cost of materials and its
availability.
Essentials of Material Control
The following are the essentials of material control:
1. There should be co-operation and co-ordination among the departments.
2. Centralization of purchasing function.

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 3. Standardization of control procedure and use of standard forms upon which alone
properly written instructions are acceptable.
4. Scheduling material requirements and the preparation of the material budget.
5. Classification and coding of materials.
6. Operation of a system of internal check to ensure that the work of one is
automatically checked by the other.
7. Purchase of material only when required and properly authorized.
8. Fixation of stock levels.
9. Proper records should be maintained to ensure that there is minimum wastage.

STAGES/ STEPS FOR MATERIAL CONTROL

The material control is guaranteed through lying down proper methods for Storing,
Purchasing, Issuing and minimizing material losses through identifying slow moving,
obsolete, dormant material and also through minimizing scrap, wastages, spoilages and
defectives. These steps are discussed below.

1. Purchase Control
2. Stores Control
3. Proper Issue of Materials.

A. PURCHASE CONTROL

Purchase control is the control of the cost of materials through systematic purchase of
materials, so that, right quality materials are made available at right quantity at right time.

Purchasing Department

Purchase department is a department which entrusted with the duty of purchasing materials. It
plays a very important role in an organization because purchasing has its effect on every
factor in the manufacture, cost, quality, efficiency and prompt delivery of goods to the
customers. Purchasing is an important function of materials management. According to the
size of the organization, there should be a separate purchasing department and all types of
materials purchasing responsibility should be entrusted to this department. The head of this
department is known as the Purchase Manager.

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 Functions/ Duties of Purchasing Department/ Purchase Manager

This department/ manager is entrusted with all purchasing activities. The following are the
major duties of purchase manager.

 Preparation of purchase budget

 Receiving purchase requisition
 Ascertaining the source of materials
 Selecting the supplier
 Issue of purchase order
 Economic purchase
 Minimum investment in materials
 Purchase of quality materials
 Better supplier relationship
 Develop alternate sources of supply
Centralized Purchasing
Centralized purchasing is the system of purchasing, where all purchases are
made through one department or one office or one person specialized in
purchasing. There is only one purchasing department and all the purchases are
made by this department. This department is headed by the purchase manger.
Advantages of Centralized Purchasing
 More trade discount
 Reduced transportation cost
 Maintenance of quality of materials
 Avoidance of unnecessary purchase
 Less capital investment
 Avoidance of obsolescence

Disadvantages of Centralized Purchasing

 High cost of maintaining the department

 Losing the benefit of local purchasing
 Delay in procurement
 Not suitable for all concerns

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  Chance of wrong purchase

Decentralized Purchasing

Decentralized purchasing is the system of purchasing, where the purchases are made by the
respective production departments to meet their material requirements. The materials
purchased are stored in separate stores situated in various production centres.

Advantages of Decentralized Purchasing

 Low cost of purchasing

 Easy availability of materials
 Less capital investment
 Low material handling charges
 Issue of required quality materials

Limitations of Decentralized Purchasing

* Less trade discount

* High transportation cost
* Unnecessary purchase
* More capital investment
* Inefficient purchase personnel

Purchase Procedure / Purchase Routine/ Steps in Purchasing

The main function of purchase department to buy the materials at reasonable price and supply
them when required without interruption. To perform this function properly purchase
department follows the following steps:

1. Purchase Requisition

A purchase requisition is a formal request to the purchasing department to purchase materials.

For regular purchase of materials, it is prepared by the stores department and it is known as
regular purchase requisitions. But for any materials required for production, it is prepared by
the production department and it is known as special purchase requisitions. It is prepared in

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triplicate. The original copy is sent to the purchasing department, duplicate is kept by the
storekeeper and the other for the department which prepares it.

2. Calling for Tenders and Selecting Suppliers

Quotations are invited from the suppliers and a comparative study should be made to decide
who should be selected. A rational selection is made after considering the capabilities of the
supplier.

3. Placing the Purchase Order

A purchase order is a formal order prepared and sent by the purchasing department to the
supplier as per the specifications fixed. It is a written authorization to the supplier to supply
materials.

4. Receiving the Materials

Once the goods are received, the goods receiving clerk enters all details in the Goods
Received Note. Five copies of the note are prepared. One copy is kept by the receiving
department, other copies are sent to the store keeper and he will sign all the copies. One copy
will be retained by him and the remaining ones will be sent to the purchase department,
accounts department and the departments initiating the requisition.

5. Inspecting the Materials

Usually, there will be a separate Material Inspection Department for inspecting the quality of
materials received. Once the goods are inspected, the material inspector enters all details in
the Goods Inspection Note.

6. Making Arrangement for Payment

The invoice received from the supplier is sent to the accounts department for payment. The
quantity and price in the invoice are checked with reference to the Goods Received Note and
Purchase Order. Having verified the invoice in all respects, the accounting department passes
the invoice for payment and the cashier can make payment.

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B. STORES/ INVENTORY CONTROL

Store is a place where the various items of materials are kept safely till they are issued to
production. All manufacturing firms maintains a store under the control of a person called
Storekeeper. Materials required for the production department will be issued from the store as
and when it is needed. It act as a link between the purchasing department and production
department.

Stores control is the control of the cost of the materials by eliminating all wastages in storing.

Types of Stores

Size, nature and financial position of the concern determine the type of store. There are three
types of stores: Centralized stores, Decentralized stores, and Centralized stores with sub
stores.

Centralized Stores: it is a store located at a central place where all materials are stored.
All items of materials purchased for the firm is stored in the centralized store and are issued
to all production departments from this store.

Advantages:

- Better supervision
- Better layout of stores
- Economy
- Minimum investment in stock
- Easy verification and stock taking
- Avoidance of loss due to obsolescence

Decentralized Stores: Decentralized stores are those stores located at different locations,
preferably near production centres. These are the stores where materials are received and
issued from the same place. A large companies maintain decentralized stores near to its
production centre so that they can avoid production disruption and minimize the carrying cost
of inventory.

Central Stores with Sub Stores (Imprest System): It is a combination of both

centralized and decentralized stores. In big factories, where production departments are

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situated at a distance from the central stores, a sub store is established near the production
department, in order to minimize the material handling charges.

Store keeper/ Stores Manager

A store keeper is an executive of the organization who is entrusted with the duty of proper
upkeep of different stores items.

Duties/ Responsibilities/ Functions of Store Keeper

- Receiving of materials
- Classifying the materials
- Finding a place for each item
- Fixation of stock levels
- Maintains stores record
- Issue of materials
- Issuing purchase requisition

INVENTORY/ STORES MANAGEMENT

Inventory management is that part of materials management, where optimum level of raw
materials, work-in-progress, finished goods, consumables, spares, and supplies are
maintained, so that, regular supply of material is assured for continuous flow of production
and other activities. Inventory management involves following techniques:

1. Fixation of Economic Ordering Quantity (EOQ)

2. Stock levels of Materials
3. Stock Turnover/ Inventory Turnover
4. Selective Inventory Control (Analysis of Inventories)
a) ABC Analysis
b) VED Analysis
c) FSN Analysis
d) JIT System
5. Stores Records
a) Bin card or Bin Tag or Stock Card
b) Double Bin System

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 c) Stores Ledger
6. Inventory System/ Stock Taking
a) Periodic and Annual Inventory System
b) Perpetual Inventory System
c) Continuous Stock Taking
1. Fixation of Economic Ordering Quantity (EOQ):Economic Ordering
Quantity is that quantity of a material to be purchased at a time in lot, so that, the cost
per unit of the material supplied to production will be the lowest. EOQ is an important
factor in controlling inventory. The quantity to be purchased at the minimum cost is
called Economic Order Quantity. The quantity to be ordered depends on two factors.
They are ordering cost and carrying cost. Economic Order Quantity is determined by
balancing these costs.
a) Ordering Cost: It is the cost of placing one order at a time to purchase a
particular material. It includes all the costs for getting an item into the firm’s
inventory.
b) Inventory Carrying Cost: Carrying cost is the cost incurred on carrying or
storing or maintaining inventory in the store.
Economic Order Quantity can be ascertained from the following formula.

EOQ = √2CO/I

Where, C= Consumption of the material per annum

O= Ordering cost per order
I= Inventory carrying cost per unit per annum
2. Stock Levels of Materials:The major objective of material control is to maintain
the stock of raw material as low as possible and to ensure the availability of materials
as and when required.Overstocking leads to unnecessary blocking up of working
capital and understocking may interrupt production. The object of fixing stock level is
to maintain required quantity of material in the store. The different stock levels are:
a) Minimum Stock Level/ Safety Stock: Minimum Stock Level is the minimum
quantity or minimum number of units of material to be made available in the store
at any time. Materials should not be allowed to fall below this level. If the stock
falls below this level, the production will be held up for want of materials.
The factors taken for fixing the minimum level are:

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 - Average rate of consumption of material
- Lead time (time required to get fresh delivery)
- Re-order level
- Special allowance to cover emergencies.

Formula :

Minimum Level= Reorder level- (Normal Consumption x Normal Reorder Period)

Normal (Avg) Consumption= Min.Consumption+Max.Consumption
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b) Maximum Stock Level: Maximum stock level is that level of stock above which
the stock in hand should never be allowed to exceed. It is the largest quantity of a
particular material which may be held in the store at any time.
Formula:

Maximum Level= Reorder level + Reorder Quantity – (min.consum. x Min.reorder period)

c) Reorder Stock Level: Reorder stock level is the stock level at which the stores
department issues purchase requisition and the purchasing department places
order for fresh supply of materials. This level is fixed between minimum and
maximum levels. This level is fixed above the minimum level to guard against the
abnormal usage of material. When the stock of material reaches tis point, the store
keeper initiates purchase requisition.
Formula :
Re-order Level = Maximum Consumption x Maximum Reorder Period
OR
= Min. Level + (Normal Consumption x Normal Reorder Period)
d) Average Stock Level: Average Stock Level is the average quantity of materials to
be kept in the store.
Formula:
Average Stock Level = Minimum Level + ½ Reorder Quantity
OR
= Min. Level + Max. Level
2

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 e) Danger Level: Danger level is the level set below the minimum stock level, at
which, the stores department is cautious in issuing materials. When stock of
material reaches this level, normal issues will be stopped.
Formula:
Danger Level = Average Consumption x Emergency supply time
Reorder Period: It is the time required for getting fresh supply of materials on
placing orders. It is also called as Lead Time. Normal reorder period is the normal
or average time required for getting fresh supply.
Formula:
Normal ( Avg.) reorder period = Min. reorder period + Max. reorder period
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3. Stock Turnover/Inventory Turnover: Stock turnover indicates the rate of
speed at which materials are consumed. The aim of ascertaining stock turnover ratio
is to ensure the availability of all types of materials required and to avoid over or
under investment in materials.
Formula:
Stock turnover ratio (in times) = Value of materials consumed
Avng.value of materials kept during the period
Value of materials consumed= Opening stock of materials + materials purchased
during the period – closing stock of materials
Avg. stock = Op.Stock + Cl.Stock
2
Stock turnover ratio (in days) = 365/ Material turnover ratio in times
4. Analysis of Inventories: The following are the selective control methods,
a) ABC Analysis: Always Better Control technique is a method, where, stock of
materials are categorised on the basis of their relative economic importance or
value. Under this system the stores are categorised into A,B and C on the basis of
their relative value and quantity.
Category ‘A’ include very costly materials, but form only a small part of the total
inventory in volume and it requires greater care and control. Materials which
constitute a major portion of the total inventory but relatively of small value are
grouped under ‘C’Category and it require comparatively less care. Items of

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 materials whose quantity and value are more or less same are brought under
Category ‘B’ and it requires normal care and attention.
Advantages/ Need of ABC Analysis
1. Provides better means of material control: Grouping of material provides a
better means of material cost control.
2. More attention on costly items:It categorises the material on the basis of
their value, it helps to give more attention and care on those materials of high
value.
3. Less attention to less costly items: In ABC analysis, C category items are
large in quantity with very less value. Such items require only routine care.
4. Reduction in investment:under this method A category items are purchased
only to the minimum requirement, so that, the capital investment in those
items are kept at the minimum.
5. Low carrying cost:In this method, more storage cost can be incurred for more
valuable items but only less storage cost is required for low valuable items.
This will reduces total carrying cost.
6. Strict control:Under this method, strict control can be excercised to the
materials in group A that have higher value.
b) VED Analysis: Vital, Essential and Desirable Analysis is a material control
device applied based on the basis of essentially and relative importance of
availability of certain materials. On the basis of relative importance, spare parts
are classified as 3 categories viz., Vital, Essential and Desirable. Vital spare parts
are those parts whose non-availability may lead to stoppage of production.
Production may not be interrupted due to the non- availability of Essential spares
for some hours, beyond which production will be stopped. Desirable spares are
those which are needed but their absence for certain days may not lead to stoppage
of production.
Advantages of VED Analysis
1. Ensuring availability of very essential items.
2. Avoiding stoppage of work by maintaining vital items and materials through
selective control.
3. Unnecessary locking up of capital can be avoided.
4. Avoiding loss due to obsolescence.
5. Continuous flow of work

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c) FSN Analysis: Fast moving, Slow moving and Non moving analysis is a method
of categorising materials in the store, on the basis of their speed of movement
from the store. In this method, the inventories are classified into Fast moving,
Slow moving and Non moving items. Frequently used materials are called Fast
moving materials. Its inventory turnover ratio will be very high. Slow moving
items are not frequently used. The turnover ratio of such materials will be low.
Non moving or Dormant stock are the items which are not moving currently, but
its movement is expected in future.
Advantages of FSN Analysis
1. Avoidance of loss due to obsolescence
2. Unnecessary locking up of capital can be avoided through stocking minimum
quantity or by stocking no quantity at all.
3. Facilitates continuous flow of production
4. Less storage cost
d) Just-In-Time Inventory System: it is a modern technique of inventory control
that aims at minimising the stock of raw materials, work in progress and finished
products. Under this system, the purchasing of materials or goods when they are
needed. JIT Producing is production of articles only when they are required. JIT
Delivering is, delivering the articles only when they are required to be delivered.
Advantages of JIT Purchasing
1. Reduced invest in inventories
2. Reduced carrying cost
3. Reduced ordering cost
4. Reduced number of suppliers
5. Avoiding loss due to obsolescence
6. Ensuring availability
5. Stores Records: For proper control over materials, certain documents and
records are to be maintained. Such records are,
1. Bin Card (MGU FEB 2021): A bin card is defined as, “a written document
attached to each bin for recording the receipts, issues and balance of an item of
material quantitatively.” A bin card is also known as ‘BinTag.’ Bin is a place
where materials are stored. It may be a rack, shelf or drawer. A bin card is
attached to each bin. Bin card gives full details of material movements.

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 2. Double Bin System (M G U, OCT. 2019):A system in which two bins are
used for each item of material is called double bin system. The first bin
constitutes the main bin from which materials are issued and the second bin
contains the safety stock, from which issues are made only when stock in the
main bin is exhausted.
3. Stores Ledger: Stores ledger is the stores record maintained by the costing
department showing the quantity, price and value of materials received, issued
and the balance in stock.

6. Inventory System/ Stock Taking: Stock Taking is the verification and

comparison of physical stock of materials in the stores with the balance of
materials in the stores records. There are three methods of stock taking,
namely:
a) Periodic and Annual Inventory System: Periodic Stock Taking refers to
physical verification of entire stock in a periodically like monthly, half
yearly. Annual stock taking is a system of stock taking, where stock is
taken only at the end of the accounting year.
b) Perpetual Inventory System: ICMA London defines perpetual inventory
system as “a system of records maintained by the controlling department
which reflects the physical movement of stocks and their current balance.”
c) Continuous Stock Taking: It is a system of stock taking in which
physical verification of each and every item of stock is made a number of
times, each year, by a team of persons specially deputed for the purpose.
According to CIMA, continuous stock taking as “the process of counting
and valuing selected items at different times on a rotating basis”
Difference between Bin Card and Stores Ledger

BIN CARD STORES LEDGER

It is maintained by the costing
It is kept attached to the Bin
department
It is a record of both quantity and
It is a record of quantity or units
value

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 Entries are written by cost clerks
Entries are made by stores personnel

Entries are supported by material

Entries are the made for the actual
requisition and goods received notes
quantity

Transfer of material between

Inter- departmental transfers are not
departments and jobs are recorded for
recorded
costing purpose
Posted long after the transaction has
Normally entered while the
taken place
transaction is taking place
Transaction may be entered in
Each transaction is posted separately
summary, periodically

It contains a detailed information of

It does not contain the detailed
materials received and issued.
information of materials received and
issued.

Difference between Periodic Inventory system and Perpetual Inventory System

Perpetual inventory system Periodic inventory

Basis
system
Stock taking is held Stock taking is held only
Period
throughout the year periodically
Discrepancies are located Discrepancies are located
Location of
then & there very late
discrepancies

Discrepancies can be rectified There may be delay in

Rectification
immediately rectification
Production will not be Production will be
Interruption
interrupted interrupted

More costly Comparatively cheap

Cost

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 Random checking All items are checked
Items checked
Personnels in charge of the Persons from other
Personnel
materials are sufficient departments may be
involved
temporarily appointed.

Distinction between Perpetual Inventory System and Continuous Stock Taking

Continuous Stock Taking

Perpetual Inventory System
It is a physical verification of a number
It is a system of recording stores
of items daily
balance after every receipts and issue
of materials.
Emphasis on the verification of stores
Emphasis on recording book balance

Done by a specially selected teams

Done by the persons in charge of the
materials at stores
Value of stock also is calculated
Stress is given to physical verification

MATERIAL LOSSES

When manufacturing activities are carried out, there may be losses due to waste, scrap,
spoilage and defective work. Every such loss is a financial loss and it is necessary that such
losses are kept under control. Loss of material may be divided into Normal Loss or Abnormal
Loss.

Normal Loss

Normal loss is an unavoidable loss which occurs due to the inherent nature of the materials
and production process under normal conditions. It can be estimated in advance based the
past experiences. It may be in the form of normal wastage, normal scrap, normal spoilage,
normal defective, etc.

Abnormal Loss

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Abnormal loss is an avoidable or accidental loss which occurs due to the abnormal reasons
like carelessness of workers, unplanned operations, substandard materials, etc.

Types of Material Losses

1. Wastage:Wastage is a loss which is invisible or which cannot be collected or which

does not have any saleable value.It is a complete loss. Wastage may be Normal or
Abnormal. Normal wastage occurs due to the inherent nature of material and is borne
by the good unit produced. Any wastage over and above the normal wastage may be
called as Abnormal wastage.
ICMA defines wastage as “that portion of the basic raw material lost in
processing, having no recovery value.”
2. Scrap (MGU FEB 2021, JAN 2022): Scrap is the incidental residue of small value
which arises from certain types of manufacture. The scrap value can be recovered
without any further processing. A scarp is always visible. Scarp is deducted from
factory overheads to compute works cost.

Features:

 Scarp is incidentally produced from manufacturing process.

 Scarp is usually of small value
 No further processing is required
 Scarp is always physically available

Accounting Treatment-

 Sale of scarp may be credited to P&L A/C

 Sale value of scarp may be deducted from cost of materials consumed/factory OH
 The realisable value of scarp may be credited to Job or Process.

3. Spoilage (MGU JAN 2022): Spoilage is that portion of raw material which has been
spoiled or destroyed in the manufacturing process, but which can be used again in
manufacture as raw materials or sold as second. Spoilage may be Normal or
Abnormal. Normal spoilage is inherent in production and is beyond control. If the

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 actual spoilage is more than the normal spoilage the excess is termed as Abnormal
spoilage.
Accounting Treatment-
The cost of normal spoilage should be borne by good unit
Abnormal spoilage should be transferred to Costing P&L A/C

4. Defectives: Defectives are those units of finished products which are imperfect and
not upto the standard. The defect can be rectified in certain cases by incurring further
cost.

C. PRICING OF ISSUE OF MATERIAL

The process of fixation of the price of materials issued from the stores department to
production departments is called material pricing. There are several methods of pricing issues
of materials. The various methods of pricing issues of materials are:

1. First In First Out (FIFO)

2. Last In First Out (LIFO)
3. Simple Average
4. Weighted Average.
1. First In First Out (FIFO) Method: Under this method, the materials are issued in
the order in which they are received in the stores. The pricing of the issue of the first
lot is done at the rate it is purchased. On issuing materials from the second lot, the
purchase price of that lot is taken as the issue price. This method is more suitable
when the prices show a falling trend.

Advantages:-

 Simple to understand and easy to operate

 It recovers the entire material cost to production
 Closing stock is shown at current market price.
 It is more suitable where the items are bulky, slow moving and costly
 It is more suitable when the prices of material are falling.

Disadvantages:-

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 Calculation becomes complicated when prices fluctuate
 When there is price fluctuation, cost of material charged to production vary.
 When price declines, jobs are charged at higher rates and stocks are undervalued
resulting in lower margin of profit.
2. Last In First Out (LIFO) Method: Under this method, the materials received last
are issued first. In this method, the price of the last purchase is used for pricing the
materials until the entire quantity from the lot is used up. After this, the price of the
just previous purchase lot becomes the issue price.

Advantages:-

 It is useful at the time of rising price.

 Production is charged at the recent prices.
 It is more suitable for bulky materials with high unit price.
 It is simple and easy to operate.
 In times of inflation, this method is more suitable because closing stock will be valued
at the lowest price.

Disadvantages:-

 It involves considerable clerical work.

 It tends to inflate profits in times of falling prices.
 It does not represent the current price levels.
 Under this method, comparison between one job and the other job will become
difficult.
3. Simple Average Method (MGU OCT. 2019):The issue price under this method is
calculated by dividing the total of prices of materials in hand by the number of prices.
The simple average means only the adding up of two prices and dividing the sum by
two. This method does not consider the quantity of material purchased when the issue
price is computed.

Advantages:-

 Simple to understand and easy to operate.

 It may bring profits in the issue of materials.
 It can be used satisfactorily where prices of materials is comparatively low.

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 It minimises the variances in the cost and market price.

Disadvantages:-

 Material cost does not represent actual cost price.

 It does not give satisfactory results when the prices of materials fluctuates
considerably.
 Identify of materials in stores is lost.

4. Weighted Average Method (MGU JAN.2022): ICMA London, defines weighted

average price as “a price which is calculated by dividing the total cost of materials in
stock by the total quantity of materials in that stock”. The issue price is calculated by
dividing the total cost of material in stock by the total quantity in stock.

Weighted average Price = Total cost of material

Total units in stock

Advantages:-

 This method maintains the issue prices near to the market price.
 It is useful where prices fluctuate considerably.
 It is based on actual cost. Therefore, there is no unrealised profit or loss.
 It acceptable to Income Tax authorities.

Disadvantages:-

 As the issues are not priced at actual cost there may be profit or loss on the issue of
materials.
 Under this method, the closing stock does not represent the current market value.

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Difference between Simple Average Method & Weighted Average Method (MGU
FEB.2021)

Simple Average Method Weighted Average Method

Basis

Issue price is calculated by dividing Issue price is calculated by dividing

Issue price
the sum of rated by total no. of lots sum of products of price and quantity
by total no. of quantity.
When materials are received in When quantity purchased under each
Suitability
uniform lots of similar quantity and lot are different.
price do not fluctuate.
Quantity of materials is not Quantity of materials is considered
Quantity of
considered for calculating the issue for calculating the issue price.
materials
price.
Lot1- 200 units @ Rs.10 Lot1-200 units @Rs.10
Examples
Lot2- 400 units @Rs.12 Lot2-400 units @Rs. 12
Issue price = (10+12)/2=11 Issue price =
(10*200)+(12*400)/600=11.33

Packing Materials

Materials required for packing the products are called packing materials. Packing may be:

- Primary Packing
- Secondary Packing

Primary Packing Material: Primary packing is one which is essential and without which the
product cannot be sold out. The cost of primary packing materials forms a part of the cost of
production of goods. The cost of such packing is a part of theprime cost and should be added
to cost of materials or shown separately as direct charge.

Secondary Packing Material: The secondary packing materials are those that facilitate easy
distribution of goods besides having publicity value. The cost of secondary packing material

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is a part of the selling and distribution overhead. The selling price includes the cost of the
secondary packing also.

Important Problems

1. Calculate EOQ from the following information:

Consumption of the material per annum = 6000units
Ordering cost per order = Rs.15 per order
Inventory carrying cost = Rs.0.50
Solution:
C = 6000 units, O = Rs. 15, I = 0.5
EOQ = √2CO/I
EOQ = √2 x 6000 x 15/0.5 = 600 units
2. From the following information find out
a) EOQ
b) No. of orders placed in a year
c) Time gap between two orders.

Consumption per month- 10 units, buying cost per order- Rs.20, price per unit- Rs.
100, storage and carrying cost as a percentage of average inventory 12%.

Solution:

a) EOQ = √2CO/I
√ 2 x 120 x 20 / 12 = 20 units

b) No. of orders placed during the year = annual consumption/EOQ

120/20 = 6 orders
c) Time gap between two orders = 12 months/6 = 2 months
3. From the following information, calculate (a) EOQ, (b) the no. of orders per year, (c)
how frequently should orders be placed, (d) total ordering cost, (e)total carrying cost,
(f) total carrying and ordering cost at that quantity.
Annual consumption of input 48000 unitspurchase price of input unit Rs.25
Annual carrying cost 12% ordering cost per order Rs.180

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 Solution:
a) EOQ = √2CO/I
EOQ = √2x 48000 x 180 / 3 = 2400 units
b) No. of orders per year = Total annual consumption / order size
= 48000units/2400units = 20 orders
c) Frequency of orders = 365/20 orders = 18.25 days
d) Total ordering cost = No. of orders x ordering cost per order
= 20 x 180 = 3600
e) Total carrying cost = order size / 2 x carrying cost per unit p.a
= 2400/2 x 3 = 3600
f) Total annual carrying and ordering cost = ordering cost + carrying cost
= 3600 + 3600 = Rs. 7200

4. A manufacturer buys certain equipmentfrom outside suppliers at Rs.30 per unit. Half
yearly requirement is 400 units.
The following further data are available:
Annual return on investment 10%
Rent, taxes, insurance per unit per year Rs.1
Cost of placing an order Rs.100
Determine the EOQ.
EOQ = √2CO/I
C=400 x 2 = 800 Units
O=100
I= 30 x 10/100 = 3 + 1 = 4
EOQ = = √2x 800 x 100/4
EOQ = √1,60,000/4 = √40000

EOQ = 200 Units

5. Two components X and Y are used as follows:

Minimum usage: 25 units each per week
Maximum usage: 75 units each per week
Reorder quantity: X 400 units; Y 600 units
Reorder period: X 4-6 weeks; Y 2-4 weeks.
Emergency supply time: X 2 weeks; Y 1 week
Calculate for each component:
(a) Reorder level (b) Minimum level (c) Maximum level (d) Average level (e) Danger
level.

Solution :

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 (a) Reorder level = Maximum usage x Maximum reorder period
X = 75 x 6 = 450 units
Y = 75 x 4 = 300 units
(b) Minimum level = Reorder level – (Avg. usage x Avg. reorder period)
Average usage = minimum + maximum / 2 = 25+75/2=50
X = 450-(50 x 4+6/2) = 450-250 200 units
Y= 300-(50 x 2+4/2) = 300-150= 150 units

© Maximum level = Reorder level + Reorder quantity – (minimum usage x minimum

reorder period)

X = 450+400-(25x4)=850-100=750 units

Y = 300+600-(25x2)=900-50=850 units

(c) Average stock level = Minimum level + ½ reordering Qty

X=200+1/2 400= 200+200=400 units
Y= 150+1/2 600= 150+300= 450 units
(d) Danger level = Avg. consumption x Emergency supply time
X = 50 units x 2 = 100 units
Y = 50 units x 1 = 50 units
6. From the following data for the last 12 months, Compute the Average Stock Level for
a component:
Maximum Usage in a month : 300 units
Minimum Usage in a month : 200 Units
Average Usage in a month : 225 Units
Time lag for procurements : Maximum 6 months ; Minimum 2 months
Reorder quantity 750 Units

Solution:

Average Stock Level = Minimum Level + ½ Reorder Quantity

Reorder Level = Maximum Usage x Maximum reorder period
= 300 x 6 = 1,800 Units
Minimum Stock Level = Reorder level – (Normal usage x Normal reorder period)
= 1,800 – (225 x 4)
= 1,800 –900 = 900
Average Stock Level = 900 + ½ x 750
= 900 + 375 = 1,275 Units

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7. Two Components A and B are used as follows:
Normal Usage 3,000 units per week each
Minimum Usage –1,500 units per week each
Maximum Usage –4,500 units per week each
Reorder Quantity –A 13,000 units, B 14,000 Units
Reorder Period –A 4 to 6 Weeks B 2 to 4 weeks
Emergency Supply Period A 2 Weeks B 1 Week
Calculate for each component (a) Reorder Level (b) Minimum Level (c) Maximum
Level (d) Average Stock Level (e) Danger Level
(a) Reorder Level (A)= Maximum Usage x Maximum reorder period
= 4,500 x 6 = 27,000 Units
Reorder Level (B)= Maximum Usage x Maximum reorder period
= 4,500 x 4 = 18,000 Units
(b)Minimum Stock Level (A) = Reorder level –(Normal usage x Normal reorder
period)
= 27,000 –(3,000 x 5)
= 27,000 –15,000 = 12,000 Units
Minimum Stock Level (B) = Reorder level –(Normal usage x Normal reorder period)
= 18,000 –( 3,000 x 3)
= 18,000 –9,000 = 9,000 Units
© Maximum Stock Level (A) = Reorder Level + Reordering Quantity –(Minimum
Usage x Minimum Reorder Period)
= 27,000 + 13,000 –(1,500 x 4)
= 27,000 + 13,000 –6,000 = 34,000 Units
Maximum Stock Level (B) = Reorder Level + Reordering Quantity –(Minimum
Usage x Minimum Reorder Period)
= 18,000 + 14,000 –(1,500 x 2)
= 18,000 + 14,000 –3,000 = 29,000 Units
(d) Average Stock level(A) = Minimum Level + ½ Reorder Quantity
= 12,000 + ½ x 13,000
= 12,000 + 6,500 = 18,500 Units
Average Stock level(B) = Minimum Level + ½ Reorder Quantity
= 9,000 + ½ x 14,000
= 9,000 + 7,000 = 16,000 Units
(e) Danger Stock Level (A) = Average Consumption x Emergency Supply Time
= 3,000 x 2 = 6,000 Units
Danger Stock Level (B) = Average Consumption x Emergency Supply Time
= 3,000 x 1 = 3,000 Units
8. Calculate material turnover ratio for the year 2005 from the following details:
Particulars Material A(Rs.) Material B(Rs.)
Op.Stock 15000 28000
Cl.Stock 28000 17500
Purchases 228000 103250
Determine the first moving material.
Solution:

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 Computation of Material Turnover Ratio:
Material A (Rs.) Material B (Rs.)
Opening stock 15000 28000
Add: Purchase of materials 228000 103250
243000 131250
Less: Closing stock 28000 17500
Value of materials consumed 215000 113750

Average inventory:
Op.Stock + Cl.Stock 21500 22750
2
Material Turnover ratio( in times):
Materials consumed 215000 113750
Average materials 21500 22750
10 times 5 times
Stock turnover ratio (in days):
365/ material turnover ratio (in times) 365/10 365/5
36.5 days 73 days

Turnover ratio of Material A is 10 times and that of Material B is only 5 times. It

means that the rate of consumption of Material A is double that of B.
The stock turnover ratio (in days) also indicate that Material A is consumed at double
the rate faster than that of Material B.

9. From the following particulars, write up the priced Stores Ledger under LIFO
method:
December 1. Stock in hand 500 units @ Rs. 20
3. Issued 200 units
3. purchased 150 units @Rs. 22
4. Issued 100 units
5. Purchased 200 units @Rs. 25
6. Issued 300 units
6. Returned to store 10 units (Issued on 4th Dec.)
7. Issued 100 units

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 8. Issued 50 units
On 10th it was noticed that there is a shortage of 10 units.
Solution:
Stores Ledger Account (LIFO)
Receipt Issue Balance
Date Qty. Rate Qty. Rate Qty. Rate
Amount Amount Amount
units Rs. units Rs. units Rs.
Dec. 1 500 20 10000
3 - - - 200 20 4000 300 20 6000
300 20 6000
3 150 22 3300 - - -
150 22 3300
300 20 6000
4 - - - 100 22 2200
50 22 1100
300 20 6000
5 200 25 5000 - - - 50 22 1100
200 25 5000
200 25 5000
6 - - - 50 22 1100 -
50 20 1000 250 20 5000
250 20 5000
6 10 22 220 - - -
10 22 220
10 22 220
7 - - -
90 20 1800 160 20 3200
8 - - - 50 20 1000 110 20 2200
10 - - - 10 20 200 100 20 2000

10. Prepare a store ledger account from the following transactions assuming that the issue
of stores has been priced on the principle of First-In-First-Out Method.
January 1. Opening stock 2000 units @ Rs. 26 each
2. Issued 1000 units
3. Issued 800 units
4. Purchased 1500 units @ Rs. 27.50 each
4. Issued 400 units

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 5. Issued 320 units
6. Purchased 1000 units @ Rs. 29 each
7. Issued 1400 units
8. Returns to Vendor, purchased on 6th Jan. 30 units
9. Received back from work order, issued on 5th Jan. 40 units
10. Issued 500 units.
On 10th Jan. when the stock is verified, it is found that the actual stock is more by 20
units.

Solution:
Stores Ledger Account (FIFO)
Date Receipt Issue Balance
Qty. Rate Amount Qty. Rate Amount Qty. Rate Amount
units Rs. units Rs. units Rs.
Jan.1 - - - - - - 2000 26 52000
2 - - - 1000 26 26000 1000 26 26000
3 - - - 800 26 20800 200 26 5200
4 1500 27.50 41250 - - - 200 26 5200
1500 27.50 41250
4 - - - 200 26 5200
200 27.50 5500 1300 27.50 35750
5 - - - 320 27.50 8800 980 27.50 26950
6 1000 29 29000 - - - 980 27.50 26950
1000 29 29000
7 - - - 980 27.50 26950
420 29 12180 580 29 16820
8 - - - 30 29 870 550 29 15950
9 40 27.50 1100 - - - 40 27.50 1100
550 29 15950
10 - - - 40 27.50 1100
460 29 13340 90 29 2610
10 20 29 580 - - - 110 29 3190

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11. The following transactions took place in respect of a material during the month of
June 2014.
Date Particulars Qty/Kg Rate per unit
Received 500 10
2014, June 1
Received 300 12
10
Issued 700 -
15
Received 400 14
20
Issued 300 -
25
Received 500 11
27

You are required to prepare the Stores Ledger Account under Simple Average Price
Method and Weighted Average Price Method.

Solution:
Stores Ledger Account (Simple Average)
Date Receipt Issue Balance
Qty. Rate Amount Qty. Rate Amount Qty. Rate Amount
Kg. Rs. Kg. Rs. Kg. Rs.
500 10 5000 - - - 500 10 5000
June
1
300 12 3600 - - - 800 8600
10
- - - 700 11 7700 100 900
15
400 14 5600 - - - 500 6500
20
- - - 300 13 3900 200 2600
25
500 11 5500 - - - 700 8100
27

Average price = 10+12/2=Rs.11.00 (June 15)

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 Average price = 12+14/2=Rs.13.00 (June 25)
Stores Ledger Account (Weighted Average Method)
Date Receipt Issue Balance
Qty. Rate Amount Qty. Rate Amount Qty.
Kg. Rs. Kg. Rs. Kg.
500 10 5000 - - - 500 10 5000
June
1
300 12 3600 - - - 800 10.75 8600
10
- - - 700 10.75 7525 100 10.75 1075
15
400 14 5600 - - - 500 13.35 6675
20
- - - 300 13.35 4005 200 13.35 2670
25
500 11 5500 - - - 700 11.67 8170
27

12. Calculate the Re-ordering level of material A from the following particulars:
 Minimum limit 500 units
 Maximum limit 2500 units
 Daily requirement of material 100 units
 Time required for fresh delivery 10 days
Re-ordering Level= Maximum Consumption x Max. Reorder Period
= 100 x 10 = 1000 units. (MGU JAN 2022)
13. Calculate the Inventory Turnover Ratio from the following details:

Material X (Rs.) Material Y (Rs.)

25000 87500
Opening stock
15000 62500
Closing stock
190000 125000
Purchase

Determine the fast moving material.

Solution:

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Inventory Turnover Ratio = Cost of materials consumed/ Avg.stock of materials
during the period
Average stock = opening stock + closing stock / 2
Cost of materials consumed = Opening Stock + Purchases – Closing Stock
Material X
Average stock = 25000+15000/2=20000
Cost of materials consumed = 25000+190000-15000=200000
Inventory turnover ratio = 200000/20000=10 times
Material Y
Average stock =87500+62500/2=75000
Cost of materials consumed = 87500+125000-62500=150000
Inventory turnover ratio = 150000/75000=2 times
Since, Inventory turnover ratio is higher in the case of material X, it can be considered
as the fast moving material. ( MGU JAN 2022)

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