MATERIAL COSTING

Learning objectives
• Recognizing and understanding the
relevance of the concept of material
control, purchase and storage of materials.
 MEANING OF MATERIAL
It refers to all commodities consumed in the
process of manufacturing.

According to CIMA OF UK;

Material cost is the cost of commodities
supplied to an undertaking.
 Classification of material
• Direct material: leather in shoes, timber used in furniture

• Indirect material:
– Small and inexpensive items: pins, screw, nuts and bolts
– Items do not physically become part of finished goods: lubricating oil

• Supplies: indirect material used in production which do not

become part of finished product oil and grease, soap used by
workmen
 Contd…
• Finished/ component parts : tyres in car
manufacturing

• Stores : Raw material, WIP, finished stock, tools,

maintenance material

• Inventory: Raw material, WIP, finished stock

 MATERIAL OR INVENTORY CONTROL
CONTROL

It is defined as, “safeguarding of company

property in the form of materials by a
proper system of recording and also to
maintain them at the optimum level
considering operating requirement and
financial resources of the business.
 Material control
• Efficient purchasing of material

• Their efficient storing

• Efficient use or consumption

 Contd…

Material control is a systematic control over

the purchasing, storing and using of
material to minimizing the possible cost.
 Objectives of Material Control
• No under stocking
• No overstocking
• Minimum wastage
• Economy in purchasing (favorable price)
• Proper quality of materials
• Information about material
• Material report to management
 Essential requirement or principles of
inventory control
• Coordination between various departments

• Central purchasing by expert purchase manager

• Classification and codification

• Planning of material required

• Perpetual inventory

• Proper records
 Contd…
• Proper storage

• Stock levels should be fixed( min, max)

• Budgeting & purchase of material should be

controlled

• Inventory control- internal audit

• Regular reporting
 Techniques of inventory control
• ABC technique
• Minimum, maximum and re order levels
• Economic order quantity
• Proper purchase procedure
• Proper storage of material
• Inventory turnover ratio
• Perpetual inventory system
• Fixation of material cost standard
• Preparation of material budgets.
ABC-Always
better control
 CONTD…

Large manufacturing companies, where stocks of direct material and

component parts consist of many thousands of different items,
companies find it useful to divide materials, parts, supplies and
finished goods into sub classifications for the purposes of inventory
control.
 Basis of classification
% number of items contributing to proportion
of total value of inventories

Inventory items are ranked according to

investments in each item in the inventory
Let us define ABC/ Pareto Analysis
• A- Significant few
items few in number contributing high
proportion of value of
inventories

B- Not few, not too many

neither very cheap nor very costly

C- Insignificant many
relatively large no. of items
normally inexpensive
 2. Mechanism of ABC
Group% of items(no.) % of costs
A 8%(160) 75%(7,50,000)
B 25%(500) 20%(2,00,000)
C 67%(1340) 5%(50,000)
TOTAL 2,000 items Rs.10,00,000
Graphical presentation
 Control mechanism of ABC
ITEM “A” “B” “C”
Stock very low Low high

Follow up Maximum periodic Expediting

exceptionally
Handled by Senior Middle Fully
officials level delegated
managers
 Advantages of ABC Analysis

1. Strict control is exercised

(More on A and less on C)

2. Investment in inventory is
reduced
(Control of A is more)

3. Storage cost is reduced

4. Management time is saved

(Attention to some)
 VED Analysis:
Analysis is used primarily for
control of spare parts.

The spare parts can be

divided into 3 categories-
1-Vital
2-Essential
3-Desirable

Depending upon their

criticality for production.
 Vital spares
The spares, the stock-out of which even for
a short time will stop production for quite
sometime

Eg bearings for a kiln in a cement plant will

be considered vital.
 Essential spares
The spares, the absence of which cannot be tolerated for
more than few hours or a day & which are essential for
the production to continue.

Eg bearings for motors of pumps will be classified as

essential.

.
 Desirable spares
• These are those spares which are needed but their
absence for even a week or so will not lead to stoppage
of production.

• Eg gaskets for piping connection.

 EOQ
• Optimum quantity which should be purchased each time
the purchases are to be made.

• Cost of carrying cost

– Cost of holding material in the store
– Warehouse charges, insurance, losses, transportation, rent, taxes
etc.

• Cost of ordering cost

– Cost of placing order for the purchase of materials.
– Cost of stationary, postage, telephone charges, cost of paper work
Economic Order Quantity

2C O
EOQ 
I
C = Annual demand (units)
O = Cost of placing an order
I = Cost of carrying inventory
 EXAMPLE

• Annual usage -6000

• cost of placing order- Rs 30
• Carrying cost -20%
• Cost per unit of material- Rs 5
• Find EOQ?
 SOLUTION

2  6000  30
EOQ 
5 * 20%
3,60,000
 600UNITS
 REORDER LEVEL
• Point at which if stock of a particular material in a store
approaches, the storekeeper should initiate the purchase
requisition for fresh supplies of that material.

• Lead time- time lag between placing and receiving of the

material

• Re- Order Level=Maximum re- order period* Maximum usage

• Re- Order Level= safety stock +(Average Usage*Average re-

order point or lead time)
 EXAMPLE
Calculate reorder level from following
information

• Maximum consumption= 300 units per day

• Minimum consumption=200 units
• Re- order period=8 to 10 days

• Re- Order Level=Maximum re- order period* Maximum usage

 SOLUTION
• Re- Order Level=Maximum re- order
period* Maximum usage
=300*10=3000 units
 Safety / minimum stock level
• Minimum quantity of material which must
be maintained in hand at all the times.

• Safety / minimum stock level =Re Order

level- ( Average Rate consumption*
Average re-order period)
 Example
• Maximum consumption per week (in units)- 150
• Average consumption per week (in units)- 100
• Minimum consumption per week (in units)-50
• Re- order period-(in weeks)=8 to 12
• Re-order quantity(in units)=400

• Safety stock level =Re-Order level- ( Average Rate consumption*Average Re-order period)
• Safety / minimum stock level =Ordering
level- ( Average Rate consumption* re-
order period)

• Reorder level =max. consumption*max

reorder period
Reorder level =150*12=1800 units
Minimum level=1800-(100*10)=800 units
 MAXIMUM STOCK LEVEL
• Maximum quantity of an item of material
which can be held in stock at any time.

• Overstocking should be avoided

• = Re- order level+ EOQ-(Minimum

consumption* Minimum re-order period)
 Example
• Maximum consumption per week (in units)-
150
• Average consumption per week (in units)- 100
• Minimum consumption per week (in units)-50
• Re- order period-(in weeks)=8 to 12
• Re-order quantity(in units)=400

• Re- order level+ EOQ-(Minimum consumption* Minimum re-order period)

 Solution
• Re- order level+ EOQ-(Minimum
consumption* Minimum re-order period)
• =1800 +400-(50*8)=1800 units

» Reorder level =150*12=1800 units

Average stock level

Minimum + maximum
2

Or

Minimum stock level + Re-order quantity

2
 Stock levels
• Maximum level
Reorder Level+ Reorder Quantity- (Minimum consumption× Minimum
re order period)
 Minimum level
Re order level – (Normal consumption ×normal re order period)
 Re order level
Maximum consumption ×maximum re order period
 Danger level
Normal consumption × maximum re order period for emergency
purchases
 Average stock level
Minimum level +maximum level/2 or minimum level +1/2re order
quantity
Methods of pricing material issues

There are three methods of calculating the

value of material issued for production.
These are as follows:-

• First In First Out Method(FIFO)

• Last In First Out Method (LIFO)
• Simple Average method
 First-in-First-out:
• First-in-First-out:

• Under this method, materials which are received first are also
issued first.
• In other words, the pricing of the issue of the first lot is done
at the cost at which that lot was acquired.
• As such, the closing inventories are valued at latest purchase
price and thus it will represent current condition as far as
possible. That is, closing inventories are always out of the
latest lots acquired or purchased or manufactured.
• Example:
• In a factory, stores are issued and accounted for on FIFO method. If the
stock of a particular material on 1st Jan. 1992 is 1,000 units valued at Rs. 5
per unit and the particulars of purchases and issues during the month of
Jan. 1992 are as follows, prepare a statement showing how the value of
issues should be arrived at:
Solution
 Last-in-First Out:

• Under this method, it is assumed that the materials

purchased are issued in the reverse order to FIFO.

• The last receipt is the first issue or the latest lots of

inventories are exhausted first. In short, inventories are
valued at earlier purchase price.
 Example
• In a factory, stores are issued and accounted for on LIFO method. If
the stock of a particular material on 1st Jan. 1992 is 1,000 units
valued at Rs. 5 per unit and the particulars of purchases and issues
during the month of Jan. 1992 are as follows, prepare a statement
showing how the value of issues should be arrived at
Solution
Simple Average Method

• Under this method, averages of different prices are only

considered without having regard to the quantities
involved.

• The simple average cost is calculated by adding the

different prices and thereafter divided by the total
number of purchases.

• This method is applicable where there is a wide

fluctuation in prices.
 Example
• In a factory, stores are issued and accounted for on Simple Average
Method. If the stock of a particular material on 1st Jan. 1992 is
1,000 units valued at Rs. 5 per unit and the particulars of purchases
and issues during the month of Jan. 1992 are as follows, prepare a
statement showing how the value of issues should be arrived at:
Solution
 Working Notes

• 1st Issue Price = (Rs. 5 + Rs. 5.50)/2 = Rs. 5.25

• 2nd Issue Price = (Rs. 5.50 + Rs. 6)/2 = Rs. 5.75

• 3rd Issue Price = (Rs. 6 + Rs. 6.50)/2 = Rs. 6.25

• Any Query ?????????