Module 3 - Material Costing - Theory & Practical Questions (2024-25) PDF

F.Y.Bcom (Hons) – Semester I – Cost Accounting [Academic Year 2024-25] “We become what we think about.” Module 3: Material Costing Meaning of Material: Material refers to all commodities that are consumed in the process of manufacture. It is...

F.Y.Bcom (Hons) – Semester I – Cost Accounting [Academic Year 2024-25] “We become what we think about.” Module 3: Material Costing Meaning of Material: Material refers to all commodities that are consumed in the process of manufacture. It is defined as “anything that can be stored, stacked or stockpiled”. Classification of Materials: Materials are classified into direct materials and indirect materials. Direct materials are those whose consumption may be identified with specific production units and which usually become a part of the finished product. It also includes: a) Component parts used in a product e.g. Tyres and tubes in a car, picture tube in a television. b) Any material used in production and wholly consumed in the production process. e.g. fertilizer used in growing plants. c) Any primary packing material e.g. containers with final product, cans, bottles, etc. Meaning of Material Control: Material or inventory control may defined as a systematic control and regulation of purchase, storage and usage of materials in such a way so as to maintain an even flow of production, at the same time avoiding excessive investment in inventories. Efficient material control cuts out losses and wastages of materials that otherwise pass unnoticed. Objectives of Material or Inventory Control: 1. No under stocking. 2. No over stocking. 3. Economy in purchasing. 4. Proper quality. 5. Minimum wastage. 6. Information about materials. Essential Requirements or Principles of Inventory Control: 1. Proper Co-ordination between departments. 2. Competent purchase manager (Centralised purchase department). 3. Proper classification and coding of materials. 4. Planned and upto date inventory system. 5. Adequate inventory records. 6. Well planned storage. 7. Parameters should be fixed. 8. Budgetory control of stocks. 9. Efficient internal audit and check. 10.Regular Management reporting. NMIMS (Deemed to be University) 1|Page F.Y.Bcom (Hons) – Semester I – Cost Accounting [Academic Year 2024-25] “Be not afraid of going slowly, be afraid only of standing still.” Techniques of Inventory Control 1) ABC Technique: ABC technique is a value based system of material control. In this technique, materials are analysed according to their value. high value (A), medium value (B) and low values (C) – so that the costly items and more material items are given greater attention and care. Category A: These are ‘high value items’ which may consist of only a small percentage of the total items handled. On account of their high cost, these materials should be under the ‘tightest control’ and the responsibility of the most experienced personnel. Category B: These are ‘medium value materials’ which should be under the ‘normal control’ procedures. Category C: These are ‘low value materials’ which may represent a very large number of items. These materials should be under ‘simple and economical methods of control’. The point of classifying stock into A, B and C categories is to ensure that material management focuses on A items where sophisticated controls should be installed. B items may be given less attention and C items least attention. 2) Stock levels – Minimum, maximum and re order levels: In order to guard against under stocking and over stocking, most of the large companies adopt a scientific approach of fixing stock levels. These levels are: (i) Maximum level. (ii) Minimum level. (iii) Re-order level. (iv) Re-order quantity. By adhering to these levels each item of material will automatically be held within appropriate limits of control. These levels are not permanent and must be changed to suit changing circumstances. (i) Re-order level: This is that level of material at which purchase requisition is initiated for fresh supplies. This level is fixed somewhere above minimum level. In this case, new supplies will be received just before the minimum level is reached. The formula is: Re-order level = Max. Consumption x Maximum re-order period (ii) Danger Level: Sometimes purchased materials are not received in time and stock level goes below the minimum level. In order to meet such a situation a danger level is fixed. The formula is: Danger = Normal x Max re-order period under Level consumption emergency conditions (iii) Average Stock Level Average Stock Level = (Minimum level + Maximum level) ½ NMIMS (Deemed to be University) 2|Page F.Y.Bcom (Hons) – Semester I – Cost Accounting [Academic Year 2024-25] (iv) Maximum level: This is the level above which stocks should not normally be allowed to rise. The maximum level may, however, be exceeded in certain cases. E.g. when unusually favourable purchasing conditions arise. Maximum level is calculated by the following formula: Maximum Level = Re-order level (ROL) + Reorder quantity (ROQ) – {Min. Consumption x Min. Reorder period} The idea of setting maximum stock level is to ensure that capital is not unnecessarily blocked in stores and also to avoid loss due to obsolescence and deterioration. (v) Minimum level: It is that level below which stock should not normally be allowed to fall. This is essentially a safety stock and is not normally touched. Minimum level = Re-order level – {Normal consumption x normal re-order period} Note: Normal consumption means Average consumption. Average consumption = (Maximum consumption + Minimum consumption) ÷ 2 3) Economic order quantity (EOQ): Example for understanding Economic order quantity Annual Consumption = 2,400 units. Ordering Cost per order = Rs. 10. Holding Cost = Re. 0.30 per unit (A) (B) (C) (D) (E) (F) Number of units per Average Ordering Holding Cost Total No. of order Inventory cost = (C) x Re. Cost Orders (Annual consumption ÷ (In units) = (A) x Rs. 10 0.30 (D) + ( E) No. of orders) = (B) ÷ 2 1 2,400 1,200 10 360 370 2 1,200 600 20 180 200 3 800 400 30 120 150 4 600 300 40 90 130 5 480 240 50 72 122 6 400 200 60* 60* 120 7 343 172 70 52 122 8 300 150 80 45 125 * Generally, at EOQ level ordering cost and storage will be equal. ✓ Re-order quantity is the quantity for which order is placed when stock reaches re-order level. By fixing this quantity the purchaser doesn’t have to recalculate the quantity to be purchased each time when he places order for materials. ✓ Ordering cost is the cost incurred for placing one order. ✓ Carrying costs are the cost for holding / carrying of inventories in the store such as the cost of fund invested in inventories, cost of storage, insurance cost, obsolescence etc. ✓ Economic Order Quantity is also known as Re-order quantity because it is the quantity which is most economical to order. In other words, EOQ is the level at which the total cost (ordering cost + carrying cost) is minimum. NMIMS (Deemed to be University) 3|Page F.Y.Bcom (Hons) – Semester I – Cost Accounting [Academic Year 2024-25] Formula for calculating Economic order quantity is as follows: Economic order quantity = 2AB ÷ CS Where, A = Annual consumption in units (Raw Materials) B = Buying or ordering cost per order C = Cost per unit S = Storage or carrying cost as a percentage of inventory. 4) Annual Inventory Cost = Raw material purchase cost + Ordering Cost + Storage Cost Raw material purchase cost = Annual consumption of raw material x cost per unit of raw material. Ordering Cost = (Annual consumption of raw material ÷ EOQ) x Ordering cost per order. Average Storage cost = (EOQ ÷ 2) x Storage cost per unit per annum (cost per unit x storage cost as % of cost per unit) 5) Proper purchase procedure: Purchasing is a function of buying raw materials, general supplies, tools, office stationery and other items. The essentials of efficient purchasing are right quantity, right quality, right time, right price, right source and delivery at the right place. Just in time (JIT) Purchasing: JIT purchasing is the purchase of materials immediately before these are required for use in production. The purpose of JIT purchasing is to reduce stock levels to the minimum through creating closer relationship with suppliers and arranging frequent deliveries of materials in smaller quantities. An important effect of JIT purchasing is that with frequent purchasing the issue price is likely to be closer to market prices. Centralised and Decentralised Purchasing: Centralised purchasing: It means that all purchases are made by a single purchase department. Decentralised purchasing: In Decentralised purchasing, each branch or department makes its own purchases. E.g. branches located at different places. Purchase Procedure: Steps in purchasing and receiving of materials are as follows: (i) Purchase Requisition: Purchases of materials are initiated through purchase requisitions. A purchase requisition is a formal request by the head of a department or an authorized officer to the purchase manager to purchase the specified materials. Such requisitions are received from people like store keeper, production manager, plant engineer, department heads, etc. Purchase requisitions are an important form of written record of inventory transactions. (ii) Selection of Suppliers: When the purchasing department receives a duly authorized purchase requisition, a source of supply has to be selected. A list of suppliers would generally be available from which the most appropriate one will be selected after thorough inquiries. In some industries long term contracts are entered into which provide benefit of economy as well as continuous supply as and when required. NMIMS (Deemed to be University) 4|Page F.Y.Bcom (Hons) – Semester I – Cost Accounting [Academic Year 2024-25] (iii) Purchase Order and follow up: A purchase order has to be prepared once the supplier has been selected which authorizes the supplier to supply the specific materials at the price and terms stated therein. It is a legal contract between the parties concerned. Usually 5 copies of the purchase order are prepared to be provided in various departments or places. (iv) Receipt of Materials: All incoming materials should be received by the Receiving Department. This department performs the functions of unpacking and verifying the quantities and conditions of goods. The quantity received is duly verified with the purchase order and supplier’s advice note. Usually four copies of receipt of materials is prepared to be sent to purchase dept, storekeeper, accounting department and one copy is retained with the receiving department. (v) Inspection and Testing of Materials: Goods received should be inspected for quality to ensure that they comply with specifications stated on the purchase order. If lab testing is a pre requisite then the same should have a report of the same. An inspection report is prepared to show the results of the inspection and is forwarded to the purchasing department. (vi) Return of Rejected Materials: Where materials received are damaged o tar not in accordance with the specifications, these are usually returned to the supplier along with a Debit Note. When such a claim is accepted by the supplier, he signifies his acceptance by the issue of a Credit Note. (vii) Passing Invoices for Payment: When the invoices are received by the purchasing department, the process of assembling the business papers connected with each purchase and preparation of voucher begins. Invoices are numbered serially and entered in the Invoice Register. The following documents are assembled in support of the invoice: a) Purchase order. b) Goods received note. c) Inspection Report. d) Debit or Credit Note. Important Note: Real Material Cost will be arrived at after adjusting the following items in the purchase price: (a) Quantity discount, (b) Trade discount, (c) Cash discount, (d) Sales tax and other levies, (e) transport charges, (f) cost of containers. 6) Proper storage of materials: Storekeeping is the function of receiving materials, storing them and issuing these to departments. The stores department is under the control of a person known as storekeeper or store superintendent. Objectives of good Storekeeping: a) Protection of materials from losses due to fire, evaporation, obsolescence. b) Avoiding over stocking and under stocking. c) Economical use of storage space. d) Upto date stores records. e) Immediate location of materials required. f) Facilitating perpetual inventory. NMIMS (Deemed to be University) 5|Page F.Y.Bcom (Hons) – Semester I – Cost Accounting [Academic Year 2024-25] g) Speedy receipts and issues of stores. h) Minimize storage cost. Functions and Duties of Storekeeper: a) Maintaining materials in a tidy manner. b) Proper maintenance of material records. c) Accepting materials into the stores after verifying specifications on the GRN. d) Issuing materials against authorized Stores. e) Requisitioning further supplies from purchasing department. f) Preventing the entry of unauthorized persons in the storeroom. g) Periodic comparison of bin card balances with physical quantities in the bins. h) Advising management on obsolete and slow moving stocks. 7) Perpetual inventory system: Periodic inventory system of stock taking is undertaken at the end of the accounting year. It has certain disadvantages which the perpetual inventory system overcomes. A perpetual inventory is defined as “the method of recording stores balance after each receipt and issue to facilitate regular checking and obviate closing down for stock taking.” Advantages of Perpetual Inventory System: a) Avoids long and costly physical checking work at the year end. b) It avoids dislocation in production. c) P & L account and B/s can be easily prepared due to availability of information. d) Acts as a moral check between and within departments. e) Internal Check remains in operation. f) Easy detection and rectification of Discrepancies. g) Helps in maintaining stock within levels which prevents blockage of capital. h) A detailed check on stores is obtained. Methods of Pricing Material Issues 1) First in first out (FIFO) Method: This method is base on the assumption that materials which are purchased first are issued first. It uses the price of the first batch of materials purchased for all issues until all units from this batch have been issued. Thus, materials are issued at the oldest cost price listed in the stores ledger account and thus, the materials in stock are valued at the price of the latest purchases. Effects of using FIFO method: Three important effects of using FIFO method are: a) Materials are priced at the actual cost. b) Charge to production for material cost is at the oldest prices of materials in stock. c) Closing stock is valued at the latest price paid. Advantages of FIFO: a) It is based on a realistic assumption that materials are issued in the order of their receipts. b) Materials are issued at actual cost and thus no unrealized profit or loss arises from the operation of this method. NMIMS (Deemed to be University) 6|Page F.Y.Bcom (Hons) – Semester I – Cost Accounting [Academic Year 2024-25] c) Valuation of closing inventory is at cost as well as at the latest prices paid. d) This method is easy to understand and simple to operate. Disadvantages of FIFO: a) As materials are charged at old prices, cost of production may lag behind current economic values. b) This method does not permit comparability since different materials may be charged at different period of time c) When prices fluctuating, this method involves cumbersome record keeping. 2) Last in first out (LIFO) Method – excluded from syllabus 3) Simple Average Method – omitted from syllabus 4) Weighted Average Method (WAM): This method give due weightage to the quantities held at each price when calculating the average price. The weighted average price is calculated by dividing the total cost of material in stock, from which the material to be priced could have been drawn, by the total quantity of material in that stock. The simple formula is weighted average price at any time is the balance value figure divided by the balance units figure. Advantages of WAM: a) This method smoothens out the effect of fluctuations in purchase price. b) A new issue price is calculated at the time of each new purchase and not at the time of each issue. c) No unrealized profit or loss arises by the use of this method. Disadvantages of WAM: a) Issue prices may not be at the current market prices. b) The method calls for many calculations where purchases are made frequently. c) To avoid errors, the average price must be calculated to a sufficient number of decimal points which makes calculations tedious. d) Excessively high or low prices paid in the past are reflected in the average for a considerable time after expensive or inexpensive material has been consumed. ******************** ALL IS WELL ******************** PRACTICAL QUESTIONS Example 1: (Stock levels) Two materials A and B are used as follows: Minimum usage 5,000 units per week each Maximum usage 15,000 units per week each Normal usage 10,000 units per week each Re-order quantity A – 60,000 units; B – 100,000 units Delivery period A – 4 to 6 weeks; B – 2-4 weeks Calculate the various stock levels. NMIMS (Deemed to be University) 7|Page F.Y.Bcom (Hons) – Semester I – Cost Accounting [Academic Year 2024-25] Example 2: (EOQ – Carrying cost is given as % of cost per unit) Calculate Economic Order Quantity from the following information: Estimated requirement p.a. 60,000 units Ordering cost per order Rs. 12 Cost per unit Rs. 20 Carrying cost 5% p.a. Example 3: (Do it yourself) (Stock levels) Two components X and Y are used as follows: Normal usage 6,000 units per week each Maximum usage 9,000 units per week each Minimum usage 3,000 units per week each Re order quantity X – 48,000 units; Y – 72,000 units Re order period X – 4 to 6 weeks; Y – 2 to 4 weeks Calculate the various stock levels for both materials Example 4: (EOQ – Carrying cost is given Rupees.) The annual demand for a raw material is 6,400 units. Inventory carrying cost is Rs. 1.50 per unit per annum. If the cost of one procurement is Rs. 75, determine: (a) Economic order quantity. (b) Number of orders per year. (c) Time between two consecutive orders Example 5: (Do it yourself) (EOQ – Carrying cost is given as % of cost per unit) Determine the EOQ from the following information: Annual consumption 12,000 units Cost of ordering Rs. 15 per order Cost of material Rs. 1.25 per unit Carrying cost 20% p.a. Example 6: (Do it yourself) (Stock levels) From the following information you are required to calculate for each product: (a) Re-order level (b) Maximum stock (c) Minimum Stock and (d) Average Stock Particulars Material X Material Y Average consumption per week 500 500 Minimum requirement per week 250 250 Maximum usage per week 750 750 EOQ 3,000 5,000 Replacement time 4 to 6 weeks 2 to 4 weeks Example 7: (Stock levels + EOQ) Shriram enterprises manufactures a special product ZED. The following particulars were collected for the year 2017: a) Monthly demand for ZED – 10,000 units b) Cost of placing an order Rs. 1500/- c) Annual carrying cost per unit Rs. 30/- Details of Raw Material Consumption: d) Normal Consumption 500 units per week e) Minimum Consumption 250 units per week f) Maximum Consumption 750 units per week g) Re order period 4-6 weeks Compute the Re-Order Quantity, Re-order Level, Minimum level, Maximum level and Average Stock level from the above information assuming 50 weeks for one year. NMIMS (Deemed to be University) 8|Page F.Y.Bcom (Hons) – Semester I – Cost Accounting [Academic Year 2024-25] Example 8: (Stock levels) (Two raw materials) (Do it yourself) In manufacturing its product Z, a company uses two raw materials A and B, in respect of which the following information is supplied. One unit of Z requires 10 kgs of A and 4 kgs of B materials. Price per kg of A material is Rs. 10 and that of B is Rs. 20. Re order quantities of A and B materials are 10,000 kgs and 5,000 kgs. Re order level of A and B materials are 8,000 kgs and 4,750 kgs respectively. Weekly production varied from 175 units to 225 units averaging 200 units. Delivery period of A material is 1 to 3 weeks and B material is 3 to 5 weeks. Compute minimum, maximum and average stock levels. Example 9: (EOQ & Annual Inventory cost) The monthly demand of a Product is 5,000 units. The company requires 50 kg of raw material for each unit of the product. The supplier of the said raw material, M/s Shah and Company, sells the said raw material at a cost of Rs. 250 per unit. The ordering cost paid per order by the company is Rs. 400 and the storage cost per unit per annum is Rs. 24. You are required to calculate the Economic Order Quantity and number of orders during the year. Also calculate Annual Inventory Cost. (F.Y. B. Com (Hon) – Final Exam – Nov 2018) Example 10: (EOQ & Annual Inventory cost) (Do it yourself) A company manufactures 1,500 units of product EXE per month at a cost of Rs. 150 per unit. It requires ten units of raw material to manufacture one unit of EXE. The raw material is supplied to the company at Rs. 12 per unit. The supplier is willing to give a discount of Rs.2 if the company commits to buy at least 1,00,000 units per annum. The cost of procurement for the company is Rs. 50 for every 2 orders. The cost of storage is 10% p.a. You are required to find the optimum quantity that the company should order to minimize cost. Also calculate Annual Inventory Cost. (F.Y.B. Com (Hon) – Mid Term Exam – Nov 2019) Example 11: (EOQ & Annual Inventory cost) (Do it yourself) Maxis Enterprises manufactures a special product MAC. The following particulars were collected for the year 2021: a) Monthly demand for MAC – 15,000 units. b) Cost of placing an order Rs. 1,600/- c) The Cost per unit of Raw materials is Rs. 200. d) Carrying Cost is 2.5% per quarter. e) Normal Consumption 500 units per week. f) Minimum Consumption 250 units per week. g) Maximum Consumption 750 units per week. h) Re order period 4-6 weeks. Assuming a period of 50 weeks, you are required to calculate all the Material Levels and the Annual Inventory Cost of the company. Would it be beneficial for the company to order 4,000 units per order instead? (Note: Do not round off partial orders) (January 2022 – TEE – FYBCom (Honours) Example 12: Harsha Limited produces a product which has a monthly demand of 4,000 units. The product required a component X which is purchased at a cost of Rs. 20 p.u. For every finished product, one unit of component X is required. The ordering cost is Rs. 120 per order and the holding cost is 2.5% per quarter. You are required to calculate: (i) Economic Order Quantity. (ii) If the minimum lot size to be supplied is 4,000 units, what is the extra cost to be incurred? NMIMS (Deemed to be University) 9|Page F.Y.Bcom (Hons) – Semester I – Cost Accounting [Academic Year 2024-25] Example 13: The following is the relevant data for one of the components bought by Mazda Limited: Ordering Cost Rs. 50 Holding Cost 40% p.a. Cost per component Rs. 100 Annual Demand 1,000 units The purchase manager placed 5 orders of equal quantity in order to avail the discount of 5% on the cost of the components. Work out the gain or loss to the organisation due to his ordering policy for the component. "If you lose faith, you lose all." - Eleanor Roosevelt. PRACTICAL QUESTIONS – STOCK LEDGER Example 14: From the following transactions, prepare a stores ledger account using FIFO method : July 2015 Document 1 Opening stock 5000 units @ Rs. 20 each 4 Purchased GRN 574 4000 units @ Rs. 21 each 6 Issued SR 251 6000 units 8 Purchased GRN 578 8000 units @ Rs. @24 9 Issued SR 258 5000 units 13 Issued SR 262 3000 units 24 Purchased GRN 584 5000 units @ Rs. 25 each 28 Issued SR 269 4000 units GRN = Goods received note and SR = Stores requisition. "Believe in yourself, and the rest will fall into place” Example 15: The following is the summary of the receipts and issue of materials in a factory during January: January Particulars 1 Opening stock 500 units at Rs. 25 per unit 2 Issued 70 units 3 Issued 100 units 8 Issued 80 units 13 Received from suppliers 200 units at Rs. 24.50 per unit 14 Returned to stores 15 units at Rs. 24 per unit 16 Issued 180 units 20 Received from suppliers 240 units at Rs. 24.75 24 Issued 304 units 25 Received from suppliers 320 units at Rs. 24.50 per unit 26 Issued 112 units 27 Returned to stores 12 units out of the issue dated 16th 28 Received from suppliers 100 units Rs. 25 per unit You are required to prepare the stores ledger on the basis of First in first out. The physical verification revealed that on the 15th, there was a shortage of five units and another on the 27 th of eight units. NMIMS (Deemed to be University) 10 | P a g e F.Y.Bcom (Hons) – Semester I – Cost Accounting [Academic Year 2024-25] "Success is the sum of small efforts, repeated day-in and day-out." Example 16: The following is the record of receipts and issues of a certain material in the factory during a week: April 2015 Particulars 1 Opening balance 50 tonnes @ Rs. 10 per tone Issued 30 tonnes 2 Received 60 tonnes @ Rs. 10.20 per tone 3 Issued 25 tonnes (stock verification reveals loss of 1 tonne) 4 Received back from orders 10 tonnes (Previously issued at Rs. 9.15 per tonne) 5 Issued 40 tonnes 6 Received 22 tonnes @ Rs. 10.30 per tone 7 Issued 38 tonnes Prepare stores ledger as per FIFO. Example 17: The following transactions occur in the purchase and issue of a material: Date Details Units Rate per unit Jan 2 Purchased 4,000 Rs. 4.00 Jan 20 Purchased 500 Rs. 5.00 Feb 5 Issued 2,000 -- Feb 10 Purchased 6,000 Rs. 6.00 Feb 12 Issued 4,000 -- Mar 2 Issued 1,000 -- Mar 5 Issued 2,000 -- Mar 15 Purchased 4,500 Rs. 5.50 Mar 20 Issued 3,000 -- From the above, prepare the Stores Ledger Account as per FIFO method of charging material issues. Example 18: From the following details of stores receipts and issues of material X, prepare a Stores Ledger Account using weighted average price method. Dec 1 Opening stock 2000 units @ Rs. 5 each 3 Issued 1500 units to production 5 Received 4500 units @ Rs. 6 each 8 Issued 1600 units to production 10 Returned to stores 100 units by production (from issue of Dec. 3) 16 Received 2400 units @ Rs. 6.50 18 Retuned to supplier 200 units (out of receipt on Dec. 5) 20 Received 1000 units @ Rs. 7.00 24 Issued 2100 units to production 28 Received 1200 units @ 7.50 each 30 Issued 2800 units to production Note: Calculate issue rate upto two decimal points. NMIMS (Deemed to be University) 11 | P a g e F.Y.Bcom (Hons) – Semester I – Cost Accounting [Academic Year 2024-25] “You need to battle with fear of failure to achieve your goals in life.” Example 19: The following were the receipts and issues of material ZED during March 2005. March Particulars 1 Opening balance – 1100 units Rs. 60 per unit 3 Issue – 140 units 4 Issue – 250 units 8 Issue – 210 units 13 Received from vendor 400 units at Rs. 59 per unit 14 Refund of surplus from a work order 30 units at Rs. 58 p.u. 16 Issue 350 units 20 Received from vendor 480 units at Rs. 62 per unit 24 Issue 608 units 25 Received from vendor 640 units at Rs. 60 per unit 26 Issue 524 units 28 Refund of surplus from a work order 24 units (issued on March 3) 31 Received from vendor 150 units at Rs. 64 per unit From the above, write the Stores Ledger Account on FIFO and weighted Average Basis. “Just when the caterpillar thought the world was ending, he turned into a butterfly.” NMIMS (Deemed to be University) 12 | P a g e