,

2

Direct Materials

In a manufacturing industry, material cost forms an important element of total costs. It is estimated that the investment in material constitutes up to 90% of total capital. The word ‘material’ generally represents raw material. Since material constitutes a major chunk of economic resources, a proper cost accounting system with respect to materials is indispensable for manufacturing industries. Raw material is the keystone of the cost of product. In this chapter all the aspects with respect to materials are discussed in detail.

2.1 DIRECT MATERIALS

Raw materials may be defined as goods purchased for incorporation into products for sale. Materials may be classified into (1) direct materials and (2) indirect materials.

2.1.1 Meaning of Direct Material and Its Constituents

The materials which are easily identifiable with the product are known as direct materials. Direct materials form part of finished product. Cost of direct material forms an important element of prime cost. It may be said otherwise as all such materials the costs of which can be conveniently measured and charged directly to the products. Generally, the following items are included in direct materials:

1. All materials which have been purchased
2. All materials which were issued from stores department for a specified order, job or process
3. All materials which have been specially purchased for a specified order, job or process
4. All materials which have been transferred from one process to another
5. Materials used for primary packing

2.1.2 Indirect Materials

All those materials which cannot be classified under direct materials are called indirect materials. Direct materials having small values, quantities are also treated as indirect materials. Cost of indirect materials is to be treated as overhead. The segregation of materials into direct and indirect categories facilitates control. While direct materials having high value require strict control, indirect materials having low value need not require so.

2.2 PURCHASING FUNCTION

Purchasing of raw material for trading and manufacturing concerns is performed by the purchasing department under an official designated as purchase manager.

2.2.1 Objectives of Purchase Department

The following are the objectives of the purchase department:

1. To purchase materials at the lowest cost
2. To purchase quality materials
3. To ensure that the materials are available on time
4. To ensure continuity in supply of materials.

Following are the responsibilities of purchase department:

1. To know about the sources from where materials are to be purchased and their lead time
2. To act as a proper link between the suppliers and production department
3. To be aware of the requirement of materials
4. To have proper knowledge about their specifications
5. To update continuously the price, availability, various available sources, competition, substitutes and the like factors
6. To keep an updated supplier list duly rated

2.2.2 Methods of Purchasing

The management has to devote much attention to the task of purchases, failing which may lead to collapse of the entire edifice. The methods of purchasing may be broadly classified into: (1) centralized purchasing and (2) decentralized (localized) purchasing.

2.2.2.1 Centralized Purchasing

When purchasing department is located at only one place and the entire purchases are made by it, such purchasing is known as centralized purchasing. All purchases are made by a single unit for various manufacturing units of an organization.

Following are the advantages of centralized purchasing:

1. Facilitates uniform procedure and policies to procure materials
2. Advantages of bulk purchases
3. Ensures standardization of materials
4. Reduces cost of purchase
5. Facilitates the task in case import
6. Development of expertise in purchasing
7. Reduces investment in inventories
8. Exercises greater control

2.2.2.2 Decentralized Purchasing

If purchase department is situated at different places and is responsible for purchasing the materials for that manufacturing unit, such purchasing is known as decentralized purchasing. Each unit makes its own purchases.

Following are the advantages of decentralized purchasing

1. Facilitates direct contact with suppliers
2. Reduces time lag between indent and receipt of materials
3. Leads to reduction in paper work
4. Reduces operation cost
5. Easy replacement of defective materials

Factors that determine the choice between centralized and decentralized purchasing are:

1. Type of product (homogeneity)
2. Type of material bought
3. Location of plant
4. Availability of expertise
5. Availability of local suppliers
6. Management policy

2.3 PURCHASE PROCEDURE

Each concern adopts its own procedure regarding purchase of materials. Forms and records may differ slightly but the procedure is the same which is explained as follows:

 

Stage I:	Indenting for materials
Stage II:	Issuing tenders
Stage III:	Receiving quotations
Stage IV:	Placing order
Stage V:	Inspecting stores received
Stage VI:	Receiving the stores accepted in inspection
Stage VII:	Passing bills for payment

Let us explain each stage in detail.

2.3.1 Stage I: Indenting for Materials

Actually the purchase procedure starts from the stores department. The stores department prepares indents for the purchase of materials and forwards the same to the purchase department. Indents may be classified into two categories: (1) regular indents and (2) special indents.

Regular indents: (i) These indents are meant for replenishment of stocks. (ii) Regular indents are prepared periodically. (iii) They are placed when the ordering level for various items of stocks are reached. (iv) They must be certified by the stores department.

Special indents: (i) Special indents are meant for a special job. (ii) They are prepared only when necessity arises. (iii) Special indents are based on the demands received from respective departments (planning or production). (iv) These indents are to be certified by the department from where it gets originated.

2.3.2 Stage II: Issue of Tenders

It is the duty of the purchase department to issue tenders to suppliers. In order to obtain quotations from prospective suppliers of goods and services, business organizations float tenders. Specific type of tender may be adopted for different types of tenders:

1. Single tender: Enquiries are issued to one supplier only. It holds good for propriety items.
2. Open tender: In case of large quantity of goods with high value, this type is adopted. Usually this type is published in leading newspapers and reputed trade journals.
3. Limited tender: Tenders are issued only to limited number of suppliers chosen from the list of vendors.
4. Global tender: The firms advertise in international trade journals. This method is used when international financial institutions are involved and when the order value is high.

Tenders are prepared in triplicate. Two copies will be sent to the supplier. Of these two, one copy will be retained by the supplier, the other copy (usually original) will be sent by the supplier to the purchase department by stating their terms and conditions of supply of goods or services. The third one is retained by the firm (purchase department).

2.3.3 Stage III: Receiving Quotations

When quotations are received from suppliers, they have to be processed cautiously. A comparative statement is used. The prospective suppliers are to be ranked based on the prices quoted by them. Further, the following factors have to be considered while processing the tenders:

1. The quality of goods
2. Time to be taken for delivery
3. Financial capability of the supplier
4. Integrity of the supplier

At times, purchases may be made without inviting quotations. In such cases, the cost component and the price have to be taken into consideration for such cost plus contract basis purchases.

2.3.4 Stage IV: Placing Purchase Orders

After receiving and analysing the tenders, the purchase order is to be prepared. The purchase order is prepared in six copies. They are routed to (i) accounts department, (ii) the supplier, (iii) purchase department, (iv) receiving department, (v) originating department, and (vi) inspection department, one copy each.

In general, the order is issued to the supplier who has offered the lowest price and who has committed to supply the goods with required specification within the stipulated period.

The purchase order has legal and accounting significance. Legally, it binds both the parties in terms of contract. From the accounting point of view, it envisages the stores department to accept the goods and the accounts department to accept the bill.

2.3.5 Stage V: Inspecting Stores Received

After receipt of the goods, the stores department checks the goods (against the supplier’s delivery challan) with the purchase order. It is ascertained whether materials conform to the order in respect of description and quantity.

After this, materials are sent to inspection department, where an inspection note is prepared. The material inspection note is a document which depicts the material code, description, specifications, quantity received for inspection, quantity accepted, quantity rejected and reasons for rejection. An inspection note has to be prepared in four copies. One copy is sent to the stores department, one copy is sent to the supplier, one to the purchase department and one to accounts department.

 

2.3.6 Stage VI: Receiving Stores

After inspection is completed, goods are sent back to the stores department. At this stage, the stores department prepares a stores receipt note or goods received note. It shows the materials received from suppliers. This is a document which shows the material code, description, specifications, quantity, unit price and value of materials. After issuing stores receipt note (goods received note), the storekeeper is responsible for stocks. This is a document for the posting of receipts in bin card and stores ledger. The stores note is circulated to the production planning and control department, accounts department, inspection department and the costing department.

 

2.3.7 Stage VII: Passing Bills for Payment

Bills sent by suppliers were received first by the purchase department. Then they are forwarded to stores accounting section. They check the authenticity regarding quantity and price and its arithmetical accuracy. Other special items shown in the bill like packaging and forwarding charges are verified with the purchase order. The bill is finally passed for payment.

 

2.4 PRICING OF STORES RECEIPTS (ACCOUNTING FOR DIRECT MATERIAL COST)

All expenses incurred in receiving and storing the material form part of the cost of materials. When the direct material that is used in the manufacture of finished goods is translated into financial terms, the resultant is direct material cost.

Direct material cost can be easily identified with a cost unit.

Direct material cost is the price per unit paid to the supplier with respect to items purchased from the supplier. It comprises of:

1. Purchase of item
2. Local taxes and duties
3. Inward freight
4. Cash discount
5. Volume discount
6. Trade discount
7. Rebates, duty drawback, modvat and subsidies
8. Packing expenses, delivery
9. Joint purchase cost
10. Extra/spare parts
11. Cost of containers (in case of returnable containers, the difference between the charge for returnable containers and the sum refunded on return of containers) is taken as expense
12. Provisional pricing of materials

Illustration 2.1

Model: Direct material cost and issue price of materials to jobs.

X Ltd purchased two kinds of raw materials for the manufacture of its product. From the following information given in the supplier’s bill, you are required to calculate (a) direct material cost and (b) issue price of materials:

 

	Rs.
Raw material X: 250 Nos of Rs. 5 each	1,250
Raw material Y: 500 Nos of Rs. 2 each	1,000
Insurance	45
Central excise duty: Raw material X:	80
Raw material Y:	120
Packing, storage and delivery charges	150
Sales tax	270
Freight	300

 

The purchaser paid Octroi duty at Rs. 2 per unit. During the checking of incoming materials at the buyer’s factory, it was found that 5 units of raw material X and 10 units of raw material Y were in broken condition. It was found from past experience that 20% of materials deteriorate in storage.

Solution

The following calculations will have to be made, before computing material cost.

Working *1: Insurance will have to be distributed in the ratio of material value purchased as:

Purchase price of raw materials purchased:

∴ Insurance for raw material

Insurance for raw material

*2: Packing, storage and delivery will be distributed among the raw material X and Y in the ratio of quantity raw materials.

∴ Packing, storage & delivery expenses for raw material

Packing, storage & delivery expenses for raw material : Y

*3: Freight would be distributed in the same ratio as in (2).

Freight inward for material

Freight inward for material

*4: Sales tax will be distributed in the same ratio as in (1): that is, 5:4

Sales tax for raw material

Sales tax for raw material

(a) Statement showing computation of direct material cost

Particulars	Raw Material X Rs.	Raw Material Y Rs.
Step 1 → Purchase price (excluding excise duty)         (Given)	1,250	1,000
Step 2 → ADD
(i) Central excise duty (given)	80	120
(ii) Packing, storage and delivery (Ref: *2)	50	100
(iii) Insurance (Ref: *1 (value basis))	25	20
(iv) Freight inward (Ref: *3 (quantity basis))	100	200
(v) Sales tax: (Ref: *4 (Value basis))	150	120
(vi) Octroi (X: 250 Nos × 2; Y: 500 Nos × 2)         Given	500	1,000
Step 3 → Direct material cost	2,155	2,560
(Step 1 + Step 2 (i to vi))

(b) Statement showing issue price of materials

Particulars	Raw Material X Rs.	Raw Material Y Rs.
	Nos.	Nos.
Step 1 → Purchase of raw materials (in nos) (Given)	250	500
Step 2 → Less: Damage in transit (Given)	5	10
	245	490
Step 3 → Less: Deterioration in storage − 20% (Given)	49	98
Step 4 → Quality available for issue	196	392
Step 5 → Direct material cost         (Ref: Statement (a))
Rs.	2,155	2,560
Step 6 → Issue Price per Unit         (Step 5 ÷ Step 4)                   Rs.	10.99	5.22

Important note

1. Insurance and sales tax are to be apportioned based value, that is, in the ratio of purchase price of raw materials.
2. Packing, storage and delivery charges and freight are to be apportioned based on quantity i.e numbers.

2.4.1 Joint Purchase Costs

Sometimes, supplier’s invoices contain item of materials having more than one specification. Usually they will be shown as a lot and consolidated amount is mentioned against it. In such a situation, the purchaser will ascertain the current market price of each kind of material. The consolidated amount is to be apportioned based on value, that is, in the ratio of market prices. In case market prices are not given, technical estimates serve as a basis of apportionment. Insurance charges based on the value of materials, carriage inwards based on quantity (volume or weight) should form the basis of apportionment (as explained in Illustration 2.1) for consolidated amount.

2.4.2 Storage and Issue Losses

From the date of receipt of materials till the date of issue of the same, that is, during the storage period, some losses are unavoidable. Some losses occur in the stores department due to the following factors:

1. Evaporation, shrinkage, drying and the like
2. Inability to measure precisely
3. Difference in units of issue from units of purchase (some materials are purchased on weight basis and are issued by number basis)

By inflating the material price per unit, such losses can be recovered.

Abnormal loss will be duly charged against costing profit and loss account.

Illustration 2.2

Model: Storage and issue losses

A firm purchases 1000 litres of a chemical at Rs. 75 a litre. The normal loss from issue and storage is 25%. You are required to compute the material issue price per unit.

Solution

Normal loss from issue and storage = 25%

Normal loss for 1,000 litres

2.5 STORES FUNCTIONS

Store keeping (stores functions) is an important function. Store keeping is the function of receiving materials, storing them and issuing them to workshops or departments. The stores department is headed by a stores manager (store keeper).

2.5.1 Main Objectives of Store Keeping

The main objectives of store keeping are:

1. To protect stores against losses
2. To keep materials ready for issue
3. To avoid overstocking and understocking
4. To facilitate perpetual inventory

2.5.2 Duties and Functions of a Store Keeper

Important functions of store keeping (stores department) are as follows:

1. Receipt of materials: Materials are received and verified properly. Then they are transferred to stores.
2. Maintenance of materials: The store keeper classifies the materials and stores them in appropriate places. They are maintained in an orderly manner in the stores.
3. Record keeping: The stores records are maintained properly. Records are to be maintained in such a way that any information can be obtained quickly and without difficulty. Records are to be maintained up to date.
4. Storage: Materials should be protected safely. Proper storage devices have to be installed.
5. Issuing stores: All issues from the stores should be recorded promptly and accurately. All issues should be duly authorized. Procedures laid down should be complied with utmost care.
6. Periodical check-up: Materials should be checked by reconciliation of stores balance as per bin card with the physical stock on a periodical basis.
7. Coordination: The store keeper is responsible for coordination with materials control.
8. Desired level: Stores should be maintained at required optimum levels of stock.
9. Periodical review: Periodical review of various scales, measuring instruments, conversion ratios should be undertaken with utmost sincerity.
10. Protection: Proper protection of stores from fire, rust, erosion, theft, deterioration and other Nature furies is necessary.

2.5.3 Centralized Stores

When stores department of an organization is located at one place only, it is known as centralized stores. If the stores department is situated at different places, it is known as decentralized stores. Where there is only one stores department, it is called a central store. Where more than one stores department exists, they are called sub-stores or subsidiary stores.

2.5.3.1 Advantages of Centralized Stores

1. There will be adequate security of stores department.
2. Stock may be maintained at a lower level.
3. Location, layout, mechanization of stores may be well designed.
4. Lesser staff, fewer records result in economy and lower expenditure.
5. Better control is possible.

2.5.3.2 Disadvantages of Centralized Stores

1. There may be delay in service.
2. Cost of handling materials is higher.
3. Any risk (such as loss of fire) might result in great loss.
4. In case if a central store is large and unwieldy, it is difficult to manage it.

2.5.4 Imprest Stores

Imprest stores system is based on the imprest system of petty cash. This system is introduced to overcome the disadvantages of centralized stores. A sub-store is attached to each production department. This operates with an operating stock marginally higher than the normal requirements. At the end of specified period, the exact quantity is replenished just as in the system of petty cash.

2.5.4.1 Advantages

1. Issue of stores will be quick.
2. As materials are requisitioned only once in the period, there is much reduction in clerical work.
3. It leads to the simplification of control of stores.
4. It reduces inventory-handling costs.
5. Delay in production is avoided as raw materials are available in the production department itself.
6. It combines the advantages of both the centralized and decentralized storing systems.

2.6 CLASSIFICATION AND CODIFICATION OF MATERIALS

To identify materials easily and quickly and to prevent mixing of one type of materials with another, a proper system of classification and codification of materials is of vital importance to any organization.

Stores are classified either by nature or usage of stores. Similar items are classified into sub-groups and a number of such sub-groups constitute the major group.

Codification is a unique procedure of assigning codes for each item of store.

2.6.1 Some Important Methods of Codification of Materials

1. Alphabetical method: In this method, each item is denoted by a combination of alphabets. For instance, iron rods may be coded as IR and iron wires may be coded as IW.
2. Numerical method: Each item is given a number. A list of materials is prepared comprising entire materials. Each type of material is assigned a number. Usually the first two digits of the code number may indicate the department for which the materials are meant and the other two digits may indicate the name of materials shown in the list. For example, if the code number of the material is 1111, the first two digits 11 (represent) indicate the department for which the materials are meant, and the other two digits 11 indicates material number.
3. Alphanumerical method: It is a combination of both the alphabetical and Numerical methods for codification of materials.
4. Decimal method: Basically it is a numeric system. In this method sub-group may be indicated by decimals.

2.6.2 Advantages of Codification

1. It is easy to identify.
2. It reduces clerical work.
3. It facilitates mechanized accounting.
4. It ensures secrecy.

2.7 INVENTORY CONTROL

2.7.1 Meaning of Inventory Control

As materials constitute a major part of the total production cost of a product, they occupy an important position in manufacturing enterprises. Hence the need arises for a proper control on it. In fact, inventory control is the core of materials management. Inventory control should be planned in such a way that purchasing and storing should be done judiciously without affecting production in any manner. Funds should not get locked unnecessarily in surplus stocks. Lack of control over inventory may result in an increase in the cost of production. Inventory control is the systematic control and regulation of purchase, storage and usage of materials in such a way as to maintain the even flow of production and at the same time avoiding excessive investment in inventories.

2.7.2 Techniques of Inventory Control

A number of techniques and mathematical models are employed in the process of inventory control. Inventory control is exercised over raw materials and work-in-progress.

The main aim of inventory control is to maintain optimum level of inventory. For this, an organization has to determine:

1. The quantity that they should be ordered and
2. The time when they should be ordered.

The first aspect—the quantity—how much to order is associated with the determination of economic order quantity.

The second one—the time—when they should be ordered is associated with the determination of re-order level.

2.7.3 Economic Order Quantity (EOQ)

This method makes an attempt to resolve the issue: How much to order at a time? EOQ refers to the quantity of order which gives maximum economy in acquiring materials. It puts much thrust on standard ordering quantity. In order to understand EOQ, the costs associated with it have to be analysed first. They are (i) carrying costs, (ii) ordering costs and (iii) costs of stock-out (shortage).

1. Carrying costs: These are “costs of holding” the inventory. These are the costs of keeping items in stock. These costs include store-keeping cost, interest on capital blocked in inventory, insurance premium, handling costs, stores staff, maintenance of equipment costs, cost of warehousing, cost of perpetual inventory and continuous stock taking, deterioration, obsolescence etc.
2. Ordering costs: These are the costs of placing an order and receiving the supplies. These costs include expenses involved in purchasing, raising of stores requisition, follow-up, transportation, receipt in store, sorting inspection, storage etc.
3. Stock-out costs (shortage/inadequate inventory): These costs incur due to the shortage of inventories for meeting the needs of production and consumer demand. These costs include uneconomic production schedules, push-up cost of production, crash and expedite purchases at high costs, customer loss, erosion of goodwill etc. These costs are not easy to measure as many of the costs are intangible. These two costs, ordering costs and stock-out costs, are called “cost of acquiring”.

The optimum ordering quantity—the quantity for which the cost of holding plus the cost of acquiring is the minimum—is referred to as “economic ordering quantity”.

The economic ordering quantity is computed by using the formula:

where E.O.Q = Economic ordering quantity

              U = Units purchased (or) used in a year

              P = Cost of placing an order

              S = Annual cost of storage of one unit

Illustration 2.3

Model: EOQ

X Ltd manufactures a product and the particulars relating to it are as follows:

Monthly demand (units): 500

Cost of placing an order: 90

Annual carrying cost per unit: 10

Normal usage (units/week): 40

You are required to calculate economic ordering quantity.

Solution

First, annual consumption has to be calculated.

Normal usage per week = 40 units

.^.. Normal usage per year = 40 × 52 weeks

Cost of placing an order = Rs. 90 (P) Given

Annual carrying cost/unit = Rs. 10 (S) Given

Formula                 

Substituting the values we get,

Sometimes, stock holding cost may be given in percentage (i.e., the inventory-carrying charges). In such cases the formula differs a little, which is shown below:

where U = Annual consumptions during the year (units)

     P = Cost of placing an order

H.C = Holding cost as percentage of average stock value

     C = Price/unit

Depending on the figures (given in the problem), we have to choose the formula and compute EOQ.

Illustration 2.4

Model EOQ

You are provided:

        Cost of placing an order = Rs. 10 (ordering cost)

        Annual demand = 900 units

        Price per unit = Rs. 5

        Normal lead time = 10 days

        Safety stock = 20 days

You are required to compute:

1. What is the quantity that should be ordered each time?
2. How many orders should be placed with the supplier during a year?
3. What would be the level of stock just before the material which has been ordered is received?

Solution

1. Economic order quantity is the quantity that should be ordered each time.
   

   where U = Annual consumption during the year = 900 units

         P = Cost of placing an order = Rs. 10

      H.C = Stock holding cost = 15%

         C = Price per unit = Rs. 5 Substituting the figures in the formula, we get

   Substituting the figures in the formula, we get

   
2. No of order to be placed in year
   
3. Safety stock is the level of stock immediately before the material order is received.

   Safety stock = Average usage × Period for which safety stock is kept

   

Illustration 2.5

A computer manufacturer purchases 800 units of a certain component from a supplier. The annual usage is 800 units. The order placing cost is Rs. 100 and the cost of carrying one unit for the year is Rs. 4. You are required to compute economic ordering quantity, number of orders and time interval between two orders in a year and to tabulate your results.

Solution

First EOQ is ascertained as follows:

Formula:

Substitute the values in the formula,

Table showing the economic ordering quantity:

1. From the above table we can see that the total cost is minimum when each order is of 200 units. Total cost is only Rs. 800, when order level is of 200 units. EOQ = 200 units.
2. Number of orders in a year will be 4 only. Refer column number 2.
3. The time interval between two orders
   
4. The same may be represented in the form of graphical chart as below:

Illustration 2.6

X Ltd manufactures a product which has a monthly demand of 2,500 units. The product requires a component AA¹, which is purchased at Rs. 10. For every finished product, one unit of component is required. The ordering cost is Rs. 100 per order and the holding cost is 10% p.a. You are required to calculate:

1. Economic ordering quantity
2. If the minimum lot size to be supplied is 5,000 units, what is the extra cost the company has to incur?
3. What is the minimum cost the company has to incur?

Solution

1. As holding cost percentage is given along with the price per unit, the formula for computation of EOQ is:
   

   where U = Annual consumption = 12 × 2,500 = 30,000 units

             P = Cost of placing an order = Rs. 100

         H.C = Holding cost percentage = 10%

              C = Purchase cost (price) per unit = Rs. 10

   Substituting the values in the formula, we get:

   
2. Computation of extra cost incurred by the company:

   (i) Total cost (when order size is 5,000 units)

   

   (ii) Total cost (when order size is 2,450 units)

   
3. Computation of minimum carrying cost = The carrying cost (or) storage cost depends on the size of the order. Hence, it will be minimum when the order size is less.

   In this problem, there are two order sizes, viz., 2,500 units and 5,000 units. Of these 2,500 units is the least one. As such, carrying cost will be minimum at this order size.

   Minimum carrying cost

   

2.7.4 Quantity Discounts and EOQ

In practice, when the size of order increases, suppliers allow quantity discounts. Due to this, the price per unit comes down. But EOQ assumes that the unit purchase price is constant.

When quantity discounts are involved, the computation of EOQ will be as follows.

First ascertain the EOQ using the standard formula.

1. In case the derived figure is equal to (or) higher than the quantity necessary to avail of quantity discount, it is known as optimal order size.
2. If the resultant figure is less than the minimum quantity to be ordered for availing quantity discount, the change in profit resulting from increasing the order quantity has to be calculated.

Illustration 2.7

Model: EOQ and quantity discounts

JP Ltd manufacturers of a special product, follows the policy of EOQ for one of its components. The component’s details are as follows:

 

	Rs.
Purchase price per component	200
Cost of an order	100
Annual cost of carrying unit in inventory	10% of purchase price
Total cost of inventory and ordering per annum	4,000

The company has been offered a discount of 2% on the price of the component provided the lot size is 2,000 components at a time.

1. Compute the EOQ
2. Advise whether the quantity discount offer can be accepted [Assume that the inventory carrying cost does not vary according to discount policy.]
3. Would your advice differ if the company is offered 5% discount on a single order?

[CA. (Inter), November 1994]

Solution

STAGE I: EOQ is calculated as follows:

Step 1 → Figures given in the question have to be written one by one:

Step 2 → Total annual consumption is to be found out by using the following equation:

Substituting the figures in this equation, we get:

Step 3 → Computation of EOQ

Formula

Substituting the values we get,

STAGE II: Decision on Discount Offer:	Rs.
Step 1 → When order size is 2,000, number of orders (4000/2000) = 2
Step 2 → Ordering cost (2 × cost of an order (Rs. 100))	200
Step 3 → Add: Storage cost (1,000 × Rs. 20)	20,000
Step 4 → Less: Savings due to discount	20,200
	16,000
Step 5 → Net cost	4,200

Decision: The net cost is Rs. 200 higher (Rs. 4,200 − Rs. 4,000) than the present cost.

Hence this offer should not be accepted.

 

STAGE III: If the discount offer is 5% on a single order:	Rs.
Step 1 → No. of order = 1
Step 2 → Ordering cost (1 × Rs. 100)   =	100
Add: Step 3 → Storage cost (2,000 × Rs. 20)   =	40,000
	40,100
Less: Step 4 → Savings due to discount (5% × 4000 × 200)	40,000
Step 5 → Net cost	100

Decision: Net cost is Rs. 3,900 (Rs. 4,000 − Rs. 100) less than the present cost.

Hence, this offer must be accepted.

NOTE: To arrive at a decision, compare the net cost with the present cost.

If the net cost is higher than the present cost, such offer should not be accepted.

If the net cost is lower than the present cost, such offer SHOULD BE ACCEPTED.

Illustration 2.8

A firm is able to obtain quantity discounts on its orders of material as follows:

 

Price per kg
Rs.	kg
8.00	less than 250
7.90	250 and less than 500
7.80	500 and less than 1,000
7.60	1,000 and less than 2,000
7.50	2,000 and above

The annual demand for the material is 2,000 kg. Stock holding costs are 20% of material cost per annum. The delivery cost per order is Rs. 8.

You are required to calculate the best quantity to order.

 

[CA. (Inter). Modified]

Solution

First, EOQ is computed by using the formula:

NOTE: It is assumed that staggering the delivery in 146 kg is not possible. The best quantity to order is computed as:

Decision: Least cost is Rs. 15,976 when the order quantity is 1,000 kg.

The optimum ordering quantity = 1,000 kg.

2.8 FIXATION OF STOCK LEVELS

One of the important functions of a store keeper is to replenish the stock in stores department. In fixing stock levels, the vital factors to be considered are:

1. Maximum level
2. Minimum level
3. Re-order level
4. Danger level

2.8.1 Maximum Stock Level

The maximum level is the largest quantity of a particular material that should be kept in the store at any period. This represents the stock level beyond which stock should not be allowed. This is to avoid blocking up of capital in inventories.

The factors that should be considered to fix maximum stock level are:

1. Capital required and available
2. Storage space
3. Rate of consumption of materials
4. Lead time—the time necessary to obtain deliveries of materials from the date of order
5. Cost of storage, insurance
6. Seasonal considerations
7. Nature and quality of materials like evaporation, deterioration etc.
8. Price considerations on bulk purchase
9. Possibilities of changes in habit, fashion
10. Government regulations
11. Economic ordering quantity

Formula to determine maximum level of stock:

 

2.8.2 Minimum Stock Level

This is also known as “safety or buffer stock.” Stocks must not be allowed to fall below this level. This is to avoid stoppage of production for want of materials.

The factors that should be decided in determining the minimum stock level are:

1. Average rate of consumption of materials
2. Lead time
3. Stock-out costs like loss of goodwill, loss of combination, margins etc.
4. Re-order level
5. In case of compulsory or emergency or special acquisition of materials, the question of minimum level does not arise

Formula to determine the minimum level of stock:

 

2.8.3 Danger (or) Safety Level

This is the level of stock fixed below the minimum level of stock. When this level is reached, the purchase manager has to take speedy efforts to acquire the needed materials. The storekeeper at the same time should not issue materials to production department.

At times, the danger level is fixed above minimum level but below the re-order level.

To take corrective action, this level is fixed below the minimum level, and to take preventive action, this level is fixed above the minimum level.

Formula to determine the safety level of stock:

 

2.8.4 Ordering Level (or) Re-Order Level

This is the level fixed between maximum and minimum stock levels. Further supplies should be ordered once the level of stock reaches this state. The re-order level is fixed at a level, higher than minimum stock level to protect against (i) abnormal usage and (ii) unexpected delay in supply of materials.

The factors to be determined for fixing re-order level are

1. The minimum level
2. The expected maximum consumption
3. The lead time, that is, the time lag between the date of issuing orders and the date of receipt of materials

Formula to determine the re-order level of stock:

 

Illustration 2.9

Model: Fixation of level of stock

Materials A and B are used as follows:

 

 

You are required to calculate for each material:

1. Maximum level
2. Minimum level
3. Re-order level
4. Average stock level

[I.C.W.A (Inter). Modified]

Solution

NOTE:

1. For answering questions relating to stock level, the required figures for each level have to be computed first, and then substituted in the formula to determine desired stock level.
2. Generally, re-order level is computed first because this figure is a base for computing other stock levels.

(1) Re-order level:

Step (i)   Formula:

 

(2) Minimum level:

Step (i)   Formula:

 

 

Step (ii) Needed figures = Re-order level (worked out in step 1)

Step (iii) Substituting the figures in the formula, we get:

 

For material A	=	750 units − (100 units × 4 weeks)
	=	750 − 400 = 350 units
For material B	=	1,050 units − (100 units × 6 weeks)
	=	1,050 − 600 = 450 units

 

(3) Maximum level:

Step (i)   Formula:

 

 

Step (ii) Needed figures:

 

	A	B
Re-order level	750	1,050
	(Stage 1)	(Stage 1)
Re-order quantity	500	800
	(Given)	(Given)
Minimum consumption	50	50
	(Given)	(Given)
Minimum re-order period	3 weeks	5 weeks
	(Given)	(Given)

Step (iii) Substituting the figures in the formula, we get:

 

For material A = 750 + 500 − (50 × 3) = 1,250 − 150 = 1,100 units

For material A = 10,50 + 800 − (50 × 5) = 1,850 − 250 = 1,600 units

(4) Average-stock level.

Step (i) Formula:

 

Average stock level = Minimum stock level

Step (ii) Needed figures:

 

	A	B
Minimum stock level (Ref: Stage 2 (iii))	350	450
Re-order level (Ref: Stage 1 (iii))	750	1,050

Step (iii) Substituting the figures in the formula, we get:

2.9 ABC ANALYSIS

So far we have discussed what quantity has to be ordered at a time, the time to place an order, and the various stock levels to be maintained. Now, monitoring and control of inventories will be explained.

It is also known as “always better control”. Its origin is attributable to General Electric Company, America. This is based upon segregation of materials according to their value for control. A small percentage of inventory items account for a large percentage of usage value and vice versa. It is found that

1. 15% of items have 80% of value
2. 35% of items have 15% of value, and
3. 50% of items have 5% of value

Applying this yardstick, the first category is classified into “A”, the second category into “B” and the third category into “C”.

A category is composed of items which are relatively highly expensive or used in large quantities. Hence, tight inventory control is essential. The management has to monitor and control inventories by adopting all possible and needed devices.

Category B consists of items which are of moderate quantity and of moderate value. They are neither expensive nor cheap. This category requires moderate inventory control.

Category C consists of items which are used in small quantities. These items are comparatively inexpensive. This category requires control but not that much compared to other categories.

2.9.1 Steps Involved in ABC Analysis

1. Ascertain future use of each item of stock (in terms of physical quantities).
2. Price per unit of each item has to be ascertained.
3. Ascertain the total project cost of each item (this is done by multiplying the units by the price/unit of respective item).
4. Arrange different items in descending order of their total cost (as determined in the previous step).
5. Units of each item has to be expressed as a percentage of total costs of all items.
6. Finally, compute the total cost of each item as a percentage of total costs of all items.

Example:

 

2.10 VED ANALYSIS

The ABC analysis system gives priority to usage value and ignores the criticality of items, which is not so in practice. Really there are many items which do not possess high usage value but are critical. One component may not belong to either of the groups in the ABC category, but may make matters worse.

To overcome this limitation, another technique known as VED analysis is an important device for management of materials. Under this technique, inventory items are classified and grouped in descending order of criticality. Items are grouped into three categories V, E and D, where V denotes items which are Vital, E denotes Essential and D stands for Desirable.

V category of items are vital for process of production. The production will come to a standstill, if the items of these category are not available in time. Hence, strict and proper analysis has to be carried out, stock level has to be maintained adequately and network of suppliers should be proper and reliable. Items grouped under category E are essential, but their absence would not do much harm in production. D category items will not have an immediate consequence on production.

2.11 PARETO ANALYSIS

This analysis is also known as 80:20 rule. Pareto’s rule stipulates that 20% of stock must be strictly controlled by adopting suitable policies, procedures and devices. The balance 80% of stocks will have to be analysed in established norms, procedures. Pareto analysis may be said to be a technique of selective inventory management.

2.12 FNSD ANALYSIS

FNSD F stands for Fast moving

     N stands for Normal moving

     S stands for Slow moving

     D stands for dead/dormant stock

Under this technique, inventory is classified into four different categories for the analysis of movement of inventory. This technique is based on stock turnover ratio.

F—Fast moving items are consumed within a short period of time. Generally, stock velocity of items belonging to this category is relatively very high. Every effort should be made to ensure that no stock-outs occur.

N—Normal moving items are consumed within a year. Their stock turnover ratio may be moderate.

S—Slow moving items are consumed in a period extending over 2 years. They have very low stock turnover ratio.

D—Dormant or dead stock denotes stock which remains idle in stores. For them no present demand exists. Nor forecast can be made on future demand.

Continuous and proper monitoring is an essential and indispensable task of inventory management control.

2.13 TWO BIN SYSTEM

The very name indicates the usage of two bins for maintaining stock of materials. In general, material is used from one bin only till it gets emptied. Under this system, for each item of stock, two bins or piles or bundles are used for maintaining stock of materials. The first bin stocks sufficient quantity of inventory for the specified period (period between receipt of an order and placing of next order). The second bin contains stock (safety stock—normal level) to provide service till new stocks arrive and fill the first bin. Reorder takes place when the stock in the first bin is empty. No need to wait for the re-order date. Perpetual inventory record is not in practice under this system because no bin-tag (quantity record of materials) card is in vogue, which is a great disadvantage of the two-bin system.

2.14 CONTINUOUS STOCK TAKING

The terminology of CIMA defines continuous stock taking as “the process of counting and valuing selected items at different times on a rotating basis”.

Under this method, the stock-taking work is planned in such a way that all items of work are to be verified during the year. Stock-taking plan may vary from one firm to other. Some employ man hour basis, while some other firms use category basis for stock verification.

Stock as shown in company’s records is compared with stock taken physically. Differences may arise. Such differences should be checked with bin card balance. Bin card shows the actual stock in hand. So adjustments can be made in stores ledger. The balance in stores ledger and bin card must be reconciled.

Discrepancies should be analysed by causes and responsibility centres, and properly investigated. If the value is high due to surplus/deficiency, it should be reported to authorities for approval.

2.14.1 Advantages of Continuous Stock Taking

1. It helps in early detection of discrepancies.
2. As it is of routine affair, more time is available for physical verification—no need to rush through.
3. It does not cause any disruption—normal and routine work is carried out without any interruption.
4. It serves as a moral check on stores personnel.
5. No man power is wasted unnecessarily.
6. It facilitates better control.
7. Corrective measures may be undertaken immediately.

2.15 PERPETUAL INVENTORY SYSTEM

The terminology of CIMA defines perpetual inventory system as “the recording as they occur of receipts, issues and the resulting balances of individual items of stock in either quantity or quantity and value.”

The aim of a perpetual inventory system is to keep proper track of inventory and provide accurate information to the management timely.

Under this system, receipts, issues, returns, work-in-progress etc. of materials are recorded on a daily and continuous basis. Up-to-date records are always available. Hence, it facilitates verification of stock at any time. The important functions of perpetual inventory are:

1. Continuous recording of receipts, issues and returns of materials in (a) bin card and (b) stores ledger.
2. Continuous verification of physical stock.

2.15.1 Advantages of Perpetual Inventory System

1. Stocks can be checked continuously thereby avoiding any malpractices
2. Production is unaffected.
3. It facilitates proper inventory control, production planning and production control.
4. This promotes moral health on personnel.
5. On detection of discrepancies, remedial measures can be taken immediately.
6. Reliable and accurate financial statements can be prepared from these records.
7. Stocks may be kept at minimum level, thereby effecting savings in investment in stock.
8. Loss of interest on capital invested in stock, loss due to deterioration can be avoided or kept at minimum.
9. A proper perpetual inventory system leads to the introduction of continuous stock taking.
10. These records reveal the cost of materials, which in turn facilitates exercising control over costs.

Most important records used in this system are (1) bin card and (2) stores ledger. Let these be discussed in detail in Sections 16 and 17.

2.16 BIN CARD

This record (document) is prepared by the stores department. It is a quantitative record of receipts, issues and balances of materials in stores. Quantity of any specified materials can be easily known from bin, at any point of time.

How does is function? Each item of material is entered in a separate bin card. It is attached to the bin or rack when the materials are stored. When a transaction takes place (issue or receipt), the bin card is posted. Only after the transaction is recorded, the items are received or issued. When materials are received, the quantity is entered in the bin card. The balance is updated. The various levels indicated in a bin card facilitate the task of store keeper in the preparation of requisition materials as and when required. Similarly all issues, return of materials are entered in bin card. Quantity on order and quantity reserved are also shown separately.

 

2.17 STORES LEDGER

The stores ledger is a record maintained by the accounts department. All receipts and issues of materials are recorded in it. Once receipt or issue or return of goods is entered in the bin card, the same document is used for posting in stores ledger. It has a separate page or folio for each material code. It is a subsidiary ledger. It constitutes part of double-entry book-keeping.

 

2.17.1 Differences between Bin Card and Stores Ledger

Basis of Distinction	Bin Card	Stores Ledger
1. Nature of record	Bin card is a record of quantity.	Stores ledger is a record of quantity and value.
2. Maintenance of record	It is maintained by the store keeper.	It is maintained by the costs/accounts department.
3. Place where it is kept	It is kept in the stores.	It is not kept in the stores.
4. Time of posting	The postings are done before the transactions take place.	The postings are done after the transactions take place.
5. Posting	Each transaction is posted individually.	Transactions are posted in total.
6. Role	Bin card cannot take the role of ledger and it is not a subsidiary book.	It takes the role of ledger and it is like a subsidiary book.

2.18 PERIODIC STOCK TAKING SYSTEM

The terminology of CIMA defines periodic stock taking system as “a process whereby all stock items are physically counted and then valued”.

Physical stocktaking is conducted at the end of fixed intervals, under periodic stock taking. A “cut-off date” is selected during which no movement of stock takes place. Bin cards and stores ledgers have to be kept up-to-date and they must have been reconciled with physical stocks. Then only stock taking takes place. During the physical verification of stock, one item has to be verified at a time and the physical stock noted down in the stock sheet. Discrepancies between physical stock and stock as per records, if any, have to be reported to the top-level management. After the stock taking, the details are to be entered in pre-printed stock sheets. They are serially numbered. The main drawback of this method is that during stock taking no movement of materials is permitted and the production is stopped abruptly.

2.19 CONTROL RATIO—INVENTORY TURNOVER RATIO

Inventory turnover ratio depicts the relationship between the cost of goods sold and average inventory. This ratio indicates the velocity of stock.

Formula:

where

Any increase in stock turnover ratio indicates that stocks consumption is high. It is a good indicator. On the other hand, any decrease in ratio will indicate negative results, to be observed cautiously and required corrective measures to be undertaken to improve this ratio.

2.19.1 Advantages of Inventory Turnover Ratio

1. This ratio helps the management to identify excess stocks and through proper control minimize capital being locked up in inventories.
2. It helps in inventory control regarding obsolescence and idle stocks, thereby minimizing loss to the management.
3. It assists in improving stock-keeping efficiency. The inventory turnover ratio (in terms of days) can be computed by using the formula:
   

   This formula is used to calculate the number of days for which the stocks are held up in stores department.

Illustration 2.10

Model: Inventory turnover ratio

From the following data compute inventory turnover:

	Material A	Material B
	Rs.	Rs.
Opening stock	1,000	1,500
Purchases made during the year	2,000	2,500
Closing stock	500	1,000

Solution

(A) First, average inventory has to be calculated:

*³ Since only materials are given, they are cost of goods sold.

(B) Computation of inventory turnover ratio:

Particulars	Material A	Material B
Step 1 → Opening stock	1,000	1,500
Step 2 → Add: Purchases	2,000	2,500
	3,000	4,000
Step 3 → Less: Closing stock	500	1,000
Step 4 → Consumption of materials during the period	2,500	3,000
Step 4 → Inventory turnover ratio= *3
	= 3.33	= 2.4

Result: Turnover ratio for material A is 3.33 and for B is 2.4. Material A is being turned over 3.33 times. Material B is being turned over 2.4 times. Material B is being held for a longer period. Hence, the stock of material B is always high.

Decision: The management should take the needed action to manage Material B.

2.20 ISSUE OF MATERIALS

2.20.1 Factors to Be Considered on Issue of Materials

1. Planning: All requirements of materials have to be well planned in advance. The bill of materials assists in providing estimates of different items of stores.
2. Requisition of materials: The bill of materials serves as a basis for placing material requisition note. Materials cannot be issued in excess of quantities mentioned in the bill of materials. Such situations warrant additional bill of materials.
3. Audit of issues: All issue of materials must be audited. Any discrepancies should be explained and accounted for.
4. Wastage control: It should be seen that actual wastage should not exceed standard and normal wastage. Any variance should be reported and remedial action should follow.
5. Sundry items: Certain stores (materials) are required in more than one department. Such sundry items are in need of special attention.

Bill of material and material requisition are noted above. Now we have to discuss the above records—specimen, purpose, features and advantages of each.

2.20.2 Material Requisition Note

Material requisition may be defined as “a document which authorizes and records the issue of material for use”. This document is prepared by the production or other departments. Materials should be issued by the store keeper only on presentation of a duly authorized material requisition note. This is an instruction to the stores department to issue materials for the department which is in need of materials. A material requisition note is prepared in triplicate. One copy is sent to the stores, one copy to the costing department and the third is retained by the department that made such note.

 

2.20.3 Bill of Materials

This document is prepared by the design or engineering or production planning and control department. This document contains the quantity required by such departments. Following are the purpose underlying the preparation of bill of materials:

1. It serves as a basis for the computation of direct material cost when quotations are submitted.
2. It serves the purpose of intimation to purchase department to purchase materials.
3. It serves as a guideline to production department.
4. It facilitates accounting of materials consumed as needed data can be passed on to relevant jobs or processes.
5. It functions as a controlling technique.

Four copies of bill of materials are prepared. One copy each is sent to the production, stores and cost accounting departments, and one copy is retained by the planning or engineering department.

 

2.20.4 Material Return Note

When the materials issued to production or other departments are defective or no longer required, this document is prepared by the concerned department. The materials are returned to the stores department along with this material return note. This is prepared in duplicate, one copy will be kept by the stores and the other copy is returned to the department by the stores with proper acknowledgement.

 

2.20.5 Material Transfer Note

When materials are transferred from one department to another department, the transferrer department raises a material transfer note. It is sent to the transferee department along with the materials. One copy is sent to cost accounting department, and the other copy is sent to production planning and control department.

 

2.20.6 Kardex System

This technique is of latest development. It can also be said that it is an improvement over loose leaf card system. Under this technique a card has to be maintained for each item of material. The cards are kept in Kardex cabinets, specially designed for this purpose.

These cards have columns both in terms of quantity and value for the materials (i) received—receipt column, (ii) issued—issue column and (iii) balance column, just similar to stock ledger sheets. Whenever transactions take place, they are to be entered in the respective columns.

2.21 PRICING OF MATERIAL ISSUES

Objectives of materials pricing are:

1. To provide a satisfactory basis for the valuation of closing stock to prepare financial accounts
2. To charge cost of materials used for measuring the cost of production and cost of sales

Materials are issued from stores to various processes or contracts or jobs or work orders etc. These jobs are charged with the value of materials issued to them. Here arises the difficulty regarding the price at which materials issued are to be charged. This is due to the fact that the stock of materials consists of different consignments received at different dates and at different prices. The various methods used for the pricing of materials are as follows:

1. Based on cost price: Cost Price Methods
   1. Specific Price Method
   2. First in First Out Method (FIFO)
   3. Last in First Out Method (LIFO)
   4. Highest in First Out Method (HIFO)
   5. Next in First Out Method (NIFO)
   6. Base Stock Method
2. Average Price Method
   1. Simple Average Method
   2. Weighted Average Method
   3. Periodic Simple Average Method
   4. Moving Simple Average Method
   5. Moving Weighted Average Method
3. Notional Price Method—Based on notional price
   1. Standard Price Method
      1. Current standard
      2. Basic standard
   2. Inflated Price Method
   3. Market Price Method
      1. Replacement Price Method
      2. Realizable Price Method
      3. Re-use Price Method

Let us discuss the methods one by one:

2.21.1 Specific Price Method

In this method, materials are issued at the price at which they were purchased. This involves identification of each lot purchased. This method can be used when the materials have been purchased for a specific job. Materials are to be issued only against the job for which such materials are purchased. This method cannot be used when the material is meant for all jobs, that is, general use. Because of this, this method has limited applications.

Illustration 2.11

Following is the record of receipt of materials:

 

2 June	Received 500 units for Job No. 15 @ Rs. 10 per unit
8 June	Received 400 units for Job No. 16 @ Rs. 12 per unit
15 June	Received 200 units for Job No. 17 @ Rs. 13 per unit
28 June	Received 300 units for Job No. 18 @ Rs. 15 per unit

 

During the same month, following issues of materials are made:

 

9 June	Issued 250 units for Job No. 15
17 June	Issued 200 units for Job No. 16
18 June	Issued 250 units for Job No. 15
20 June	Issued 200 units for Job No. 17
22 June	Issued 100 units for Job No. 16
29 June	Issued 150 units for Job No. 18

 

You are required to show how these transactions will appear in the stores ledger.

Solution

Note that job numbers are given. This implies that materials have been purchased for specific jobs. When they are issued for the particular job, they are priced at the respective prices only. For example, materials were received on 2 June, for job no. 15 @ Rs. 10 per unit. Whenever materials are issued for job no. 15, they are to be priced at Rs. 10 per unit. (9 June and 18 June). The same principle has to be applied, in a similar manner, to other job orders and tabulated as follows in the stores ledger:

 

2.21.2 First in First Out Method

Under this method, it is assumed that the materials first received are the first to be issued. This method seeks to price issues based on the order in which they are received. Units issued are priced at the oldest cost price listed on the stock ledger.

2.21.2.1 Advantages

1. This method is simple to understand and easy to operate.
2. The clerical work is minimal.
3. As the oldest units are issued first, it results in good inventory management.
4. Accounting standard recognizes this method.
5. It facilitates inter-firm and intra-firm comparisons.
6. Valuation of inventory and cost of finished goods is consistent and realistic (as it is near to replacement cost).

2.21.2.2 Disadvantages

1. When prices are rising, the product cost tends to be understated.
2. Comparison of cost of various jobs will be difficult, as they are charged with different prices in respect of the same materials.
3. When prices are falling, the product costs tend to be overcharged resulting in high value of quotations which may be deterrent to sales volume.
4. The cost of production is not linked to current costs.
5. The pricing of “material returns” will be difficult.
6. Replacement of used materials will create additional problem especially during high inflation period.
7. True picture will not emerge when many lots are purchased at different prices.

Illustration 2.12

Model: FIFO method

A firm maintains its stores ledger on the FIFO method. During the month of June 2009, the following receipts and issues of materials were made. You are required to record these transactions in the stores ledger.

Receipts:

 

1 June	Balance 100 units @ Rs. 5 per unit
4 June	Purchase Order No. 101, 80 units @ Rs. 4/unit
8 June	Purchase Order No. 103, 60 units @ Rs. 5/unit
15 June	Purchase Order No. 102, 40 units @ Rs. 3/unit
25 June	Purchase Order No. 104, 80 units @ Rs. 6/unit

 

Issues:

 

11 June	Material Requisition No. 21, 120 units
14 June	Material Requisition No. 22, 50 units
16 June	Material Requisition No. 23, 40 units
20 June	Material Requisition No. 24, 20 units
27 June	Material Requisition No. 25, 30 units

Solution

Under FIFO method, materials purchased first are to be issued first.

In this problem, “Balance—100 units—price Rs. 5/unit” is to be taken as first received. This price has to be charged for the materials that are issued first, that is, on 11 June—first issue takes place. Those issues must be charged @ Rs. 5/unit. Units issued are 120 units. 100 units are to be charged @ Rs. 5/unit. There are 20 units more. These units have to be charged on the next in order, that is, 4 June level of price @ Rs. 4/unit. This method of pricing is to be carried out for other issues which are shown in the stores ledger as follows:

 

2.21.3 Last in First Out Method (LIFO)

Under this method, materials which had been received last are issued first. This is also called the replacement cost method, as the current cost of materials is applied to the cost of units. The purchase price of the latest batch of materials (received from suppliers) is used for pricing the issue of materials. Once this gets exhausted, then the next latest consignment pricing is used and so on.

2.21.3.1 Advantages

1. It is simple and easy to operate.
2. As issues are priced at the current market price, this method is suitable when prices are rising.
3. This method gives realistic product cost.
4. Unrealized gains from stock is minimized.
5. It is a good method for tax calculations.
6. It is in compliance with the principle of matching, that is, matches current costs with current revenues.

2.21.3.2 Disadvantages

1. Accounting standard does not recognize this method of pricing issues.
2. This method may not be suitable when price fluctuation dominates the market.
3. Inter-and intra-firm comparisons may not be possible, as there is great variation in the cost of materials belonging to different lots.
4. This method involves much clerical work.
5. Statutory auditors do not accept this method of valuation of stocks for preparation of financial accounts.
6. When prices fall, the stocks require to be adjusted, which is a complicated procedure.

This method may be explained by the following illustration:

Illustration 2.13

Model: LIFO method

A firm maintains the stores ledger on the LIFO method. During the month of July 2009, the following receipts and issues of materials were made. You are required to record these transactions in the stores ledger:

Receipts:

 

1 July	Balance 100 units @ Rs. 10 per unit
5 July	Purchase Order No. 15, 80 units @ Rs. 8/unit
8 July	Purchase Order No. 16, 60 units @ Rs. 9/unit
15 July	Purchase Order No. 17, 40 units @ Rs. 10/unit
28 July	Purchase Order No. 18, 80 units @ Rs. 6/unit

 

Issues:

 

10 July	Materials Requisition No. 11, 140 units
12 July	Materials Requisition No. 12, 20 units
20 July	Materials Requisition No. 13, 40 units
25 July	Materials Requisition No. 14, 20 units
31July	Shortage 10 units

Solution

Under this method, the purchase price of the latest batch of materials is used for pricing the issue of materials.

In this question the issue on 10 July is priced @ Rs. 9/unit, being the latest purchase, that is, on 8 July. Materials issued are 140 units, whereas the lot on 8 July consists of 60 units only so the remaining units are to be priced at the next latest purchase, that is, on 5 July @ Rs. 8/unit and so on. All the other issues are priced in the same way and the results are tabulated in the stores ledger as follows:

 

2.21.4 Highest in First Out Method (HIFO)

Under this method, materials having highest prices are issued first. This is based on the assumption that the inventory should be valued at the lowest possible price. Costliest materials are issued first, irrespective of the date of purchase. The main factor underlying this method is that when market prices of materials are fluctuating, the product will be able to absorb the cost of materials and provide product costs. This method is widely used for monopoly products, cost plus contracts and the like. A secret reserve has to be created when stocks are undervalued.

2.21.4.1 Advantages

1. It is useful only for certain type of products.
2. When there is shortage of materials, this method will yield desired results.

2.21.4.2 Disadvantages

1. It violates the basic accounting principles and hence it is not accepted by accounting authorities.

Illustration 2.14

Based on the same information provided in Illustration 2.13, you are required to prepare a stores ledger account under HIFO method.

Solution

Under this method, while issues are to priced, look at the prices of purchase and use the maximum or highest price first and then follow in the descending order of prices. Ignore the date of purchase. The results are tabulated in the stores ledger account as follows:

 

2.21.5 Base Stock Method

A specified quantity of materials is always held in stock by all organizations. This quantity of stock is known as base stock. The base stock is deemed to have been created out of the first lot purchased. Hence, it is always valued at this price and it is carried forward as a fixed asset. It is important to observe here that any quantity over and above the base stock is valued in accordance with any other method (FIFO or LIFO methods).

2.21.6 Next-in-First Out Method

Under this method, the issues are to be valued at the next price. The next price denotes the price of materials which have been ordered but not yet received. In other words, the issues are priced at an actual price which is approximately equal to the market price. The policy is to keep the price at the level of the market price.

Under this method, materials will be issued at a price at which a new order is placed. Till the next order is placed, the same price will be applicable to issue of materials.

To illustrate, on May 10, 1000 kg of material are lying in the stores purchased at the cost of Rs. 25 per kg. On May 15, another order is placed to procure 500 kg @Rs. 30 per kg, on the same day. A requisition is received from the department for 300 kg, then it will be priced at Rs. 30 per kg, eventhough the materials are yet to be received.

As it is difficult to follow the procedure, this method is not in use anymore.

Illustration 2.15

With the information provided in Illustration 2.13, you are required to prepare a stores ledger account showing the receipts and issues of materials which would be recorded under LIFO method taking base stock as 80 units.

Solution

First issue took place on 10 July—no. of units to be issued is 160.

80 units are to be treated as base stock unit (Given) at Rs. 8/unit (Given). Remaining 60 units are to be priced @ Rs. 9/unit (under LIFO). The remaining issues are to be priced similarly and tabulated in the stores ledger as follows:

 

2.21.6.1 Advantages

1. The movement of prices over a period is indicted by this method.
2. Materials are charged at actual costs.

2.21.6.2 Disadvantages

1. This method is acceptable only under standard accounting practices.

2.21.7 Simple Average Method

Under the method the price is calculated by dividing the total rates of materials by the number of rates of prices. It ignores the quantity of materials purchased. Every time an issue is made, a new average is computed. Unit prices of latest consignments are taken into account.

2.21.7.1 Advantages

1. It is simple to understand and easy to operate.
2. When prices do not fluctuate much, this method will yield good results.
3. This method can be used when stock values are not high.

2.21.7.2 Disadvantages

1. It does not give realistic product cost.
2. It does not take into account the quantity of materials.
3. On each issue, a new average price has to be worked out which involves heavy clerical work.

Illustration 2.16

Based on the same information provided in Illustration 2.13, you are required to prepare a stores ledger account showing the receipts and issues of materials by using simple average price method.

Solution

First issue takes place on 10 July. There are three receipts prior to this date of issue. On 1 July—price is Rs. 10, on 5 July price is Rs. 8 and on 8 July the price is Rs. 9.

Hence, the issue price of materials on 10 July is Rs. 9/unit. Similarly, for other issues simple average price is calculated and the results are tabulated as follows:

 

The stock on 31 July shows 130 units and its value is Rs. 996.67.

If simple average is applied 130 units × 8.33 = Rs. 1,082.90. But the stock appears at Rs. 996.67 only. This reveals that the production is overcharged by Rs. 86.23 (Rs. 1082.90 − Rs. 996.67).

2.21.8 Periodic Simple Average Price Method

Under this method, average price is calculated periodically (weekly or monthly). It is not calculated at the time of each issue of materials as done in the previous method. The average price is to be calculated by adding all the prices (excluding the prices of opening stock—balance) during the period (say month) and dividing the sum of these prices by the number of prices.

2.21.8.1 Advantages

1. All prices are taken into account during the period. Hence one calculation will be enough for one period.
2. Compared to the simple average price method, this is more representative.

2.21.8.2 Disadvantages

1. It does not take into account the quantities.
2. It is not an exact cost method.
3. It ignores fluctuations in price level.

Illustration 2.17

Based on the same information given in Illustration 2.13 you are required to prepare a stores ledger account showing the receipts and issue of materials by periodic simple average method.

Solution

No need of calculation for each issue of materials separately Periodic simple average rate is calculated as follows:

Take all prices of receipts (excluding opening balance):

i.e., Rs. 8 + Rs. 9 + Rs. 10 + Rs. 6.

Divide this by the number of prices, i.e., 4

Each issue of materials made during the month of July 2009 has to be valued at Rs. 8.25. The results are tabulated as follows:

 

The table shows that the book value of stocks is Rs. 1162.50.

But the average rate is 130 units × Rs. 8.25 = Rs. 1072.50.

This discrepancy arises because actual quantities are not taken into account, while computing the average rate.

2.21.9 Weighted Average Price Method

Under this method, the issue price is computed every time a receipt of materials occurs. The average price is computed based on both the quantities received and their cost. This method operates as follows: Average price is calculated after every purchase by adding the quantity received to the stock in hand and the cost of this purchase to the cost of stock in hand. Total cost is to be divided by the total quantity. The result is the average price computed under weighted average price method. A new average should be found out after each and every receipt of materials.

2.21.9.1 Advantages

1. It smoothes out fluctuations in the prices of materials.
2. Changes in prices would not affect issues and inventory.
3. The closing stock is according to accounting principles.
4. No need arises to identify each batch or lot separately.

2.21.9.2 Disadvantages

1. It involves more clerical work.
2. The issue price thus calculated would not reflect the actual purchase price.

Illustration 2.18

Based on the information given in Illustration 2.13, you are required to prepare a stores ledger account assuming that issues of materials are to be valued using weighted average price method.

Solution

For every receipt of materials, average price has to be calculated as follows:

On 5 July, As per P.O. No. 15, a new receipt takes place with 80 units @ Rs. 8 per unit.

Add these 80 units with the previous receipt of 100 units.

Similarly, on 8 July = 60 units @ Rs. 9 = Rs. 540.

Total units on 8 July = 100 + 80 + 60 = 240 units

Total value on 8 July = Rs. 1640 + Rs. 540 = Rs. 2,180

Results are tabulated for other receipts as follows:

2.21.10 Periodic Weighted Average Method

Under this method, average price is computed periodically and not on each new receipt of materials. The average price is calculated by dividing the total value of materials purchased during a period by the total quantity purchased during the same period. Opening stock (value and quantity) is not to be included in this computation. It is to be calculated at the end of the period only.

2.21.10.1 Advantages

1. This method is useful in process costing.
2. The issue price will not be affected by short-term fluctuations.

2.21.10.2 Disadvantages

1. Actual cost is not charged from production.
2. It is not useful for job or product costing.

Illustration 2.19

Based on the information given in Illustration 2.13 you are required to prepare stores ledger account for pricing issue of materials as per periodic weighted average price method.

Solution

Average rate will be calculated at the end of period, that is, end of July.

Hence, till we arrive at the figure of this average rate, Issue column—Rate and amount will not be filled up and only after ascertaining the rate, it will be filled up.

Tabulation will be as follows:

 

This rate has to be filled up for all issues.

2.21.11 Moving Simple Average Price Method

The moving simple average price is the average of the simple average prices for a specified number of periods. The period chosen should cover the period in which the material is issued. The moving average is computed by dividing periodic average prices by the number of periods. To put in other words, we can say that periodic simple average prices are further averaged.

2.21.11.1 Advantages

1. It is not limited to the current average price only. The average prices for a given number of preceding years are also taken into account.
2. This is suitable when there are seasonal fluctuations in prices.

2.21.11.2 Disadvantages

1. This method does not show current price level.
2. At the end of the given period, heavy clerical work is needed.

Illustration 2.20

You are required to compute the simple moving average rates in a chocolate company purchasing raw materials at different monthly rates as shown below. Six months moving average is to be shown from September 2009. How shall the material issued in the months of September, October and November 2009 be priced according to Moving simple average price method?

 

		Price per kg
	Month	(Rs.)
	April	12.00
	May	11.50
	June	12.50
	July	12.00
	August	11.50
	September	12.50
	October	11.00
	November	12.00

Solution

Moving average price is calculated by dividing periodic average prices by the number of periods given.

In this problem, the number of periods given is 6 months. Hence from April to September prices have to be added and divided by 6. Hence the unit price will be 72 ÷ 6 = Rs. 12 for September. For October, add from May to October and divide by 6 and so on. Results are tabulated as follows:

 

Result:

1. Issue price of materials in September = Rs. 12.00
2. Issue price of materials in October = Rs. 11.83
3. Issue price of materials in November = Rs. 11.92

2.21.12 Moving Weighted Average Price Method

Under this method, the issue price of materials will be calculated by dividing the total of the periodic weighted average prices for a number of periods by the total number of such periods. This method is not widely used. This method has the same advantages and disadvantages as those of periodic weighted average method.

2.21.13 Standard Cost Method (or) Standard Price Method

Under this method, the price of issues for each item is predetermined. This predetermined price is known as standard price. The standard price is predetermined by taking into account the important factors that affect price such as market trends, freight and warehousing expenses. All issues and inventory should be kept at standard price. This can be revised.

2.21.13.1 Advantages

1. Accounting procedure is simplified.
2. It is easy to operate as all issues of materials are to be priced at the same standard rate.
3. Selling prices can be predetermined.
4. It is useful in determining the purchasing efficiency.
5. Firms which maintain their cost accounts on standard costing system mostly use this method.

2.21.13.2 Disadvantages

1. It aims at a target which is not based on actual cost.

Illustration 2.21

Based on the information given in Illustration 2.13, you are required to prepare the stores ledger account according to standard price method, assuming that standard price per unit is Rs. 8.

Solution

All issues of materials are priced at standard price. The results are tabulated as follows:

 

Result: The value of stock at standard price is 130 × Rs. 8 = Rs. 1,040. The discrepancy occurred due to the use of this account. This difference Rs. 180 is to be transferred to purchase price variance account.

NOTE: Cost accountants may advise the firm to fix the standard price at a price higher than Rs. 8 per unit as loss of Rs. 180 occurred.

2.21.14 Inflated Price Method

This method is used in certain types of materials in which losses or wastage cannot be avoided due to their inherent nature. This inflated price includes carrying costs, losses due to evaporation, deterioration due to natural calamities and seasonal character. For such materials, the production will be charged at an inflated price. Its aim is to recover full costs of materials purchased.

2.21.15 Market Price Method

There are three different methods under this category:

1. Replacement price method: The replacement price is the cost of same type of materials in the market.
2. Realisable value method: The price at which the material would fetch, if it is sold in the market is known as Realisable value.
3. Re-use price method: The price at which the material is available for which the reprocessed material has been used, is known as Re use Price method.

2.21.15.1 Advantages

1. Market price methods match current revenues with current costs.
2. These methods are useful in case of placing tenders or quotations.
3. These facilitate the efficient buying of stock.

2.21.15.2 Disadvantages

1. These methods emphasize profit / loss factor, whereas cost accounting primarily concerns only with costs.
2. These methods introduce elements of uncertainty.

2.21.16 Selection of Material Pricing Method

We have discussed various methods of pricing issue of materials. Their advantages and disadvantages have been explained. Each method is unique. The choice of a method depends on many factors which are as below:

1. The nature of materials
2. The nature and size of business
3. The management policy
4. Frequency of purchases
5. Price fluctuations
6. Method of stock valuation
7. Frequency of issues
8. Purpose: contract, quotation, tender and the like
9. Stock turnover rate
10. Level of stock—including EOQ
11. Percentage cost of raw materials to total cost of products
12. Costing system
13. Efficiency of clerical staff
14. Storage conditions
15. Variation in cost
16. Valuation of closing stock
17. Consideration to uniform costing, standard costing systems

Among these methods, the method which has the least disadvantages is periodic weighted average price method. But the decision of management and cost accountant will prevail over the choice of the method.

2.22 PRICING OF MATERIAL RETURNS

2.22.1 Pricing of Materials Returned to Vendor

Sometimes, the firms will return materials back to the vendor (supplier). Materials returned are valued at the price at which they were purchased in financial books. But the procedure varies in cost books. Usually, the following procedure will be adopted.

Situation 1: If the materials to be returned are still in stock in stores ledger at the price at which they are received from the vendor, the returned materials will be priced at the value at which they appear in the books (both financial and costing).

Situation 2: If the materials to be returned are not in stock in stores ledger, the returned materials will be priced at the value at which ordinarily issues of materials to production department should have been priced accounting to the method of valuation of stores issues followed by the firms.

But even in this situation, if the defective materials are to be returned to the vendor, they will have to be valued at the price at which they were received.

However, whatever may be the situation, the quantity and value of materials returned to the vendor will be shown DISTINCTLY in the receipts column of stores ledger. Alternatively they may be shown in issues column.

2.22.2 Pricing of Materials Returned to Stock Room

Sometimes, materials are returned by the requisitioning departments (departments which received the materials on requisition) to the stock room (stores room) for credit. The following procedure has to be adopted while valuing materials:

Situation 1: If the firms adopt FIFO or LIFO or HIFO methods, the returned materials will be valued at the price at which they were originally issued. These units should be issued at the old price on the next requisition received.

Situation 2: In case average price method is adopted by the firm, the returned materials should be recorded at the price issued originally. A new average cost would be calculated as if the goods returned were a new purchase, that is, they have to be treated as new receipt.

The quantity and value of materials returned to the stock room will be shown DISTINCTIVELY in the issue column. Again it may be shown in receipts column.

Illustration 2.22

X Ltd takes a periodic inventory of the stocks of material AA’ at the end of each month. The physical inventory taken on 31 December shows a balance of 2000 kg of material AA’ in hand @ Rs. 5.50 per kg.

The following purchases were made during January:

 

2 January	28,000 kg @ Rs. 5.75
9 January	25,000 kg @ Rs. 5.80
16 January	35,000 kg @ Rs. 5.85
23 January	10,000 kg @ Rs. 5.90

 

A physical inventory on 31 January discloses that there is a stock of 15,000 kg.

You are required to compute the inventory value on 31 January, by each of the following methods alternatively:

1. FIFO method
2. LIFO method
3. Average cost method

Solution

 

			Rs.
(a)	23 January	10,000 kg @ Rs. 5.90	59,000
	16 January	5,000 kg @ 5.85	29,250

(b)	31 December	2000 kg @ 5.50	11,000
	2 January	13000 kg @ 5.75	74,750

(c)	31 December	2,000 kg @ 5.50 =	11,000
	2 January	28,000 kg @ 5.75 =	1,61,000
	9 January	25,000 kg @ 5.80 =	1,45,000
	16 January	35,000 kg @ 5.85 =	2,04,750
	23 January	10,000 kg @ 5.90 =	59,000
	Total	1,00,000 kg	5,80,750
	Average cost per kg		Rs. 5.8075
	Value of inventory on 31 January 15,000 kg × Rs. 5.8075
		= Rs. 87,112.50

2.23 MATERIAL LOSSES

Generally, difference exists between the input of material in production process and the output. Such difference arises due to loss of materials in a process, which are in the form of scrap, waste, spoilage or defectives.

2.23.1 Scrap

Scrap may be defined as “the incidental residue from certain types of manufacture usually of small amount and low value recoverable without further processing”.

Scrap may be in the form of off-cuts in leather industry, saw-dust in timber industry, turnings, borings or filings in metal industry.

2.23.1.1 Control of Scrap

For effective control of scrap, scrap is classified into different types:

Type 1 Administrative scrap: This type of scrap stems from administrative decisions taken by the firm’s management. Example: Withdrawal from sale, changes in design.

Type 2 Legitimate scrap: Anticipation or predetermination of scrap belongs to this type. Example: Foundry sprue, mill turnings etc.

Type 3 Defective scrap: This type of scrap is not planned. It results from avoidable causes. Example: Sub-standard raw materials, poor handling of plant and machinery control of scrap may be carried on in the following ways:

1. There should be proper design of products.
2. Raw materials should be of high quality.
3. Plant and machinery—Purchase of standard make, proper installation, effective handling by skilled and trained personnel are essential.
4. Proper control system installation should form part of the firms.

2.23.1.2 Accounting Treatment of Scrap

1. Significant value and non-identifiable with specific process or job: The selling cost is deducted from the sales value and the net amount is credited to the factory overhead account or material account. The effect will be reduction in factory overhead or material cost.
2. Insignificant value: If the value of scrap is low or negligible, it is to be treated as other income. The good units are made to bear the cost of scrap.
3. Significant value and identifiable with job or process: Sale proceeds from scrap are credited to job or process. The cost of scrap is transferred to scrap account. Any loss on sale of scrap is debited to costing profit and loss account.

2.23.2 Waste

Waste is defined as that portion of a basic raw material lost during processing or storage having no recovery value. Waste arises due to evaporation and shrinkage. Waste may be classified into two categories:

1. Normal waste: When waste is inevitable to the manufacturing process it is said to be normal waste.
2. Abnormal waste: Any waste in excess of normal waste is called abnormal waste.

Waste may also be classified in another way: (1) visible and (2) invisible loss. Visible waste can be seen, while invisible loss cannot be seen.

2.23.2.1 Control of Waste

Control over waste may be exercised as follows:

1. Proper records: Records have to be kept properly with respect to opening stock, purchase, suppliers, closing stock waste, suppliers whose materials result in maximum wastage etc.
2. Maintenance of plant and machinery: Proper maintenance of plant and machinery is one way of controlling waste. Preventive maintenance has to be carried out in a planned way.
3. Storage and handling of materials: Depending on the nature of materials, proper storage facilities have to be provided. Some materials are to be stored at proper, specified temperature, and free ventilation system for certain other materials is essential for minimise loss.
4. Quality of raw materials: The purchasing department should take much responsibility in purchasing quality raw materials.
5. Control system: A Proper well planned control system should form past of an organization.

2.23.2.2 Accounting Treatment

1. Normal waste: Normal waste is unavoidable in the manufacturing process. It includes both visible and invisible waste. Normal waste has to be treated as part of production cost and the good units have to be made to bear the cost.
2. Abnormal waste: This is in excess of prescribed standards. The cost resulting from abnormal waste is to be separated from total cost and charged to costing profit and loss account.

At times, a waste may be used as a substitute raw material. In such a case, the selling price should be suitably fixed based on the market value of raw material substituted.

2.23.3 Spoiled Work

Spoiled work may be defined as “Work that cannot be reconditioned or brought up to standard and the units must be sold either as scrap or as second or third grade products”.

During manufacturing process, some are so damaged that they cannot be rectified or repaired. These units have to be sold without further processing. Such units are referred to as spoiled work or spoilage. These do not comply with the standards laid down by the management, as they are damaged in course of manufacturing process. This occurs on account of some defects in operations. Generally, they are incapable of economical rectification.

Spoiled work may be either normal or abnormal. If it is within limits, it is normal; if it exceeds the limit, it is said to be abnormal spoilage.

2.23.3.1 Control of Spoilage

Control over spoilage may be carried out in the following ways:

1. Purchases department’s responsibility of proper selection of materials can minimize spoilage.
2. Proper design of the product may result in minimum spoilage.
3. Selection of plant and machinery is important.
4. Proper handling of plant and machinery by skilled personnel with adequate training can minimize spoilage.
5. A proper control system is essential.

2.23.3.2 Accounting of Spoilage

1. Normal spoilage: Cost of spoilage is to be charged to the particular job. It may also be debited to production overheads.
2. Abnormal spoilage: The cost of abnormal spoilage is to be charged to costing profit and loss account. In case spoiled units are used in any other process or job, the respective job or process is credited. But if spoiled units are used in the same process or job, no accounting is necessary.

2.23.3.3 Apportionment of Spoilage between Normal and Abnormal

This can be explained with the help of an example as follows:

 

     Total input: 10,000 units

     Normal spoilage: 5% of output

     Total spoiled units: 1,000 units

     Total cost: Rs. 50,000

     Sale value of spoilage: Re 1 per unit

     Standard output: Input − 5%

                            : 10,000 − 500 = 9,500 units

     Cost of abnormal spoilage =

     Net cost of abnormal spoilage = Rs. 2,368.42 − (500 × Re 1)

                    = Rs. 2,368.42 − 500

                    = Rs. 1,868.42

 

The cost of abnormal spoilage is charged to costing profit and loss account, and sale value is credited to costing profit and loss account.

2.23.4 Defective Work

There may be some imperfections in the work that can be rectified by use of additional material or processing. The defective work may be classified as follows:

1. Defective at raw material stage
2. Defective after initial processing
3. Defective finished stock on account of prolonged storage
4. Defective finished goods returned by the customers

The reasons for defective work are:

1. Poor quality of raw materials
2. Faulty product design
3. Poor workmanship
4. Lack of control
5. Improper handling of materials and machine
6. Lack of proper plan

2.23.4.1 Control of Defective Work

1. The purchase department should have to function with more responsibility by selecting standard raw materials.
2. There should be proper production design.
3. Reputed brand of plant and machinery should be selected.
4. Proper workmen with qualification, skill and experience should be selected.
5. Proper control system should be installed.

2.23.4.2 Accounting of Defectives

1. Normal and identifiable with Jobs: Cost of rectification or additional processing is debited to the specific job or process.
2. Normal and within standard limits: In case a specific department is responsible for such defective units, the cost of rectification is charged to that respective department. Goods units are made to bear the cost of defective units. In case any specific department cannot be identified, the cost of rectification is to be debited to general overheads.
3. Abnormal defectives: Cost of rectification is charged to costing profit and loss account.

Illustration 2.23

1000 kg of art board valued at Rs. 5,000 were issued for the manufacture of medium-sized cartons. The details are as follows:

1. 1000 Nos medium-sized cartons weighing 0.50 kg each were manufactured.
2. 250 kg of off-cuts were used for the manufacture of small-sized carton. This would have amounted to Rs. 500.
3. 150 medium-sized cartons were damaged and rectification costs came up to Rs. 100.
4. 50 kg of off-cuts were sold as scrap for Rs. 10.

You are required to calculate the cost of one medium-sized carton, assuming that there are no opening and closing stocks.

Solution

Input—both quantity and value to be taken as base. With this, off-cuts, value of scrap sold, waste in process (to be calculated) are to be deducted. Cost of rectification to be added. Finally cost per carton has to be computed.

(a) Calculation of waste in process:

(b)

	Quantity Kg	Value Rs.
Step 1 Input (Given):	1,000	5,000
Step 2 Less: off-cuts (transferred to small-sized cartons) (Given):	250	500
	750	4,500
Step 3 Less: Value of scrap sold (Given)	50	10
	700	4,490
Step 4 Add: Cost of rectification (Given):	—	100
	700	4,590
*Step 5 Less: Waste in process	125	—
	575	4,590
Step 6 Cost of 1,150 medium-sized cartons =	Rs. 4,590
Step 7 Cost per carton	= Rs. 7.98

Illustration 2.24

Model: Professional course students (Materials returned to store and shortage)

The following is the summary of the receipts and issues of materials in a factory during a month:

Date:

1.	Opening balance	300 units @ Rs. 20/unit
3.	Issue	50 units
5.	Issue	150 units
7.	Received	100 units @ Rs. 19/unit
9.	Returned to stores	10 units @ 19.50 per unit
11.	Issue	100 units
13.	Received	200 units @ Rs. 19.25 per unit
15.	Issue	105 units
17.	Returned to store	15 units @ 19/unit
20.	Issue	100 units

 

It was revealed that on 10^th, there was a shortage of 5 units and on 21st of 6 units. You are required to work out based on FIFO.

Solution

• Stores ledger account with columns—specimen format has to be drawn.
• It has to be recorded on FIFO basis. Materials received first are to be issued first.
• In this problem, materials returned to stores are provided. They have to be recorded first in the receipt column and they are shown in balance column till they are issued. On the date of issue, it is to be shown in issue column.
• Shortage is to be shown in issue column.

Stores ledger account is prepared as follows:

 

Illustration 2.25

Model: Standard cost

Stocks are issued at standard price and the following transactions occurred in a month with respect to a specific material:

Date

1.	Stock	25 Tons	@ Rs. 298 per tonne
3.	Purchased	5 Tons	@ Rs. 310 per tonne
5.	Issued	5 Tons
9.	Issued	10 Tons
12.	Purchased	3 Tons	@ Rs. 320 per tonne
15.	Issued	8 Tons
20.	Issued	7 Tons
25.	Purchased	4 Tons	@ Rs. 350 per tonne
27.	Issued	2 Tons

 

The debit balance of price variation on 1st of this month was Rs. 50. You are required to show that the stock account was Rs. 50. You are required to show the stock account for the material for this month. How would you deal with the difference in material price variance while preparing profit and loss account for this month?

 

[C.S. (Inter). Modified]

Solution

First, standard price has to be calculated as follows:

∴ Standard price per tonne =

Hence, each issue of material is to be priced at Rs. 300 per tonne.

Stores ledger account is prepared as follows:

		Rs.
Closing stock 5 tonne value		1,760
Closing stock 5 tonne × standard price		1,500
Difference		260 (Profit—favourable)
Material control A/C	Dr	9,600
Material price variance	Dr	260
To cost ledger		9,860

Illustration 2.26

Pumpkin Pump Co. uses about 1,50,000 valves per year and the usage is fairly constant at 12,500 valves per month. The valves cost about Rs. 3 per unit when bought in quantities and the carrying cost is estimated to be 20% of average inventory investment on annual basis. The cost to place an order and process the delivery is Rs. 36. It takes 45 days to receive delivery from the date of an order and a safety stock of 6,400 valves is desired.

You are required to determine:

1. the most economical order quantity
2. frequency of orders and
3. the order point

[C.S. (Inter). Modified]

Solution

(a) Computation of EOQ:

Step (1) → First, write the formula:

where U = Annual consumption during the year = 1,50,000 (given) valves

      P = Cost of placing an order = Rs. 3

  H.C = Stock holding cost (%) = 20%

      C = Cost/price per unit = Rs. 36

Step (2) → Substituting the values in the equation we get:

Step (3) → The most economical order quantity = 4,242 units

(b) Computation of frequency of an order:

Step (1) → Write the formula for the number of orders to be placed in a year. (First, we have to compute this figure.)

No. of orders to be placed in a year =

Step (2) → Substituting the values in the formula we get,

Step (3) → Now, write the formula for computing the frequency of order:

After every 10 days, an order has to be placed.

(c) Computation of re-order level:

Step 1 → Write the formula:

 

Step 2 → Substituting the values in the formula, we get:

Illustration 2.27

A publishing house purchases 2,000 units of a particular item per annum at a unit cost of Rs. 20. The ordering cost per order is Rs. 50 and the inventory-carrying cost is 25%.

(a) Find the optimal order quantity and the minimum total cost including purchased cost. (b) If 3% discount is offered by the supplier for the purchase in lots of 1000 units or more, should the publishing house accept the offer?

 

[C.S. (Inter)]

Solution

(a) Computation of EOQ

Step 1 → Write the formula

Step 2 → Substitute the values in the formula

(b) The acceptance of offer depends on total cost incurred under the following two situations:

1. Total cost without discount
2. Total cost with discount

Hence, total costs have to be prepared under both situations as follows:

Formula:

 

 

Statement showing total costs incurred in purchase under both situations:

Result: Total cost of purchase with 3% discount offer is higher.

Decision: The publishing house should not accept the offer, as its total cost is Rs. 325 higher.

Illustration 2.28

From the following data for the year ended 31 December 2009, calculate the inventory turnover ratio of two items, and put forward your comments on them:

	Material X	Material Y
Opening stock (1 January 2009)	20,000	18,000
Purchasing during the year	1,04,000	54,000
Closing stock (31 December 2009)	12,000	22,000

[I.C.W.A. Modified]

Solution

Computation of inventory turnover ratio of X and Y

Result: Inventory turnover is high with respect to material X when compared to that of material Y.

Decision: The management should concentrate on material Y, for which turnover ratio is only 2.5. It has to analyse the causes and take remedial measures immediately as the material Y lies idle for longer period in stores.

Illustration 2.29

For a fixed order quantity system, find out the various perimeters for an item with the following data. Annual consumption, 5,000 units; cost of one unit, Rs. 2; set-up cost, Rs. 24 per production run; the inventory-carrying cost, Re 0.48 per unit; past lead time, 12 days, 20 days, 15 days, 13 days, 25 days, 11 days.

 

[I.C.W.A. (Modified)]

(a) First, EOQ is calculated:

Step 1→ Write the formula:

where U = Annual demand = 5,000 units

          P = Cost of placing an order = Rs. 24

       H.C = Stockholding cost = 0.48

          C = Price per unit = 2

 

Step 2→ Substituting the figures in the formula, we get:

(b) Safety stock is computed:

Step 1 → Write down the formula:

Safety stock = Rate of demand (Maximum lead time Average lead time)

In order to find out safety stock, we have to get the necessary figures:

1. Rate of demand
2. Average lead time
3. Maximum lead time

Step 2 → Computation of rate of demand

Formula:

Step 3 → Averge lead time

Step 4→ Safety stock = 13.89 units × (25 days − 16 days)

                                   = 13.89 × 9

                                   =125 units

(c) Re—order level:

Formula:

 

 

Substituting the values in the formula, we get:

                        = 13.89 × 16 + 125 units

                        = 222.24 + 125 = 347.24 units

(d) Average stock level:

Formula:

Substituting the values, we get:

Illustration 2.30

A factory uses 8,000 varieties of inventory. In terms of inventory holding and inventory usage, the following information is compiled:

You are required to classify the items of inventory as per ABC analysis with reasons.

 

[C.A. (Inter). Modified]

Solution

As per ABC analysis, items are to be classified into three categories: A, B and C.

Category A:

Those 30 items (shown in table—column representing number of varieties of inventory) are grouped under this A category. Reasons for the inclusion of 30 varieties of inventory items in A category are as follows:

1. Refer the column (2) in the table. It shows 0.375% of total number of varieties of inventory items. This is the lowest figure among the classification shown in the table.
2. Refer to column (3) in the table. The total usage of these items is 50%. This is the highest figure when compared with others.
3. Refer to column (4). The total usage of these items is 85% inventory usage in end product. This usage is maximum.

Category B:

220 varieties of inventory items are grouped under B category. Reasons for inclusion in category B are:

1. Refer to column (2). It shows 2.750% of total number of inventory items. This is the via-media range among the items. Neither high nor low.
2. Refer to column (3). They constitute 30% of inventory holding which means that only moderate investment of 30% is required.
3. Refer to column (4): It shows 10% inventory usage (in end product). While comparing others, this rate of consumption is moderate.

Category C:

This category constitutes 7,750 varieties of inventory items. Reasons for including them in category C are:

1. Again refer to column (2). It shows 96.875% of total number of inventory items. This is the maximum percentage among the categories.
2. Column (3) depicts 20% of inventory holding. This means that they require investment of 20% of total usage of average inventory which is the lowest figure.
3. Column (4) reveals consumption level of 5%. This is the minimum of all the categories of items.

Illustration 2.31

A manufacturing company used raw material AA’ as the basic material. The cost of the material is Rs.50 per kg and the input—output ratio is 110%. Due to a sudden shortage in the market the material becomes non-available, and the unit is considering the use of one of the following substitutes available:

 

Material	IO Ratio	Rs. per kg.
BB’	130%	60.
CC’	105%	65.

 

You are required to recommend which of the above substitutes is to be used. Also indicate additional cost to be incurred.

 

[I.C.W.A. (Inter). Modified]

Solution

[I.O. ratio: Input—output ratio needs some explanation here. It is used in the measurement of productivity of material, labour etc. This chapter deals with only materials. This implies a relationship between the quantity of material issued to production and the quantity of material got in finished product. This is useful in controlling the cost of materials. The ratio is computed by using the formula:

This is expressed in percentage. The higher the ratio, the lower will be the productivity and vice versa.]

Substituting the figures in the formula, we get:

1. Cost of material = Rs. 55.00 per kg in final product
2. Cost of material = Rs. 78.00/kg in fi nal product
3. Cost of material = Rs. 68.25/kg in fi nal product.
   • The above calculations reveal that of the two substitutes, material CC′ is cheaper by Rs. 9.75/kg (Rs. 78 − 68.25) in the final product.
   • Additional cost to be incurred when compared to original material is (Rs. 68.25 − Rs. 55.00) = Rs. 13.25 per kg in final product.

Direct Materials: The materials that are easily identifiable with the product are called direct materials.

Indirect Materials: Those materials which can not be classified are called indirect materials.

Purchasing Function: a) Objectives of purchase department Methods of purchasing—Centralised and decentralised purchasing—advantages and disadvantages—explained.

Purchase Procedure: The important stages: in tending for materials, issuing tenders, receiving quotations, placing order, inspecting stores received, receiving the stores accepted in inspection and passing bills for payment all are explained with documents used in each stage and specimen of all those documents (Ref: 3–1 to 3–7) Ascertainment of direct materials cost, and issue price of materials to jobs (Ref: 2–1). Accounting Treatment of storage and issue losses (Ref: 2–2).

Stores Functions: Main objectives of store keeping are: To protect stores against losses, to keep materials ready for issue, to avoid overstocking and understocking, and to facilitate perpetual inventory. Important functions of store keeping are: receipt of materials, maintenance of materials, record keeping, storage, issuing stores, periodical checkup, co-ordination, maintaining desired level of stock, periodical review and protection of stores. Advantages and disadvantages of centralised stores (Ref: 5–3) Classification and codifications of materials—Important methods of codification of materials are: alphabetical method, numerical method, alpha numerical method, and decimal method.

Inventory control should be planned in such a way that purchasing and storing should be done judiciously without affecting production. Techniques of inventory control:

1. EOQ: This refers to the quantity of order that gives maximum economy in procuring materials.

   Determination of EOQ—(Ref: illustrations 2–3 to 2–8).

   Fixation of Stock Levels: Maximum level, minimum level, Re-order level and danger level—(Ref: illustrations: 2–9)

2. ABC Analysis: Otherwise known as “always better control”. segregation of materials in made according to their value for control—Small percentage of inventory items account for a large percentage of usage value and vice versa.
3. VED Analysis: Under this technique items are classified and grouped in descending order of criticality—Vital, Essential and Desirable.

Paerto analysis, FSND analysis are also employed for control and analysis of movement of inventory.

Stock Taking: Periodical stock taking and perpetual stock taking systems prevail for stock taking. Special features and advantages of each system are explained in the text (Ref: sec 14 & 15 and 18).

Issue of Materials: Factors to be considered on issue of materials are: Planning, requisition of materials, Audit of issues, wastage control and sundry items—Material Requisition Note, Bill of Materials, Materials Return Note Transfer Note—Purpose, features, advantages and specimen of these records are discussed in detail Ref: Text sec 20.2 to 20.6.

Pricing of Material Issues: The various methods used for the pricing of materials are discussed in detail with illustration Ref: the text Ref: Sec 21.1 to 21.15 Pricing of materials returned to vendor and stock room are described in section 22 of this chapter.

Accounting treatment of scrap, waste, spoiled work, defective work are discussed in section 23.

Bill of Material: A document that contains the estimated quantity of materials required for a particular job, contract or work.

Goods Received Note: A document which shows the material code, description, specification, quantity, unit price and value of materials

Bin Card: A document that shows the quantity of specified materials available in the bin at any time

Stores Ledger: A record that keeps track of movement of material from and into stores department.

Inventory: The term generally refers to raw materials and work–in–progress. It may also be referred to as “stock”, that is, stock of raw materials, work–in–progress and even some occasions finished goods that are unsold. It is a tangible property.

Economic Order Quantity (EOQ): The reorder quantity, that is, the quantity to be purchased each time an order is placed. “Decision model that calculates the optical quantity of inventory to order under a set of assumptions.”

Lead Time: The time lag between the placing of an order and replenishment of inventory.

ABC Analysis: An analytical tool to monitor and control inventories.

VED Analysis: An important technique for materials management.

Perpetual Inventory: A system of recording “as they occur of receipts, issue, and the resulting balances of individual item of stock in either quantity or quantity and value”.

Periodic Stock–Taking System: “A process whereby all stock items are physically counted and then valued”.

LIFO: A method for pricing the issue of materials in which materials that have been received last are issued first.

FIFO: First in first out; another method of pricing the issue of materials by which the materials that are received first are issued first.

Scrap: The incidental residue from certain types of manufacture usually of small amount and low value recoverable without further processing.

Waste: A Portion of basic raw material lost during manufacturing operation or storage, having no recovery value.

Defective Work: Represents work in which there are imperfections which can be rectified by use of additional process.

Spoilage: Goods damaged beyond rectification that are sold without further processing.

QUESTION BANK

 

I: State whether the following statements are true or false

1. The word direct material is synonymous with raw material.
2. Purchasing department places purchase orders based on bin of material.
3. In case of single tender, enquiries are issued by the firm to one supplier only.
4. Direct material cost can be easily identified with a cost centre.
5. Cost of indirect materials is to be treated as overhead.
6. Bin of material is a record that shows nothing but the price of materials purchased.
7. Purchase requisition is prepared by the production department.
8. Goods received note is prepared by the stores department which shows the material received from the suppliers.
9. Stores ledger, an important record, is maintained by the stores department.
10. Bin card shows the quantity of specified materials available in the bin at any point of time.
11. The main objective of inventory control is to maintain optimum level of inventory.
12. Economic order quantity model is based on certain assumptions and not on cost factors exclusively.
13. The re-order level is fixed when the stock of raw material is exhausted.
14. ABC analysis is a technique which involves analysis of inventory based on alphabetical order.
15. Two-bin System makes use of two bins to maintain stock of materials.
16. Continuous stock taking and periodic stock taking systems are one and the same.
17. An increase in stock turnover ratio indicates that stock is consumed and sold very slowly.
18. LIFO method is advantageous when prices are rising.
19. FIFO method is not recognized by statutory authority.
20. In weighted average cost method of issue price computation, the fluctuations in the prices of materials is smoothed out.
21. Scrap has no disposable value.
22. Waste has no recovery value.
23. Cost involved in the rectification of (abnormal) defective units are charged to the costing profit and loss account.
24. If spoiled units are used in the same job or process from which they arose, no accounting needs to be done.
25. Accounting standard AS (2) deals with mainly “inventory”.

Answers:

 

1. True	2. False	3. True	4. True
5. True	6. False	7. False	8. True
9. False	10. True	11. True	12. True
13. False	14. False	15. True	16. False
17. False	18. True	19. False	20. True
21. False	22. True	23. True	24. True
25. True

 

II: Fill in the blanks with apt word(s)

1. Raw material is also termed as ______ material.
2. The purchasing function is an important function performed by ______ department.
3. Firms generally float ______ to obtain prices from prospective suppliers of goods and services.
4. Raw materials may be defined as “goods purchased for ______ for sale”.
5. Material that is directly identifiable with the product and can be conveniently traced to cost units is known as ______.
6. Cost of direct materials is charged directly to the specified ______, ______ or ______.
7. The classification of material into direct and indirect facilitates ______.
8. Normal storage and issue losses are recovered by inflating ______ per unit.
9. The system of imprest stores is based on the imprest system of______.
10. ______is a document that shows the quantity of specified materials available at any point of time.
11. ______ is a document which shows the materials received from suppliers.
12. The stores ledger is maintained by the ______ department.
13. When materials are transferred from one department to another department, the transferrer department raises a______.
14. The economic order quantity is computed using the formula______.
15. Re-order level = …… × Maximum lead time.
16. Maximum level = ……+ Re-order quantity – (Minimum lead time × Maximum usage).
17. Minimum stock level = Re-order level – (Normal average lead time × ………).
18. ABC analysis is analytical tool which is used in ______.
19. Pareto analysis is also known as ______ rule.
20. A process whereby all stock items are physically counted and valued is known as ______.
21. Recording of receipts, issues, returns of materials in either quantity or quantity and valuing is known as ______.
22. Two levels of material control are______ and ______.
23. Stock adjustment account is ______ with shortage of stock and ______ with surplus of stock.
24. Inventory turnover ratio shows the relationship between the cost of goods sold (or cost of inventory consumed) and ______.
25. Optimal safety stock is the quantity at which the total of ______ and stock-out cost is the minimum.
26. Inventory is dealt with in detail in accounting standard ______.
27. When prices are rising, ______ method of pricing issue of materials is suitable.
28. ______ method is not recognized as per AS (2).
29. Sale proceeds from scrap are ______ to the job or process and any loss on sale of scrap is ______ to costing profit and loss account.
30. In case the departments responsible for defective units cannot be identified, the cost incurred in rectification are to be debited to ______.

Answers:

 

1. direct	2. purchasing
3. tenders	4. “Incorporation into products”
5. direct material	6. order, job or process
7. control	8. material issue price
9. petty cash	10. Bin card
11. good received note	12. costing
13. material transfer	14.
15. Maximum usage	16. Reorder level
17. Normal average usage	18. inventory control
19. 80:20	20. periodic stock system
21. Perpetual inventory system	22. quantity and financial
23. debited; credited	24. average inventory
25. carrying cost	26. AS (2)
27. LIFO	28. LIFO
29. credited; debited	30. general overheads

III: Multiple choice questions

1. Direct material is:
   • directly identifiable with the product
   • directly identifiable with the stores department
   • directly associated with purchase department
   • all of the above
2. Which one of the following is a direct material?
   • diesel oil used in generators
   • cream used in the manufacture of biscuits
   • paints used in shop–floor painting
   • cotton waste
3. Which one of the following is an indirect material?
   • lubricants
   • steel sheets used in the manufacture of almirahs
   • thread used in stitching garments
   • all of these
4. Bill of materials is:
   • an invoice of materials purchased
   • a voucher of materials received by supplier
   • a document that shows the materials required for a job
   • none of these
5. A purchase requisition is prepared by
   • production manager
   • purchase manager
   • accounts manager
   • stores manager
6. Bin card shows:
   • the quantity of specified materials available
   • the arrival of each labour
   • the total quantity of products produced
   • none of these
7. The purpose of inventory control is:
   • to control flow of raw materials
   • to control invention
   • to maintain optimum level of inventory
   • none of these
8. Stores department issues materials to the production department based on:
   • purchase order
   • goods received note
   • material transfer note
   • material requisition note
9. Material requisition note is raised by:
   • production department
   • purchase department
   • accounts department
   • none of the above
10. A material return note is raised for:
    • transferring material from one job to another
    • returning excess materials to stores
    • returning material from production department to stores department
    • returning defective materials to suppliers
11. Materials issued are priced at the latest purchase in:
    • FIFO
    • LIFO
    • standard price
    • weighted average
12. The value of closing stock approximates to the market value under:
    • FIFO
    • LIFO
    • NIFO
    • HIFO
13. When price fluctuates, the effect of fluctuations is smoothed out by the method:
    • FIFO
    • LIFO
    • weighted average
    • standard price
14. Spoiled items:
    • can be rectified
    • have bin value
    • have scrap value and can be sold
    • none of these
15. Economic order quantity refers to:
    • quantity to be used economically
    • the quantity of materials to be maintained
    • the quantity of materials to be reordered
    • the quantity of materials to be ordered at a time
16. Which of the following stock control method concentrates on selected items of inventory?
    • ABC analysis
    • Pareto analysis
    • JIT system
    • perpetual inventory system.
17. Lead time denotes:
    • time needed to purchase order
    • time taken between placing an order and receiving materials
    • time taken to produce an article
    • time taken in competitive market to market
18. Cost of normal spoilage is:
    • Charged to the costing profit and loss account
    • not accounted for
    • debited to production overheads
    • credited to particular job
19. The cost attributable to abnormal waste is:
    • debited to the particular department
    • credited to the particular job
    • to be ignored
    • to be charged to costing profit and loss account.
20. Small tools purchased are:
    • charged to overhead expenses at the time of purchases
    • charged to machinery account
    • charged to jobs during the period of purchase
    • charged to costing profit and loss account.

Answers:

 

1. (a)	2. (b)	3. (a)	4. (c)
5. (d)	6. (a)	7. (c)	8. (d)
9. (a)	10. (c)	11. (b)	12. (b)
13. (c)	14. (c)	15. (d)	16. (a)
17. (b)	18. (c)	19. (d)	20. (a)

1. What do you mean by direct materials?
2. Define the term direct materials cost.
3. What are the objectives of purchase department?
4. Distinguish between centralized and decentralized purchasing
5. Mention any four factors that influence the choice between centralized and decentralized purchasing
6. What is tender? Mention any four types of tenders.
7. Give any four examples of direct materials.
8. How will you treat the cost of direct materials?
9. Give any four examples for indirect materials.
10. What is meant by joint purchase costs?
11. What are the reasons for arising storage and issue losses?
12. What is the accounting treatment for the normal and abnormal storage issue losses?
13. Mention any four responsibilities of the stores department.
14. What are the advantages of a centralized store?
15. Mention the factors that influence the choice (of selection) of stores.
16. What is meant by imprest stores?
17. Mention any two advantages of imprest stores?
18. What is bin of materials? What are its contents?
19. What is purchase requisition? What are its contents?
20. Explain the function of purchase order in stores procedure?
21. Is inspection note necessary?
22. What is the importance of goods received note in purchase and stores procedure?
23. Explain the term “bin card”.
24. What do you mean by stores ledger? What is its purpose?
25. What is a material requisition?
26. Write short notes on material return note.
27. What is a material transfer note?
28. What is meant by inventory control?
29. Explain:
    • carrying costs
    • ordering costs
    • stock–out cost
30. Explain the term: economic ordering quantity.
31. What is lead time?
32. What are reorder points? How will they be determined?
33. How would you assess the maximum level of inventory?
34. How would you maintain the minimum level of stock?
35. Explain the term “ABC Analysis”.
36. What is VED analysis?
37. Explain the technique: Pareto Analysis.
38. What is meant by two bin system?
39. What is material turnover ratio?
40. What are the factors that govern the fixing of levels?
41. What are the advantages of classification and codification of materials?
42. Distinguish between bin card and stores ledger card.
43. What are the main causes for stores discrepancies?
44. Write short notes on perpetual inventory system?
45. Distinguish between perpetual inventory system and continuous stock verification.
46. What is meant by periodic inventory system?
47. Mention any four important duties of a store keeper.
48. State the various method of pricing the issue of materials.
49. Define material control. Mention the important stages in material control.
50. Define Inventory.
51. What is the significance of accounting standard AS (2)?
52. Mention the main classification of inventories.
53. What are the twofold objectives of materials pricing?
54. What is FIFO method? What is its main advantage?
55. What is LIFO method? What is its main advantage?
56. What is standard cost method? What is variance?
57. Explain: weighted average method.
58. Mention any four causes of discrepancies between physical stock and book stock?
59. How would you treat for excess stock?
60. What is the accounting treatment for shortage of stock?
61. What is meant by scrap?
62. How would you exercise control over scrap?
63. What is the accounting treatment of scrap?
64. Define waste.
65. How would you exercise control over waste?
66. How wastes are treated in cost accounting?
67. What are the main reasons for defective work?
68. How defectives are treated in cost accounting?
69. How spoiled work can be controlled?
70. How spoilage can be treated in cost accounting?
71. Mention the three methods which are used for accounting for tool costs in cost accounts?
72. Distinguish between scrap, spoilage and defectives in an engineering industry.
73. What is the objective of accounting standard AS (2)?
74. How would you compute inventory turnover ratio for (i) raw materials and (ii) finished goods?
75. While determining the purchase price of an item, mention the item that should be deducted to arrive at the correct purchase price?

1. What are the objectives and responsibilities of the purchase department? What are the merits and dements of centralized and decentralized purchasing?
2. (a) Define, (b) give example and (c) accounting treatment for (i) direct materials and direct materials cost and (2) indirect materials and indirect materials cost.
3. Elaborate the functions of stores department.
4. What are the documents used in purchases and stores procedure? Explain each with specimens.
5. Define Inventory. What is the objective of inventory control? Explain the costs involved in the context of inventory control. Explain with apt illustration how you would maintain different levels of stock.
6. Discuss the various techniques involved in monitoring inventories.
7. Discuss the stages involved in material control. What are requirements that should be complied with in order to exercise proper control over materials?
8. Discuss the various material issue pricing methods.
9. Explain in detail the various factors that should be considered while selecting a method for pricing of materials.
10. Enumerate the causes of discrepancies between physical stock and book stock.
11. How would you account for the following items in cost accounts and how would you control each of the following
    • Shortage
    • Excess
    • Scrap—normal and abnormal
    • Wastage—normal and abnormal
    • Defective work—normal and abnormal
    • Spoilage—normal and abnormal
    • Small tools cost
12. Enumerate the salient features of Accounting Standard 2.

 

[Model: Purchase price consideration]

1. A supplier quotes for material A as follows:

Lot price 100 units Rs. 10 each

Lot price 500 units Rs. 9 each

Lot price 1,000 units Rs. 8 each

Trade discount 20%; cash discount 2.5% for payment in seven days. Containers charged at Rs. 20 each Rs. 14 credited or return. The Purchaser decides to buy 600 units. Transport charges amounting to Rs. 20 and storage Rs. 4 were charged by the supplier.

Calculate the purchase price of Material ‘A’

 

[Madras University]

[Ans: Purchase price per unit: Rs. 7.30]

[Model: Material loss—Rate per unit]

2. One parcel containing two vital components was received by a factory and the invoice relating to the same discloses the following:

 

	Rs. - Paise
I	Material 500 kg at Rs. 2 per kg	1,000 - 00
II	Material 600 kg at Rs. 1.60 per kg	960 - 00
	Insurance	39 - 20
	Sales tax	98 - 00
	Freight etc.	55 - 00

 

Transit loss of 10 units of material I and 6 units of material II was noted. However, no insurance claim could be made. Find the issue rate per unit of each material. If a provision for obsolescence of 10% is to be made, find the revised issue rates.

 

[Madras University]

[Ans: Issue rate per unit of material I : Rs. 2.483

Issue rate per unit of material II : Rs. 1.978

Total cost : Material I : Rs. 1,095

Total cost : Material II: Rs. 1,057.20]

[Model: Purchase cost—Mixed lots]

3. A lorry-load of materials of mixed goods were purchased for Rs. 90,000. These were sorted into the following grades whose market rate is shown against each:

Grade A 5,000 units selling rage @ Rs. 12

Grade B 3,000 units selling rage @ Rs. 10

Grade C 2,000 units selling rage @ Rs. 5

Find the purchase rate per unit on each grade of the material assuming that all grades yield same rate of profit.

 

[Madurai Kamaraj University]

[Ans: Grade A: Rs. 10.80

Grade B: Rs. 9

Grade C: Rs. 4.50]

[Model: Selection of a supplier]

4. After inviting tenders, two quotations were received as follows:

Supplier A : Rs. 2.20 per unit

Supplier B : Rs. 2.10 per unit plus Rs. 2,000 fixed charges irrespective of units ordered.

1. Calculate the order quantity for which the purchase price per unit will be the same.
2. The purchase officer wants to place an order for 15,000 units. Which supplier should be selected?

[Kerala University 1990 & Madras University 2003]

[Ans:	(1) 20,000 units
	(2) Supplier A would be selected as it would cost Rs. 500 less]

[Model: Purchase price per unit—Mixed lots]

5. A lorry–load of materials of difference grades were purchased for Rs. 3,00,000. Materials are sorted into the following grades whose market rate is shown against each of them:

 

		selling price per unit
	units	Rs.
Grade A	20,000	6
Grade B	15,000	5
Grade C	10,000	3

Find out the purchase price per unit of each grade of the material assuming that all the grades yield the same rate of profit.

[Ans: Purchase price per unit: A, Rs. 8; B, Rs. 6.67: C, Rs. 6]

[Model: Economic order quantity Questions 6 to 20]

6. A manufacturer buys certain equipment from outside suppliers at Rs. 30 per unit. Total annual needs are 80,000 units. The following further data are available:

 

Annual return on investment	10%
Rent, insurance, taxes per unit per year	Rs. 13
Cost of placing an order	Rs. 100
Determine the EOQ

 

[Bharathidasan University]

[Ans: 1,000 units]

7. Calculate the economic order quantity:

 

Annual consumption	600 units
Order cost	Rs. 12 per order
Cost price per unit	Rs. 20
Selling and carrying cost	20%

[Madras University 2003 & 2005; Periyar University 2005]

[Ans: 60 units]

8. Calculate the EOQ from the following data:

Annual requirement 1600 units

Cost of material per unit       Rs. 40

Cost of placing and receiving one order     Rs. 50

Annual carrying cost of inventory 10% of inventory value

 

[Madras University]

[Ans: 200 units]

9. A manufacturer uses 75,000 units of a particular material per year. The material cost is 1.50 per unit and the carrying cost is estimated to be 25% p.a. of average inventory cost. The cost of placing an order is Rs. 18. You are required to determine EOQ and the frequency of order p.a.

[Ans: EOQ = 2,691 units;

Frequency of orders: 28 p.a.]

10. Compose the economic order quantity from the following data:

 

Monthly usage	150 units
Buying cost	Rs. 2 per order
Cost per unit	Re. 0.32
Storage cost	25% p.a.

 

[Osmania University]

[Ans: 300 units]

11. Find the economic order quantity when the annual consumption is 6,000 kg; ordering cost is Rs. 120 per order; price per kg is Rs. 20; and carrying cost is 20%. Also ascertain the frequency of placing orders.

 

[Bharathidasan University]

[Ans: EOQ = 600 kg; No. of orders 10 p.a; frequency one order per 1.2 months]

12. Calculate economic order quantity. Also state the number of orders to be placed in a year.

 

Consumption of material per annum	10,000 kg
Cost of material per kg	Rs. 2
Order placing costs per order	Rs. 50
Storage costs 8% on average inventory

 

[Madras University 2008]

[Ans:	EOQ : 2,500 kg
	No. of orders to be placed = 4 p.a]

13. Find out the economic ordering quantity from the following particulars:

Annual usage: Rs. 1,20,000

Cost of placing and receiving one order:    Rs. 60

Annual carrying cost: 10% of inventory value

 

[Delhi University B.Com (pass)]

[Ans: EOQ = Rs. 12,000]

(Hint = Material usage is given in Rupees)

14. An engineering company consumes 50,000 units of a component per year. The ordering, receiving and handling costs are Rs. 3 per order, while the trucking costs are Rs. 12 per order. Further details are as follows:

Interest: Rs. 0.60 per unit per year

Deterioration cost: Rs. 0.004 per unit per annum

Storage cost: Rs. 1,000 per annum for 5,000 units

Calculate the EOQ.

 

[Madras University B.A. (Corp.)]

[Ans: 2,384 units]

15. The following details are available in respect of a firm:

Inventory required per year:         6,000 units

Carrying costs per item for one year: Re 1

Cost of placing each order: Rs. 60

Alternative order sizes (units): 6,000; 3,000; 2,000; 1200; 1,000; 600.

Determine EOQ.

 

[Madras University 2006]

[Ans: EOQ = 849 units

Nearest order size is 1,000 units]

16. Find out the EOQ and order schedule for raw materials and packing materials units using the following data given to you:

 

(1) Cost of ordering:
Raw materials:	Rs. 1,000 per order
Packing materials:	Rs. 5,000 per order
(2) Cost of holding inventory:
Raw materials:	1 ps. per unit per month
Packing materials:	5 ps. per unit per month
(3) Production rate:	2,00,000 units per month

[Ans: Raw materials: 2,00,000 units; one order p.m Packing materials : 2,00,000 units; one order p.m]

17. The Jambawan Ltd uses about 75,000 valves per year and usage is at 6,250 values per month. The cost of the valve is Rs. 1.50 per unit, when bought in quantities and the carrying cost is estimated to be 20% of average inventory investment on the annual basis. The cost to place an order and to process the delivery is Rs. 18. It takes 45 days to receive delivery from the date of an order, and the safety stock of 3,250 valve is desired. You are required to determine:

1. the most suitable EOQ and
2. the order point

[Ans: (a) 3,000 values; (b) 12,625 values]

18. From the following particulars, calculate the number of orders to be placed and the total cost of EOQ:

1. Annual requirement of raw materials 60,000 units
2. Ord of deterioration, taxes, insurance etc. Rs. 1 per unit

[Ans: EOQ: 6,000 units; No. of orders : 10;

Total cost of EOQ : Rs. 12,000]

19. A manufacturer has to supply to his customer 600 units of his product per year. Storage is not allowed and the inventory–carrying costs amount to Rs. 0.60 per unit per year. The setup cost per run is Rs. 80. Find:

1. The economic order quantity
2. The minimum average yearly cost
3. The optimum number of orders per year
4. The optimum period of supply per optimum order.

[Ans: (i) 400 units; (ii) Rs. 280; (iii) 2; (iv) 8 months]

20. Following is the information relating to a type of material:

 

Annual demand	2,400 units
Unit price	Rs. 2.40
Ordering cost per order	Rs. 4.00
Storage cost	2% p.a.
Interest rate	10% p.a.
Lead time	Half month

Calculate EOQ and total annual inventory cost

[Ans: EOQ : 258 units; Total inventory cost : Rs. 5837]

Model: Stores ledger account pricing of material issues Questions 21 to 49

[Model: FIFO Method]

21. The following information is extracted from the stores ledger of Anu Ltd:

 

September 1.	Opening balance	500 units at Rs. 10
6.	Purchases	100 units at Rs. 11
20.	Purchases	700 units at Rs. 12
27.	Purchases	400 units at Rs. 13
October 13.	Purchases	1,000 units at Rs. 14
20.	Purchases	500 units at Rs. 15
November 17.	Purchases	400 units at Rs. 16

 

Issue of materials:

 

September	9	500 units
	22	500 units
	30	500 units
October	15	500 units
	22	500 units
November	11	500 units

 

Issues are to be priced on the principle of FIFO. Write the stores ledger account.

 

[Madras University 2008]

[Ans: Closing stock 600 units at Rs. 9,400]

22. The following is the record of receipts and issues of a certain material for the month of December:

 

December 3.	Opening balance 200 kg at Rs. 20 per kg
4.	Issue 100 kg
10.	Issue 50 kg
18.	Purchases 300 kg at Rs. 18 per kg
19.	Issue 300 kg
28.	Purchases 50 kg at Rs. 15 per kg
30.	Issue 100 kg
30.	Received back from completed job 5 kg
	(previously issued at Rs. 20 per kg)

 

Prepare a stores ledger account based on FIFO Method.

 

[Mysore University]

[Ans: Closing stock: 5 kg at Rs. 100]

23. The following information is extracted from the stores ledger:

 

January 1.	Opening balance 500 units at Rs. 4
5.	Purchases 200 units at Rs. 4.25
12.	Purchases 150 units at Rs. 4.10
20.	Purchases 300 units at Rs. 4.50
25.	Purchases 400 units at Rs. 4

 

Issue of materials were as follows:

 

January 4.	200 units
10.	400 units
15.	100 units
19.	100 units
26.	200 units
30.	250 units

 

Issue are to be priced on the principle of FIFO method. Write up the stores ledger account.

 

[Madras University 2007; Periyar University 2005; Dr B. R. Ambedkar Open University]

[Ans: Closing stock: 300 units at Rs. 1,200]

24. Prepare a stores ledger account from the following information adopting FIFO method of pricing of issues of materials:

 

March 1.	Opening balance	500 tonne at Rs. 200
3.	Issue	70 tonne
4.	Issue	100 tonne
8.	Issue	80 tonne
13.	Received from	200 tonne at
	supplier	Rs. 190
14.	Returned from Dept A	15 tonne
16.	Issue	180 tonne
20.	Received from	240 tonne at
	supplier	Rs. 195.
24.	Issue	300 tonne
25.	Received from	320 tonne at
	supplier	Rs. 200
26.	Issue	115 tonne
27.	Returned from Dept B	35 tonne
28.	Received from	100 tonne at
	supplier	Rs. 200.

 

[Madras University]

[Ans: Closing stock: 565 tonne at Rs. 1,12,275]

25. The records of receipts and issues of carbon chemicals of Hexa factory during December 2008 are as follows:

December 4. Opening balance 100 tonne @ Rs. 200

8. Issued 50 tonne

14. Received from supplier 40 tonne @ Rs. 190

17. Issued 36 tonne

21. Received from supplier 48 tonne @ Rs. 180

24. Issued 60 tonne

25. Returned to suppliers 10 tonne out of goods received on 21 December.

26. Received from supplier 64 tonne @ Rs. 190

29. Issued 40 tonne

30. Returned from department 6 tonne @ Rs. 190

While verifying stock, a shortage of 2 tonne on 23 December was noticed and left a note accordingly. Prepare stores ledger account under FIFO Method.

[Ans: Closing stock: 60 tonne at Rs. 11,400]

26. The Hindustan Heavy Electrical closes its account at the end of each month. The following information is available for the month of April:

 

	Rs.
Sales	5,00,000
Administrative expenses	40,000

Inventory (1 April) :

100 tonne at Rs. 1,000 per tonne 1,00,000

Purchases:

10 April 200 tonne at Rs. 900 per tonne : 1,80,000

20 April 200 tonne at Rs. 800 per tonne : 1,60,000

Inventory (30 April): 100 tonne

Compute the following under FIFO method.

1. Inventory valuation on 30 April
2. Cost of goods sold for April
3. Profit/loss for April

[Ans:	(a) Rs. 80,000 (100 tonne × Rs. 800)
	(b) Rs. 3,60,00
	(c) Profit Rs. 1,00,000]

27. From the following particulars, prepare the stores ledger under LIFO method:

January 1. Purchased 200 Units @ Rs. 5 per unit

   5. Purchased 500 Units @ Rs. 6.50 per unit

   7. Issued 350 units

   14. Purchased 450 units @ Rs. 7.10 per unit

   19. Issued 600 units

[Ans: Closing stock: 200 units at Rs. 1,000]

28. From the following information, show the stores ledger account on LIFO method:

June 1. Opening stock 800 kg @ Rs. 10 each

4. Purchased 250 kg @ Rs. 9 each

12. Purchased 400 kg @ Rs. 10 each

16. Purchased 600 kg @ Rs. 10.50 each

23. Purchased 300 kg @ Rs. 11. each

Issued to manufacturing department as follows:

On 15 June stock verification received a shortage of 8kg. The maximum level is 1,400 kg. Minimum level is 650 kg. At the end of the month, stock verification revealed that there is a surplus of 2 kg.

 

[Mysore University. Modified]

[Ans: 524 kg valued at Rs. 5,200]

29. The following information is provided by Sunrise industries for the fortnight of April: Material stock on 1 April 100 units @ Rs. 5 per unit.

Material stock on 1 April 100 units @ Rs. 5 per unit.

 

April	5. Purchases	300 units at Rs. 6
	6. Issues	250 units 8. Purchases
		500 units at Rs. 7
	10. Issues	400 units
	12. Purchases	600 units at Rs. 8
	14. Issues	500 units

Required:

Calculate using LIFO methods of pricing issues:

1. Value of materials consumed during the period
2. Value of stock of materials as on 15^th April.

[Madras University]

[Ans:	(a) Value of materials consumed: Rs. 8,300
	(b) Closing stock: 350 units at Rs. 2,300]

[Model: FIFO and LIFO methods]

30. X company has purchased and issued materials as follows:

 

June 1. Stock of materials	200 units at Rs. 2.50 per unit
3. Purchased	300 units at Rs. 3 per unit
7. Purchased	500 units at Rs. 4 per unit
10. Issued	600 units
12. Purchased	400 units at Rs. 4 per unit
18. Issued	500 units
24. Purchased	400 units at Rs. 5 per unit
28. Issued	200 units

Prepare the stores ledger account under FIFO method and LIFO method.

 

[Madras University]

[Ans: Closing stock: FIFO: 500 units at Rs.2,400 LIFO: 500 units at Rs.1,800]

[Model: FIFO and LIFO Excess stock (surplus) scrap]

31. Prepare stores ledger accounts for the month of August, pricing the materials issued based on FIFO and LIFO:

 

January 1. Opening stock:	200 tonne @ Rs. 460
2. Issued to Job No. 1:	140 tonne
5. Purchased:	350 tonne @ Rs. 450
6. Condemned due to deterioration in quality and thus scrapped:	30 tonne
10. Issued to Job No. 10:	80 tonne
11. Issued to Job No. 29:	210 tonne
15. Purchased:	200 tonne @ Rs.480
21. Issued to Job No. 39:	120 tonne
24. Purchased:	180 tonne @ Rs.470
29. Issued to Job No. 45:	280 tonne
31. Stock verification reveals excess stock of 10 tonne

 

[Ans:	Closing stock: FIFO:	80 tonne at Rs. 37,700
	LIFO:	80 tonne at Rs. 36,900 ]

[Model: FIFO and LIFO—Returns]

32. Enter the following transactions in the stores ledger of Y material using (i) FIFO and (ii) LIFO methods:

 

May 1.	Balance:	250 units at Rs.1 per unit
3.	Issued:	50 units on material requisition No. 61.
6.	Received:	800 units vide Goods Received Note No. 13 at Rs.1.10 per unit
7.	Issued: No. 63	300 units on Material Requisition
8.	Returned to stores:	20 units issued on Material Requisition No. 61.
12.	Received:	300 units as per GRN No.15 at Rs. 1.20 per unit
15.	Issued:	320 units [M.R. No. 83] 18. Received: 100 units (GRN No.77) at Rs. 1.20 per unit
20.	Issued:	80 units (M. R. No. 102)
23.	Returned to vendors 20 units from goods received Note No. 77 received on 18 May
27.	Received:	200 units on GRN No. 96 at Rs. 1 per unit
28.	Freight paid on purchase (GRN No. 96): Rs. 50
30.	Issued: 250 units on M.R. No. 113

 

[Madras University]

[Ans: Closing stock:	1. FIFO: 650 units at Rs. 781
	2. LIFO: 650 units at Rs. 695]

[Model: FIFO and LIFO—Shortage]

33. From the following transactions, prepare separately the stores ledger account using (1) FIFO and (2) LIFO.

 

January	1. Opening balance	100 units @ Rs. 5 each
	5. Received	500 units @ Rs. 6 each
	20. Issued	300 units
February	5 Issued	200 units
February	6 Received back from Work order issued on 5 Feb	10 units
	7. Received	600 units @ Rs. 5 each
	20. Issued	300 units
	25. Returned to supplier	50 units purchased on 7 February
	26. Issued	200 units
March	10. Received	500 units at Rs. 7 per unit
	15. Issued	300 units

Stock verification on 15 March revealed a shortage of 10 units.

 

[Ans: Closing stock:	FIFO: 350 units at Rs. 2,450
	LIFO: 350 units at Rs. 2,140]

[Model: Specific Price and FIFO]

34. From the following information, prepare a stores ledger account under specific pricing with FIFO:

 

April 1.	Opening balance	50 kg @ Rs. 10
2.	Issued	30 kg
4.	Purchased	60 kg @ Rs. 11
5.	Purchased	50 kg @ Rs. 12
		for a specific job to be issued on 15 April
6.	Issued	25 kg
10.	Purchased	50 kg @ Rs. 10
16.	Issued	60 kg
25.	Purchased	25 kg @ Rs. 12
30.	Issued	35 kg

 

[Madras University]

[Ans: Closing stock: 35 kg at Rs. 400]

[Model: Specific price and LIFO]

35. Prepare a stores ledger account for material X for March, pricing the material based on

LIFO with specific pricing:

[Ans: Closing stock: at Rs. 2,900 for 150 units]

[Model: FIFO and LIFO—Refund and shortage]

36. The following transactions took place in the month of February:

 

February 1. Opening Balance	500 quintals @ Rs. 25.
3. Issue	70 quintals
4. Issue	100 quintals
8. Issue	80 quintals
13. Received from vendor	200 quintals
14. Refund of surplus from a work order	15 quintals @ Rs. 24.50
16. Issue	180 quintals
20. Received from vendor	240 quintals @ Rs. 24.37
24. Issue	340 quintals
25. Received from vendor	320 quintals @ Rs. 24.31
26. Issue	112 quintals
27. Refund of surplus from a work order	12 quintals @ Rs. 24.50
28. Received from vendor	100 quintals @ Rs. 25

The store verifier of the factory noticed that on 15 February he had found a shortage of 5 quintals and on 27February another shortage of 8 quintals.

Write up the complete stores ledger account in respect of materials using (a) FIFO and (b) LIFO methods.

 

[Ans: Closing stock:	FIFO: 528 quintals at Rs. 12,194
	LIFO: 528 quintals at Rs. 13,056]

[Model: HIFO Method]

37. Lords Co. Ltd has purchased and issued material Z as follows:

 

April	1. Opening stock	3,000 units at Rs. 6 per unit
	3. Purchased	750 units at Rs. 7 per unit
	6. Purchased	1,050 units at Rs. 7.50 per unit
	9. Issued	1,100 units
	12. Purchased	450 units at Rs. 9 per unit
	14. Purchased	300 units at Rs. 8 per unit
	15. Issued	500 units
	17. Purchased	300 units at Rs. 10 per unit
	25. Purchased	250 units at Rs. 9.50 per unit
	30. Issued	300 units

Ascertain the value of closing stock under HIFO method of pricing issues.

[Ans: Closing stock: 4,200 units @ Rs. 27,275]

[Model: Base stock method with FIFO]

38. From the following particulars, write up the stores ledger card:

 

January	1. Opening stock	2,000 units at Rs. 5 each
	5. Purchased	1,800 units at Rs. 6 each
	10. Issued	2,400 units
	12. Purchased	1,600 units at Rs. 6.20 each
	15. Purchased	600 units at Rs. 6.40 each
	19. Issued	800 units
	22. Issued	1,200 units
	27. Purchased	400 units at Rs. 6.50 each
	31. Issued	1,200 units

Adopt base stock method with FIFO. Base stock is 500 units out of opening stock.

[Ans: Closing stock: 800 units at Rs. 4,450]

[Model: Base stock with LIFO]

39. From the following particulars write up the stores ledger card:

 

January	1. Purchased	500 units at Rs. 2 per unit
	10. Purchased	300 units at Rs. 2.10 per unit
	13. Issued	500 units
	20. Purchased	400 units at Rs. 2.20 per unit
	25. Issued	300 units
	27. Purchased	500 units at Rs. 2.10 per unit
	31. Issued	200 units

Adopt base stock method with LIFO. Base stock is 200 units of January 1 purchase.

[Ans: Closing stock: 700 units (200 + 500) at Rs. 1,450 (Rs. 400 + 1,050)]

[Model: Base stock with FIFO]

40. The stock of materials as on 1 January was 750 units @ Rs.1.50 per unit. Following purchases and issues of this item were made subsequently:

 

 

Prepare stores ledger account assuming that the issues are made under base stock method in conjunction with FIFO method. Base Stock Units: 400

[Bangalore University]

[Ans: Closing stock: (400 + 50 Units) at Rs. 697.50 400 × Rs1.50 + 50 × Rs. 1.95]

[Model: Simple average method]

41. From the following transactions, prepare stores ledger account using simple average price method:

 

January	1. Opening balance 100 units at Rs. 5 each
	5. Received 500 units at Rs. 6 each
	20. Issued 300 units
February	5. Issued 200 units
	6. Received 500 units at Rs. 5 each
March	10. Issued 300 units
	12. Issued 250 units

 

[Nagarjuna University]

[Ans: Closing stock: 50 units at Rs. 275]

42. From the following details, write up stores ledger account using simple average method:

 

December	1. Opening balance	100 kg @ 5.00
	Received	50 kg @ 5.20
	8. Issued	120 kg
	10. Issued	10 kg
	15. Received	80 kg @ Rs. 5.40
	18. Issued	50 kg
	20. Received	100 kg @ Rs. 5.60
	25. Issued	40 kg
	29. Issued	60 kg

The stock verifier found a shortage of 10 kg on 16 December and another shortage of 10 kg on 26 December.

 

[Calcutta University, B.com]

[Ans: Closing stock: 30 kg at Rs.158]

[Model: Weighted average method]

43. Prepare the stores ledger account based on the weighted average method of pricing issues:

 

September	24,000 kg @ Rs. 7,500 per tonne
1. Opening balance
1. Purchased	44,000 kg @ 7,600 per tonne
1. Issued	10,000 kg
5. Issued	16,000 kg
12. Issued	24,000 kg
13. Purchased	10,000 kg @ 7,800 per tonne
18. Issued	20,000 kg
22. Purchases	50,000 kg @ 8,000 per tonne
28. Issued	30,000 kg
30.Issued	22,000 kg

 

[Sri Venkateswara University, Tirupathi, A.P.]

[Ans: Closing stock: 6,000 kg at Rs. 47,686]

44. Prepare a stores ledger account by adopting the weighted average method of pricing:

 

September	1. Opening balance	50 units @ Rs. 3 per unit
	4. Issued	2 units
	8. Purchased	48 units @ Rs. 4 per unit
	9. Issued	20 units
	15. Purchased	76 units @ Rs. 3 per unit
	22. Received back into stores	19 units out of 20 units issued on 9 September
	30. Issued to production:	10 units

 

[Madurai Kamaraj University; Madras University and Bangalore University]

[Ans: Closing stock: 161 Units at Rs. 527.72]

45. From the following transactions, prepare a priced ledger sheet, pricing the issues at weighted average rate:

[Madras University 2002 & 2007; Bharathiar University 2007]

[Ans: Closing stock 300 units at Rs. 726]

[Model: Simple average and weighted average]

46. The following transactions took place in respect of a material:

Prepare stores ledger account showing the pricing of materials issued under

1. simple average method
2. weighted average method

[Ans: Closing stock: (a) 1,000 units at Rs. 6,400 (b) 1,000 units at Rs. 6,528]

47. The following receipts and issues were made of material during the month of May. Prepare stores ledger account on the basis of

1. simple average method and
2. weighted average method

Receipts:
May 1.	Opening balance of stock	300 units at Rs. 4.50 per unit
7.	Purchases	400 units at Rs. 5.00 per unit
15.	Purchases	1,000 units at Rs. 5.50 per unit
23.	Purchases	700 units at Rs. 4.80 per unit
Issues:
May 3.	Issues	300 units
8.	Issues	100 units
17.	Issues	700 units
26.	Issues	700 units

 

[Madras University]

[Ans:	(a): 600 units at Rs. 3,080
	(b): 600 units at Rs. 3,042]

[Model: Combination of any two or more methods LIFO and weighted average]

48. The following particulars relate to the receipts and issues of a material during the month of March:

 

March 4.	Received	500 units at Rs. 2.00 each
18.	Received	350 units at Rs. 2.10 each
19.	Issued	600 units
24.	Received	600 units at Rs. 2.20 each
25.	Issued	450 units
26.	Received	500 units @ Rs. 2.30 each
28.	Issued	510 units
30.	Issued	100 units

Prepare stores ledger account using (a) LIFO and (b) weighted average method.

[Nagarjuna University]

[Ans:	(a) LIFO: 290 units at Rs. 588
	(b) Weighted average: 290 units at Rs. 647]

[Model: FIFO, LIFO and weighted average method]

49. The following information is extracted from the stores ledger:

 

Purchases:
January	1.	100 units at Rs. 1 per unit
	20.	100 units at Rs. 2 per unit
Issues:
January	22.	60 units for Job W16
	23.	60 units for Job W17

Complete the receipts and issues by adopting the (1) FIFO (2) LIFO and (3) weighted average methods.

[Madras University]

[Ans: Value of closing stock:

1. FIFO: 80 units at Rs. 160
2. LIFO: 80 units at Rs. 80
3. Weighted average: 80 units at Rs. 120]

[Model: Material—stock levels, Questions 50 to 56]

50. Find out re-order level:

 

Maximum usage	300 units
Minimum usage	200 units
Re—order period	8 to 10 days

 

[Bharathidasan University]

[Ans: 3,000 units]

51. From the following information, calculate maximum, minimum and average stock levels.

 

Normal consumption	500 kg
Minimum consumption per day	200 kg
Maximum consumption per day	800 kg
Lead time	10 to 16 days
Reorder quantity	3,000 kg

 

[Madras University]

[Ans:	Maximum stock level: 13,800 kg
	Minimum stock level: 6,300 kg
	Average stock level: 7,800 kg (or) 10,050 kg]

52. Find out (a) the reorder level (b) the minimum level and (c) the maximum level:

 

Normal usage	100 units per day
Minimum usage	60 units per day
Maximum usage	130 units
EOQ	5,000 units
Reorder period	25 to 30 days

 

[Dr. Ambedkar Open University]

[Ans: (a) 3,900 units (b) 1,150 units and (c) 7,400 units]

53. In manufacturing its products, a company uses three raw materials A, B and C in respect of which the following apply:

Weekly production varies from 175 to 225 units, averaging 200. What would you expect the quantities of the following to be:

1. Minimum stock of A
2. Maximum stock of B
3. Re-order level of C
4. Average stock of A

[Poona B.Com. Modified]

[Ans: (a) 4,000 kg (b) 7,650 kg (c) 5,400 kg (d) 9,000 kg]

54. In a factory three components P, Q and R are used as follows:

Normal usage: 900 units per week each

Maximum usage: 1,350 units per week each

Minimum usage: 450 units per week each

 

Re-order quantity:	P – 7,200 units
	Q – 9,000 units
	R – 10,800 units
Re-order Period	P – 2 to 4 weeks
	Q – 4 to 6 weeks
	R – 3 to 5 weeks

Compute for each component (i) reorder level, (ii) maximum level, (iii) minimum level and (iv) average stock level.

 

[Nagarjuna University]

55. Two materials A and B are used as follows:

Normal consumption: 50 units per week each

Minimum consumption: 25 units per week each

Maximum consumption: 75 units per week each

 

Re-order quantity:	A – 300 Units
	B – 500 Units
Re-order period:	A – 4 to 6 weeks
	B – 2 to 4 weeks

Calculate (a) reorder level, (b) minimum level, (c) maximum level and (d) average stock level.

[Madras University and Periyar University—15 times—most frequently asked question]

[Ans:	(a) Re-order level: A, 450 units; B, 300 units
	(b) Minimum level: A, 200 units; B, 150 units
	(c) Maximum level: A, 650 units; B, 750 units
	(d) Average stock level: A, 425 units or 350 units; B, 450 units or 400 units]

56. The following information pertaining to a firm is available:

 

Annual consumption	12,000 units (360 days)
Cost per unit	Rs. 1
Cost per order	Rs. 12
Inventory–carrying cost	20% p.a.
Lead time:
Maximum	30 days
Normal	15 days
Minimum	5 days
Daily consumption:
Maximum	45 units
Normal	33 units
Minimum	15 units
Calculate inventory levels

 

[Madras University]

Ans:	Re-order level : 1,350 units
	EOQ : 1,200 units
	Maxim um level : 2,475 units
	Minimum level : 855 units]

[Model: Inventory turnover ratio]

57. Calculate the material turnover ratio for year 2009 from the following details:

	Material A Rs.	Material B Rs.
Opening stock	25,000	87,500
Closing stock	15,000	62,500
Purchases	1,90,000	1,25,000

Calculate:

1. Material turnover ratio
2. Fast-moving materials

[Ans: Material turnover ratio: A, 10 times; B, 2 times Fast-moving material is A because of its higher turnover]

58. From the following information, calculate

1. Material turnover ratio
2. Material turnover period in days and also months
3. Faster moving material

	Material X (units)	Material Y (units)
Opening stock	75,000	25,000
Purchases	2,00,000	4,00,000
Closing stock	25,000	50,000

 

[Ans:	(a) Material turnover ratio: X, 5 times; Y, 10 times
	(b) Material turnover period: X, 73 days or 2.4 months; Y, 36.5 days or 1.2 months
	(c) Faster moving material is Y because it has higher material turnover ratio]

 

Exercises for professional course students and postgraduate course students (C.S., C.A., I.C.W.A., B.Com (Hons) and M.Com)

59. G Ltd produces a product which has a monthly demand of 4,000 units. The product requires a component × which is purchased at Rs. 20. For every finished product, one unit of component is required. The ordering cost is Rs. 120 per order and the holding cost is 10% p.a. You are required to calculate:

1. Economic order quantity
2. If the minimum lot size to be supplied is 4,000 units, what is the extra cost the company has to incur?
3. What is the minimum carrying cost the company has to incur?

[C.A. (Inter); C.S. (Inter)]

[Ans: (i) 2,400 units, (ii) Rs. 640, (iii) Rs. 2,400]

60. The following relates to inventory costs for ABC Ltd

1. Orders must be placed in multiples of 200 units.
2. Requirements for the year are 4,00,000 units.
3. The purchase price per unit is Rs. 4.
4. The carrying cost is 20% of the purchase price of goods.
5. Cost per order placed is Rs. 25.
6. Desired safety stock is 20,000 units. This quantity is on hand initially.
7. Three days are required for delivery.

Calculate:

1. EOQ
2. How many orders the company place each year?
3. At what inventory level should an order be placed?

[I.C.W.A. (Final)]

[Ans: (a) 5,000 units, (b) 80 orders, (c) 25,333 units]

61. Following information relating to a type of raw material is available:

 

Annual demand	2,400 units
Unit Price	Rs. 2.40
Ordering cost	Rs. 4 per order
Storage cost	2% p.a.
Interest rate	10%
Lead time	Half month

Calculate EOQ and total inventory cost in respect of the particular material.

[I.C.W.A. (Inter)]

[Ans: EOQ, 258 units; Total inventory cost, Rs. 5,837.15]

62. A firm is able to obtain quantity discount on its order of material as follows:

 

Price per tonne	tonne
Rs. 6.00	Less than 250
Rs. 5.90	more than 250 and less than 800
Rs. 5.80	more than 800 and less than 2,000
Rs. 5.70	more than 2,000 and less than 4,000
Rs. 5.60	4,000 and over

The annual demand for the material is 4,000 tonne. Stock holding costs are 20% of material cost per annum. The delivery cost per order is Rs. 6. You are required to calculate the best quantity to order.

 

[C.A. (Inter)]

[Ans: EOQ, 207 tonne; Optimum ordering quantity is 800 units because of its least cost Rs. 23,694]

63. A purchase manager has decided to place orders for minimum quantity of 500 numbers of a particular item in order to get a discount of 10%. From the records it was found that in the last year, 8 orders each of size 200 numbers had been placed. Given: ordering cost is Rs. 500 per order, inventory–carrying cost is 40% of the inventory value and the cost per unit is Rs. 400.

1. Is the purchase manager justified in his decision?
2. What will be the effect of the purchase manager’s decision on the company?

[C.A. (Final)]

[Ans: EOQ, 100 units; order, 16.

Effect: Total inventory cost at EOQ level: Rs. 65,600

Total inventory cost of last year: Rs. 6,60,000

Total inventory cost due to manager’s decision: Rs. 6,14,000

∴ Savings incurred = Rs. 6,60,000 – Rs. 6,14,000

                              = Rs. 46,000.

Hence purchase manager’s decision is justified.]

64. The purchase department of your organization has received an offer of quantity discounts on its order of materials as under:

 

Price per tonne
Rs.	tonne
1,400	Less than 500
1,380	more than 500 and less than 1,000
1,360	more than 1,000 and less than 2,000
1,340	more than 2,000 and less than 3,000
1,320	3,000 and above

The annual requirement of the material is 5,000 tonne. The delivery cost per order is Rs. 1,200 and the annual stock holding cost is estimated at 20% of the average inventory.

The purchase department wants you to consider the following purchase options and advise which among them will be the most economical ordering quantity, presenting the relevant information in a tabular form.

The purchase quantity orders to be considered are 400, 500, 1,000, 2,000 and 3,000 tonne.

 

[C.A. (Inter)]

[Ans: 1,000 tonne]

65. X Ltd is committed to supply 24,000 bearings per annum to Y Ltd on a steady basis. It is estimated that it costs 10 paise as inventory–holding cost per bearing per month and that the setup cost per run of bearing manufacture is Rs. 324.

1. What would be the optimum run size for bearing manufacture
2. Assuming that the company has a policy of manufacturing 6,000 bearings per run, how much extra costs the company would be incurring as compared to the optimum run suggested in (a) above?
3. What is the minimum inventory holding cost?

[C.A. (Inter)]

[Ans: (a) 3,600 bearings, (b) Extra cost incurred, Rs. 576 and (c) Rs. 2,160]

66. The following details are available in respect of a consignment of 1,250 kg of material X:

 

(a) Invoice Price Rs. 20 per kg
(b) Excise duty	25% on invoice price
(c) Sales tax	8% on invoice price including excise duty
(d) Trade discount	10% on invoice price
(e) Insurance	1% of aggregate net price
(f) Delivery charges	Rs. 250
(g) Cost of containers @ Rs. 60 per container for 50 kg of material. Rebate is allowed at Rs. 40 per container if returned within six weeks, which is a normal feature.
(h) One container load of material was rejected on inspection and not accepted.
(i) Cost of unloading and handling @ 0.25% of the cost of materials ultimately accepted. Based on above you are required to find out the loaded cost per kg of material X.

 

[I.C.W.A. (Inter)]

[Ans: Rs. 25.92]

67. The complete Gardener is deciding on the economic order quantity for two brands of lawn fertilizer: “Super–Grow” and “Natives Own”. The following information is collected:

 

	Fertilizer
	Super–Grow	Natives Own
Annual demand	2,000 bags	1,280 bags
Relevant ordering cost per purchase order	Rs. 1,200	Rs. 1,400
Annual relevant carrying cost per bag	Rs. 480	Rs. 560

Required:

1. EOQ for Super Grow and Natives Own.
2. For the EOQ, what is the sum of the total annual relevant ordering costs and the annual relevant carrying costs for Super Grow and Natives Own?
3. For the EOQ compute the number of deliveries per year for Super Grow and Natives Own.

[C.A. (Inter)]

[Ans:	Super Grow	Natives Own
	(i) 100 bags	80 bags
	(ii) Rs. 48 ers	16 orders]

68. A publishing house purchases 2,000 units of a particular item per annum at a unit cost of Rs. 20. The ordering cost per order is Rs. 50 and the inventory carrying cost is 25%.

• Find the optical order quantity and the minimum total cost including purchase cost.
• If 3% discount offered by the supplier for the purchase in lots of 1,000 units or more, should the publishing house accept the offer?

[C.S. (Inter)]

[Ans: (a) 200 units and (b) Offer should be rejected. The total cost of purchase is Rs. 325 higher.]

69. From the following data, for the year ended 31 December 2009, calculate the inventory turnover ratio of the two items, and put forward your comments on them.

 

	Material A Rs.	Material B Rs.
Opening stock (1 January2009)	10,000	9,000
Purchases during the year	52,000	27,000
Closing stock (31 December 2009)	6,000	11,000

 

[I.C.W.A. Modified]

[Ans: Inventory turnover ratio: A, 7 times; B, 2.5 times]

70. The following data are available in respect of material X for a year.

 

	Rs.
Opening stock	90,000
Purchases during the year	2,70,000
Closing stock	1,10,000

Calculate:

1. Inventory turnover ratio
2. number of days for which the average inventory is held.

[C.A. (Inter)]

[Ans: (i) 2.5, (ii) 146 days]

71. ZEE is a manufacturer of a product out of three raw materials M, N and Q. Each unit of Zee product requires 10, 8 and 6 kg of M, N and Q respectively. The reorder levels of M and N are 15,000 and 10,000 kg respectively, while the minimum level of Q is 2,500 kg. The weekly production of ZEE varies from 300 to 500 units, while the weekly average production is 400 units. You are required to compute:

• Minimum stock level of M
• Maximum stock level of N
• Reorder quantity of Q

The following additional data are given to you:

[I. C. W A. (Inter)]

[Ans: (a) 3,000 kg, (b) 15,400 kg, (c) 15,000 kg]

72. M/S Tubes Ltd is the manufactures of picture tubes for T.V. The following are the details of their operations:

 

Average monthly market demand:	2,000 tubes
Ordering cost	Rs. 100 per order
Inventory–carrying cost	20% p.a.
Cost of tubes	Rs. 500 per tube
Normal usage	100 tubes per week
Maximum usage	200 tubes per week
Minimum usage	50 tubes per week
Lead time to supply	6 to 8 weeks

Compute from the above

1. EOQ. If the supplier is willing to supply quarterly 1,500 units at a discount of 5% is it worth accepting?
2. Maximum level of stock
3. Minimum level of stock
4. Reorder level

[C.A. (Inter)]

[Ans:	(1) 102 tubes; The offer can be accepted.
	(2) Maximum Level, 1,402 units; (3) Minimum Level, 900 units; (4) Reorder level, 1,600 units]

73. From the details given below, calculate:

1. Reordering level
2. Maximum level
3. Minimum level
4. Danger level

Reordering quantity is to be calculated based on following information:

Cost of placing a purchase order is Rs. 20.

Number of units to be purchased during the year is 5,000.

Purchase price per unit inclusive of transportation cost is Rs. 50.

Annual cost of storage per unit is Rs. 5.

 

Details of lead time: Average	10 days
Maximum	15 days
Minimum	6 days
For emergency	4 days
Rate of consumption average	15 units per day
Maximum: 20 units

 

[C.A. (Inter)]

[Ans: (i): 300 units, (ii) 440 units, (iii) 150 units, (iv) 60 units]

74. The following information is available in respect of component 20:

 

Maximum stock level	8000 units
Budget consumption	Maximum: 1500 units per month
	Minimum: 800 units per month
Estimated delivery period:	Maximum = 4 months
	Minimum = 2 months

You are required to calculate:

(a) Re–order level (b) Reorder quantity

 

[I.C.W.A. (Inter)]

[Ans: (a) 6,000 units, (b) 3,600 units]

75. In the course of physical verification of stores on 31 March year the following discrepancies are revealed in the case of AB Ltd:

Prepare journal entries in the cost ledger to give effect to the above adjustment as called for.

[I.C.W.A. (Inter)]

76. You are presented with the following information relating to the first week of a month. The transactions in connection with the materials are as follows:

 

1st day	Purchased 40 units @ Rs. 15 per unit
2nd day	Purchased 20 units @ Rs. 16.50 per unit
3rd day	Issued 30 units
4th day	Purchased 50 units @ Rs. 17.10 per unit
5th day	Issued 20 units
6th day	Issued 40 units

Calculate the cost of materials under (1) FIFO (2) LIFO and (3) Weighted average method of issue of material and the value of closing stock under the aforesaid materials

[C.S. (Inter)]

[Ans: Value of closing stock:

1. FIFO method: 20 units at Rs. 342
2. LIFO method: 20 units at Rs. 300
3. Weighted average method: 20 units at Rs. 330]

77. Show the stores ledger entries as they would appear when using (a) LIFO method and (b) weighted average method of pricing issues, in connection with the following transaction:

In a period of rising prices such as above, what are the effects of each method?

[I.C.W.A. (Inter)]

[Ans:	(a) 150 units at Rs. 300
	(b) 150 units at Rs. 342]

[In periods of rising prices, the average price is less than the current price.

In LIFO the product cost reflects current market prices whereas the stock is valued at old price which is outdated.

Hence in periods of rising prices, the weighted average method may be recommended.]

78. A consignment consisted of two chemicals A and B. The invoices gave the following data:

Chemical A – 4,000 kg @ Rs. 2.50 per kg Rs. 10,000

Chemical B – 3,200 kg @ Rs. 3.25 per kg Rs. 10,400

 

Sales tax	Rs.    816
Railway freight	Rs.    384
Total cost	Rs. 21,600

A shortage of 200 kg in A and 128 kg in B was noticed due to breakage. What stock rate would you adopt for pricing issues assuming a provision of 5% towards further deterioration?

 

[C.A. (Inter). Modified]

[Ans: Chemical A, Rs. 2.93; Chemical B, Rs. 3.76]