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Costing notes

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  • 1. CHAPTER 1-MATERIALSDirect material: All those basic raw material which are used in the manufacture of a particular article aredirect materials. Direct materials physically enter into the production and become a part of finished product.Examples: cotton used in textile mill, Timber used in the furniture etc.Indirect material: Indirect materials are those materials which do not forma part of the finished product.Itindirectly assists the direct material.Examples: cotton waste, oil, grease etc.Relationship between Stores, Stock and InventoryDirect and indirect materials are both treated as store item on other hand finished goods are treated as stock.Inventory includes stock of raw material, work in progress and finished goods. Thus stock of raw material isonly a part of inventory.Inventory Control (Material control): It may be defined as the systematic control over the procurement,storage and usage of material so as to ensure regular and timely supply of materials and avoids at the sametime overtaking of materials.Need for control of materials/Objects of material control 1. Availability of materials: There should be a continuous availability of materials of all types. 2. No excessive investment in materials: over stocking should be avoided. For this purpose a maximum quantity is fixed for each item of materials. 3. Reasonable price: While purchasing materials it is seen that it is purchased at reasonably low price. 4. Minimum wastages: There should be minimum possible wastages of material while they are used in the factory. 5. Information about the availability of material should be made: The store keeper can supply the availability of every type of materials.Essentials of material control 1. There should be proper co-ordination among different departments. 2. Purchase of materials should be centralized. 3. A good classification of materials should be followed a) There should be proper inspection of materials when they are received. 4. Storage of materials should be well planned to avoid losses from theft, damage etc. 5. A good method of issue of material should be introduced. 6. A good system of internal check should be introduced. 7. Maximum reorder level and minimum levels should be fixed. 8. Information about the availability of material should be made continuously to the management.Methods of Inventory Control (Material control)Effective control on inventory may exercised through 1. ABC Analysis or selective value approach 2. Perpetual inventory system 3. Physical stock verification 4. Inventory turnover ratio 5. Input-out analysis1. ABC Analysis or selective value approach: ABC analysis is otherwise known as Always Better Controlmethod. It is based on the principle that more care and control is necessary for costing items of material.ABCanalysis classifies the stores into 3 categories the basis of value. Materials which are costly but form only asmall part of total inventory are categorized as ‘A’.’B’ item of materials are those whose quantity and value aremore or less the same. There are certain materials which constitute a major portion of the total inventory butrelatively of small value are categorized as ‘C’. ‘A’ category materials require great care and control, ‘B’ category requires proper care and ‘C’ categoryrequires comparatively less care.
  • 2. Category % of total inventory % of total inventory of materials (Quantity) (Value) 5-10 60-70 A B 15-20 15-25 C 65-70 5-102. Perpetual inventory system(Continuous stock taking)It represents a system of records maintained by the stores department which comprises is Bin Cards and StoreLedger. It is a system of records maintained by the costing department which reflects the physical movement ofstocks and their current balance. The system helps in ascertaining the balance after every receipt and issue ofmaterials without closing down the firm for stock taking.Advantages of perpetual inventory system a) It eliminates the elaborate and costly periodical stock taking. b) There is no need of closing business for the purpose of stock taking. c) Bin cards and Stock Ledgers give ready figures of stock position at any time. d) Helps to prepare interim Profit and Loss Account. e) Stock verification is more reliable as it is done by experts. f) Possible to keep a continuous watch on materials. g) Capital investment in stores can be kept under control.3. Physical stock verification (Periodical stock verification)Periodical stock taking refers to physical verification of the entire stock once in a specified period generally onthe last day of the accounting year. It is also known as annual stock taking.Difference between perpetual inventory system and periodic inventory system Perpetual Inventory System Periodic Inventory System a. Stock taking is held throughout the year a. Stock taking is held once in a year b. Discrepancies can be rectified without delay b. There may be delay in ascertaining discrepancies c. Production will not be interrupted c. Production will be interrupted d. It is more costly d. Comparatively cheap e. Permanent personals are required e. Persons from other departments may betemporarily appointed4. Inventory Turnover ratio (ITR)/Stock Turnover Ratio (STR)/Material Turnover Ratio (MTR)It is also one method of exercising material control. The stock turnover ratio is calculated as follows: STR= Cost of materials consumed during the period Cost of average stock held during the periodThe object of inventory turnover ratio is to ascertain the speed of movement of a particular item.A high ratio indicates that the item is fast moving and a lower ratio denotes that the item is of slow moving.If the stock turnover ratio for a particular item is zero, It means that the item had not been used at all duringthe period.5. Input-Output Analysis It is the ratio of quantity of material put in to the manufacturing process and the quantity of material in the final output. This analysis helps a. To know whether the usage of material is favorable or adverse. b. To evaluate the efficiency of the manufacturing department.
  • 3. Centralized Vs Decentralized purchasing Centralized purchasing means that all purchases are made by special department organized for thespecific purpose of purchasing. In centralized purchasing only one purchase department is there and all thepurchases are made by this department. This department is headed by the purchase manager. Decentralized purchasing is exactly opposite to centralized purchasing. Decentralized purchase meansthat the purchases are made by individual departments.Merits of Centralized Purchase a. Bulk purchases can be made at a cheap rate and at good trade discount b. The purchasing department can be staffed with experts. Specialized knowledge and skill of these persons can be utilized. c. Better control on purchasing is possible d. Better layout of stores is possible. e. All records with regard to purchases are kept at one place under the supervision of the purchase officer. f. Centralized purchasing results in economy of a vendor because there is only one purchase officer is be dealt with.Demerits of decentralized purchase a. It involves high initial cost b. There may be delay in getting the material from the store because many formalities are to be made before the issue c. It is possible that material of wrong quantity may be issuedPurchase procedure/Purchase routine/Purchase cycleFollowing steps are commonly followed in purchase procedure.1. Purchase requisitionPurchase requisition is an internal document representing a formal instruction to the purchase manager to buymaterials. It is prepared by the store keeper for regular stock items and departmental heads for special items.The purchase procedure begins at the time of receiving the purchase requisition from the store keeper.2. Selecting the supplierThe purchasing department usually maintains a list of name and address of the suppliers. Tenders orquotations may be invited from the suppliers. After considering the tenders or quotations the best suppliershould be selected.3. Purchase orderAfter selecting the supplier the purchase department prepares a purchase order for the supply of materials.The order is the written authorization to the supplier to supply materials. It is evidence of the contract betweenthe buyer and the supplier.4. Receiving and inspection of materialsOnce the goods are received, an inspection is made and the goods receiving clerk enters all the details in the‘Goods Received Note’. It is prepared by the Goods Receiving Department showing the details of the goodsreceived by it.5. Checking and passing of bills for making paymentBefore making payment the relevant invoices are checked by the accounting section to confirm the authenticityas well as arithmetical accuracy. After having verified the invoice the store accounting section passes the billsfor payment and finally the cashier makes the payment. Types of Store RoomsFollowing are the three types of stores. 1. Centralized stores 2. Decentralized stores
  • 4. 3. Central stores with sub stores 1. Centralized storeIn the case of central store materials are received by and issued from one stores department. All the items ofmaterials purchased for the entire concern is stored in single store and issue is made from the store.Advantages Of centralized store a. Better control can be exercised. b. Better layout of stores is possible. c. Economy in cost- examples are reduced clerical costs and economy in records and stationary. d. Concentration of experts in one department. e. Physical verification is more simpler as all materials are kept in one place.Disadvantages of Centralized store a. It increases the internal transportation costs because one central store may not be near to every department. b. Delay and inconvenience may be caused to the departments because of the distance from the central store. c. Concentration of all items of materials at one central place enhances the risk of loss in the case of fire. d. Breakdown in transport may stop production in departments due to non-availability of materials. Decentralized storeUnder this system, materials required for each department is purchased by the respective departments itself.Under this system independent stores are situated in various departments. Central Stores with Sub StoresIn large factories, departments are situated at a distance from the central store. So in order to keep thetransportation and handling charges to minimum, sub stores should be situated near the productiondepartment.For each item of materials, a quantity is fixed and this should be kept in stock at the beginning of any period. Atthe end of the period the store keeper reimburses the material issued by the sub centre. This system is alsoknown as Imprest System of stores Control. Stock of MaterialsThe different stock levels are a. Minimum stock level b. Reorder level c. Maximum stock levelMinimum stock levelIt represents the minimum quantity of an item of materials to be kept in store at any time. Material should notbe allowed to fall below this level. This stock level is also known as Safety Stock Level or Buffer Stock. Minimum Stock level= Reorder level-(Avg. consumption * Avg. reorder period)Maximum stock levelThis represents the maximum quantity of materials which can be maintained in hand at all times. Maximum stock level= Reorder level + Reorder Qty.-(Minimum consumption*Minimum reorder Period)Reorder levelThis level is fixed between maximum and minimum stock levels.Average stock level AST=Minimum Stock Level + Maximum stock Level 2 OR AST = Minimum level+1/2 of Reorder Qty.
  • 5. Danger LevelWhen the stock level falls below the minimum level we can say that it is a case of danger level. Danger level= Average consumption * emergency supply time Economic Order Quantity (EOQ)It refers to the size of the order which gives maximum economy in purchasing any material. It is the standardordering quantity. At this point the total of carrying cost and ordering costs will be the lowest.It is also known as Optimum Quantity, Economic Lot Quantity or Ideal Quantity of Purchase. EOQ= 2AO/C A= Annual Consumption O= Cost of placing order (ordering cost) C= Annual carrying cost of one unit VED AnalysisIt is a device intended for control of spare parts. On the basis of importance spare parts may be classified intothree categories ‘V’ for Vital, ’E’ for Essential, ‘D’ for Desirable.Vital spare parts are those whose unavailability may lead to stoppage of production. Therefore every effortshould be taken to ensure availability of these spare parts. Production may not be interrupted to the non-availability of essential spare parts for one hour or for one day beyond which production will be stopped.Desirable spare parts are those spares which are needed but their absence for a week may not lead to stoppageof production. Stores RecordThe ‘Bin Cards’ and ‘Stores Ledgers’ are the two important stores records.Bin Card/Bin tag/Stock cardBin card is a quantitative detail of materials received issued and closing balance. It is maintained by the storekeeper. Bin is a place where materials are kept in. It may contain space, container, shelf etc. Bin card is attachedto each Bin.Double Bin SystemUnder this system each Bin is divided in to three parts, one, the smaller one to store the qty. equal to theminimum stock and other to keep the remaining qty. The qty. in the smaller one is kept untouched and issuesare made only out of larger portion.Stores LedgerIt is maintained by the costing department. It is a document showing the qty. and value of materials received,issued and balances at the end. Distinction between Bin card and Stores ledger Bin card Store ledger a. It is a record of quantities only. a. It is a record of quantity and value. b. It is maintained by the store keeper. b. It is maintained by the costing department. c. It is attached to each Bin. c. It is kept in the cost office. d. Postings are made before the transaction. d. Postings are made after the transaction. e. Interdepartmental transactions are not shown. e. Interdepartmental transfers are shown. f. Facilitates physical verification of closing stock. f. Facilitates valuation of closing stock.Material Requisition Note (MRN)/Stores Requisition NoteIt is prepared by the head of the department which requires raw material. It is given to the store keeper. Thestore keeper issues raw materials after getting MRN from the head of the department.Material LossesLosses of material may be wastage, scrap, spoilage and defectives. a. Wastage: It is that portion of the raw material which is lost during handling, storing or issuing and has no recoverable value. It may occur due to evaporation, loading and unloading, leakage etc.
  • 6. Wastage may be either normal or abnormal. Normal wastage This type of wastage arises due to the nature of material, so it is unavoidable. Example: evaporation The cost of normal wastage should be recovered from the final output. Abnormal wastage It does not arise due to the nature of material but it arises due to abnormal reasons such as a fire, careless handling etc. The cost of abnormal wastage is transferred to costing Profit and Loss Account.b. Scrap: It represent fragments of materials that are left from certain type of manufacture. Loss of material on account of scrap is quite common in engineering industries due to the operations like sowings, punching etc. The realizable value of scrap is credited to costing Profit and Loss Account.c. Spoilage: It is caused by defective production, human errors like parts cut to wrong size, chemical mix in wrong proportion etc. Spoilage occurs when goods are so damaged in the course of manufacturing process as to become not rectifiable without additional cost.d. Defectives: Defectives are semi finished or finishing products which are not up to the standard specifications. Defectives may arise due to substandard materials, bad supervision, careless inspection etc. They can be sold as seconds or rejected articles.

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