This document discusses materials and stock control in business accounting. It defines different types of materials like direct, indirect, work-in-progress and finished goods. It also discusses stock control methods like economic order quantity and reorder level which aim to minimize total costs of carrying, ordering and stock-out. Finally, it explains stock valuation methods like perpetual inventory system, FIFO and weighted average which are used to calculate inventory costs.

1. Materials and Labour
Business Accounting – ACC 1644

2. Chapter Outline
1. Classification of materials
i. Direct material
ii. Indirect material
iii. Work-in-progress
iv. Finished goods
v. Inventory
2. Stock control
i. Carrying costs
ii. Ordering costs
iii. Stock-out costs
iv. Lead time
v. Economic order quantity (EOQ)
vi. Reorder level (ROL)

3. 3. Stock valuation methods
i. The perpetual inventory system
ii. The periodic inventory systems
iii. First-In-First-Out Method
iv. Weighted Average Method

4. Classification of materials
 Materials can be classified as either direct or indirect
 Direct Material
Raw material that is converted into a finished product by the manufacturing process.
This material is visible in the final product, that is, it can (easily) be physically traced to the final
product.
Example: Steel in the manufacturing of motor vehicle and wood in the manufacturing of a table.
 Indirect materials
Materials used in the manufacturing process that contributes to the conversion of the direct
material.
This material cannot be physically (easily) traced to the final product.
Example: Glue, nails or screws used in the manufacturing of a table

5. Classification of materials
 Work-in-progress
Raw material that has been partially converted in the product process.
This material cannot be classified as raw materials or as a finished product.
Work-in-progress consist of a portion of all three cost elements – materials, labour and overheads
 Finished goods
Products that have passed through the entire production process and have been completed.
 Inventory
All materials (direct and indirect), work-in-progress and finished goods that the enterprise has at
any given point

6. Stock Control
 The system that a firm uses to control it’s investment instock, which includes:
Recording and monitoring stock levels
Forecasting future demand
Deciding when to order and how much to order
 The main objective of stock control is to minimize in total the costs associated with stock.
 These costs can be classified into three groups:
Carrying (holding) costs
Ordering costs
Stock-out costs

7. Stock Control
 Carrying (holding costs)
 Costs associated with the storage of the stock. These include:
Storage charges
Stores staffing
Stores equipment and maintenance
Material handling costs
Security and insurance
 The carrying costs can be calculated as: Average stock * Carrying cost per unit
 Ordering costs
 Costs associated with obtaining the stock. These include:
Administrative costs of purchasing
Transportation costs
 The ordering costs are calculated as: Number of orders * Costs per order
 The number of orders can be calculated as: Annual demand / Order size

8. Stock Control
 Stock-out costs
Costs associated with not having sufficient stock to meet the customers’ needs.
These costs tend to be intangible and include:
The loss of contribution and profit owing to being out of stock
Loss of future sales
 Lead time
Time taken from when an order is placed with the supplier, to when it arrives on the business’s
premises.
 Economic order quantity (EOQ)
The optimum quantity that should be ordered that will minimize the total combined ordering and
carrying costs.
EOQ =
2 𝑥 𝐴𝑛𝑛𝑢𝑎𝑙 𝑑𝑒𝑚𝑎𝑛𝑑 𝑥 𝑂𝑟𝑑𝑒𝑟 𝑐𝑜𝑠𝑡
𝐶𝑎𝑟𝑟𝑦𝑖𝑛𝑔 (ℎ𝑜𝑙𝑑𝑖𝑛𝑔) 𝑐𝑜𝑠𝑡 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡

9. Stock Control
 Reorder level (ROL)
The level of stock at which another order should be placed.
Reorder level depends on the lead time and the usage during the lead time.
It allows for the worst situation to occur without the danger of running out of stock.
ROL = Maximum usage * Maximum lead time; or
ROL = (Average usage * Average lead time) + Safety stock

10. Stock Valuation Methods
 Perpetual inventory system
Inventory accounts are updated after each transaction.
Inventory quantities are continuously updated.
Gross profit can be determined without an inventory count.
Physical inventory on hand can be checked against the trading inventory account.
The inventory account reflects the inventory on hand at any moment in time.
Individual items of inventory can be more easily monitored, especially if one has a computerized
system that updates the inventory record at the till.
 Periodic inventory system
The value of ending inventory is determined at the end of each accounting period by a physical
stock count.
A purchases account is used when the periodic method of recording inventory is in operation

11. Stock Valuation Methods
 First-in-first-out method
 Physical stock count is done at the end of the accounting period to determine the inventory on hand (closing
balance).
 The cost of most recent purchase is used, after which the cost of goods sold can be computed.
 Material that is purchased first is used(issued) first. The oldest stock is issued first at the price at which it
was originally purchased.
 Weighted-average-method
 Periodic Inventory System
The weighted average unit cost is used to calculate the cost of goods sold and the cost of ending inventory.
The weighted average unit cost is computed using the following formula: =
𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑢𝑛𝑖𝑡𝑠 𝑎𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝑠𝑎𝑙𝑒
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑢𝑛𝑖𝑡𝑠 𝑎𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑡𝑜 𝑠𝑎𝑙𝑒
 Perpetual Inventory System
The new material that is purchased is added to the material already in stock
An average price must be determined after each purchase.